paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 murabahah sukuk structure: the shariah challenges and the way forward abstract— murabahah sukuk is an islamic trust contract which includes a disclosure of the original cost and the mark up. murabahah in islamic jurisprudence means a contract of sale for the equivalent price of the subject matter which includes its cost along with a known additional profit. the paper discusses issues related to murabahah sukuk financing. it also provides the structural overview of murabahah in terms of sukuk issuances. the paper highlighted three different ways of structuring murabahah sukuk, it looks into the structure of murabahah for asset acquisition, murabahah with inah transaction and lastly murabahah with tawarruq transaction. the paper concluded that according to the general rules of shari’ah, murabahah sukuk should not be traded at secondary market due to the fact that it involved the sale of debt which is forbidden. however, murabahah sukuk might be negotiated at the secondary market if it forms a small part of a larger portfolio comprising other negotiable instruments such as ijarah sukuk, musharakah, and mudarabah sukuk certificates. keywordsmurabahah sukuk; structural development; shari’ah challenges i. introduction murabahah comes from the word ribh which means an increase. technically, murabahah is the mark-up disclosed to the purchaser as per the seller‟s purchase price for a trust-sale of a certain specified asset, excluding monetary assets such as cash and receivables. murabahah sale may be contracted on cash or credit basis. in the islamic financial services industry, murabahah is adopted in a transaction known as murabahah to the purchase orderer (mpo) whereby three parties are involved, namely the ifi, the supplier and the purchase orderer. the murabahah credit sale of a specified asset by an ifi to the purchase orderer is at a disclosed mark-up price based on the ifi‟s cost of financing the purchase. murabahah contract is valid if the profit is made through one of the two different methods, the first of which is bay almusawamah. in this contract the price of the good is specified, followed by the method of musawamah (price negotiation) without mentioning the seller‟s cost. the second valid murabahah contract is called bay al-amanah. in this contract, the buyer trusts the seller to honestly reveal the actual cost of the good. the buyer then proposes a fair price to offer the seller based on the seller‟s cost. according to bay amanah, if he buys the good for a price less than the actual price, then it is called al-wad‟iyyah. however, if he bought the good at cost, the transaction turns in to bay al-tauliyah. finally, if the good was bought for more than its cost (which is the norm) then the transaction becomes bay murabahah. the majority of muslim scholars have agreed that murabahah is a genuine islamic amanah based contract, its acceptance relayed on the provision of qur‟an verses, the sunnah, custom and general rules of shari‟ah. in the holy qur‟an, allah the almighty said, “but allah has permitted trade and has forbidden interest” and “there is no blame upon you for seeking bounty from your lord” and murabahah is part of that. from the sunnah, the prophet (saw) was reported to have said, “the best jobs is a handy job and any other explicable business” the prophet (saw) also said: “if the type of the subject matter is different, then you can sell it as you wish, if it is hand to hand” this hadith legalizes the sale of subject matter at whatever price, whether higher or lower than the original price. imam al-kasani has recorded ijma (consensus) on bay murabahah and said people have inherited such transactions since the early ages without any constraint, which constitutes the consensus on its acceptability. in islamic finance, the term murabahah is generally used to refer to a contractual arrangement between a customer and a financier whereby the financier would sell specified assets or commodities to the customer for spot delivery in the expectation that the customer would be able to meet its deferred payment obligations under the murabahah agreement. the deferred price would typically include the cost price at which the financier had purchased the assets, plus a pre-agreed payment representing the profit generated from the transaction. the payments of the deferred price from the customer may be structured as periodical payments on dates specified at the outset, thus creating an income stream for the financier for the term of the transaction. similar characteristics of murabahah can also be adapted as an underlying structure in a sukuk issuance. sukuk proceeds from investors may be applied by issuer/spv to acquire commodities on behalf of investors and sell such commodities to the originator to generate revenue from the murabahah deferred selling price which would be distributed to the investors throughout the term of the sukuk al murabahah. sukuk al-murabahah essentially represent right to share in receivables from the originator of the underlying murabahah, they are not negotiable instruments that can be negotiated on the secondary market because shari‟ah does not permit trading in debt except at par value. this reduces the dr. auwal adam sa‟ad, dr. uzaimah bt ibrahim, jr., and dr. muhammad deen mohd napiah ejif – european journal of islamic finance no 4, march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 popularity of sukuk al-murabaha in the global sukuk market. murabahah certificates are certificates of equal value issued for the purpose of financing the purchase of goods through murabahah so that certificate holders become the owners of the murabahah commodity. therefore, murabahah sukuk refers to securities issuances where the underlying transaction between the issuer and obligor is a sale then purchase of an asset at a mark-up of murabahah. various murabahah sukuk methods are available. firstly, a factual purchase and sale of an asset involving three basic parties in which the asset moves linearly from seller to buyer. secondly, a pre-arranged sale and buy back, or bai‟ al‟inah, of the same asset between two parties. thirdly, a three party agency sale applying commodity murabahah, i.e. tawarruq. in malaysia, the islamic commercial paper and mediumterm note programme are usually structured under murabahah notes issuance facilities. (munif), while the longer tenured programme usually structured under bai bithaman ajil with islamic debt securities (baids). the market utilizes munif for short-term maturities, while it uses baids for long-term issuances. this is, however, a market setup and not a shari‟ah arrangement. ii. murabahah sukuk structure based on inah transaction in this structure, instead of buying an asset from a third party, the spv buys an asset from the company itself at the time of issuance. the spv then sales the same asset back to the company at a higher deferred price. this structure is known as bai inah. the aaofi does not permit this method, and it is only practiced extensively in malaysia. the example of murabahah sukuk based on inah transaction is sunway city, a property developer in malaysia, the sunway is the issuer in this sukuk as there is no spv used in the structure. sunway obtained approval from sc on 10 october, 2007 to issue rm500 million murabahah sukuk under a medium-term note (mtn) program. this allows sunway to raise sukuk in different amounts within a period of 15 years. sunway will sell an identified asset to facility agent hsbc bank on behalf of the investors on a spot basis. an asset purchase agreement will be signed. the investors will buy the asset and hsbc will pay the purchase price to sunway with the proceeds raised from the issuance of sukuk. when the investors own the asset they will then sell it back to sunway through hsbc on a deferred basis, the deferred selling price will be higher than the spot purchase price. finally sunway issues the sukuk murabahah to evidence its obligation to pay the deferred selling price. once the sell contract has taken place the investors are no longer the owners of the underlying asset used to facilitate the transaction, what they own is the entitlement or rights to the sale price to be paid by sunway. iii. murabahah sukuk structure based on tawarruq transaction due to unacceptability of bai al-inah structure for murabahah sukuk in the middle east, the market in those countries applied tawarruq structure with the name murabahah sukuk. in this structure, instead of buying and selling between two parties, the arranger act as wakeel or purchasing and selling agent to trade commodities on behalf of the issuer as in the diagram below: ejif – european journal of islamic finance no 4, march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 iv. conclusion murabahah sukuk could not be traded in the secondary market according to the general islamic rules and regulations. this is because the contracts in the sukuk structure involve the sale of debt which is prohibited in the islamic law. however, the malaysian scholars of the opinion that sale of debt is permissible. their argument is based on the argument originated from ibn qayyim aljawziyyah, who demonstrates that the majority of islamic jurists are unanimous in accepting bay al-dayn in general, they only differ in opinion about selling debt to a third party for the reason that the seller will not be able to deliver the sold debt to the buyer. despite being debt instruments, murabahah sukuk certificates may still be negotiable if they form a small part of a larger portfolio comprising mostly of other negotiable instruments such as ijarah sukuk, musharakah, and mudarabah sukuk. murabahah sukuk may be structured to facilitate a true asset acquisition transaction for companies. in such a case, the company is truly interested to own the asset which is the object of the sale. but most murabahah sukuk structures are simply aim to provide the cash to a company or sovereign. this approach is achieved either through bai al-inah in malaysia or through tawarruq in the middle east. however, in all structures the sukuk represent a receivable arising from a permissible sale transaction under the relevant shari‟ah jurisdiction. thus, murabahah sukuk are generally not tradable in the secondary market, except in malaysia. references [1] abdulqadir thomas (2009). sukuk islamic capital market series, malaysia: sweet & maxwell asia bandar sunway selangor. [2] imam alauddin abubakr bin mas‟ud al-kasani alhanafi. (2005). badai‟ al-sana‟ fi tartib al-sharaa‟i. darul hadith al-qahirah, egypt. [3] imam al-sarkhasi. (2001). kitab al-mabsut. darul kutub al-„ilmiyyah beirut lebanon. [4] malaysian sukuk market handbook. (2009). your guide to the malaysian islamic capital market. ram ratings services berhad [5] mohammad hashim kamali (1990) “islamic commercial law: an analysis of futures and options” islamic text society. [6] m.a mannan (1993). understanding islamic finance: a study of the securities market in an islamic framework, by islamic research and training institute islamic development bank jeddah. [7] principles and practices of shari‟ah in islamic finance, shari‟ah advisory council of bank negara malaysia section 3 no.8 p.4 [8] shari‟ah standards for financial institutions (2008). published by the accounting and auditing organization for islamic financial institutions. [9] resolution of the securities commission shari‟ah advisory council malaysia, second edition 2007 ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 e-banking acceptance in thailand: an emphasis on islamic banks' customers abstract— the objective of the paper is to examine the level of acceptance of e-banking services in thailand, with a special focus on islamic banks' customers. the study also attempts to identify the main dimensions that would contribute to the acceptance and proper usage of e-banking services by islamic banks' customers. a survey questionnaire was distributed to 500 islamic banks' customers in thailand. the survey covered the capital city of bangkok and surrounding areas, but focused mostly on the southern part of thailand, which is majority muslim area. the collected data was subsequently analysed using descriptive statistics, one sample t-test, and structural equation modelling (sem). the findings revealed that islamic banks' customers in thailand have a high tendency of adopting ebanking services across-groups. furthermore, the results showed that perceived ease of use has a significant positive impact on perceived usefulness. in addition, both perceived ease of use and usefulness have a significant positive impact on customers' adoption of e-banking services. these findings have a significant contribution to the theory, policymakers, as well as the practitioners and regulators in the banking and islamic banking areas. keywordsthailand, islamic banking, e-banking, sem. i. introduction during the past few decades, islamic banking has emerged not only as a complementary component in modern banking systems, but has also imposed itself as viable alternative to the long existing conventional banking. nevertheless, the conventional banking is still relatively stronger in many aspects as it has been practised for a long time compared to the newly established islamic banking system. one of these aspects is the advanced e-banking system that was developed and put in place long before the development of modern islamic banking. it goes without saying that having a developed and secure e-banking system contributes in enhancing the performance and efficiency of banks. it is noteworthy that islamic banking has been introduced in thailand since early 2003, through the islamic bank of thailand (ibank). the bank was set up by the islamic bank of thailand act b.e. 2545 (2002), as a state enterprise under the ministry of finance, administered by a board of governors, with an advisory council on islamic banking and hence considered to be fully operating in accordance with the rules of sharia1. ibank has currently more than 30 branches all 1 http://www.bankthailand.info/islamic-bank-of-thailand.htm around the country, though the muslim population is mainly centered in the southern region of the country. the thai context was chosen not only because it has received less research focus in the islamic banking area, but also because islamic banking per se has been introduced to thailand for many years, but has not been performing as expected. it is noteworthy that in a similar context, that of malaysia for instance, it was observed that one of the reasons why some islamic banks were avoided by customers is their lack of a handy and useful e-banking system (echchabi and olaniyi, 2012). hence, the objective of the paper is to investigate the level of acceptance and use of e-banking services in thailand, with a special focus on islamic banks' customers. the remaining part of the paper is organised as follows: section two discusses the main studies in the area of e-banking acceptance as well as the research model. section three briefly discusses the methodology and method applied in data analysis as well as the respondents’ profile. section four presents the survey results, and section five concludes the paper with some recommendations for future studies. ii. literature review the area of internet banking acceptance has been widely emphasised both theoretically and empirically. however, most of these studies were focusing on conventional commercial banks, while very few studies examined this aspect from the islamic banks’ customers’ perspective. in this regard, krauter and faullant (2008) studied the acceptance of internet banking in austria focusing on a sample of 381 respondents and using structural equation modelling (sem). their results confirmed the influence of internet trust on risk perception and consumer attitudes towards internet banking. moreover, propensity to trust is a determinant not only for interpersonal relationships but also for trust in technological systems. aderonke and charles (2010) investigated the factors that determine users’ behavioural intentions to use electronic banking services in nigeria. the study covered a sample of 500 respondents from lagos and the surrounding areas. the results showed that banks’ customers who are active users of e-banking system use it because it is convenient, easy to use, time saving and appropriate for their transaction needs. also the network security and the security of the system in terms of abdelghani echchabi ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 privacy are the major concerns of the users and constitute hindrance to intending users. echchabi (2011) examined the customers’ intention to use online banking services in morocco. the author applied sem to a sample of 300 respondents. the results indicated that perceived ease of use has a significant positive influence on the perceived usefulness of online banking, and both the variables have a significant positive influence on the attitude towards online banking. the latter further has a significant positive influence on the intention to adopt online banking services in morocco. furthermore, the invariance analysis showed that the influence is different between male and female customers. in a different context, hassanuddin, abdullah, mansor, and hassan (2012) investigated the factors influencing the acceptance of internet banking services provided by the malaysian cooperative banks. the authors covered a sample of 171 respondents and mainly applied descriptive statistics to achieve the objective of the study. the findings revealed that ease of use, security and privacy as well as quality of internet connection are the main factors that contribute towards acceptance of internet banking services. in another context, khater, almansour, and mahmoud (2014) explored the factors influencing customers’ acceptance of internet banking services in sudan. the authors covered a sample of 207 respondents and applied sem in the analysis. their findings indicated that internet connection quality has direct effect on the behavioral intention to use internet banking in sudan. in the specific context of islamic banking, relatively fewer studies have been conducted. feraro-banta (2014) for instance attempted to examine the electronic banking services in islamic banks in bahrain. the author focused on a sample of 200 customers and applied mixed methodology. the findings revealed that islamic banks in bahrain are intensively making use of electronic services for their banking operations. furthermore, the bank customers have higher expectations as to the electronic banking services of islamic banks. in addition, there is no considerable divergence between the level of expectations of customers and the status of the electronic banking services in islamic banks in the kingdom of bahrain except for the transfer of funds. it is noteworthy that tam is one of the most widely accepted and applied models for technology-related studies. the model which was initiated by davies (1989) is based on three main dimensions, namely, perceived ease of use, perceived usefulness and behavioural intention. tam suggests that perceived ease of use has a positive effect on perceived usefulness, and both have a positive effect on the intention to adopt a technology. tam indeed gives an opportunity to include a wide range of aspects related to both easiness of using technology as well as the usefulness of the system. thus, based on the tam framework, the following hypotheses are posited: h1: perceived ease of use has a positive influence on the perceived usefulness of e-banking by islamic banks’ customers in thailand. h2: perceived ease of use has a positive influence on the customers’ intention to use e-banking by islamic banks’ customers in thailand. h3: perceived usefulness has a positive influence on the customers’ intention to use e-banking by islamic banks’ customers in thailand. h4o: the islamic banks' customers in thailand are indifferent in using e-banking. iii. methodology the current study focuses on the islamic banks' customers in thailand. particularly, in bangkok the capital city and surrounding areas, as well as in the southern region of the country. the target sample size was 500 respondents determined through the previous similar studies in this area (e.g. echchabi and abdul aziz, 2013). the survey questionnaire was specifically designed to collect information about the perception of the islamic banks' customers regarding the usefulness and easiness to use ebanking services as well as their intention to adopt and/or continue using them it in their future transactions. for measuring this information, likert type scaling was used (1 = strongly disagree and 5 = strongly agree). 15 items were listed in this section and most of them were derived from the previous studies conducted in other settings as highlighted above, as well as from the current islamic finance and internet banking literature with the necessary adaptations made for the specific context of this study, mainly from echchabi and abdul aziz (2013) and echchabi (2011). the second section of the questionnaire explored information about respondents’ profile, i.e. gender, age, education level, etc. the questionnaire was made in english and was subsequently translated into thai language and distributed in both versions. the collected data were subsequently analysed using sem and one sample t-test. the choice of this technique was inspired by hair, black, babin and anderson (2010) as well as from similar studies conducted in this area. it is worth mentioning that the analysis was performed using amos 18 and spss 18. the demographic information in table 1 indicates that 77.4 per cent of the respondents are male, while 22.6 per cent are female. in terms of age grouping, 43.2 per cent of the respondents are between 20 and 30 years old, 31.2 per cent of the respondents are aged between 31 and 40 years old, 13 per cent are aged between 41 and 50 years old, 9.2 per cent are less than 20 years old, and 3.4 per cent of the respondents are above 50 years of age. regarding the level of education, around 51.4 per cent are bachelor’s degree holders, 23.6 per cent are holding high school certificates, 13.6 per cent are holding postgraduate degrees, 6.2 per cent are holding diploma, and 5.2 per cent are ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 holding professional degrees. in terms of occupation, 51.2 per cent of the respondents are employed in the private sector, 21.6 per cent are self-employed, 16.8 per cent are students, and 10.4 per cent of the respondents are employed with the public sector. table i: profile analysis demographics categories percentage gender male 77.4 female 22.6 age less than 20 years 9.2 20 to 30 years 43.2 31 to 40 years 31.2 41 to 50 years 13 more than 50 years 3.4 education level high school certificate 23.6 diploma 6.2 professional degree 5.2 bachelor’s degree 51.4 postgraduate degrees 13.6 occupation public sector 10.4 private sector 51.2 self-employed 21.6 student 16.8 iv. results a. reliability and validity measures prior to the structural model estimation through (sem), a basic requirement is the analysis of the model’s validity. the latter is made of four main elements, namely, convergent validity, discriminant validity, face validity, and nomological validity. convergent validity refers to the requirement that the items measuring a given construct should share a high proportion of common variance. there are several tools to assess convergent validity, including average variance extracted (ave), factor loadings, as well as reliability measures (cronbach alpha for this study) (hair et al., 2010). accordingly, it is suggested that a cronbach alpha greater or equal to 0.6 is acceptable, similarly, an acceptable level of ave and factor loadings should be 0.5 and above. in this regard, table 2 shows that the cronbach alpha values are ranging between 0.73 and 0.84. furthermore, the ave values range between 0.55 and 0.6. hence, all the requirements for convergent validity are met, since all the factor loadings are also greater than 0.5. thus, convergent validity is achieved in this model. table ii: convergent validity measures constructs cronbach alpha ave perceived usefulness 0.74 0.55 perceived ease of use 0.73 0.58 behavioural intention 0.84 0.6 in addition, discriminant validity refers to the requirement that each construct in the model is distinct from the remaining constructs. there are different ways to assess discriminant validity. in this study the correlation between constructs will be fixed to 1 and the fit indices for the baseline and restricted models will then be compared. at this level, discriminant validity is achieved if the difference in fit indices between the two models is significant. in this regard, the results in table 3 show a chi square value of 179.03 and 85 degrees of freedom for the baseline model, and a chi square value of 387.42 and 88 degrees of freedom for the restricted models. this amounts to a chi square difference of 208.39 and degrees of freedom difference of 10. by comparing the chi square difference with the tabulated chi square value corresponding to a degree of freedom of 3 and a confidence margin of 0.05, namely, 7.81, it can be concluded that the fit indices for the baseline and restricted model are significantly different. hence, discriminant validity is achieved by this model. beside these two validity measures, face validity and nomological validity were also analysed by consulting the experts in this field, as well as the previous studies. table iii: discriminant validity measures elements chi square df baseline model 179.03 85 restricted model 387.42 88 change 208.39 3 finally, the results indicate that the model’s comparative fit index (cfi) is 0.965 and rmsea value is 0.046. these values are acceptable values for both indicators (broyles, leingpibul, ross and foster, 2010; singh, sandhu, metri and kaur, 2011; kim and forsythe, 2010). hence, the overall model is validated. b. structural model in order to test the hypotheses posited above, the path analysis using sem is applied for the first three hypotheses, while t-test is used to test the fourth hypothesis. in this regard, the mean values in table 4 show high t-values for all the variables including behavioural intention, with significant probability values. hence, hypothesis 4 is rejected. this mainly indicates that the respondents are satisfied with their ebanking experience and are enthusiastic about it and intend to continue using these services. this is illustrated by their appreciation of the usefulness and ease of use of e-banking which is a prerequisite for regularly using it in their daily studies. table iv: descriptive analysis and t-test constructs mean t standard deviation perceived ease of use 3.81 30.26*** 0.63 perceived usefulness 4 37.7*** 0.64 behavioural intention 3.81 26.83*** 0.72 *** refer to significant t-test at 1% ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 the results of the path analysis summarised in table 5 indicate that perceived ease of use has a significant positive impact on the perceived usefulness of e-banking services. hence, hypothesis 1 is supported. this is in line with the findings of davies (1989). this implies that the usefulness of e-banking services for the islamic banks is highly dependent on the extent to which the e-banking procedures and transactions are easy to understand and apply. in addition, it also depends on the extent to which the islamic banks’ customers perceive e-banking to be useful in helping them efficiently conduct their daily banking operations. furthermore, the perceived ease of use is also found to have a significant positive influence on the intention to use ebanking. hence, hypothesis 2 is supported. this is also in line with the findings of davies (1989), and it indicates that the above mentioned dimensions equally motivate the customers to effectively use e-banking services. on the other hand, perceived usefulness has a significant positive impact on the intention to use e-banking services. hence, hypothesis 3 is supported. this is in line with davies (1989). particularly, the usefulness of these services is mainly perceived by the islamic banks’ customers in terms of efficiency/time saving in conducting banking operations, in terms of cost saving, as well as in terms of the social prestige that they provide compared to the traditional ways of banking. table v: standardised total effects perceived usefulness perceived ease of use behavioural intention 0.28*** 0.49*** perceived usefulness 0.62*** v. discussions and conclusions the objective of the current study was to explore the intention of the islamic banks’ customers to use e-banking and to determine the factors that influence it. overall, the results indicated that the respondents are intending to use e-banking services. on the other hand, the findings revealed that the perceived ease of use has a positive effect on perceived usefulness, and both have a significant positive effect on behavioural intention to use e-banking. these findings have significant implications for the theory, for the policy makers and regulators as well as for the practitioners. particularly, this study is an extension of the technology acceptance model to a different setting and a different area of study that has been poorly studied previously; hence this study proves the applicability of this theory in this new context. similarly, the current study provides insights to the practitioners and policymakers on the important dimensions to be emphasized to enhance the e-banking usage by islamic banks’ customers in thailand and similar settings. this is expected to promote the islamic banks’ activities and render them to be relatively more competitive. the current study has a number of limitations that should be taken into account in the future studies in this area. firstly, the sample size is relatively limited, though accurately calculated, hence the results cannot be generalised to the whole population of islamic banks’ customers in thailand. thus, the future studies are recommended to select a larger and more representative sample size, in order to generalise the results to the whole country. the future studies are also recommended to extend these findings to other contexts and preferably using other models as well. references aderonke, a. and charles, a. 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(2011), “organisational performance and retail challenges: a structural equation approach”, ibusiness, vol. 3, pp. 159-168. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 a qualitative framework to learn from failures: reducing risks and developing effective financial policies abstract— this article explores policy failures phenomena and makes suggestions to draw lessons from past mistakes in order to improve financial policies in the future. existing studies offer limited insights into the methodology of policy failure analysis, since studies generally focus on the mere conceptualization of the topic. this article attempts to answer a key question, namely how to develop a qualitative framework to analyse financial disasters and determine lessons from past financial catastrophes. the results indicate that the proposed framework can inform policymakers and legislative stakeholders in endeavours to develop more effective financial policies and reduce financial failure risks. keywordsfinancial policy disasters; policy failure; policy learning; policy improvement; policy risks. i. introduction governments throughout the world seem cursed to suffer periodic policy failures. a modest list would include the global financial crisis 2003, currency policies (egypt), agricultural policies (nigeria), invasion of iraq (usa), poll tax and child support agency (uk), and the home insulation program (australia). failure of public policies is extremely dangerous, because policy failures prevent governments from achieving their policy goals and can involve the economic costs of trying to ‘fix’ problems through (often fruitless) reform initiatives; consume inordinate amounts of agenda time that might be better spent by politicians, media and citizens on other issues of greater public concern. policy failures can also cause electoral and reputational damage to governments, and even lead to the downfall of public officials, politicians, governments and regimes [14]. with all these risks caused by policy failure, we have to think about building a framework that will help us to learning from past disasters. since bovens and t’ hart's study of policy fiascos (1996) [1], a range of contributions in this context can be found. the most important we note is that; the focus on the subject in terms of concept and differentiation between the different types of failure without interest of developing the methodology of analysis. for example, when we talk about banking systems, we find many contributions that talk about the types of banks and the difference between the islamic bank and the conventional bank. but what we want to talk about here is how we can draw lessons from past mistakes to minimize future risks. the purpose of this article is to develop a qualitative framework to draw lessons from past financial policy disasters. this will enhance opportunities of policymakers to improve policies in the future. this a framework also allows to learn from past financial mistakes, analyze their causes and try to avoid them in the future, which means controlling the potential risks of policy failure. in this context, the article focuses essentially on two related sets of issues. first, overview of the concept and methodology in policy failure literatures. second, develop a qualitative framework to analyze failed policies and draw lessons for learning. ii. policy failure in literature: conceptualisation and methodology public policy failure is one of the most widely used concepts in policy fields, public administration, media, and interest groups [20]. it is also frequently reflected in discussions between experts, bureaucrats, and researchers. this has led to multiple labels in policy literature related to the concept of policy failure or one of its various aspects or types [20]. the table below contains some of most a prominent term that refers to policy failure (see table 1). table i. different labels of the concept "policy failure": policy fiascos _ mark bovens and paul t' hart, 1996 policy disasters dunleavy, 1995 [3]. governance failure vining and weimer, 1990; wolf, 1979, 1987 policy catastrophesmoran, 2001 policy anomalieshall, 1993 policy accidents cobb and primo, 2003; kingdon, 1984 source: author it is worth mentioning that recent studies of the failure of policies use the term "policy failure" frequently. we are convinced that it is necessary to a unification of meaning and content when we are talk about a particular term. if we are talking about policy failures, we should not use the term "policy anomalies" or "policy accidents"; because the meaning of each concept is different from the other in terms of differences in the role of agency or in the levels of severity and politicization [2]. conceptions of concepts may vary from mustafa m. hamed ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 person to person depending on their cultural background. so we can talk about the term policy failure to express the intended phenomenon of study. concerning the methodologies are used in literature of policy failure, it is noted that the prevailing pattern reflects two main trends: the first trend refers to the relativistic approach. in its interpretation of the failure of public policies, it does not rely on the presentation of results objectively; it is based on personal or subjective judgments which are inherently derived from data produced by political actors from previous policies. it has made it difficult for analysts to draw general conclusions about the nature and causes of policy failures [7]. studies have relied on this approach to analyse policy failures, such as walsh's study of british security policy after the cold war [19], the kingston study of nuclear regulation in japan [11], and the study of kearns and lawson on reforms of housing policies in scotland [10]. the second trend refers to the technical approach that is used for the analysis. it includes a series of studies such as howlett, mark bovens &'t hart and mcconnell studies that attempt to overcome a number of difficulties associated with the concept of policy failure. besides, it focuses on the aspects and features associated with policy outcomes such as whether they have achieved the original objectives set, or whether policies have a negative or positive impact on target groups relying on objective criteria that support any claim of policy failure [9]. these claims only help to visualize success or failure through different evaluation tools, but they do not specify the clarity of the source of the policy failure and its reasons. thus, they simply lay the groundwork for the claims made by assessing the nature of policies and their results. positive or negative impact on target groups, whether the problem it was intended to address has receded or not, and several other key dimensions of a problem area [17]. (see table 2). table ii. criteria for successful prosecution or failure of a particular policy source: hewlett et al. (2015:204-220). it is worth noting that case studies may be somewhat useful in taking advantage of past policy errors and attempting to avoid them in the future. however, focusing on the specificity of each case does not help in setting general patterns of failure analysis [5]. we believe that methodologies in use were not enough, especially with regard to how to learn from the mistakes of the past in order to improve policies in the future and reduce the degree of risks to acceptable level. iii. guidance points of the framework we seek here to provide a systematic framework that helps to analyze policy failures and enhance the capacity of policy makers to learn from past failures as an input to better policy design in the future. that framework offer a set of analytical steps that can be relied upon to build the knowledge needed for learning processes through the analysis of policy failures. linking policy learning and what went wrong to the different dimensions of policy failure helps bring clarity to the discussion of these subjects and helps to situate policy learning better both as an exercise in technical knowledge acquisition and its application and as a ‘deeper’ phenomenon centred on drawing lessons about the policy process and political aspects of policy-making in order to enhance the potential for policy success [7]. we can see some government interventions that demonstrate learning. for example, with regard to the egyptian food support program, from 1976 to 2008, the government relied on a paper card system to all people with two methods (full partial). then, the government realized some weaknesses in this system and made some adjustments to the conditions of entitlement. from 2008 to 2011, there has been so-called total support only and the reduction of subsidies on certain categories using paper cards as well. in 2012, the government realized a number of disadvantages associated with the paper card system, which resulted in some problems, such as manipulation from dealers and the disbursement of rations for themselves, leakage of support for non-beneficiaries. from here, the ministry of supply and foreign trade made some changes in 2012 to the system and started using the smart cards. when the government realized its mistakes, it had the ability to learn and make changes. this framework consists of four main steps preceded by building an analytical team whose members are carefully selected according to their technical and professional capacities, taking into account the diversity of its components, then starting with the following steps: a. determine the failure types in his recent work, mcconnell has usefully argued that the origins of policy failure lie in three aspects of policy which must be reconciled if policy failure is to occur: the political, the process, and the programme aspects [14] [15] [16] [17]. ( see table 3). the first type is process failure: governments engage in the process of producing programmes and taking authoritative decisions. this process involves multiple activities from basis of claim claim of success claim of failure original objectives achieved not achieved target group positive impact negative impact results problem improvement problem worsening significance important to act failing to act source of support/opposition key groups support key groups oppose jurisdictional comparisons best practice or superior performance someone is doing this better elsewhere balance sheet high benefits high costs level of innovation new changes old response ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 defining problems, narrowing down options for appraisal, deciding on who/when/if to consult, and so on. while they ‘may’ fail in any of these tasks, a more useful and aggregated way of thinking about the process of policy production is to conceive of several aspects of process failure [17]. common policy process failures by stage of the policy cycle over reaching governments establishing or agreeing to establish overburdened or unattainable policy agendas agenda setting attempting to deal with problems without investigating or researching problem causes and identifying the probable effects of policy alternatives . policy formulation failing to decide on a policy within a reasonable period of time or distorting its intent through bargaining and log-rolling. decisionmaking failing to deal with implementation problems including lack of resources, principle– agent problems, oversight failures, and others policy implementation lack of learning due to lack of, ineffective, or inappropriate policy monitoring and/or feedback processes and structures policy evaluation source: hewlett et al. (2015:204-220). the second type is the program's failures: what governments do to achieve key goals in accordance with the policy adopted by the government [12]. the program includes a set of policies that serve a specific sector, category, or to achieve a general goal of the government. for example, health policy includes many programs that cover everything from prenatal care and preventive medicine to death. the failure of programs is one of the failures of public policies. failure of programs can be measured by measuring the results achieved from the program compared to the goals already planned, the extent to which the target groups of the program, and the extent to which standards must be observed, such as efficiency, rationalization, effectiveness and the size of the opposition and criticism of the program and the extent of supporting his allies, and the quality of the means used to achieve the goals. the third type is the political failure. this type is attributed to the failure that is the product of the political ideology adopted by the government, the political methods and maneuvers that has already taken, and how this may result from what the government may fail to do from programs and operations [13], their credibility in the political agendas of their parties, and to discredit confidence in the policies adopted by the government [8]. this is mainly due to the dynamics of political action with public policies and the administrative process in society and the strong interdependence among them. so the failure of governments to formulate policies and the failure of programs to achieve their goals may lead to political damage to politicians, parties, and governments and may reach the damage to the entire system. the nature of this failure is inextricably linked to the identification of its causes. each species has its own causes and characteristics which are different from other species. even if the causes overlap, it is necessary to separate them and distinguish the causes of each species independently. identifying what type of failure and their causes can allow more effective learning, leading to positive change in the future. b. identify errors  individual error: identify all errors that committed by individuals, both politically and administrative, during the design and implementation of policies.  institutional errors: determine the errors associated with the weakness of systems and procedures that have been followed in the design and implementation of policies and their ability to cope with the various environmental changes, both internal and external. c. identify the causes for this type of failure in fact, reasons and factors that leading to the failure of policies unlimited. this may due to the complex nature of public policies that are formulated and implemented by individuals in a large institutional context. not to mention the different environmental conditions that change from time to time and from policy to other. the team should identify the causes for each failure type in policy processes (brain storming root cause analysis). a failure cause is the specific reason for the failure, preferably found by asking “why” until the root cause is determined [18]. d. recommended actions after identifying the reasons of failure and identifying the errors that occurred during operations, policy makers address these errors by taking a set of actions to rectify the errors or obstacles. after that, policy makers can take some action at the current policy or improve new policies in the future. learning from policy failures is a very complex process, and needs to be further studied theoretically. furthermore, it should be further utilized and communicated to practical reality through working groups of analysts and researchers in this context. otherwise, our research and studies will not matter. thus, it is important to identify the different challenges facing learning from policy failures. iv. conclusion in closing this contribution, it might be useful to reflect on the underlying purpose of studying policy failure. most analysts who analyse policy failures probably are driven by a desire to create knowledge that will help prevent the recurrence of failure. the article provides a framework to learning from past disasters, in the hope that it will pave the way for policy makers to improve policies and reducing risks in future. by documenting what went wrong and explaining why, policy analysts create a knowledge base that should enable future policymakers to do better. one cannot help but wonder if we have gotten any closer to achieving that objective to get complex organizations and policy networks to actually learn from feedback, rather than make symbolic, opportunistic or minimal impact changes in response to it, about their past ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 performance is hard enough – that much we know from the spate of studies on policy change and policy learning across a wide range of sectors. references [1] bovens, m. and 't 'hart, “understanding policy fiascos,” new brunswick, nj: transaction, 1996. [2] bovens, m. & ‘t hart, p. “revisiting the study of policy failures,” journal of european public policy, 2016, vol. 23 (5), pp. 653-666. [3] dunleavy, p, “policy disasters: explaining the uk`s record', public policy and administration,” 1995, vol. 10 (2), pp. 52-70. [4] gomaa, sh, “policy analysis in the 21st century,” in gomaa s (ed.), policy analysis in the arab world, cairo university, faculty of economics and political science, center for public administration studies and consultations, 2004, pp. 29-64. [5] hewlett, m., ramesh, m. and wu, x., “understanding the persistence of policy failures: the role of politics, governance and uncertainty,” public policy and administration, 2015, vol. 30(3-4), pp. 204-220. [6] howlett, m., “the lesson of failure: learning and blame avoidance in public policy – making,” international political science review, 2012, vol. 33 (5), pp. 534-555. [7] howlett, m., “policy analytical as a source of policy failure,” canadian political science association, university of saskatchwan, 2013. [8] kay, a. and boxall, a., “success and failure in public policy: twin imposters or avenues for reform? selected evidence from 40 years of health care reform in australia,” australian journal of public administration, 2015, vol. 74 (1), pp. 33-41 . [9] kearns, a. and lawson, l., “ (de) construction policy failure: housing stock transfer in glasgow,” evidence & policy, 2009, vol. 5(4), pp. 449470 . [10] kingston, j., “ousting kan naoto: the politics of nuclear crisis and renewable energy in japan,” asia-pacific journal, 2011. online available at: japanfocus.org/-jeff-kingston/3724/article . [11] march, d. and mcconnell, a, “towards a framework for examining policy success,” australian political studies association conference, australia, 2008. [12] may, p, “implementation failures revisited: policy regime perspectives,” public policy and administration, 2015, vol. 30 (3-4), pp. 277-299 . [13] mcconnell, a., “a public policy approach to understanding the nature and causes of foreign policy failure', journal of european public policy, 2016, vol. 23 (5), pp. 667-684. [14] mcconnell, a., “what is policy failure? a primer to help navigate the maze,” public policy and administration, 2015, vol. 30, (3-4), pp. 221-242. [15] mcconnell, a., “why do policies fail? a starting point for exploration,” paper presented at political studies association (psa): 64thannual international conference, manchester. 2014. [16] mcconnell, a., “policy success, policy failure and grey area in between,” cambridge university press, 2010, vol. 30 ( 3), pp. 345-362 . [17] richard m and dade b, “failure modes and effects analysis ( fmea, fmeca) ,” clinical and laboratory standards institute, 2006. [18] walsh, j. i., “policy failure and policy change: british security policy after the cold war,” comparative political studies, 2006, vol. 39, pp. 490-518. [19] zittoun, p.h., “analyzing policy failure as an argumentative strategy in the policymaking process: a pragmatist perspective,” public policy and administration, 2015, vol. 30 (3-4), pp. 243260. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 does it pay to be shariah-compliant? evidence from the european stock market a lum jean monnet university, italy, salvi@lum.it b lum jean monnet university, italy, zito.phdstudent@lum.it c lum jean monnet university, italy, caragnano.phdstudent@lum.it abstract— the comparison of financial results between different cultural and religious systems is still an open academic debate. there is no consensus among scholars on the existence and magnitude of financial performance differences for companies acting under diverse cultural and religious background. the aim of this paper is to compare the performance of european listed firms applying shariah principles and those who do not act according to such guidelines. to serve such purpose we have built a sample of companies operating with shariah-based principles of management and compared the latter with a control comprising companies that do not adopt shariah parameters over the period 2005–2017. results suggest that the shariah-compliant sample performs better than the conventional one. in particular, during the recent recession, shariah-compliant companies obtained better periodical stock market returns and even in the event of negative returns, losses posted by these companies were lower than those of conventional companies. moreover, shariah-compliant sample presents a lower risk-profile than conventional one. keywordsislamic finance, shariah-compliant stocks, european markets, financial performance, ethical investments i. introduction the global islamic finance industry has rapidly grown over the past two decades. in line with this growth, attention towards shariah-compliant financial products and services has increased in non-muslim countries as well. western economic and financial systems have perceived the potential of islamic financial products not only as a plausible alternative to conventional sources of financing, but also as a potential instrument supporting integration and financial inclusion policies, especially in european countries with a significant and growing muslim population. in the light of the ethical and moral rules and also of the relatively high degree of prudence characterizing islamic investments, islamic finance seems to represent an interesting alternative for international investors. the central role assumed by responsible and sustainable finance along with the implementation of united nations sustainable development goals over the past few years have led to greater awareness regarding islamic finance, which is deemed to create an equitable financing system with a positive impact on society. although there has been a considerable diffusion of shariahcompliant economic and financial systems, it is also true that all types of investors (inspired or not by shariah principles) are increasingly looking for investments with the potential to generate a positive social impact (bennet and iqbal, 2013) [1]. however, the comparison of results between the financial performance of shariah-compliant and conventional stocks still remains an open question among scholars and practitioners (reddy and fu, 2014) [2]. the aim of our study is to delve deeper into any performance differences between shariahcompliant and conventional companies over the period 2005 – 2017 within the european stock markets. ii. literature review islamic finance has experienced a significant growth in the last couple of decades and it is a growing area of this industry. although the islamic finance industry only started to flourish recently, its roots date back centuries (biancone and radwan, 2015) [3].western investors are increasingly considering investing in islamic financial products (bennet and iqbal, 2013) [1], considering them an ethical, non-risky and attractive financial instrument also for non-muslim investors. the increasing growth of the sri philosophy among conventional investors may encourage the acceptance of shariah-compliant products by non-muslim investors, attentive to investments with a positive social impact. the attention towards shariahcompliant financial instruments, as well as towards the whole islamic financial sector, has progressively attracted scholars’ scrutiny; scientific literature has investigated the potential of ethical and religious screening to affect firm financial performance (mazouz, mohamed and saadouni, 2016) [4]. nainggolan, how and verhoeven (2016) [5] highlighted that ethical screening can reduce the investment universe available to investors while yielding a mean variance efficient frontier that is less optimal than the one currently available to conventional investors. other scholars maintain that ethical screening has the potential to guarantee that the selected investments are consistent with investors’ personal values, a factor that may put pressure on firms less responsive to social and ethical concerns to change their attitude (sauer, 1997) [6]. a common approach that can be seen in literature compares ethical-religious funds’ performance with that of traditional funds; however, this comparison has not yet generated conclusive results. moving further, several empirical studies salvi antonioa, zito mariannab, and caragnano alessandrac mailto:zito.phdstudent@lum.it mailto:caragnano.phdstudent@lum.it ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 have investigated the characteristics and properties of islamic financial products through the analysis of their returns, risks, and performance in various markets. on the other hand, from a geographical point of view, a series of works has focused on emerging countries, whereas the study of such issue in the us and european markets has met a lower level of attention so far (jawadi, jawadi and louhichi, 2014) [7]. researchers have reached conflicting findings with respect to the performance of conventional and islamic indices (setiawan and oktariza, 2013; ahmad and ibrahim, 2002; husein and omran, 2005; aka, 2009; albaity and ahmad, 2008, 2011; dharani and natarajan, 2011; ho, abd rahman, muhamad yusuf and zamzamin, 2014) [8, 9, 10, 11, 12, 13, 14, 15]. some scholars have extended the analysis of differences in risk and return between islamic investment instruments and conventional investments to equity funds (hayat and kraussl, 2011; elfakhani and kabir, 2005; fikriyah, hassan and shamsher, 2007) [16, 17, 18]. in conclusion, it seems that there is still no consensus on whether shariah-compliant stocks perform better than conventional ones. iii. data and methodology in order to investigate potential differences between shariah-compliant companies and conventional ones over the period 2005 – 2017 in the european stock markets, we have drawn data regarding the eurostoxx 600 index1 covering this period. daily stock prices and financial ratios of companies listed on the eurostoxx 600 for the period 2005 – 2017 have been collected from the eurostoxx 600 site, datastream and bloomberg. before carrying out the qualitative and quantitative parts of our analysis, we have chosen to obtain two samples from the selected index, the shariah-compliant and the conventional one. during this first stage, we have eliminated 145 companies with missing data. we have followed two criteria in order to classify a company as sharia-compliant: qualitative and quantitative. qualitative criteria reflect the company’s core business: we have thus excluded companies that do not pass this first screening from any additional quantitative consideration. our selection has been carried out according to the most relevant literature in the field based on the principles guiding the creation of stock market shariah-compliant indices, such as the dow jones islamic market indices, the msci islamic index, the ftse shariah global equity index series and the s&p shariah indices. such classification typically does not include haram businesses, i.e. companies operating in alcohol, pork related products, pornography, tobacco, gambling, conventional financial services, weapons and defense, 1 the stoxx europe 600 index is derived from the stoxx europe total market index (tmi) and is a subset of the stoxx global 1800 index. with a fixed number of 600 components, the stoxx europe 600 index represents large, mid and small capitalization companies across 17 countries of the european region: austria, belgium, czech republic, denmark, finland, france, germany, ireland, italy, luxembourg, the netherlands, norway, portugal, spain, sweden, switzerland and the united kingdom. (www.stoxxx.com) biological human and animal genetic engineering, and media and advertising companies with exception to news channels, newspapers, and sports (biancone and radwan, 2016) [19]. in line with this selection criterion, with reference to eurostoxx 600, we have excluded firms that operate in the following businesses: consumer goods (beverages, food producers, tobacco); consumer services (media, food & drug retailers, travel & leisure, general retailers); financials (financial services, banks, real estate investment trusts, real estate investment & services, life and non-life insurance); industrials (aerospace & defense, support services related to financial services). more specifically, for companies operating in the consumer goods sector, in order to verify their involvement in haram businesses, we have carried out controls on company individual websites. applying this additional filter, especially regarding the sub-sectors of food products and food retailers & wholesalers, meat producers, commercial chains, retailers and supermarkets have been excluded as they may produce pork meat and/or produce alcohol. the qualitative screening process of our analysis has resulted in the exclusion of 160 companies from the original sample. once companies have passed the qualitative criterion, we have moved on to the second phase of the screening, considering quantitative factors. specific financial ratios of the sample companies were considered to this regard. in order to be shariah-compliant, companies should not be heavily financially indebted, should not base their ability to generate revenues mainly on trade credits and, finally, should not hold an “excessive” amount of “idle” cash among their assets. the three ratios used to this regard are the following (collina and gatti, 2009) [20]:  d/e = total debt / 12 months average market capitalization  ar/e = accounts receivables / 12 months average market capitalization  ca+s/e = cash + interest bearing securities / 12 months average market capitalization the d/e ratio measures the level of debt a company has assumed compared to its market value; the ar/e ratio measures the level to which a company allows delayed payments to its clients compared to its market size; ca+s/e measures the percentage (as a function of size) of company liquidity that a company invests in illicit products. in order to be maintained in our sample, companies must post a lower than 33.33% for all the three ratios. once the qualitative and quantitative factors have been considered in the analysis, our final shariah-compliant sample includes 48 companies. at the same time, the conventional control sample is made up of 407 companies basically made of those companies which haven’t overcome the initial qualitative test and the quantitative one if only for one year of the period examined here. the annual average returns of both samples have been calculated, starting from the daily prices of individual ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 companies and individual stocks based on the following formula (reddy and fu, 2014) [2]: rt = ln (pt/pt-1) (1) where pt is the stock price in period t and pt-1 is the stock price in period t-1. the annual average return of the two samples has been compared in order to identify potential differences between shariah-compliant and conventional companies over the period 2005 – 2017 in the european stock markets. figure i. comparison between shariahcompliant and conventional company returns the previous figure shows that returns of the shariahcompliant sample are generally higher than conventional ones. while many researchers argue whether the global financial crisis has had a lower impact on shariah-compliant stocks compared to conventional ones, interestingly enough, our findings suggest that during recessions, shariah-compliant companies have shown greater returns and, even in the event of negative returns, losses were limited. our findings are in line with prior studies, such as ho, abd rahman, muhamad yusuf and zamzamin (2014) [15] who found support for islamic indices outperforming their conventional counterparts during crisis periods. the authors deduced that this may be due to the conservative nature of shariah-compliant investments that, in this case, may represent a valid investment alternative during times of crisis. afterwards, an analysis on a sector-level between the two samples has been carried out among the following sectors: basic materials, consumer goods, health care, industrials and technology. such comparison aims at highlighting differences between shariah-compliant and conventional stock returns, comparing specific samples made up of companies belonging to the same sector (table i). table i. comparison between shariah-compliant and conventional stock returns on a sector-level as shown in the previous table, comparing stock returns for the two samples on a sector-level, a positive trend emerges, concerning the shariah-compliant companies belonging the basic materials and industrials sectors, while in the other observed sectors (consumer goods, health care, and technology) the conventional sample appears to perform better. in particular, if we consider the basic materials sector, the shariah-compliant sample has registered better performance in almost all the analysis years, except for 2006, 2011, 2012 and 2017. this negative trend could be due to the aftermath of the recession as well as to problems closely linked to the sector in object. moreover, if we consider the industrials, the shariah-compliant sample has registered better performance in almost all the analysis years, except for 2009, 2013, 2014 and 2015. concerning the other sectors, namely consumer goods, health care, and technology, we observe that the two samples registered an erratic performance during the considered timeframe, with a slightly improved performance on behalf of conventional firms. in order to ensure a detailed and complete analysis as well as to account for potential differences concerning the risk factor between the two samples considered, the annual average levered beta has been calculated for both samples. levered beta measures the risk of a firm with both debt and equity in its capital structure with respect to the volatility of the market (damodaran, 2003) [21]. it is viewed as a proxy for the total risk of a firm and used to estimate the volatility of an investment (reddy and fu, 2014) [2]. figure ii. comparison of levered beta between the shariah-compliant and the conventional samples ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 the previous figure shows that the beta of the shariahcompliant sample is permanently lower than the beta of the conventional sample during the considered timeframe. thus, the shariah-compliant sample presents a lower risk-profile than the conventional one. moreover, it is possible to observe that the values of the levered beta of the shariah-compliant sample always lie below the unit, highlighting that the stocks belonging to the aforementioned sample tend to limit market fluctuations. diversely, the stocks belonging to the conventional sample post average beta values above the unit in almost all the analysis years, highlighting a propensity to amplify market fluctuations. next, a sector level analysis has been carried out for the two samples, using the same sectors mentioned in our previous analysis: basic materials, consumer goods, health care, industrials and technology. this comparison aims to highlight eventual differences between the shariah-compliant stock beta and the one of conventional firms. table ii. comparison of levered beta between the shariahcompliant and the conventional samples on a sector-level as shown in the table, comparing the two samples’ beta on a sector-level, the values of beta for the shariah-compliant sample are lower for each sector in almost all the analysis years. this finding may be explained by the initial quantitative screening applied for firms in our overall sample. considering the basic materials, results show that the shariah-compliant sample has registered a lower beta in almost all the analysis years, with the exception of 2006, 2009, 2010 and 2013. furthermore, if we consider the consumer goods sector, we can notice that, in this case as well, the shariah-compliant sample has registered a lower beta in almost all the analysis years, except for 2008. moreover, starting from 2009 the difference between the beta values of the shariah-compliant sample and those of the conventional one is greater; in particular, from 2009 to 2014 the conventional sample beta registered values, which were well above the unit. moving on to the next sector, healthcare, the shariah-compliant sample has registered a lower beta in almost all the analysis years, except for 2005, 2006 and 2007. it is interesting to observe that in all the analysis period the beta values of both samples never exceeded the unit. in the industrials sector, the shariahcompliant sample has registered a lower beta in all the analysis years, with values ranging from a minimum of about 0.6 to a maximum of around 1. finally, as seen in the previous table, considering technology, the shariah-compliant sample has posted a lower beta in all the analysis years, with values exceeding one only in the first three years of the period (from 2005 to 2007). iv. conclusions islamic finance has assumed a central role in recent years not only in muslim countries; western economic and financial systems have perceived the potential of islamic finance as a plausible alternative to conventional sources of financing. stability during the years of recession and compliance with ethical principles represent the major reasons for western countries to demonstrate heated interest in the field. in this perspective, shariah-compliant stocks represent an ethical, non-risky and attractive opportunity for non-muslim investors as well. in fact, this study research findings have revealed that stock returns of shariah-compliant firms have been higher than those of traditional counterparts for a great portion of the past decade. in particular, during the recession, shariah-compliant companies not only presented greater returns but even in the event of negative returns their losses were limited. the second part of our analysis based on a sector focus also highlighted unequivocal results, although varying according to the examined sectors. moreover, also considering the differences concerning the risk factor between the two samples analysed, we have found that shariah-compliant firms’ beta values are lower than the ones of conventional firms in almost all the analysis years. notwithstanding the former, because of the reduced starting sample and due to a lack of data, given the broad time horizon considered, it was impossible to extend our analysis to all sectors of companies listed on the eurostoxx 600 index. regarding future research ideas, we could improve our research considering other factors and measures for returns and risk-profile stocks in order to obtain diverse but comparable evidence concerning the comparison between shariahcompliant sample and the conventional one. moreover, it might be interesting to widen the geographical area of observation and above all, make further comparisons on more core levels (eg. sub-sectors). finally, in the light of the constant evolution and the open academic debate on the topics analyzed in this research work, our results will offer further food for thought for future surveys and research activities. ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 references [1] m. bennet and z. iqbal, “how socially responsible investing can help bridge the gap between islamic and conventional financial markets”, international journal of islamic and middle eastern finance and management, 2013. [2] k. reddy and m. fu, “does shariah compliant stocks perform better than the conventional stocks? a comparative study of stocks listed on the australian stock exchange”, asian journal of finance & accounting, 2014. [3] p. p. biancone and m. radwan, “sharia compliant “possibility for italian smes””, european journal of islamic finance, 2015. [4] k. mazouz, a. mohamed and b. saadouni, “price reaction of ethically screened stocks: a study of the dow jones islamic market world index”, journal of business ethics, 2016. [5] y. nainggolan, j. how, and p. verhoeven, “ethical screening and financial performance: the case of islamic equity funds”, journal of business ethics, 2016. [6] d. sauer, “the impact of social‐responsibility screens on investment performance: evidence from the domini 400 social index and domini equity mutual fund”, review of financial economics, 1997. [7] f. jawadi, m. jawadi, and w. louhichi, “conventional and islamic stock price performance: an empirical investigation”, international economics, 2014. [8] c. setiawan and h. oktariza, “syariah and conventional stocks performance of public companies listed on indonesia stock exchange”, journal of accounting, finance and economics, 2013. [9] z. ahmad and h. ibrahim, “a study of the performance of the klse syari'ah index”, malaysian management journal, 2002. [10] k. husein and m. omran, “ethical investment revisited: evidence from dow jones islamic indexes”, journal of investing, 2005. [11] j. aka, “shariah investing: through bull and bear markets?”, sei investments, 2009. [12] m. albaity and r. ahmad, “performance of syariah and composite indices: evidence from bursa malaysia”, asian academy of management journals of accounting and finance, 2008. [13] m. albaity and r. ahmad, “a comparative analysis of the firm specific determinants of syariah compliant versus non-syariah compliant firms in bursa malaysia”, asian journal of business and accounting, 2011. [14] m. dharani and p. natarajan, “seasonal anomalies between s&p cnx nifty shari’ah index and s&p cnx nifty index in india”, journal of social development sciences, 2011. [15] c. s. f. ho, n. a. abd rahman, n. h. muhamad yusuf, and z. zamzamin, “performance of global islamic versus conventional share indices: international evidence”, pacific-basin finance journal, 2014. [16] r. hayat and r. kraussl, “risk and return characteristics of islamic equity funds”. emerging markets review, 2011. [17] s. elfakhani and h. kabir, h. “the performance of islamic mutual funds”, working paper n. 2005-2, economic research forum, 2005. [18] a. fikriyah, t. hassan, and m. shamsher, “investigation of performance of malaysian islamic unit trust funds”, managerial finance, 2007. [19] p. p. biancone and m. radwan, “european companies: evaluation for sharia compliance “opportunities and challenges.””, european journal of islamic finance, 2016. [20] s. collina and s. gatti, “islamic equity funds: an italian perspective”, 2009. [21] a. damodaran, “corporate finance, theory and practice”; john wiley & sons inc, 2003. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) an analysis of takaful: the potential and role in financial inclusion and challenges ahead * ma islamic banking center for islamic banking, finance and economics university of sarajevo; university of bolton + msc strategic project management heriot-watt university; politecnico di milano; umea university abstract — this paper will look to analyze takaful and the takaful industry in existence today with regards to its potential for growth and the challenges associated with its development. the possibilities associated with takaful are numerous primarily due to its widened market reach and adaptability; takaful, unlike conventional insurance, is permissible to muslims and non-muslims alike providing more versatile offerings. the takaful industry is also one of the fastest growing businesses, substantially contributing to the global insurance industry. however, despite the prospects of takaful, the industry today faces many obstacles. above all, the total value of the takaful industry with regards to its combined total assets and contributions (premium) is negligible if we consider both the size of the muslim population and the conventional insurance industry. not to mention the challenges associated with monitoring and transparency, standardization and lack of knowledge. therefore, this paper will analyze the economic potential and influence of the takaful industry as well as investigate the role of takaful in poverty alleviation, where some research has already proven successful. it will also consider the challenges faced by the industry, stalling its development and deterring it from reaching its full potential. keywords islamic insurance, poverty alleviation, financial inclusion, economic development i. introduction takaful, or islamic insurance, emerged as an alternative to conventional insurance, primarily for muslims who desired a shari’ah compliant product offering the same services. the industry has since grown and developed, holding a significant share in the global insurance market. it has yet to surpass other products and services offered by the islamic banking and finance industry, however, its sustainable growth year by year has shown just how vast the potential of the takaful industry is. this paper will look at the potential of takaful which is primarily linked to it being a shari’ah complaint alternative to conventional insurance. this means it caters to the everincreasing muslim population worldwide. studies show that the muslim population continues to grow at significantly faster rates than the non-muslim population. not to mention the growth in the americas and europe which will significantly help the takaful industry penetrate these markets where its share is otherwise minimal. this paper will also discuss the economic potential of takaful, primarily with regards to poverty alleviation. the challenges currently being faced by the takaful industry will also be highlighted to see where improvement is needed. it is necessary to highlight the obstacles being faced by the industry and takaful operators to better understand what the steps are moving forward with regards to growth and development. ii. literature review many academics have begun to consider the link between the development of the financial sector and economic growth [13; 14; 15; 16; 17; 18]. there are multiple arguments for this albeit the type of relationship is a matter of debate. while some academics claim that economic growth is a result of the supply of financial products, others claim that the demand for such products is a result of growth. the supply argument states that a country needs to develop new financial instruments, spurring financial development which will eventually lead to overall economic development [19; 26]. in that respect, the institutions that offer these new instruments need to place the products on the market which requires increasing financial inclusion for maximum impact. advocates of the demand argument believe that financial development does not lead to economic growth but rather growth in the economy creates demand for financial instruments and service providers, ergo leading to financial development [20; 25; 26]. they argue that financial inclusion is limited in underdeveloped economies because there is shortage of demand [19]. alternatively, some authors believe it is a combination of the two whereby both supply and demand of financial products on the market eventually leads to economic development [23; 24]. ultimately, there is no consensus in the literature on the direction of causality between financial development and economic growth [26]. while the majority of the literature considers the financial industry as a whole, none of the research considers the insurance sector, particularly related to islamic finance. abduh and omar (2012) [21] analysed the development of the islamic banking sector on the economic growth of indonesia, however they did not look at the insurance sector. chen et al. (2012) [22] investigated how life insurance affected economic development but only in terms of the conventional system. the role that islamic insurance, or takaful, plays in contributing to economic growth, namely in terms of increasing financial inclusion, has yet to be investigated in the literature, to the best of our knowledge. amela trokic http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) iii. methodology the methodology is based on a literature review approach, whereby the researcher mainly used secondary data. to determine the source of materials for review, a structured approach was implemented. peer/reviewed literature was the primary information and data source. a limited amount of grey literature, or literature which is not necessarily considered to be of the highest quality academically speaking, was used. that is to say, sources outside the standard literature databases. peerreviewed articles and dissertations were found using databases such as science direct, jstor, emerald insight and university library databases, on the topic of takaful, islamic insurance, islamic finance, financial inclusion and poverty alleviation. more general searches were also conducted using google scholar as a generic search engine. searches were limited to research conducted in english. in the decision process, when choosing which sources/articles will be included or excluded, the researcher based the decision on key criteria. namely, the abstract was first reviewed to search for key terms and concepts directly related to the concept of the paper. if the abstract proved to be interesting, or if it did not provide enough detail, the entire document was skimmed to determine if it met the inclusion criteria, that is if it was related to the theme of our paper. inclusion criteria included sources which discusses takaful or islamic insurance, its role in poverty alleviation, financial inclusion and/or economic development. exclusion criteria included sources which only mentioned takaful within islamic finance without discussing its role or demand. in other words, sources which only skimmed the surface of the takaful phenomenon without providing more in-depth information. sources and articles were not excluded based on their publication date. iv. growth of takaful in the global market takaful is the shari’ah alternative to conventional insurance, or sometimes referred to as islamic insurance. it is based on islamic principles, primarily the concept of mutual care and fulfilment of one’s needs. this means that takaful should be void of all elements not permitted by the shari’ah, including but not limited to, gharar (uncertainty), riba (interest), maysir (gambling) and so forth. takaful has a responsibility towards all parties involved in the practice, encouraging brotherhood, solidarity and mutual financial security to protect takaful participants against defined risks [1]. in this sense, the main aim of takaful is not to earn profit but to provide aid to others facing risk and misfortune by sharing the responsibility figure 1 – number of takaful operators in 2010 [2] takaful appeared as a result of fiqh rulings stating that conventional insurance practices were haram, or went against islamic practices. thus, a need for an islamic alternative spurred the birth and development of islamic insurance practices in the late 1980s in both sudan and malaysia [3]. the main difference between conventional and islamic insurance, or takaful, is that conventional insurance is essentially a contract of risk transfer while takaful is a contract of risk transfer [12]. the takaful industry is one of the fastest growing industries in the world today, contributing positively to the growth of the global economy. from year to year, its growth has remained in the double digits with forecasts predicting this to continue. the industry has now reached a level of sustainable growth with an expected increase of 17.114 percent in 2015 [4]. this translates to an average growth of 20 percent yearly [4]. the takaful industry’s growth can be noted by the increased number of takaful operators worldwide. by the end of 2010, the number of takaful operators reached 195 (figure 1), 82 more than the 113 estimate in 2006. as can be seen in figure 1, most takaful operators are located in the gulf cooperation council (gcc) countries with nearly 40 percent of total takaful business occurring there. south east asia comes in a distant second to the gcc with only an 11.8 percent share in the takaful market. with that said it is no surprise then that the gcc contributes more than 62 percent of the gross takaful premiums globally [5]. in terms of the overall global financial industry, the takaful market share makes up only about 5 percent, which is a relatively small segment. similarly, its contribution to the global insurance industry remains minor despite its consistent growth. even within the islamic financial industry, it maintains the smallest market share. nonetheless, it is continuously developing with substantial contributions to both the islamic financial industry and the global industry with moody estimating its full potential at nearly 5 trillion usd [6]. v. the need and demand for takaful as discussed earlier, the need for a takaful market became evident in the late 1970s when it was apparent that identify applicable sponsor/s here. if no sponsors, delete this text box. (sponsors) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) conventional insurance practices were not shari’ah compatible. for those who follow the faith of islam, the desire to adhere by the religion’s principles rendered conventional insurance noncompatible with their lifestyle choices and beliefs. thus, it was necessary to produce an islamic equivalent which would provide the same or similar service as conventional insurance, while adhering to the principles of shari’ah. after emerging onto the market, it was clear that the demand for takaful only increased, as can be seen by its consistent 20 percent yearly growth. innovations in the industry also helped push the demand for islamic insurance, increasing the scope and breadth of the takaful industry. the main factors contributing to the demand and need for takaful can be summarized as follows [7]: 1. demand for shari’ah compliant products – there is a growing need for products that are shari’ah compliant where demand rather than supply is fueling the development of such products, including takaful. there are an increasing number of islamic banking clients who are constantly looking for new islamic financial instruments to meet all their financial needs. 2. liquidity – oil-producing nations have experienced an increase in liquidity due to sustained high oil prices over the years. individuals involved in the industry have prospered and as a result became more concerned with protecting their investments, particularly in the form of takaful coverage. 3. re-takaful – the emergence of international reinsurers entering the re-takaful business has helped push the demand and growth of the takaful industry. 4. improved takaful distribution channels – takaful operators have improved their cooperation with other financial institutions, increasing the takaful penetration rate and, consequently, demand. 5. micro-takaful – the introduction of micro-takaful products has helped increase the demand among the poor. 6. muslim population size – the ever-increasing size of the muslim population globally has continuously contributed to the demand for takaful. we will discuss this factor in detail below. a. takaful demand and population size takaful, as a shari’ah compliant alternative to conventional insurance, is a product made for everyone. however, it cannot be denied that although non-muslims can benefit from takaful products, the primary target is the muslim market. as such, the growth and demand in the takaful industry is expected to increase with the muslim population; and the global muslim population has significantly increased over the years with further projections of growth. population projections estimate that the muslim population will increase by 35 percent from 2010 to 2030. that is a rise from 1.6 billion to 2.2 billion muslim (figure 2) worldwide, or an expected 26.4 percent of the world’s total population in 2030 [2]. although the muslim population is expected to grow, it will increase at a smaller rate than in previous years. nonetheless, the growth rate will still far surpass that of the non-muslim population. figure 2 – muslim population projections (pew research center's forum on religion & public life, 2011) what is interesting to note is the increase in the muslim population in the americas and europe. in the united states of america, the muslim population is expected to more than double from 2.6 million in 2010 to 6.2 million in 2030 [2]. in this same period, the muslim population is expected to increase in europe as a whole by nearly one-third. that brings the european muslim population to 53.2 million from 44.1 million; in other words, muslims will comprise 8 percent of europe’s total population by 2030 [2]. in terms of the takaful industry and its products, this means that demand will increase in the americas and europe [8]. considering that the takaful market share in these regions is currently minimal, with most contributions coming from the gcc and asian regions, this is a significant factor to explore. this is especially important seeing as the us is a preferred market primarily due to it being the third most populous country in the world [8]. the increasing muslim population will make it easier to penetrate the american and european markets, initially by offering services to muslims and eventually to non-muslims in search of alternatives. vi. takaful in poverty alleviation and financial inclusion despite the size of the muslim population, a very small percentage of muslims live in developed countries. of the 35 least human developed countries, according to the human development report 2000, 18 of them have a majority muslim population while the rest have muslim populations above 20 percent [9]. it is clear, that a significant number of muslims live in poverty and are unable to receive the same benefits, be they educational, economic or similar. in terms of insurance, it has increasingly become recognized for its potential and contribution to poverty alleviation. studies have shown that individuals living in poverty have a desire to save and safeguard themselves against possible future risk but often lack the opportunity or support to do so. insurance can provide the poor with coverage, reducing their vulnerability in terms of disease, theft, disability and other threats [8]. yet, providing insurance to the poor is a difficult feat particularly due to the unfavorable circumstances associated with it such as high costs, corruption, low collateral, http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) uncertain profitability and similar. not to mention the high start-up costs and need for an economically and politically stable environment [8]. consequently, the responsibility of providing insurance to the poor has been left to the informal sector with minimal success. the cooperative insurance structure is perhaps the best option for providing insurance to the poor. a cooperative is an autonomous association of individuals who voluntarily cooperate to achieve mutual benefit whether of a social, economic or cultural nature [8]. takaful is very similar to the cooperative and mutual insurance schemes and can, therefore, be effective in contributing to poverty alleviation [10]. this can primarily be conducted through the creation of micro-takaful products as a part of a larger poverty alleviation strategy, as takaful alone cannot solve the poverty problem. vii. the challenges ahead despite significant development and the growing demand and potential of the takaful industry, there are many challenges faced by takaful operators. these challenges affect the supply of takaful products as they are often associated with structural issues. the challenges faced by the takaful industry can be divided into five categories which each have their individual challenges that need to be addressed by takaful operators to strengthen the supply of takaful products [5]. 1. governance and regulatory compliance [11]: o more consistency of regulatory frameworks o optimizing capital adequacy through consolidation 2. risk management and internal controls: o risk--based business a priority unified with strategic planning o improve risk and shari'ah disclosures and governance excellence 3. operational and business excellence o improved technology capabilities to achieve cost efficiency and productivity o new business models accommodating for new market niches 4. product governance and strategy o improve product governance and product development process o emphasis on target markets, sales and distribution 5. capacity building: talent and leadership development o switching emphasis to internal development to build specialized knowledge o refocus on competency-based training and leadership program conclusion the takaful industry has significant potential for growth and further market penetration to continue contributing to the global insurance industry. from its emergence, it has continuously grown year by year, offering new products and services worldwide. this paper showed both the development and potential for further progress particularly on the back of a growing muslim population. particularly the increasing muslim population in the americas and europe have shown to be significant indicators for the potential market penetration in terms of takaful products. taking advantage of the change in demographics should be one of the takaful industry’s main strategies. yet, it is shown that the takaful industry is still not performing to its maximum potential despite its sustainable growth rate. it holds a very small market share in both the global insurance market and the islamic banking and finance market alike. the potential role of takaful in poverty alleviation was also presented and showed a significant potential. takaful can be effective in providing strategies for bettering the economic situation of poorer populations, when used in partnership with other mechanisms. this is mainly because takaful is similar to mutual funds and cooperatives. as was also shown, despite the increased growth of the takaful industry, there are many challenges still left to face. many of these challenges are associated with governance, regulation, operation, capacity building and risk management. takaful operators need to work on alleviating these obstacles and challenges to better compete on the global insurance market. therefore, significant work is still needed to ensure that the takaful industry operates at its full potential. references [1] kabir, h., and lewis, m. (2007). handbook of islamic banking. 1st ed. cheltenham, uk: edward elgar. [2] pew forum and the pew research center (2011). the future of the global muslim population. pew-templeton global religious futures project. pew forum. [3] jacky, l., fahmi idris, m., and carissa, y. (2010). history, progress and future challenge of islamic insurance (takaful) in malaysia. proceedings from oxford business and economics conference program. [4] ey.com, (2014). ey global islamic insurance industry insights 2013. accessed june 18 2014. available at: <http://www.ey.com/my/en/industries/financialservices/insurance/ey-global-islamic-insurance-industry-insights2013>. [5] the deloitte me islamic finance knowledge center – ifkc (2014). the global takaful insurance market: charting the road to mass markets. a deloitte me ifkc practice insights series. manama: deloitte. [6] bhatty, a. (2010). the growing importance of takaful insurance. in: oecd and bank negara malaysia. proceedings from asia regional seminar kuala lumpur, 23-24 september 2010, malaysia. [7] islamic financial services board (2013). islamic financial services industry stability report. jeddah: islamic financial services board. [8] abdulrahman, z. (2009). takaful: potential demand and growth. islamic economics, 22 (1), pp. 171-188. [9] patel, s. (2005). takaful and poverty alleviation. cheshire, uk: the international cooperative and mutual insurance federation (icmif). http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 http://www.ey.com/my/en/industries/financial-services/insurance/ey-global-islamic-insurance-industry-insights-2013 http://www.ey.com/my/en/industries/financial-services/insurance/ey-global-islamic-insurance-industry-insights-2013 http://www.ey.com/my/en/industries/financial-services/insurance/ey-global-islamic-insurance-industry-insights-2013 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) [10] erlbeck, a., altuntas, m., and berry-stolzle, t.r. (2011). microtakaful: field study evidence and conceptual issues. department of risk management and insurance, university of cologne. [11] archer, s., rifaat a.a.k., and nienhaus, v. (2009). takaful islamic insurance. 1st ed. singapore: john wiley & sons (asia) ltd. [12] khan, h. (2015). optimal incentives for takaful (islamic insurance) operators. journal of economic behavior & organization, 109, pp. 135144. [13] mundaca, b. g., 2009. remittances, financial market development, and economic growth: the case of latin america and the caribbean. review of development economics 13(2), 288-303. [14] enisan, a. a., olufisayo, a. o., 2009. stock market development and economic growth: evidence from seven sub-sahara african countries. journal of economics and business 61(2), 162-171. [15] hassan, m. k., sanchez, b., yu, j. s., 2011. financial development and economic growth: new evidence from panel data. the quarterly review of economics and finance 51(1), 88-104. [16] bittencourt, m., 2012. financial development and economic growth in latin america: is schumpeter right?. journal of policy modeling 34(3), 341-355. [17] zhang, j., wang, l., wang, s., 2012. financial development and economic growth: recent evidence from china. journal of comparative economics 40(3), 393-412. [18] greenwood, j., sanchez, j. m., wang, c., 2013. quantifying the impact of financial development on economic development. review of economic dynamics 16(1), 194-215. [19] quartey, p., prah, f., 2008. financial development and economic growth in ghana: is there a causal link? african finance journal 10(1), 28–54. [20] demirgüç-kunt, a., levine, r., 2008. finance, financial sector policies, and long-run growth. world bank policy research working paper series. [21] abduh, m. omar, m.a., 2012. islamic banking and economic growth: the indonesian experience. international journal of islamic and middle eastern finance and management 5(1), pp.35–47. [22] chen, p., lee, c., lee, c., 2012. how does the development of the life insurance market affect economic growth ? some international evidence. journal of international development 24, 865–893. [23] greenwood, j., smith, b. d., 1997. financial markets in development, and the development of financial markets. journal of economic dynamics and control 21(1), 145-181. [24] blackburn, k., bose, n., capasso, s., 2005. financial development, financing choice and economic growth. review of development economics 9(2), 135-149. [25] wolde-rufael, y., 2009. re-examining the financial development and economic growth nexus in kenya. economic modelling 26(6), 1140– 1146. [26] muye, i.m. and hasan, a.f.s. (2016). does islamic insurance development promote economic growth? a panel data analysis. procedia economics and finance, 35, pp. 368-373. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, portsmouth university, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france i. introduction ii. literature review iii. methodology iv. growth of takaful in the global market v. the need and demand for takaful a. takaful demand and population size vi. takaful in poverty alleviation and financial inclusion editorial_board.pdf editor in chief editorial board critical assessment of the legal recourse for the case of sukuk default for the asset-backed and asset-based sukuk structures a institute of islamic banking and finance, international islamic university malaysia b inceif-the global university of islamic finance, kuala lumpur, malaysia. abstract— the paper critically assesses and analyze the islamic certificate of investments (sukuk) and its two different structures; asset-backed and asset-based. the focus in this paper is on the issue of legal recourse following the default in asset-based or assetbacked sukuk as well as its structures. it also provides discussion on the emergence of the sukuk market as well as the issue of legal recourse in event of default. based on the relevant literature it is evident that sukuk default by the institution cannot occur in its true sense, as they're not debt instruments issued by the issuer. rather, they represent the possession of the sukuk holders on the underlying assets. from our study, we depicted that, the default has taken place are all asset-based type and shared a common structure that is of debt instrument. however, none of the assetbacked sukuk has defaulted due to following the structure of profit and loss sharing. there is an identical gap between these two instruments and it’s essential to reconcile the gap. this can be done by revisiting the roots of islamic finance and its essential requirements. besides, we need to get the consensus on how sukuk differ from conventional instruments and on how they need to be structured to comply with the shariah. keywords: asset-backed sukuk, asset-based sukuk, legal recourse, sukuk default. i. introduction: sukuk are islamic certificates of investment. they signify coownership of productive resources; services or investment activities known as the underlying assets, that generate fixed or floating returns according to islamic principles. sukuk instruments offer an alternative funding tool to conventional bonds and can be structured for a vast array of purposes. typically, sukuk are categorized into ‘trade-based’ and ‘participatory’, depending on whether they are issued to finance trade or investment. but, in recent years, sukuk products have seen significant innovation with the introduction of hybrid, convertible, perpetual, retail and regulatory liquidity/capital sukuk. this development has been followed by some cases of defaults in issued sukuk, which has raised several questions about the underlying structures and viability of the sukuk as an alternative source of funding. more pertinent concern is the issue of legal recourse in the event of default. sukuk are advertised as securities backed by real assets, therein case, the investors should solely be exposed to the risk of monetary loss, the danger that arises owing to fluctuations in the market value of underlying assets, and the periodic rental returns generated by these assets. but normally there would be no default of the complete principal sukuk quantity, as sukuk holders are presumed to own recourse to the sukuk assets, being the legal owner of these assets. however, notable from close observation of the cases of sukuk default, it noticeable that most defaults so far occur mostly asset-based type of sukuk that shared a common structure of debt-instruments. in the case of asset-based sukuk, the issuers need to guarantee the fixed income (interest) and the capital to the sukuk holders, which is simply the replication of conventional bonds. alike bonds, asset-based sukuk has the possibility of default. some scholars [2] maintained that this kind of sukuk defaulted in part due to the monetary crisis and the economic downturn that triggered it originators did not earn sufficient revenues to make the promised payments. on the other hand, none of the asset-backed sukuk has defaulted, due to the notion that they follow the structure of profit and loss sharing, hence they don’t have any debt instrument. the focus in this paper is on the issue of legal recourse following the default in asset-based or asset-backed sukuk discerning their respective structures, not on viability of the sukuk as an alternative source of funding to begin with. like [12], we analyzed some cases of sukuk (near) defaults from an islamic finance perspective. more specifically, we discussed the asset-based and asset-backed sukuk as contemporary types of sukuk along with their distinctive structures. we also provided discussion on the emergence of the sukuk market as well as the issue of legal recourse in event of default. finally, we provided assessment on some cases of sukuk defaults with basic information on each sukuk issuance (issuer, arranger, spv, term period, rate of return etc.). this analysis provides mashiyat tasniaa, is’haq muhammad mustaphab and mohammad hassan shakilb http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) crucial insights if the development to the islamic capital markets is to be continued through sukuk. the recent fragility in the conventional financial sector adds to the relevance of the topic, as investors remain keen on alternative capital market instruments. the remainder of the paper is structured as follows. we first give a brief overview of the emergence of sukuk in the islamic capital market instruments (section ii). we then more sharply define the precise concept and structure of sukuk (section iii). in section iv, we present the legal recourse on the event of sukuk default. section v, discusses the case studies of sukuk default and critical issues that emerge from the defaults. section 6 concludes the paper. ii. the islamic capital market instruments: emergence of sukuk the development of modern islamic finance began in the 1970’s and the success of islamic financial institutions led to a demand for capital market instruments for management of their balance-sheet liquidity. for the purpose, the council of the islamic fiqh academy of the organization of islamic conference (oic) legitimized the concept of sukuk in 1988. this paved the way for an alternative source of financing to meet diverse risk-return profiles and needs of islamic issuers as well as investors who are not allowed under the shari’ah principles to trade in interest-bearing debt securities. more recently, the islamic capital market (icm) has overtaken the islamic banking to be the fastest growing component of the overall islamic finance system, despite being a late entrant into the industry starting in the mid-1990s [4]. akin to the trends observed in the global capital markets, the islamic capital market is also exposed to some volatile movements and setbacks including contractions in returns and asset values. however, the icm has maintained a remarkable positive momentum in attracting diverse investors and issuers from around the world, maintaining steady growth in depth and size. typically, the islamic capital markets comprise of three major sectors: islamic equities market facilitated by the availability of shariah-compliant indices; the sukuk or as sometimes regarded as the islamic bond market; and the islamic funds market. these three sub-sectors have enabled investors to achieve ethical and shariah-compliant returns on their capital. however, among its three sub-sectors, the sukuk market has garnered the most interest in recent years and issuers in as many as 31 domiciles have now tapped into the shariah-compliant liquidity pool by issuing sukuk instruments [5]. interestingly, the first sukuk was issued in 1990 by a foreign owned and non-islamic corporation, shell mds in malaysia. it was a malaysian ringgit (rm) denominated issue with a modest size of rm 125 million equivalent to us dollar 30 million approximately [6]. in the year 2000, the sudanese government issued 77 million sudanese pound (sdg) domestic sovereign short-term government musharakah certificates (gmc’s). this was followed by an international debut in the year 2001, with the issuance of the first united states dollar (usd) denominated international sovereign sukuk al ijarah of usd 100 million (5year tenor) and a series of domestic sovereign short-term (less than 1-year tenor) sukuk al salam issued by the central bank of bahrain on behalf of the government of bahrain. in the same year, the first 5-year international corporate sukuk al ijarah of usd 150 million was issued by a malaysian corporate kumpulan guthrie berhad or guthrie group limited. more so, german saxonyanhalt became the first non-muslim state to tap into this market: it issued 5-year sukuk to raise eur 100 million in 2004 with aaa rating by fitch3 [10]. similarly, the world bank issued its first sukuk in 2005 to raise 760 million malaysian ringgit (rm), 4 while its private sector arm, the international finance corporation, issued sukuk of rm 500 million in 2005 and usd100 million in 2009 [7]. thereafter, many sovereign and corporate sukuk issues (domestic and international) have been offered in various jurisdictions such as the united arab emirates (uae), saudi arabia, indonesia, qatar, pakistan, brunei darussalam, singapore, kuwait etc. recently, the issuer base of sukuk further expanded with debut issuances by the sultanate of oman and cote d’ivoire in the sovereign sector, and a return of issuance by the world bank’s international finance corporation (ifc). the global sukuk outstanding reached an all-time high of usd300.9 billion as at end-2014, recording a resounding post-financial crisis doubledigit cagr of 19.56% between 2009 and 2014 (see chart 1 ). this growth had been spurred by the heightened activity in the primary sukuk market where annual issuances had surpassed the milestone usd100 billion mark for three consecutive years between 2012 and 2014 [5]. chart 1: global sukuk outstanding trend (2003–11m15) source: zawya, bloomberg, ifsb (2016). however, the global sukuk outstanding had a 3.4% contraction at the end of 2015 compared to the record value as of end-2014 to be valued at usd290.58 billion [5]. this drop in outstanding volume has been attributed to the global financial trend and a combination of factors, including a decline in issuances activity in 2015 as well as currency exchange rate movements where local currency sukuk outstanding are now valued lower in us dollar terms. the emergence of the sukuk market as one of the main sections of the islamic financial services industry has been well 290.58 0 50 100 150 200 250 300 350 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 11m15 u s d b ill io n 2009–14 cagr: 19.56% http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) supported by innovation its structures such as ijarah, musharakah, mudarabah, hybrid, exchangeable and convertible sukuk structures. iii. concept and structure of sukuk: the basic concept behind issuing sukuk, however, is for the holders of the sukuk to share in the profits of large enterprises or in their revenues [11]. in the islamic capital market, there are two structures of sukuk that are becoming more popular, namely asset-backed sukuk and asset-based sukuk. a. asset-based sukuk 1) definition: asset-based sukuk is a securitization of receivable. it involves a beneficial ownership where no right to dispose of the underlying asset. according to ram (rating agency malaysia), the underlying asset in asset-based sukuk is not the one to be considered as the fund generator and the capital payments. rather it is a mechanism to fulfil the requirement of the shariah. as such, the entity bears the risk of non-payment in the case of redemption of sukuk [8]. so, the danger of non-payment is rapt towards the entity just in case of redemption of sukuk 2) structure of asset-based sukuk: in an asset-based sukuk, although an asset may be used in the structure, it does not necessarily drive the return to the sukuk holders. through several credit enhancement features (purchase undertaking, liquidity facility, etc.), the recourse of the sukuk holders is not to the asset but to the issuer. if the asset is not performing, the issuer may still have to pay the expected return by exercising the credit enhancements. if the issuer defaults, the sukuk holders will only have limited right of disposal because they will be required to sell the asset to the issuer. asset-based sukuk attempts to emulate the behavior of bond issuance in the conventional space [8]. 3) secured asset-based sukuk: in this structure, the originator can deliver the security for assurance and conviction to the sukuk holders, which will be to secure their dealing. this secured asset-based sukuk is known as nakheel sukuk. these securities are granted to the special purpose vehicle (spv) underneath the dealing documents to secure the investors. usually, they don’t organize directly. the establishment against the originator, the safety is implemented during the time of default and its recoveries from such are a part of the funds obligatory for the reimbursement to the investors. this security isn’t additionally interconnected with the underlying quality. the following figure depicts an example of asset-based sukuk in malaysia. fig 1: example of asset-based sukuk – malaysian global sukuk ijarah a. the sukuk investors will pay sukuk proceeds to the special purpose vehicle (spv) b. upon receiving the proceeds, the spv then issue the sukuk certificates to the sukuk investors. c. the spv will then purchase an asset from the obligor/ originator and obtains the ownership of the asset. d. the spv in its capacity as a lessor (act on behalf of investors) will lease through an ijarah agreement the same asset back to the obligor. e. the obligor in its capacity as a lessee will pay rentals to the spv of the asset. f. the rentals will be distributed back to the sukuk holders. b. asset-backed sukuk 1) definition: asset-backed sukuk means the ownership of the underlying asset is fully transferred. asset-backed sukuk are based on true sale. it is the process of securitization of tangible assets and has a legal ownership right to dispose of the underlying asset. rating agency malaysia (ram), outlined asset-backed sukuk as recourse-able sukuk. in asset-backed sukuk, the capital payments and profits are solely generated by the underlying asset; just in case of such sukuk arrangements; the underlying asset’s performance i.e. money flows and/or the assets’ maturity price might concern the credit risk. it should be deepseated with vigorous securitization constituents through that, the obligator will effectively delink from the credit risk profile of the sukuk [8]. 2) structure of asset-backed sukuk in this type of sukuk, underlying asset is fully shifted to the special purpose vehicle (spv) with elements of a true sale. the recourse is to the sukuk-holders. thus, cases of impairment or non-performance of sukuk asset are directly reflected in the value of the sukuk held by the investors. as described by the islamic financial services board (ifsb), the investor in an asset-backed sukuk, bears any losses due to the impairment of http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) the asset(s). more so, the sukuk holders have recourse to the asset(s) and not to the originator. therefore, in case of default, investors will not be able to hold the originator liable, rather, they have to recourse to the asset directly. this exposes them to losses in case of any impairment to the asset. the following figure shows the structure of asset-backed sukuk fig 2: asset-backed sukuk structure a. the originator will sell the shari’ah compliant assets to an spv. in the abs guidelines 2004, it clearly states that any transfer of assets to an spv in a securitisation transaction (this includes islamic financing receivables) must comply with the criteria of a truesale. b. the spv then issues the asset-backed sukuk to the investors. the money paid by the investors in subscribing to the asset-backed sukuk includes the proceeds of the issuance that will be used to pay the originator in return for the sale of the assets. c. an asset-backed sukuk provide sukuk-holders with an undivided proportionate beneficial interest in the assets, thus permitting them to receive the streams of cash flow attached to the assets. asset-backed sukuk lead to full transfer of the legal ownership of the underlying asset. c. difference between asset-based and asset-backed sukuk there are several features that clearly distinct the two the assetbased and asset-backed sukuk. the following table shows the differences. asset-based difference asset-backed more debt-like structures, “similar” to conventional bonds structure more equity-based murabahah, ijarah contracts musharakah, mudarabah true sale does not occur, ownership merely “on paper” occurrence of true sale sukuk holders genuinely own identified assets in event of default, sukuk holders do not have recourse to specific assets default in event of default, sukuk holders have recourse to specific assets cash flow typically fixed or tied to a benchmark (libor) cash flow cash flow varies with actual performance of sukuk assets have been criticized as mere replication of conventional bonds acceptance deemed by some as “more islamic” most sukuk on issuance today are of this category issuance there are very few asset-backed sukuk table 1: 3. difference between asset-based and asset-backed sukuk iv. legal recourse in event of default: with the current structure of sukuk, the problems still revolve around form over substance of the sukuk structures whereby asset-based sukuk structures are prevalent in the islamic capital market [9]. asset-based sukuk just has the usufruct or recipient privileges of the hidden resource. the action plan of the sukuk is regarded to be unrealistic as the sukuk is totally considering fico score and record as a consumer of the gathering sorting out of the sukuk underwriter or co-parties in commitment to its originator. such classification of sukuk does not award speculation testament to the holder of right to aura of hidden resource if there should arise an occurrence of default. the lawful and option approach to get the speculation declaration for the holders is to organize a meeting under the trustee of the special purpose vehicle (spv). after that, they can issue legal notification to the originator for embrace the buy-back of the hidden resource if there should be an occurrence of default or maturity. however, another legal action that could be used in case of default is the restructuring of the debt raised, by discounted pricing in the principle outstanding. this will make them legally responsible to the originator of the sukuk and the parties may agree that they may own the legal rights to the transactional documents of the restructured debt. in case of asset-backed sukuk, the underlying asset’s legal ownership is transferred to the spv on a true sale contract basis. under this type of sukuk, if the originator defaults, the http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) investment certificate holders will exercise their legal right to control over the asset. the securitization of this sukuk structure is obligatory. the money flows that is generated from the asset can measure its credit risk performance. the securitization of the asset to the special purpose vehicle is to require removed from the credit risk of the originator in order that just in case of bankruptcy of the originator for the sukuk investment certificate holders could claim the underlying asset through the spv. the investment certificate holder contains varieties of these instruments. thus the default increases when the minor defaults rise due to the slow payments by the underlying asset as the investment certificates holders will be compensated according to their respective claim classes. the sukuk’s underlying asset is transferred to the sukuk holders or investors free of claims of creditors or others. but doing so will create an occurrence where they do not own limited interests in the assets. v. real case of sukuk: a. east cameron gas company asset-backed sukuk default examining the case of east cameron gas organization (ecgc) 2009 that issued a benefit backed sukuk, documented their insolvency insurance in a judicial court expressing that their offshore wells didn't meet the expectations of the returns due to natural hazardous situation. the question raised by the court was whether the investors really have the legal ownership in the oil & gas royalties of the company? the company denied that there was no exchange of legitimate ownership of eminences to cayman spv, and it totally was just an advance secured on the oil and gas sovereignties and exhorted the financial specialists to impart the weight to various loan losses inside of the occasion of liquidation of the fundamental resource. the court made the decision in favor of the sukuk holders expressing that “sukuk holders invested in sukuk as transfer of oil and gas royalties’ interest as true sale” the adjudicator affirmed the assertion of sale and purchase between the ecgc, their properties found offshore, and conjointly pronounced that the title ought to be exchanged to the sukuk holders in the contract. the sukuk holders won the case owing to the asset-backed structure of the sukuk that open venues for the investors to require administration over the benefit inside of the occasion. b. issues and facts behind the case: since the sukuk is the first run through sponsored by the united states oil and gas resources, it required different thought by the non-islamic powers. here the legitimate standard of shariah sees with the shariah fund and venture view of the traditional lawful framework. numerous lawful individual from the ecp group concurred with it. the achievement of the shariah compliant obligation raising (sukuk) could have related to numerous contemplations. firstly, oil and gas which are regarded as shariah agreeable resources. this was the first sukuk to be appraised by s&p (standard and poor's), the first with hedging mechanism and true sale features. the spv was cayman island exempted company and it was more towards risk sharing as the corporate guarantee was absent and investors have no recourse to the ultimate issuer of the underlying assets. the structure also included a few risk mitigating factors like security interest, reserve account etc. rather these risk mitigation factors shifted the risk away from the oil and gas royalties to the originator [1]. c. nakheel group llc –issues on sukuk default nakheel holdings 1 llc is the originator of the nakheel sukuk. it’s one among three nakheel world llc subsidiaries (along with nakheel holdings 2 llc and nakheel holding 3 llc, these 3 firms along acting as co-guarantor of the sukuk) that are 100 percent in hand by dubai world, a 100 percent stated-owned company of the government of dubai. nakheel sukuk had 2 major problems. the legal concern and the sukuk structure that was asset-based. the laws of dubai didn't supply apparent pointers on however the investors would be treated and what would be the recourse. in ijarah sukuk, the sale and lease back concept was applied, in which there was no real transfer of asset by the originator to the spv, rather it simply provides a leasehold interest of the asset until maturity. under uae law, the lease hold rights are not considered as legal or property right which limited investor claims and law to be enforced. however, there was supplementary guarantee by the parent company to make sure that the investors are protected. this assumption misled the investors in their risk-return choices. the parent company backed off as a guarantor asking nakheel to settle sukuk. the investors were conjointly supplied with further mortgage security through a security agent however they were unaware of the dubai law that within the case of recourse to such assets, they can't claim the govt. assets consistent to law no. 10 of 2005 amending government proceedings code no. 3 of 1996 (as amended by law no. 4 of 1997), which provides that a government institution may be sued, however that no liability or obligation of such establishment may recovered by means of an attachment on its assets or properties. additionally, the sukuk issuing conjointly restricted investor’s ability to enforce the encumbered security. the concept of beneficial interest and trust at the sukuk by the english law were not recognized in dubai. therefore, the outcome that typically will come back from the legal proceedings was obvious. therefore, in 2009 december, the abu dhabi granted dubai $10billion to repay its partial debts. the sukuk holders were paid through this loan and their claims were settled and sukuk was ransomed rather than defaulting. the sukuk holders during these dealings had not effectively thought about the uae and dubai’s financial legislation; above all, they didn't take into consideration, the legal framework in dubai regarding specific needs for granting security rights like the rights created in a very mortgage agreement. the robust legal protection and specific legal limitations regarding governmental entities under uae law conjointly had a serious impact on the legal choices of parties. lastly, private jurisprudence, and the social control of english judgments within the uae, above all, formed what would are a big obstacle if legal proceedings had advanced [3]. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) vi. conclusion: islamic finance instruments occupy an apace growing niche in world capital markets. sukuk, specifically, has been bestowed as an alternate to interest-based conventional bonds. they are often seen as asset-backed securities freed from interest and meeting the requirements of islamic finance. issued by islamic and non-islamic entities alike, sukuk secure access to an oversized pool of capital in the islamic world whereas eliminating the elevated risk taking incentives characteristic of conventional financial instruments. the development of the two types of sukuk created something of a crisis in the sukuk industry, reflecting differing visions of islamic securitization. one vision seeks to implement profit and loss sharing, while the other appears satisfied with replicating conventional bonds and achieving at least formal if not substantive compliance with the shariah. from our study we depicted that, the default has taken place are mostly assetbased type and shared a common structure that is of debtinstrument. however, none of the asset-backed sukuk has defaulted due to following the structure of profit and loss sharing. there is a gap between these two instruments and it’s essential to reconcile these. this can be done by revisiting the roots of islamic finance and its essential requirements [2]. vii. reference: [1] abdel-khaleq, a. h., & richardson, c. f. (2006). new horizons for islamic securities: emerging trends in sukuk offerings. chi. j. int'l l., 7, 409. [2] abdullah, a. k. (2012). asset-based vs asset-backed sukuk. islam and civilisational renewal (icr), 3(4). [3] hassan, k. a., & kholid, m. (2010). bankruptcy resolution and investor protection in sukuk markets. islamic finance: instruments and markets, (united kingdom: bloomsbury information ltd). [4] ifsb (2015). islamic financial services industry stability report, kuala lumpur: islamic financial services board (ifsb), pp. 17-23 [5] ifsb (2016). islamic financial services industry stability report, kuala lumpur: islamic financial services board (ifsb), pp. 7-9, 13-22 [6] iifm (2011). iifm sukuk report: a comprehensive study of the global sukuk market. international islamic financial market (iifm), pp. 9-14. [7] iqbal, z., & tsubota, h. (2006). emerging islamic capital markets. [8] isra (2011), islamic financial system principles and operations. kuala lumpur: international shariah research academy (isra), pp. 390-392, 395-400 [9] nazar, j. k. (2011). regulatory and financial implications of sukuk’s legal challenges for sustainable sukuk development in islamic capital market. 8th international conference on islamic economics and finance, pp. 1–16. [10] stimpfle, a. (2011), islamic finance made in germany: the 2004 sukuk issue by the state of saxony-anhalt, (grin publishing gmbh., munich). [11] usmani, m. t. (2008). musharakah and mudarabah as modes of finance. accessed on (april 16, 2017). [12] van wijnbergen, s., & zaheer, s. (2013). sukuk defaults: on distress resolution in islamic finance. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, portsmouth university, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france i. introduction: ii. the islamic capital market instruments: emergence of sukuk iii. concept and structure of sukuk: a. asset-based sukuk 1) definition: 2) structure of asset-based sukuk: 3) secured asset-based sukuk: b. asset-backed sukuk 1) definition: 2) structure of asset-backed sukuk c. difference between asset-based and asset-backed sukuk iv. legal recourse in event of default: v. real case of sukuk: a. east cameron gas company asset-backed sukuk default b. issues and facts behind the case: c. nakheel group llc –issues on sukuk default vi. conclusion: vii. reference: editorial_board.pdf editor in chief editorial board http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 sukuk-waqf: the islamic solution for public finance deficits lahsen oubdia, abdessamad raghibib auniversity professor, national school of business & management, entrepreneurship, finance and audit laboratory, ibn zohr university. l.oubdi@uiz.ac.ma bphd candidate, national school of business & management, ibn zohr university. abdessamad.raghibi@edu.uiz.ac.ma abstract-the majority of muslim countries face increasing pressure on their budget, which pushes to more public spending. eventually, the main victim of this situation will be the welfare of muslim communities. despite islam does not tolerate negligence regarding the importance of state as major player in preserving the welfare of muslim communities, it offers a third option to support public effort through the institution of waqf. indeed, this institution has played a crucial role all along muslim civilization and it is invited to more innovation to answer to today’s challenges. sukuk-waqf can be seen as the perfect sustainable financing instrument offered by islam to help sustain public spending by the people and for the people. this paper will try to examine the concept of waqf, cash waqf and sukuk waqf is islam and their evolution during muslim civilization. finally, it will go through modern attempts to implement this model that can answer the need for financing to support public effort to preserve the welfare of muslim citizens. key words: sukuk-waqf, public spending, sustainability. i. introduction upon this earth, wealth belongs to allah as he is the sole creator of everything. however, humans were chosen to accomplish the duty of viceregency on this earth by exploiting the bounties given to him through economic activities permitted by islam. consequently, humans acquire and transfer properties through different form of contract that can be divided into lucrative and non-profit transaction. waqf can be categorized under the second type of contract of non-profit transaction. it be defined as the concept of dedicating any property for posterity from which its profit may be used for any charitable intention [3]. prophet muhammad once said: "the record [book of deeds] is closed when a person passes away, yet those who leave behind knowledge, good children or 1 khaybar is a city 153km north of medina, it was the place of one of the battle conducted by the prophet against the jews. works of charity are exceptions. good deeds will continue to be written in that person's record." prophet muhammad founded waqf himself and advised his devotees and future muslims followed his advice. he donated the date garden in khyber1 to muslims. waqf-like charity has a history older than islam, which seems to have existed in ancient mesopotamia, greece, rome as well as pre-islamic arab societies [7]; [15]; [18]. lately, all empires that ruled on muslim territories have given a crucial place to waqf institution as a tool to develop and secure the welfare of muslim communities. indeed, throughout history, muslim civilizations have adopted the concept of waqf mainly to mitigate the burden of public services especially during the ottoman empire where the size of muslim population reached more than twelve million and a half muslim [13]. one can say that no such thing as municipal authorities had ever existed in those cities, the waqf proved the most important (if not the only) means by which ottoman sultans and senior state officials could provide their citizens with the most basic and essential public services [14]. moreover, waqf has been promoted to a viable pillar of state governing as it considerably helps rulers to optimally govern with a high level of financial ease. even government financing of education used to take form of constructing a school and assigning certain waqf property that provides regular revenues to cover operating expenses of the school [6]. the current economic situation of almost all muslim countries in terms of their illiteracy rate, lack of good healthcare, high unemployment rate, and the spread of poverty is a call to policy makers and researchers to rethink strategies to re-born waqf institution. furthermore, the need for growing infrastructure project is a crucial component of the growth equation for any country. however, states mailto:l.oubdi@uiz.ac.ma file:///c:/users/hp%20folio/appdata/roaming/microsoft/word/abdessamad.raghibi@edu.uiz.ac.ma ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 cannot afford taking big investment project alone anymore due to budget constraints, global recovery slow down and the fallen of raw materials prices. in fact, basic social needs should maintain a parallel growth similar to the demographic growth as to satisfy the population’s demand but the lack of financial resources breaches this rule leaving the way to disequilibrium within the society that can put the stability of states in jeopardy. consequently, public sector and government should search for sufficient sources of financing and private sector sounds to be the optimal fit for this equation. nevertheless, muslim communities have another way that might solve the problematic of infrastructure financing which is the development of sukuk-waqf as an efficient instrument to secure sustainable financing for the growing needs for infrastructure. the adoption of such instruments aims to combine both religious duty of charitable spending and economic development. this paper aims to raise the attention of public to the crucial role of waqf to solve the current lack of financing towards infrastructure projects that impedes the development of muslim countries. the proposed instrument is composed of two islamic products, which are sukuk and waqf. both of them will help to make the idea of waqf within reach of all muslim in order to make economic development a matter of all the community. ii. theoritical framework of waqf in the arabic language, the word “waqf” (pl. awqaf) literally means to hold, confine, prohibit, detain, prevent, or restrain. legally, it means “to protect something, by preventing it from becoming the property of a third person” [11]. in other terms, waqf is an endowment made by the rich to benefit the poor. it is one of the important elements in islam in alleviating poverty through providing basic needs to increase general welfare of people [19]. in islamic law, waqf requires restriction of a particular property as it is highlighted from the literal definition despite the existence of some divergences regarding the periodicity of waqf. the hanafis, chafi’is and hanbalis2 opt for a permanent waqf. however, it could be temporary for the malikis who confirm that the waqif has the right to define a certain period for the contract, which by its end the property returns to him3. in other terms, waqf is also explained as an action of conserving some property for a specific charity that prohibits any use of it outside the specific purpose [5]. property/money provided as waqf ceases to belong 2 islamic schools of thought are in the number of four: maliki, shafi’i, hanbali and hanafi. 3 al-charh al-saghir li-dardir 4/94 to the contributing individual or organization. waqf cannot be transferred to anyone, inherited or put up for sale, since it is considered to belong to allah (swt) [10]. the structure of waqf is based on four elements: the waqif, the element endowed (mawquf), the beneficiary (mawquf ‘alayh) and the form of the contract (al-sighah). for each element cited below, there is certain condition by which the process of waqf is considered valid. according to elkhatib (2016) the waqif or founder of the waqf must be a:  ‘aqil: (someone in full possession of their mental capacity)  baligh (adult)  hurr (free person)  capable of transferring the ownership of the asset or property from himself to the ownership of allah according to mahmood (2008), the corpus must be entirely owned by the donor before he/she contributes it and he/she understands that his/her has to relinquish responsibility of the assets since ownership is transferred to allah (swt). once the element endowed is given to the waqf, the role of the donor toward his/her assets becomes inactive, and a manager or trustee of the waqf property will take over responsibility to utilize the property in line with the donor intentions [4]. the founder should specify the beneficiaries in his will or waqf deed. they should be members of the family of the founder or members of public who are in need for financial assistance. the benefit of the trust can also be allocated to activities such as building a medical facility, mosque, or setting up a shelter or a school [8]. the contract is normally prepared in writing (orally declaration is also allowed), to avoid disagreements or misunderstandings in the future and also for record purposes [4]. an example of alsighah4 normally employed is “i donate my land as a waqf for the sake of helping needy”. originally, the periodicity of waqf is to be eternal according the hanafis, hanbalis and shafi’is5. however, the malikis authorize a waqf restriction of one year or so for a known period to which after its achievement, the ownership returns to the waqif or other6. 4 the forms by which waqf contract is been established. 5 bada’i’ al-sana’i’ lil-kassani 336/6. 6 al-charh al-saghir 106/4. ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 from maqasid al-shari’ah7 perspective, cheikh tayyeb ibn achour listed four roles of waqf in islam: 1. encouraging and multiplying waqf actions as it brings public and private interest (maslahah). for that, it is recognized by shari’ah as deeds which divine reward is continuous after one’s death. the messenger of allah peace be upon him said, "when a man dies, his deeds come to an end except for three things: sadaqah jariyah (ceaseless charity); a knowledge which is beneficial, or a virtuous descendant who prays for him (for the deceased)."8 2. for the waqf to be given from a clear and unhesitating conscious because it is consider as a ma’rouf and a generous act. also, waqf is given with no expectation of an instant compensation. therefore, the highest intention of waqif is public good and allah’s reward. 3. offering and providing a multitude of means by which waqf can be achieved. this objective fully falls into the first one of inciting and encouraging waqf actions. 4. not making waqf an excuse to waste the money of heirs or debtors as it was the case during the time of jahiliyya9. it is obvious that waqf represents the highest form of giving in islam because of its privileged value and the sustainability that it presents. it can be seen as a genius response of islam to public financing through unconventional ways. indeed, as most of countries suffer budget cuts and the pressure of public debts, waqf can be the perfect instrument to rebalance the equation and preserve the welfare of muslim communities. iii. cash-waqf the cash waqf is a form of certificates with different denominations to raise money against the planned projects. the issued certificate will be bought by a number of individuals or institution to finance the planned projects. separate cash waqf will be raised for each individual waqf activity [12]. historically speaking, çizakça (1998) stated in his paper that during ottoman economy, cash waqf played important role. according to classical scholars of hanbalis and shafi’is cash waqf is not permissible, because cash 7 maqasid al-shari’ah refers to the highest goals of islam. 8 sahih muslim ‘an abi-hurayra n°1631 9 before the rise of islam. waqf results of consuming the money in order to spend it. because of that, the element endowed in this case money is destroyed by the act of spending10. oppositely, the malikis and hanbalis consider cash waqf permissible. ibn taimiyyah quoted from ahmad bin hanbal and said that cash waqf is beneficial through utilizing it. in its fifteenth meeting, al-mujamma’ al-fiqhi (islamic fiqh academy) issued a statement n°140 that confirms the permissibility of cash waqf ending the discussion of this issue. based on maqasid al-shari’ah cited in the previous section, ahmed hadad the grand mufti of dubai11 extended these maqasid to cash waqf. they can be resumed as follow: 1. the implementation of cash waqf will, evidently, encourage more individuals to restrict part of their wealth, as contribution would take form of small amount of money, which will amplify the practice of waqf. 2. as for the matter of clear and willing conscious, cash waqf through small or big amount is obvious evidence that the waqif does not ask for anything else except the blessing of allah. 3. the expansion of cash waqf falls logically in the maqsid of diversifying the means by which waqf is practiced and offers an alternative to those with small means. 4. the maqsid of not wasting others wealth exists in cash waqf because of the structure of such instruments that accepts all amount of contribution, which cannot cause any harm for anyone’s wealth or heritage. the current structure of cash waqf can be presented as follow: figure i. the general structure of cash-waqf operation 10 see al-mughni by ibn-kudama 5/640 11 fiqh al-waqf ahmed hadda pp: 48-51. ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 source: the global islamic finance report 2015 the presented structure offers a high level of flexibility regarding the use of the proceeds depending on the need of community. although the waqif specifies the use of its money within the contract, the structure can be personalize to match the needs of the community though different pools. additionally, cash waqf is a special type of endowment that differs from the ordinary real estate waqf in that its original capital consists, purely or partially, of cash. social islamic bank in bangladesh has been offering a cash waqf deposit for a few years now. other banks offering deposits based on the cash waqf include islamic bank bangladesh, exim bank, bank asia, shahjalal islami bank, al-arafah islami bank, prime bank (all in bangladesh) and bank islam in malaysia. all these are examples of indirect cash waqf models12. iv. sukuk-waqf the origins of sukuk can be traced back to the classical islamic period (700-1300ad) where a sakk (singular of sukuk) was used to describe any document representing financial liability. this instrument represents financial obligations resulting from trade and other commercial activities. such practice was practiced in conformity with verse 2:282 of the holy qur’an: “when ye deal with each other, in transactions involving future obligations in a fixed period of time, reduce them to writing…it is more just in the sight of god, more suitable as evidence and more convenient to prevent doubts among yourselves.” the international islamic fiqh academy issued a statement in 1988, holding that “any combination of assets (or the usufruct of such assets) can be represented in the form of written financial instruments which can be sold at a market price provided that the composition of the groups of assets represented by the sukuk consist of a majority of tangible assets”. according to aaoifi, sukuk is defined as: “investment sukuk are certificates of equal value representing undivided shares in ownership of tangible assets, usufructs and services or (in the ownership of) the assets of particular projects or special investment activity, however, this is true after receipt of the value of the sukuk, the closing of subscription and the employment of funds received for the purpose for which the sukuk were issued.”13 12 global islamic finance report 2015 the securitization of assets is a highly important stage for the development of capital raising because of its standardization and regulation. all strategies that aims to raise sufficient funds through public source shall opt for bond or sukuk in the case of islamic finance. sukuk-waqf is composed of a merger of sukuk based contract and waqf. it can be defined as tradable certificate of equal monetary value that represent the money restricted (al-mal al-mawquf) [17]. there is a variety of types of sukuk, which are based on the existing islamic contracts: murabahah, ijarah, mudarabah, musharakah, wakalah and salam. other hybrid and complex structure of sukuk can be found depending on the development of islamic financial engineering. the general process of sukuk issuance which will be later used for sukuk-waqf structuring can be presented as follow:  creation of an spv to represent the investors;  issuance of the certificates and putting them into circulation;  secure the cash-flow through the period of the contract from the issuer to the investor. also, it is worth to note the main parties involved in the issuance of sukuk:  the originator, which is the company wishing to raise funds,  the issuer of the sukuk, which will be an existing or a newly incorporated special purpose vehicle (“spv”);  the lead arranger/manager, which is the party arranging/managing the whole sukuk process;  the trustee, who is an appointed party to represent and oversee the rights of the sukuk holders from the beginning of the arrangement of sukuk issuance until the full redemption of the sukuk by the spv; and  the sukuk holders, who are the investors intending to invest in the project, and who holds the sukuk certificates as evidence of their investment in the sukuk. the structuring of sukuk-waqf may not differ from the structure of investment sukuk in the form but in the purpose. in fact, the holder of normal investment sukuk aims at profit based on the rule of “alghunmu bil ghurm”. however, the holder of waqfsukuk is not driven by any lucrative consideration as 13 accounting and auditing organization for islamic financial institutions aaoifi, shari’s standard no. 17, 2008, p.307. ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 he only aims at allah’s blessing and serving public interest. it is important to note that it should be feasible to merge other form of financing in the case of big public project because of insufficient fund or time pressure. al-qard al-hassan could be one the instrument that could complete the structure of the project [16]. the structure by which public authorities could raise fund for socioeconomic project can be presented as follow: figure ii. the structure of a sukuk-waqf operation source: adapted from hassan (2014) the mention of qard al-hassan14 within the model does not mean its prevalence; it is strictly a support instrument in case of big project. the equation below explains with more light the statement above: 𝐾𝑝 = 𝑎 𝑤 + 𝑐 ; 𝑤 ∈ [0, 𝐾𝑝 𝑎 ] ; 𝑐 ≥ 0 with: kp: the total amount of the project; a: nominal value of waqf certificates; w: the slope; c: total amount of qard al-hassan. the other issue that may arise with the use of a debt component within the structure is the element of 14 qard al-hassan means a debt that does not generates any interest. guaranties as the amount borrowed is due on the waqf fund. for that, it is advised to subscribe to a takaful product for more insurance and viability of the project. the next point that requires clarification is the provenance of the funds. normally, the most common way would be spontaneous acts from people seeking charitable activities. however, as we aim into making this instrument a sustainable support for the state in providing decent socioeconomic services to its community, effort to standardize and regulate sources of funds must be undertaken. as most of muslim countries now have islamic banks, the ideal path would the implication of banks in spreading the instrument of sukuk-waqf and makes it a commonplace within their daily life. government bodies through intensive media campaign must also engage in explaining the idea of sukuk-waqf to their citizens and its consequences on their socioeconomic development. many would wonder why choosing to merge a tool of complete lucrative goals with a charitable instrument like waqf. in fact, he market for sukuk is now maturing and there is an increasing momentum in the wake of interest from issuers and investors. sukuk have confirmed their viability as an alternative means to mobilize medium to long-term savings and investments from a huge investor base. consequently, the chances of raising important funds through sukuk-waqf are more likely to happen within the environment of sukuk market. v. waqf and public budget financing thoughout history a closer look into the history of our civilization will show the crucial place of waqf within the structure of muslim empires. from the age of the prophet peace be on him to the ottoman empire, waqf played a big role in education, healthcare and defense replacing the conventional tools of public financing such as tax. one of the first example of a waqf for social purposes was a drinking water well (called rummah), which was bought from a jewish man to provide free drinking water to all. although the primitive role of waqf used to finance mosques and religious teachers, it is important to note the expansion of the financing to all forms of education from the umayyad and abbasside reign15. in fact, in their periods, it was fact that there were no organized structures of waqf institutions as specific departments or ministers for taking care of public works, roads, bridges, mosques, schools, libraries and hospitals in order to cover those public needs. 15 global islamic finance report 2015 ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 zubaidah, the wife of harun al-rashid16, as an individual, made land as well as cash waqfs in order to construct high ways from baghdad to makkah, bridges, and shelters for helpless [1]. awqaf of the ayubites (1171-1249) and the mamalik (1249-1517) in palestine, syria, lebanon and egypt are good examples. jerusalem had 64 schools at the beginning of the twentieth century all of them are waqf and supported by awqaf agricultural and metropolitan properties in palestine, turkey and syria [6]. at its creation in 1923, threequarters of the arable land in the republic of turkey belonged to awqaf. also, one-eighth of all cultivated soil in egypt and one-seventh of that in iran were known to be waqf property. in the middle of the 19th century, one-half of the agricultural land in algeria, and in 1883 one-third of that in tunisia, was owned by awqaf. it is surprisingly clear the remarquable value of waqf and its stake in the economy was, which shows the leverage that it plays in creating a third option separate from the profit-based private sector and the official public sector. the waqf institution has reached its peak during the ottoman empire where waqf is directly involved in the economic cycle through job creation, agricultural, education and public welfare. roadhouses and arcades, bakeries, grinders, workshops of candle and lead, bozahouses, abattoirs, etc., fair and market places, which were built in order to provide religious, cultural and social institutions, generally located around a mosque, such as madrasah, library, foodhouse (imaret), guesthouse (tabhane), hospital (darussifa), bath (hamam), caravansary and residences of the officers and employee of these institutions as well as infrastructure facilities such as water channel and sewerage system with regular income (each one is to be allocated to a group of art or trade competent), comprised the skeleton of the new city or district to be built or an old city (barkan ve ayverdi, 1970) quoted from [20]. also, most of our architectural masterpieces such as suleymaniye and selimiye were created with the help of waqfs [20]. also, it has also been estimated that the ratio of people employed by the waqf institutions to those employed directly by the state turkey in 1931 was 8.23% to 12.68% [1]. this shows the role of waqf in alleviating the civilization through rapid and selffinanced urbanization far from the intervention of the state. 16 harun al-rashid (763-809) was one of the abbassid-era’s caliph. vi. sukuk-waqf and its modern application questions about the viability and applicability of sukuk-waqf should be raised by this stage. it is believed that such papers and models are always left behind after short formal discussion. however, the current awareness about the social dimension of islamic finance has brought public attention towards waqf again. indeed, projects based on sukuk-waqf have started to merge. the most important one would the initiative of isra to lunch a social project in new zealand based on sukuk-waqf. the project will be implemented conjointly by awqaf new zealand, isra and security commission of malaysia. the goal is to issue the world`s first waqf-sukuk worth of $1bn. the proceeds of the sukuk will be utilized to establish farming industry in new zealand and canada. via these farms, qurbani (slaughtering animals) will be provided for muslims particularly in the west. the waste of the animals and skins will be used to produce shoes and bags etc. the revenue will be used for charitable and social purposes all over the world. also, indonesia has joined the path of implementing sukuk-waqf to develop social property assets to be commercially self-sustaining. addition to these examples, has launched an initiative to develop and finance existing waqf properties through sukuk issuance. the issuance conducted by the muis (majlis ugama islam singapura) has raised a total of usd60 million which is significant looking at the nature of the operation. hence, the success of this operation has led the muis to further extend its willingness to issue more sukuk in order to develop the existing waqf properties in singapore. it is clear that this project with its worldwide dimension would provide an astonishing framework for muslim countries to lunch the experience of sukuk-waqf and merge it within their financing planning. conclusion islamic moral economy has provided the umma with the adequate tools to maintain its prosperity and social development. waqf represents the perfect illustration for this system. it played a tremendous role throughout the history of muslim civilization. now, it is the time that waqf should go through an innovative process in order for it to maintain its viable role within muslim societies. hence, sukukhttp://www.isra.my/ http://www.sc.com.my/ ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 waqf seems to be the suitable instrument that could enhance the role of waqf and make it a common and familiar tool for muslims who seek divine blessing and mercy. as most of states struggle to match deficit limit, it becomes difficult to provide enough financing for the growing socioeconomic needs pressured by an exponential demographic decrease. hence, sukukwaqf seems to be the suitable remedy for public authorities to match their budget goal along with ensuring a constant prosperity for their citizens. sukuk-waqf can be considered as the perfect tool to mobilize fund from muslim communities through a regular and sustainable way. it combines the flexibility of sukuk and the sustainability of waqf. we believe that waqf could be the adequate answer for the socioeconomic problems that imped development in most muslim countries. however, this concept would find a way to success without the engagement of both public authorities and muslim individuals, which are aware of the current challenges that face the umma. references [1] ali, md yussof & khanom, f (2014). understanding cash waqf: it’s role toward alleviating poverty in contemporary context. universiti sains islam malaysia. [2] çizakça, m. (1998). awqaf in history and its implications for modern islamic economies. islamic economic studies, vol. 6, no. 1. [3] dahlan, n. k., yaa’kub, n. i., hamid, m. a., & palil, m. r. (2014). waqf ( endowment ) practice in malaysian society. international journal of islamic thought, vol. 5, no. 6; pp 56–61. [4] jalil, yahya, & pitchay. (2016). the contemporary model of waqf structure. in the international conference on islamic leadership and management 2016. [5] kahf, m. (1998). financing the development of awqaf property. in seminar on development of awqaf, irti, pp 2–4. [6] kahf, m. (2015). waqf: a quick overview monzer kahf. [7] laum, b. (1914). die stiftungen in der griechischen und ramischen antika, quoted in cizakca (1998). [8] m. elkhatib. (2016). waqf in shariah, its rules and applicationsin islamic finance. inceif, (march), pp 0–12. [9] mahamood, s. m. (2008). waqf in malaysia : legal and administrative perspective. iiumlj, 191. [10] man, & abdulwaheed. (2011). new dimension in the mobilization of waqf funds. kuwait chapter of arabian journal of business and management review, vol. 1, no. 1; pp 155–175. [11] mohammad, m. t. s. h., iman, a. h. m., & omar, i. (2005). an ideal fnancial mechanism for the development of the waqf properties in malaysia. johor: pusat pengurusan penyelidikan, universiti teknologi malaysia. pusat pengurusan penyelidikan, universiti teknologi malaysia. [12] nurrachmi, r. (2012). the implication of cash waqf in the society. al infaq islamic economic journal, vol.2, no. 5; pp 150–155. [13] mutlu, s. (2015). late ottoman population and its ethnic distribution. turkish journal of population studies, vol. 25, no.8; pp 3–38. [14] oded peri, "waqf and ottoman welfare policy, the poor kitchen of hasseki sultan in eighteenth-century jerusalem." journal of economic and social history of the orient xxxv; pp 107-186. [15] othman. m. z. b. h. (1982). islamic law with special reference to the institution of waqf. kuala lumpur: the prime minister’s department. [16] rahim hassan (2014). taskik mashari’ alwaqf al-muntij. global islamic economics magazine,vol. 23, no. 4; pp 2-6. [17] ramli, h. (2014). furas tamwil al-waqf aljaza’iri bil-i’timad ala sukuk al-waqfiya. in producst and innovation by financial ingeenering between conventional finance and islamic finance. [18] rockwell, j. c. (1909). private baustiftungan for die stadtgemeinde anf inschriften der kaiserceit im westen des romischen reiches, quoted in cizakca (1998). [19] sadeq, a.h.m. (2002), waqf, perpetual charity and poverty alleviation, international journal of social economics, vol. 29 no. i/2; pp 135 – 151. [20] saduman, s & aysun, e (2009). the socioeconomic role of waqf system in the muslimottoman cities: formation and evolution. trakia journal of sciences, vol. 7, no. 2; pp 272-275. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 islamic financial intermediation: the emergence of a new model abstract—being the main function of any banking system, financial intermediation is defined in the islamic economy based on certain parameters that confer on the organizations that operate it a particular financial activity and various objectives. admittedly, the two theories of intermediation, whether conventional or islamic, converge at the level of interposition between economic agents with a need for financing and agents with financing capacity to reach an optimal flow of funds; however, they differ as to the procedures put in place to ensure the function of intermediation. in other words, the islamic financial intermediation has distinctive characteristics because, in addition to its economic vocation which shares it with its conventional counterparts, they support a social and ethical vocation constituting the specificity of islamic banks in terms of intermediation. this paper focuses on the study of characteristics related to the financial intermediation of islamic banks. it seeks to reconcile the theoretical approach of intermediation and the reality of islamic intermediation while conducting a comparative analysis with that established by conventional banks. alongside this analysis, we will present the inventory of financial risks specific to islamic financial activity. keywords-component: financial intermediation, islamic bank, conventional bank, sharia, risk management. i. introduction having emerged in the seventh century ad and then reappeared in the twentieth century with a number of innovations, islamic finance had as its main vocation met the needs of a muslim community excluded from the so-called conventional financial system deemed inadequate to the principles of the islam, before expanding, thriving and deepening to become an alternative financial system that would make up for the shortcomings of the conventional financial system. indeed, the last financial crisis that the world experienced in 2008 from the euphoria of real estate loans in the united states and the massive use of securitization and derivatives have increased the attractiveness of islamic finance in particular with regard to its potential for systemic stability, an essential condition for ensuring steady development and growth of economic activity. in fact, the strong impact of the financial crisis on the economies of developed and emerging countries prompted several economists and analysts to examine the reasons for this crisis by highlighting the lack of prudential regulation appropriate to the risk [18], the fragile situation of the global economy and the loosening of the conditions for granting loans [2] , not to mention the conflicts of interest between the rating agencies and the unethical practices of risk management practiced by banks and the massive resort to speculation [15]. thus, more than ever, to admit that an economic system is efficient is correlated to an efficient functioning of its financial system. in this context, islamic finance distinguished primarily by its moral and religious dimensions in the definition of economic problems, can participate actively in the development of its economic environment or even spare the last financial crisis even if islamic financial institutions had also suffered a slowdown in their global economic activity. it is then that several empirical works have flooded in order to establish a comparative analysis concerning the degree of resistance of the conventional banks and the islamic banks to this crisis of which we quote someone to know: the comparative study on the effectiveness of banks conducted by shafique, a., faheem, ma, & abdullah, i. in 2012, [25] , he analysis of johnes, j., izzeldin, m., & pappas, v. (2014), whose goal is to compare the effectiveness of islamic and conventional banks during the period 2004-2009. other authors used data envelopment analysis (dea) and meta border analysis (mfa) [16]. other studies, such as that of said, a. (2013), aimed at comparing the evolution of the efficiency of the various banks, particularly islamic and conventional ones, which occurred during the economic slowdown from 2007 to 2009 [22]. to this end, for toussi (2010), islamic banks have a different understanding of financial intermediation based on a zero-rated banking intermediation model. it is therefore socalled free interest finance [27]. it also requires the backing of all transactions to a tangible asset while being based on the sharing of profits and losses. on the other hand, the precision of the specificity of the financial intermediation of islamic banks compared to conventional banks remains an important challenge. the financial intermediation industry relies on a zero-rated banking intermediation model. it is in fact a socalled free interest finance which also requires the backing of s. drissi1 (phd student), k. angade1 (ph.d.) 1laboratory of entrepreneurship, finance and audit, university ibn zohr (morocco) ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 all transactions to a tangible asset while being based on the principle of sharing profits and losses. thus, we seek, through this work, to analyze the financial intermediation activity for the case of islamic banks which obviously have distinctive characteristics compared to their conventional counterparts. this difference can be illustrated by the agency relationship model adopted by each bank. for islamic banks, for example, it is not limited to the mere relationship between the lender and the borrower, but goes beyond this dimension to encompass the agency's dual agency relationship with the lender. on the one hand and with the applicant on the other hand. in this perspective, islamic financial intermediation enhances the efficiency of the savings / investment process by eliminating incompatibilities between savers and investors in terms of maturity, funds and risk. this article is structured as follows: the second part is a general presentation of the islamic banking profession as financial intermediaries. the third part specifies the distinguishing characteristics of so-called participative intermediation in an asymmetric information framework. as for the last part, we will focus on risk management and discuss the main challenges of participatory intermediation. ii. islamic banks: specificities and reasons for being admittedly, the combination of the two terms "bank" and "islamic" may at first glance seem paradoxical. however, the notion of islamic banking refers to a logic that fits into that of the islamic economy in general and islamic finance in particular. thus, in presenting the central function of a banking system, financial intermediation is defined in the islamic economy from a number of parameters that confer on the institutions that operate it a financial activity that is both specific and varied goals [19]. a. presentation of islamic banks it is true islamic banks present themselves as institutions whose main activity is financial intermediation in the developed sense. these operate with the aim of making profits in accordance with the principles of sharia, while recognizing the uncertain nature of the outcome of the operations financed. although the majority of the works consider that the islamic banks are a recent phenomenon appeared in the 70's. historically, the role of financial intermediation in the islamic economy is derived from the principle «el moudharib youdharib» which can be interpreted as such; "whoever raises funds on the basis of profit sharing by offering them to users on the same basis". indeed, this practice has existed in muslim society since the early days of islam, when most caravan goods were financed by the mudarabah. the existence of these banks is explained from an economic point of view, in the same way as that of the conventional banks, this financial system is based on principles inspired by the “fiqh el mou'amalat” which constitutes the branch of sharia which organizes the relationships between individuals. we present them below in four groups:  the prohibition of interest (riba): it is surely the main principle of this economic system. according to the muslim religion, nobody should lend a sum of money to another for a given period, which he must then repay in full with a surplus that is called "interest" and which represents a method that generates profits without exposing himself to the risk of loss. you have to run a risk to make a profit; hence the principle of sharing profits and losses (pls).  asset-backing: for the islamic economy, money is a measure of value to facilitate trade, not a commodity in itself. in this perspective no eigenvalue should be attributed to money. it is a capital requiring the association with another source to generate a productive activity; hence the principle of backing up a tangible asset (asset-backing).  the illegality of the activity: based on a moral dimension dictated by religion, islamic banks cannot afford to finance illegal activities or those directly related to them, such as casinos, distilleries, alcohol, pork [3]…  transparency and fairness: transparency and fairness that must characterize financial transactions by prohibiting excessive uncertainty (gharar) whose modern meaning refers to risk or hazard. in conventional finance, the two areas deeply affected by gharar are insurance and derivatives such as futures, options and swaps. b. the functioning of islamic banks the islamic bank provides the same services as the conventional bank; it is an intermediary between capital redenters and borrowers. 1) the financial ressources of islamic banks in addition to capital and their own capital, which may be very high, islamic banks find their main resources in the following operations:  demand deposits: used to finance exchange transactions and payments. their nominal values are guaranteed by the bank. holders of these deposits receive neither profits nor income, but they must pay fees for the administration of these accounts.  savings accounts: manage according to the principle of wadia deposit. the bank has the agreement of the depositors to exploit these funds against its own risks. however, the bank does not guarantee them a fixed remuneration in advance, but proportional to the investment result actually after deduction of the zakat [7].  investment accounts: this category of account traditionally constitutes the main resource of an islamic bank. indeed, in this type of account no guarantee of nominal value or rate of return is given. depositors are treated as if they were shareholders [21]. in this case, ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 they are entitled to a share of the profits made or losses incurred by the bank. it is a participative investment account based on the principle of sharing profits and losses (3p).  the accounts of zakat and the accounts of the social service: where the amounts due to the obligation of zakat are paid respectively and donations to fund social services. the bank administers the use of these funds. since the activity of islamic banks is based on very different principles from two of their conventional counterparts, especially with regard to the question of the use of interest, it turns out that there are three types of relationship that undertake islamic banks with their depositors [20]. first, we find debt relationships where the banks guarantee the entire deposit. then, agent-principal relationships where the bank is likened to a shareholder who shares the profits and losses with his depositors. finally, the relationship of administrative services, such is the case when the bank provides administrative services and information to its customers. 2) the use of funds by islamic bank the various resources collected by the islamic bank are invested using the different types of funding recognized by the institution, of which we distinguish:  murabaha: murabaha is a kind of purchase and resale agreement in which the bank buys a tangible good from a supplier at the request of its client, the resale price being based on the cost plus a profit margin [9].  ijara: it is a lease contract assimilated to a lease credit where a property is acquired by the bank from a supplier then the bank proceeds to lease it to the customer. for the cost of the lease plus the margin, they are spread over the entire lease period.  salam: it is a sales contract with deferred delivery of the goods. in this type of contract, the bank does not act as a seller on credit of the goods acquired on order, but as an acquirer, with cash payment of a commodity delivered to term.  istisnâa: it is a contract under which two parties, plaintiff and a manufacturer, the first undertakes to acquire from the second a particular product [9]. payment can be made either in cash, installment or term.  financial investments: they are carried out on the real estate markets, the goods and services markets and the financial markets, in particular the sukuks market either for the bank's own account or on behalf of its customers.  la moudaraba: it consists of the combination of a capital with an industrial contribution (work) in order to share the profits and the losses which can result from it. in this case, the customer brings his expertise and the bank provides the necessary financing for the realization of the operation. management is the sole responsibility of modareb (the customer who uses money in the workplace). in case of profit, the client is remunerated by his work and his expertise, while the bank is remunerated by his capital contribution. in case of loss, the client loses his job, if it is not proven that the loss is due to management negligence on his part, and the bank loses its funds. if there has been management negligence by the customer, the loss is borne by both parties. in summary, islamic banks offer several financing solutions that can be classified in sharing financing as the case of mudaraba and mucharaka and financing methods based on debt contracts, also known as deferred sales contracts such as the murabaha, the bay salam, the istisna. iii. the financial intermediation of islamic banks intermediation is essential in the financing of any economy since it consolidates the efficiency of the savings / investment process by eliminating incompatibilities between savers and investors in terms of maturity, funds and risk. in addition, this function allows economies of scale regarding transaction costs to be realized in the delivery of funds, and reduces the risks associated with asymmetric information. regarding islamic finance, the concept of intermediation is not prohibited by sharia when it respects the islamic precepts. thus, we can say that there are points of convergence and divergences between islamic banks and conventional banks in terms of financial intermediation [17]. a. conventional financial intermediation exposing the peculiarities of financial intermediation among islamic banks amounts to situating them first of all in the middle of the various financial intermediation institutions that exist in the banking landscape, namely the conventional banking system. one of the main tasks of conventional banks is financial intermediation, which manifests itself in the collection of savings before redistributing them in the form of credits. in other words, it is the link between depositors and borrowers. however, it should be noted that, unlike islamic banks, conventional banks have a bilateral relationship with the depositor and a bilateral relationship with the borrower, without any relationship between the depositor and the borrower [5]. from this perspective, conventional financial intermediation is based on two main characteristics: transaction costs related to information retrieval and transaction verification. in fact, for transaction costs, they are generally costs related to information asymmetry since the lender ignores the financial situation of the borrower in a direct and transparent manner. this is where the role played by banks is manifested in providing information about the borrower by assigning the conventional banks the role of information provider between the lender and the borrower which represents ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 a resolution to the problem of asymmetry information that the least informed party suffers [23]. the second characteristic concerns the function of transforming financial liabilities into financial assets [8]. in other words, conventional banks seek to transform deposits collected in the short or medium term into shortand mediumterm loans. thus, the main role of conventional banks can be reduced to transformation by prohibiting the use of any other activities such as commercial transactions or industrial activity with the exception of ancillary activities to cover debts [1]. b. the characteristics of islamic financial intermediation before presenting the main characteristics of islamic financial intermediation, it should be noted that the financial intermediation of either islamic banks or their conventional counterparts overlap in terms of the principle of interposition between agents with financing capacity and agents needed for an optimal flow of funds to the problems of direct finance. nevertheless, they differ in terms of the process adopted. in other words, how funds are collected and channeled, and how they impact the savings-investment process [15]. for the foundations of islamic financial intermediation, it is based on two theories: the theory of trust and the theory of the agency. 1) the theory of the trust the trust arises when a person legally transfers to a third party (the trustee) a property that the latter must manage and return after an agreed time and according to certain conditions [8]. in other words, it is an operation by which one or more constituents transfer rights and security interests, or a set of property, rights and security interests, present or future, to one or more trustees , who keep them separate their own assets, act for a specific purpose for the benefit of one or more beneficiaries [4]. there is a distinction to be made between the notion of classic property and fiduciary property. indeed, the latter is based on the appearance of a third quality namely that of the beneficiary who is none other than the person who, depending on the situation, represents the settlor, the trustee or a third party. on the other hand, in the case of classic property, we find two actors: the assignor and the assignee. in addition, the trust realizes a transfer limited in time contrary to the classic or ordinary property which remains perpetual. 2) the theory of the agency according to the theory of the agency, the owner holds three forms of rights: the usus which is the right to use a thing to discretion the property, the abuseus, the right to make a change or an alteration to the property and the fructus which is the usufruct of the property. in this perspective, the owner has the ability to allocate resources by keeping the fructus but delegating the usus to a manager. the owner keeps only synthetic decisions for himself. in this contractual relationship, the usus is leased to a third party with whom we contract. in this type of relationship, the corporate owner is the principal; the third party is the agent [26]. this agency relationship is illustrated in islamic banks in two forms: the first is the private agency, according to which the bank will collect the savings of customers in the form of deposits to intervene in a project or activity determined and proposed by the bank [14]. by accepting this modality, the customer will mandate the bank to manage a project. in this case, it turns out that the role of the bank in this case should not exceed the scope of a mandate for a commission and without being obliged to assume the risks generated by this investment. the second form is the relationship of the general agency, according to which the bank collects the client's deposits in order to invest them in a project which it sees fit in return for a commission. depositors do not have any insurance against their deposits and they have no direct control over the investment choices made by the bank. however, depositors have the option of deciding the length of time after which they can recover their funds by bearing alone the risks engendered by the investment [14]. iv. the difference between islamic and conventional financial intermediation the difference between islamic banks and conventional banks can lead to differences in financial intermediation. in fact, it does not boil down to simple loan-borrower relationships, but it develops a dual agency relationship between the bank and the depositor on the one hand and the bank and the entrepreneur on the other hand. in this spirit, we can identify some points of divergence between islamic and conventional financial intermediation including the level of regulation of financial activities and the risks incurred by islamic financial intermediation. a. level regulation of financial activity to ensure the viability and stability of a financial system, the establishment of a regulatory body remains essential. however, the activities and risks run by the islamic bank are quite contrary to those of the conventional system. such a situation leaves us to ask the following question: can the regulation provided for the conventional banking system be adapted to islamic banks? indeed, the various prudential measures all have the same objectives: to solidify the global financial system, in order to prevent banks from taking oversized risks. thus, the bank is obliged to respect all these devices to be able to exercise its banking activity. at present, the acceptance of islamic banks on the international interbank market obliges them to respect the rations established by these devices to be able to exercise their activities [6]. in addition, islamic banks operate alongside conventional banks in many countries. such a situation should make supervisors aware of the need to establish a regulatory framework that is both compatible with islamic precepts and sufficiently flexible to meet internationally accepted prudential standards and control regulations [10]. a priori, compliance with these prudential rules does not prevent the islamic bank from carrying out its activities, because it can exercise them while respecting these rules. these are not blocking points but an opening to the practice of islamic finance activities. on the other hand, even if these provisions do not constitute a point preventing islamic financial activity, they can ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 hinder the smooth functioning of islamic banks and make them less competitive compared to their conventional counterparts. as a result, in the long term, these can turn into troublesome factors because the accumulation of bad returns can lead the islamic bank into bankruptcy. b. the risks specific to islamic intermediation according to conventional theory, banks' risk behavior provides additional justification for financial intermediation. risk and risk management have always conveyed the value created by banks [24]. for the islamic banking activity, it may incur the same risks that are those of any banking activity such as credit risk, market risk, liquidity risk and operational risks which are moreover higher in conventional banks because of some of their speculative activities. nevertheless, there are certain risks that are specific to the islamic banking activity, so their coverage will not be the same. for galloux (1993), these risks, which are peculiar to the islamic banking activity, are to the incorporation of participative financing in the portfolio of islamic banks and which are also the riskiest for the simple reason that they are based on the confidence in the contractor. thus, pls financing makes the islamic bank more vulnerable [11]. in particular, participatory financial intermediation entails the following risks that are specific to islamic banking:  the displaced commercial risk: this is the risk that a lack of return on the assets of the islamic bank will translate into a liquidity crisis, a consequence of the dissatisfaction of the depositors. this risk is defined by the islamic financial services board (ifsb) as the one referring to the losses that the islamic bank absorbs to ensure that the holders of the investment accounts are remunerated at a rate of return equivalent to a rate of reference to ensure that depositors of the bank will not withdraw their funds if their income is lower than that paid by other banks.  the managerial risk: this is the risk related to investors' doubts as to the conformity of banking behavior under the terms of the contract).  the liquidity risk: the liquidity risk arises mainly from the difficulty of acquiring liquidity at a reasonable cost either by borrowing or by selling the assets. the liquidity risk of these two channels is important for the islamic bank. indeed, since interestbearing loans are prohibited by sharia law, on the one hand, islamic banks will not be able to solve their liquidity needs by borrowing financial resources, and on the other hand, the chariâa does not allow the sale of the debt only at face value. as a result, the islamic bank will not be able to use these financing instruments to increase its financial capacity.  the risk of arbitration sharia: the diversity, the difference and the standardization of the financial contracts used by the islamic banks represent an obstacle to the correct functioning of this islamic financial system, because each islamic bank defines, independently of the others, its own instruments according to its own understanding of the sharia. , its internal regulations, and its needs. such a situation may give rise to a form of competition related to the application of religious principles. one bank can claim to be "more islamic" than another.  the legal risk: the legal risk comes from the lack of standardized contracts and the absence of a legal system to intervene in the case of a dispute related to islamic contracts [12]. from this perspective, islamic finance implies a specific risk taking that is completely different from the instruments used by conventional banks. in addition, islamic financial intermediation is characterized by entanglement of risks given the tripartite transactions linking the three following actors: the depositor, the bank and the company. however, islamic bank accounting does not allow easy identification and separation of risk classes [13]. it thus turns out that the efficient management of the aforementioned risks is of crucial importance for the islamic banks as it allows them to enjoy a strategic positioning and the efficient use of their capital. in summary, islamic financial intermediation expresses a desire to promote social justice, equity and freedom of enterprise and an attitude of moderation not speculative while respecting the precepts of sharia to ensure their adequacy with the jurisprudential rules of muslim ethics. nevertheless, it appears that shariah compliant banking products expose islamic banks to risks similar to their conventional counterparts such as credit risk, market risk, operational risk and liquidity risk. islamic banking intermediation can expose banks to another category of risk called risk specific to islamic financial intermediation namely, business risk shifted, fiduciary risk, reputational risk, risk of non-compliance with shariah etc. as a result, the challenge facing islamic banks is to know how to manage and control these risks in a legal and regulatory context often unsuitable for islamic banks. v. conclusion the rapid expansion of the islamic finance industry as an alternative model of financial intermediation reflects its ability to become a true financial system. indeed, based on a theory of financial intermediation quite different from that used by conventional banks, linked to the prohibition of the interest rate and its corollary the principle of sharing profits and losses, the islamic financial intermediation offers distinctive features by offering a solution to ex ante and ex post information asymmetries, better risk sharing and more efficient use of capital. in this perspective, it should be mentioned that despite the existence of a certain number of divergences which invaded the positioning of the islamic bank on the same level as the conventional banks at the level of these three main aspects: the absence of rates of interest, lack of depositor protection, and lack of collateral on deposits, they guarantee the same functions as conventional banks. indeed, they are payment ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 administrators, financial intermediaries; finance projects, and provide financial services [28]. in other words, the purpose of the intermediation of these banks can be explained, from an economic point of view, in the same way as those of their conventional counterparts, even if they have quite different characteristics. . moreover, in addition to their economic vocation, linked to the financing of investments by mobilizing savings for viable economic sectors and helping businesses to access funds, they also hold an ethical and social vocation insofar as it proposes shariacompliant products, in addition to developing the spirit of partnership and sharing within society. in this context, and in the face of its various challenges, risk management must be strengthened at the level of these institutions to further promote participatory intermediation. in addition, to being exposed to the same banking risks as conventional banks, they also face risks of a particular nature due to their particular modes of operation. faced with this situation, islamic banks are being asked to develop more rigorous risk identification and management systems to promote this growing industry. references [1] algabid, hamid. 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(2009). le système bancaire islamique : guide à l'intention des petites et moyennes entreprises. genève: centre du commerce international (itc). [9] el qorchi, mohammed. "islamic finance gears up." finance and development 42, no. 4 (2005): 46. [10] errico, mr luca, and ms mitra farahbaksh. islamic banking: issues in prudential regulations and supervision. international monetary fund, 1998 . [11] galloux, michel. "egypte: réforme bancaire et finance islamique." monde arabe: maghreb machrek, no. 141 (1993): 53-62. [12] hassoune, anouar. "la gestion des risques dans les banques islamiques." moody’s investors (2008). [13] hassoune, anouar, and senior credit officer. "les fonds propres des banques islamiques face aux exigences réglementaires." paris, janvier (2010). [14] ibrahim, mounir b. "la gestion des marchés et des institutions financières ". editions el -lahari (egypte 2002). [15] obaidullah, m., & mohamed-saleem, a. (2008). innovations in islamic microfinance: lessons from muslim aid's sri lankan experiment. [15] jedidia, k ben. "l'intermédiation financière participative des banques islamiques." etudes en economie islamique 6, no. 1 (2012): 17-31. [16] johnes, jill, marwan izzeldin, and vasileios pappas. "a comparison of performance of islamic and conventional banks 2004–2009." journal of economic behavior & organization 103 (2014): s93-s107. [17] jouaber-snoussi, kaouther. "i. un panorama de l'industrie de la finance islamique." repères (2012): 5-34. [18] lele, pascal. après la crise des subprimes: le nouveau partenariat social: performance opérationnelle: réduction des pertes, prévention des risques psychosociaux et bonus. vol. 1: peter lang, 2010. [19] mokhefi, mr amine. "les banques islamiques: fondements theoriques." [20] muljawan, d, h dar, and mjb hall. "a capital adequacy framework for islamic banks: the need to reconcile depositors' risk aversion with managers' risk taking. economics research paper no. 02-13." loughborough university institutional repository (2002). [21] ould-bah, mohamed fall. les systèmes financiers islamiques: approche anthropologique et historique. karthala editions, 2011. [22] said, alo. "comparing the change in efficiency of the western and islamic banking systems." journal of money, investment and banking 23, no. 1 (2012): 149-80. [23] saïdane, dhafer. la finance islamique à l'heure de la mondialisation. la revue banque, 2009. [24] scholtens, bert, and dick van wensveen. the theory of financial intermediation: an essay on what it does (not) explain. suerf studies, 2003. [25] shafique, azam, muhammad asim faheem, and iqra abdullah. "impact of global financial crises on the islamic banking system: analysis of islamic financial system during financial crunch 2008." arabian journal of business and management review (oman chapter) 1, no. 9 (2012): 124. [26] siagh, lachemi. l'islam et le monde des affaires: argent, éthique et gouvernance. editions d'organisation, 2003 [27] toussi, ali. la banque dans un système financier islamique [in french]. paris: l'harmattan, 2013. [28] toussi, ali la banque dans un système financier islamique. editions l'harmattan, 2010. [29] biancone, p. p., & radwan, m. (2019). social finance and financing social enterprises: an islamic finance prospective. european journal of islamic finance. [30] biancone, p. p., & radwan, m. (2018). social finance and unconventional financing alternatives: an overview. european journal of islamic finance, (10) ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 restructuring rental rate components to be more innovative sharia compliance product in islamic home financing* abstract— this study attempts to restructure a more innovative sharia compliant product in islamic home financing. by examining the components of residential rental index and addressing some unresolved issues particularly in musyarakah mutanaqisah, the study seeks to propose rental index as an alternative benchmark to current interest rates. this paper employs library research derived from the pedigree of islamic home financing. however, some mathematical modelings are employed to strengthen the analysis. the paper proposes a new structure of rental rate as a benchmark instead of the conventional interest rate in pricing of loans. this structure comprises of islamic rental rates, risk premium, overhead expenses and profit margin. our findings suggest that these components are better-able to capture the market conditions as compared to the element of interest in blr (base lending rate) as practiced by banking industry. this paper also recommends the solution for default payment and at the same time addresses inconsistencies of mm contract offered by islamic banks. since rental index is regarded as new approach in islamic home financing, this study limits its scope with one contract namely musharakah mutanaqishah. this limitation might wreak different views from industries for implementation and thus needs to be further tested. the findings also reveal some future challenges in applying more innovative sharia compliant approach since up to date, there are no general consensus derived from different schools of thought in resolving the issues of pricing in islamic home financing. islamic banks might be resistant in accepting this newly proposed structure of rental rate since it generates lesser amount of profits. keywords; sharia, innovative sharia product, islamic home financing, musharakah mutanaqishah i. introduction a. background the rapid growth of the industry reflects the increasing demand for shari’ah-compliant financing products throughout the world. continuous efforts are undertaken to further refine and improve the products and services offered by the islamic financial institutions. this has resulted in the focus on ensuring the shari’ah compliancy of islamic banking products, developing new banking products and services, measuring performance of the islamic banks, and evaluating the social and macroeconomic implications of developing the islamic financial system (yusof et al, 2009). musharakah mutanaqishah (mm), a hybrid contract, where it comprises of three contracts namely musharakah (partnership), ijarah (leasing) and bay’ (sale). according to aaoifi (accounting and auditing organization for islamic financial institution) shariah standards, it is permissible in shariah to combine more than one contract in one set, without imposing one contract as a condition on the other and provided that each contract is permissible as its own this type of contract combination is acceptable unless it contravenes with shariah principles. the vast compendium on mm hitherto remains an arduous problem to be resolved. the recourse of this contract varies in respect to policy of respective islamic banks where many of them are reluctant to apply mm particularly the local islamic banks in malaysia. although musharakah mutanaqishah is believed to be more sharia compliant, there are some issues that impede the implementation of this contract. this phenomenon wreaks dire dispute among muslim scholars on how to embrace mm into more sharia compliance. many studies have been conducted pertaining to the issue of mm but few of them ended with more comprehensive resolutions. some of the issues are documentation approaches to default, early settlement, abandonment of the project, wa’ad, type of syirkah (aqd or al-milk), risk sharing, rental index, maintenance and issue of charges and fees. against this backdrop, it is therefore imperative to investigate the unresolved shariah issues of mm and at the same time, understand why its implementation by banks are still with reservations.. among the most contentious issues of mm is the determination of rental rate in pricing of home financing. to date, the existing rental rate adopted by banks regardless the mode of financing is still benchmarked against the conventional practices. there are two reasons for this. firstly, profits that banks earned are indeed linked to cost of funds akhmad affandi mahfudz*, nor hayati ahmad**., rosylin mohd yusof**, asmadi mohd naim**, turkhan ali*** *international shariah research academy, ** universiti utara malaysia, ***islamic research and training institute http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 which are inevitably associated with the conventional interest rates. secondly, the conventional interest benchmarking cannot be avoided as the country is adopting dual banking system. a fairer basis to determine the rate based on actual data is lacking in islamic home financing as this rate reflects justice, fairness, resembles mutual consent and understanding and uplift the spirit of cooperation and risk sharing. however, these values are not found in any islamic home financing pricing. as result, home ownership and affordability remain an unresolved issue and even islamic banks tend to have similar pricing structure as opposed to those of conventional practices.. affordability and sharia compliant products now become a trending topic that hitherto remain an arduous to resolve. the component of rental rate however is inseparable with the interest of bank for banks to earn higher profit. in addition, islamic and conventional banks are exposed to similar structure of cost of funds, risk premiums and other risks that are already embedded in calculating the profit rate. furthermore, no general consensus by fiqh scholar son how to determine the rental rate that comply with sharia principles have been derived and according to obaidullah (2005), it is merely a profit rate or mark up for the interest rate and hence, leads to the convergence of both the islamic and the conventional home financing. in order to generate profit, islamic banks tend to mitigate the risk by securing the profit in the beginning and avoid the loss regardless of the sharia compliance element. islamic banks also in practice, transfer the risk of loss to the customer particularly in the event of default of customer. in this case, the bank will ask the customer (with wa’ad) to purchase all shares of bank. in line with these observations, islamic rental rate is an imperative issue to be resolved in islamic home financing albeit suggestion that might wreak dispute and further discussion. this study therefore attempts to restructure the existing rental rate by way of formulating more appropriate components that mostly comply to the tenets of sharia and propose a solution to replace the interest rate with more innovative sharia compliant product in home financing. b. objectives in order to determine the structure of rental rate, this paper attempts but not limited to: a. substitute interest rate into rri (islamic rental rate) to eliminate the element of maysir/gambling, gharar/uncertainty, riba/usury. b. propose a pricing model or a comprehensive structure of rental rate which includes risk premium, over-head expenses and profit margin. these components will hopefully better-able to capture the interests of banking institutions but at the same time offers a fairpriced financing to the customer which in turn leads to greater affordability of home ownership ii. literature review as a preamble, this paper seeks to first highlight some unresolved issues in islamic home financing particularly pertaining to sharia compliance. this section then deliberates on the rental rate in conventional practices followed by discussion on existing studies address the issue of rental rate in islamic home financing: a. unresolved issues in islamic home financing there are numerous issues in mm pertaining to its sharia compliance in islamic home financing as offered by islamic banks. this paper only focuses on assessing and examining the unresolved is-sues in mm contract for home financing. naim (2011) finds that at initial stage of the mm con-tract, comprises the elements of shirkah al-milk (co-ownership) . however, it does not fulfill the spirit of partnership in the event of default. in this case, the bank is not willing to share the risk with the customer and customer is forced to buy the share of the bank. he also argued that the second undertaking to purchase the bank’s share by the customer explicitly contradicts the qur’anic verse which obliges the debtor to postpone the debt repayment when the borrower is genuinely unable to pay. besides the unresolved issues, a study on the potentials of mm contract also has been conducted by smolo and hasan (2011). smolo & hassan (2011) compared mm with murabahah and bai bithaman ajil in home financing. however, they acknowledged that mm is not a perfect contract as they raised the issue of double taxation, the price of both rent and shares. according to the aaofi standards, it is prohibited to sell shares in mm contract at a price that is fixed in ad-vance. in this case, the partners do not share profit and loss of their investment (aaoifi, 2004, p. 214). in addition to that, they argued that it is an imperative for the islamic bank to share the loss with the customer in the event of default. this can then be regarded as an avenue for corpo-rate social responsibility, of which banks these days are expected to perform.. current laws and regulations may be not in support of mm but as long as there is political will from the government and private sectors, the modification of mm to be more innovative and sharia compliant is possible. a case study conducted on mm conducted by asian institute of finance (2013) by highlighting the issue of documentation, approaches to default, early settlement and abandonment of the pro-ject. in addition to these issues, aif (2013) also raised the issue of wa’ad (unilateral promise) as legally binding and enforceable and whether the bank had the right to seek legal enforcement of the promise in the court of law. if the wa’d is immediately enforceable, it is no longer a promise. instead it is a contract, which rendered the mm partnership to be in conflict with the shariah. meanwhile, on the other side, the spirit of partnership in equity financing has been disputed among the scholars. initially, mustafa al-zarqa (2004, p.354) was among the scholars who pio-neered the discussion of shirkat al-milk. he has elaborated this issue in the topic of ‘undivided ownership’ (al-milkiyyah al-sha’iah) and explained that where a shirkat almilk is “subject to a condition that there is no contract jointly benefiting it in profitable means, or to jointly invest it in *the authors wish to express great appreciation to the international research and training institute (irti), islamic development bank, jeddah for funding this study. we acknowledge with thanks to those who have contributed towards successful completion of this project. http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 business or leasing and etc from any commercial activities.” this means that any guarantee of cap-ital or profit is not permitted (naim, 2011) b. rental rate determination. since the practice of benchmarking home financing to interest rate is indeed the pulse of any transaction, islamic banks are therefore free to determine the own rental rate according to their own pricing structure. on average, house prices tend to be more volatile in markets. fluctuations in residential property prices tend to have a bigger wealth effect than those of financial assets. this will have an impact on the residential rental market and consequently impacts the rental rate in pricing of home financing. meanwhile, the issue of benchmarking to interest in islamic banking remains one of the contentious issues which impedes the purity of contract to be deemed as shariah based. they are many factors to determine the rental rate as highlighted by linz and behrmann (2004),who provided at least three factors in determining house prices, namely physical, location-al and generally price variables. the similar study with different factors are also conducted by day (2003), can (1990), and palmon et al. (2004). the significance of demographic attributes to determine the rental rate has also been found by marco (2007), hui et al. (2007) and ibrahim et al. (2005). they provided evidence that factors such as location, crime rate, age, total floor area, floor level and occupancy rate significantly af-fect the rental rate. these demographic attributes derived from diverse countries also explain the differences in rental rates across types of properties, location and other identified attributes. macroeconomic variables that significantly determine rental rate have been analyzed by chow et al. (2002), matysiak and tsolacos (2003). they posit that selected economic and financial variables can be used as leading indicators in explaining the monthly variation in property rent. variety of methods have been -employed to quantify and determine the property rental values. broadly categorized, these methods can be divided into two approaches: the hedonic pricing model and more recently, the econometric analysis (yusof et al, 2009). according to dunse and jones (1998), ibrahim et al. (2005), the hedonic pricing model (hpm) is one of the most widely adopted methods to quantify rental values. hedonic regression analysis is a statistical technique which can be applied to a series of property values, together with their associated characteristics to identify and quantify the significance of the characteristics in determining the property’s val-ue. these findings are in line with the study conducted by hofmann (2004) and tsatsaronis and zhu (2004) who examined the determinants of house prices in a number of industrialized econo-mies, and find that economic growth, inflation, interest rates, bank lending and equity prices have significant explanatory power. the scholars generally agree on the usage of actual rental value of property as an alternative to benchmarking to conventional interest rate.(meera and razak, 2009). however, they argued that the formula used in mm is similar to that of conventional loan where conventional financing uses the standard formula for present value of annuities to compute for the monthly payments. in this case the opinion of taqi usmani (2004), which is supported by wahaba al-zuhayli (2003) which said that “a sale without naming the price is defective and invalid “one cannot agree to buy or rent something without knowing the price one must pay. furthermore, (meera and razak, 2009) raised the issue of tendency to substitute rental rate with market interest rate. the issue is based on the ground that the bank’s cost of funds is likely to be tied to market interest rates. second, under convergence, the use of interest rate instead of rental rate would give an amortization schedule similar to conventional financing. meera & razak (2009) also asserted that the interest rate is usually higher than the rental rate. rentals can be cumbersome and impose additional costs particularly if services of independent value are sought unless there are already national or regional rental indices. iii. unresolved issues in islamic home financing a. default payment 1) the current practice of mm in home financing in islamic banking industry is believed not to be perfect in terms of the elements of partnership.. in the event of default payment, bank is reluctant to share the risk whereas, the customer suffers the loss. in this case, the bank does not implement shirkah almilk (joint ownership) as the main value of mm. although there are diverse views on the implementation of shirkah almilk but most banks would prefer to undertake shirkah al-uqud on the ground that it is not contradicting with sharia rulings. the preference of this contract is given to middle-upper income income customers to mitigate the risk of default among lower in-come customers.. in the beginning of the contract, bank will anticipate the worse case scenario by extending this contract based on the concept of shirkah al-uqud and not with shirkah al-milk as required in mm contract where a joint ownership of the house is established. banks will try as much as possible to avoid losses by way of making others (customer) worse off. in other words, islamic banking industry today apply shirkah al-uqud since the banks generate profit and willnot incur losses since the t customer is liable to buy all shares of the bank. 2) as for abandoned project, most of islamic banks are reluctant to switch from “sell then build” (stb) rather than “build and sell” (bts) principle as a way out to alleviate default payments by customers. this preference becomes apparent especially in the case of abandoned projects by its developer and where islamic banks possess more shares and thus have to bear more losses com-pared to the customer. in the end, the customer is forced to buy all the bank’s share. this indeed, is not coherent to the principle of profit and loss sharing as propagated by the concept of shirkah al-milk . in this case, islamic banks practice is similar to that of the conventional banks. this issue can actually be resolved by http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 taking prudent financial reform to mitigate the risk. the selection of customer and potential investor (developer) is an imperative to successful projects. islamic bank should not totally discard its responsibility as a partner with the customer. proper and close moni-toring of the housing project is needed to ensure completion of the project.. as agreed by all schools of thought, all parties involved must contribute towards the completion of the project and not mere extending the financing. 3) the issue of wa’ad (purchase undertaking) also remains unresolved in mm home financing. in this case, the customer promised to buy the bank’s outstanding share of ownership in the event of default such as non-payment, breach of facility’s terms and conditions, and bankruptcy. at this juncture, the bank will terminate the contract and oblige customer to buy the bank’s entire out-standing share of ownership and pay the settlement amount in full. if the customer fails to do, the bank will sell the property to the market by way of auction. any proceeds of this sale will be used to settle all outstanding payment by the customer, legal and other fees. if there is short, then the bank will ask the customer to pay the remaining short. this practice is totally unfair to cus-tomer. the implementation of mm should not carry the obligation of wa’ad. without wa’ad is thus more recommended for both parties since all proceeds of this contract is the liability of all parties involved. although islamic bank is a commercial entity but they are binded with the con-cept of partnership, cooperation and mutual consent without making others worse off. b. inconsistency islamic banking industry today is said to be inconsistent with the elements of mm as practised in home financing.. many islamic banks are not able to implement traditional mm due to complexi-ty, agency problem, trustworthiness, duration and termination of the contract (bacha, 2006). alt-hough this inconsistency does not deviate from the tenets of sharia ruling but in reality it is found to make the customer worse off while banks are generating profit and therefore there is a question and dispute on this matter. as mm is a joint partnership in equity financing, risks and losses are also to be shared by both the customer as well as the bank. in other words, the concept of shirkah al milk should be preceded regardless the outcome of the project financing. in this case, the bank must not be inconsistent in terms of the implementation throughout of the con-tract, i.e., undertake shirkah al milk but in the event of default switched into shirkah al-uqud. in addition, the spirit of partnership must not lapse in the event of default payment by the customer. in fact the customer has to be guided to resolve the issue of default and possess the right to share the proceed of mm in case where the property appreciates in value or profits are generated. this spirit of partnership is in line with the initial definition of mm where according to al-fayruzabadi, alqemus (1997), and al-munjid (1992), mm is a combination of two words, musharakah and mutanaqisah. musharakah is derived from the root word sharaka, meaning ‘one joining others’ as supported by al-kasani (2000), ibn rushd al-hafid (1995) and ibn qudamah al-bajuri (1999). in fact according to haneef et al (2011) and naim (2011) the mm was arguably in the form of shirkat al-aqd if the intention of at least one of the parties was to earn returns. the malaysian banking practice, however, considered mm to be shirkat al-milk from the commence-ment of the contract until the end of its tenure. however, many islamic banks arguethat mm is permissible as long as all contracts (aqd) are independent (al-uqud al mustaqillah) therefore, in the event of default, it is justifiable to opt for shirkah al-uqud rather than shirkah al-milk as both are inherent in mm. nevertheless, this reason is not acceptable as it makes the other partner (custom-er) worse off while the bank enjoys the benefit. the other inconsistency is derived during re-scheduling or refinancing as requested by the customer to avoid the default. in this case, the bank still insists the customer to pay the charges and other fees since the customer fails to abide by the payment schedule although the customer’s intention is to pay the monthly payment ac-cording to their capability. as mentioned by shuib et al (2013), the bank in this case once again is inconsistent with sharia compliance process in home financing. the bank does not implement the real concept of equity financing where all cost of this contract are the liability of both parties and all risks should be shared accordingly. although the ownership of the property belongs to the customer upon maturity, but the process of joint ownership is still binding and at the same time enforceable. in this regard, all parties involved incorporate the spirits and values of of brother-hood, partnership and mutual understanding as well as consent. iv. findings and discussion the word “rental” is derived from the understanding of mm concept as it comprises of three con-tracts namely; musharakah, ijarah and bay’. it also refers to the purchase of bank’s share of usu-fruct of such property to the customer where the share bof rental for the customer increases until maturity. as of now, rental rate determinations that comply with the tenets of sharia remain un-resolved. there is no such consensus on how to determine islamic rental rate. in fact, it was only a suggestion for future study as revealed by meera and dzuljastri (2005, 2009). they acknowl-edged the dire problem of mm in rental rate determination since most of countries which adopt-ed mm are in fact dual banking system that always refers to interest rate albeit for small transac-tion. in fact, iibr (international islamic banking rate) which is currently adopted as reference for many islamic banks is dominantly derived from islamic banking that hitherto confined its us-age for certain banks. as long as countries adopt dual banking system, islamic rental rate wreaks dire problem and remains an arduous task to resolve. in other words, the power of interest rate albeit small portion is still inherent in islamic banking system. there are increasing concerns about the ability of many stake holders to determine more appropriate rental rates in islamic home financing to cater for more sharia compliant product. the price of home financing can therefore be fairer http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 and just to the consumers. price determination to yield more appropriate components of rental rate is an imperative that must be preceded prior to price determination of home financing. the time has come for the quest to model a structure that is totally free from any unlawful element of home financing. to recapitulate the above discussion, , consider the following formula as being practiced now in mm home financing: (1) where: rental rate price of property customer’s share equation (1) as revealed by meera and dzuljasti (2009) merely gives the formula to the extent that x is given with the assumption on the price of rental. this formula is also being practiced by bank sregardless of the mode of financing. the weakness of this formula is that, it is unable to resolve the existing issue of mm in home financing since there is no alternative thus far canreplace x. however, by introducing new innovation in mm home financing, x can be replaced by rri (islamic rental rate) where this paper attempts to propose a new component of rental rate as follow: (2) rpi is the monthly rental price of the property market across the types, aand locations in a specific country. rpi measures changes in the price charged for renting private housing while hpi measures average price changes in repeat sales or re-financings on the same properties. in order to replace x, the new component of rental rate is given as follow: rri + risk premium + overhead expenses + profit margin (3) in this case, risk premium comprises of credit risk, liquidity risk and market risk and rri is given to replace blr (base lending rate) as practiced in conventional loan. risk premium in this case would be the same as in conventional since islamic bank also possess identical characteristic to play as financial intermediary. however, blr now still remains as benchmark but is not taken into account in this formula due to its prohibition in shariah..equation (3) resembles more just and fairer price for consumer since it removes blr. the output of this formula is expected to be more expensive compared to conventional approach but deemed to be more islamic. in addition, islamic bank still earn profits even in the event of default payment by customer. the issue here is whether islamic bank can opt to bebetter off without making others worse off (externalities). the other issue is whether islamic banks are willing to earn smaller profits but adopts full sharia compliance with higher profit but having shariah legality issues. although rri is additional component to replace blr, it has to undergo some simulation and scenario to examine precisely the sharia issues. as this component uses indices, there is a possibility of loss accuracy. prices and rental of real estate properties are sensitive to many factors. even within the same locality, particular location can affect prices and rentals. however, these changes can be managed to avoid the inclusion of uncertainties and speculation. v. conclusion this paper highlights the practical issue of rental rate to wreak more sharia compliant product in islamic home financing. in addition, this paper also points out some unresolved issues that affect changes in rental rate such as default payment and inconsistency of islamic banks in the imple-mentation of comprehensive mm. this paper has proven that current practice of mm in islamic bank still contains the element of interest particularly in determining rental rate. although rental rate might be affected by elemenst of uncertainties and speculation, but these issues can be resolved. islamic bank has to be con-sistent with the real value of mm and upholding the spirit of partnership and mutual consent. in the event of default, the loss that incurred by the customer should be shared proportionally with islamic bank albeit fees, charges and other cost. therefore all parties involved share the value of brotherhood, partnership and mutual understanding and consent. as for rental rate, this paper has restructured a new component of rental rate that comprises of rental price index and house price index. in this case, in order to replace interest and base lend-ing rate (blr), the new structure would comprises of islamic rental rate, risk premium, over-head expenses and profit margin. the new price of this component is expected to yield more ex-pensive price compared to existing component but believed to be more sharia compliant product. however, islamic bank does not incur any lossesbut only a slight change in profit. in this case, stimulation by regulators and other relevant stake holders to support islamic bank is an imperative action whilst islamic bank attempts to have more sharia compliance product. references [1] aaoifi: shari’a standards, accounting and auditing organization for islamic financial institutions, bahrain, 2004 [2] can, ayse. the measurement of neighborhood dynamics in urban house prices, economic geography, no. 66, pp. 254-272. 1990 [3] chow, y.l., ong, s.e., thang, d.c-l.t. a cointegration approach to understanding singapore’s industrial space supply, journal of property investment and finance, vol. 20, no. 2, pp. 96-115. 2002 [4] day, brett. submarket identification in property markets: a hedonic price model for glasgow, cserge working paper edm 03-09. 2003 [5] hofmann, b. bank lending and property prices: some international evidence, work-ing paper. 2004 http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 [6] hui, e.c.m., yiu, c.y and yau, y. retail properties in hong kong: a rental analysis, journal of property investment and finance, vol. 25, no.2, pp. 136-146, 2007 [7] ibrahim, m.f., cheng, f.j., and eng, k.h. automated valuation model: an application to the public housing resale market in singapore, property management, vol. 23, no. 5, pp. 357-373. 2005 [8] linz, stefan and behrmann, timm. using hedonic pricing for the german house price index, available at: malaysian quarterly property market report-various issues.2004 [9] marco, larissa. determinants of new york city residential rental prices, the michigan journal of business, vol. 1, no. 1, pp. 61-83, 2007 [10] matysiak, g. and tsolacos, s. (2003), identifying short-tern leading indicators for real estate rental performance, journal of property investment and finance, vol. 21, no. 3, pp. 212-232. 2003 [11] meera, a.k.m. and dzuljastri, a.r. islamic home financing through musha r̄akah mu-tana q̄isah and al-bay’ bithaman ajil contracts: a comparative analysis, review of islamic economics, vol. 9 no. 2, pp. 530. 2009 [12] meera, a.k.m. and dzuljastri, a.r. home financing through the musha ̄ rakah mutana ̄ qisah contracts: some practical issues”, journal of king abdul aziz university: islamic econom-ics., vol. 22 no. 1, pp. 3-27. 2005 [13] naim, asmadi mohamed. purchase undertaking issues in musharakah mutanaqishah home financing, isra international journal of islamic finance, vol. 3, issue 1. 2011 [14] obaidullah, m. islamic financial services, king abdulazis university, jeddah: islamic economics research centre, 2005 [15] palmon, oded, smith, barton a. and sopranzetti, b. j. clustering in real estate prices: determinants and consequences, journal of real estate research, pp. 115-136. 2004 [16] rafe haneef, sherin kunhibava and edib smolo. musharakah mutanaqisah and legal issues: case study of malaysia”. isra international journal of islamic finance, 2011. [17] smolo, edib., hasan, m kabir. the potentials of musha ̄rakah mutana q̄isah for islamic housing finance”, international journal of islamic and middle eastern finance and management, vol. 4 no. 3 pp. 237 – 258, 2011 [18] tsatsaronis, k and h zhu. what drives housing price dynamics: cross-country evi-dence”, bis quarterly review, march, pp 65-78, 2004 [19] usmani, muhammad taqi. an introduction to islamic finance, maktab maa’rul quran, karachi-pakistan. 2004 [20] wahaba al-zuhayli. islamic jurisprudence and its proofs”, dar al-fikr, p. 33; 56. 2003 [21] yusof, rosylin mohd., kassim, salina h., majid, m shabri abd., hamid, zarina. mod-eling an alternative benchmarking for home financing: a comparative analysis between ma-laysia and the united kingdom, final report bank negara malaysia shari’ah research grant.(unpublished). 2009 http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france prepared by: mudeer ahmed khattak student id: 15 http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 protection and distribution of wealth, commercial and financial transactions: maqasid al-shariah perspective mudeer ahmed khattak*, *universiti kuala lumpur business school, universiti kuala lumpur abstract--this research discusses briefly about the maqasid alshari’ah, in the reference to protection and distribution of wealth in society as well as its relevance in commercial and financial transactions in islamic finance and on society. the paper will cover specifically the major facets of maqasid that are essential in the preservation and distribution of wealth for islamic financial practices and as well as transactions. maqasid al-sharia’s role in consonance to islamic financial services industry will also be discussed in brief to undermine the importance and to enlighten the relevance where maqasid play a vital role in harmonizing shari’ah rulings for a just and fair distribution of wealth in the society and to involve it under strategical behaviour of businesses, firms and banks, commercially and financially. keywords--maqasid al-shari’ah; wealth; islamic finance; commercial and financial transactions; implications of maqasid al-shariah methodology/design—this paper is a discussion on different aspects of how we can achieve the protection and distribution of wealth in commercial and financial transactions following objectives of shariah. i.introduction the objectives of shari’ah or maqasid al-shari’ah nurture benefits and avoid harms. imam shatibi’s view mentioned by nyazee on the objectives as “to free man from the grip of his own whims and fancy, so that he may be the servant of allah by choice, as he is one without it” [1]. though these objectives are not conveyed comprehensively, but are mentioned in almost every law in shari’ah. the importance of these objectives is noteworthy in development of the islamic finance industry as it has been mentioned in maqasid, the preservation of wealth along with other important factors. while some of the basic doctrines of usul al-fiqh like ‘general consensus’ (ijma), ‘analogical reasoning’ (qiyaas) and ijtihaad seem not be in practice, which might disturb the state of hormany in current sociopolitical environment of today’s muslim states. since these objectives offer a ready and convenient access to the shari’ah in emerging field of islamic finance, these objectives have become the point of attention around the globe. there are many importnant reasons to encourage the realization of these objectives in islamic finance industry. ii.protection and distribution of wealth from maqasid al-shariah the preservation and growth of wealth is also one of the main objectives of shari’ah which falls in daruriyah category. protection of individual’s wealth and private property are of a vital importnance to have a just society. here, we address the penultimate daroori. al-maal is often interpreted as possessions, property, and wealth. the term maal come from a verb maala that means ‘to digress/to turn away’ as “maala bihi al-qalb” that means “heart is turned away or deviated by it”. this leads us to the saying that “money is a necessary evil.” the recent financial crises is a clear exapmle of this saying because it is so deep rooted and connected to society’s problems, however, it is also nessessity for us today, and thats what makes it darooriyat, the protection of which is one of the objectives of shari’ah. the preservation of wealth and assets refer to the sanctity of the wealth of the society members, with an emphasis on earning through halal means. concentration of wealth in few hands lead to increase the gap between rich and poor and makes the poor unable to meet the basic needs like food and health. islam, for this purpose, provides a detailed law governing mu‘amalat and transactions in a society. protecting the wealth is one of the main objectives of shari’ah. allah says in holy quran: “and give not unto the foolish your property which allah has made a means of support for you , but feed and clothe them therewith, and speak to them words of kindness and justice”.(4:5). this also applies to the financial industry. islam recommends efficiency and stability in financial sector. preservtion of wealth shari’ah highly encourages the steps towards preservation of wealth. some ways to achive the objectove is as follows: encouragement of trade and investment to keep an economy flourishing and developing, money should be kept in motion, going from the hands of those who have money in surplus to those who need it for their basic needs. that should be done in exchange for goods, services or profit while storing and monopolisation of wealth is strictly prohibited in shari’ah [2]. with the passage of time, paper money has replaced gold, silver along with other commodities. in the begining paper money was thought to be ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 very convenient as a replacement for having carry around gold and silver and it used to be backed by gold or silver. however,today, this is not a requirement while priniting more currency notes which makes it “just a paper”. this paper money is called fiat money. some scholars argue that too much reliance on paper money is one of the main causes of the current crisis and turbulance in the economy. shari’ah encourages trade and investment, this encouragement is not absolute and there are clear guidelines governing the nature of the investments like the formation of financial contracts etc. trade and investment are two ways to keep wealth in motion, however, there is also a clear line between “lending” of money for a share in a business to make profit and the lending of money to earn interest. the lending money on interest is explicitly forbidden by the shari’ah. permissibility of private ownership the very human nature of having a desire to enjoy the pearls of hardwork is aknowledged, respected and appreciated by shari’ah. thus, acquiring and owning private property is not forbidden in principles of islamic economic system. the principles of capitalism and communism are not in line with shariah. private ownership in the islamic worldview is radically different since the ownership is deemed to be temporary and ultimately a trust from allah for the duration of our lives. where investment and trade is encouraged, it is also necessary to have regulations to ensure that wealth is not hoarded and not concentrated, and the means of production are not monopolised. there are guidelines in qur’an and sunnah which serve the overall objective of promoting justice and equality in the society and protecting wealth of its members. in communisim and capitalism, some guidelines are clearly opposed to shari’ah. any such system that adheres to the principles given by in islamic law can be considered islamic. protect the wealth of certain categories of people it may be necessary to withhold wealth and assets to preserve it from squandering,even from the rightful owners, especially from those who are not expert in managing their financial affairs. sufahaa that means ‘foolish’ or ‘incompetent’. it applies to those who are not deemed legally responsible. extending this logic, this can be applied to children and minors, those below the certain age (which is different in different school of thoughts). their wealth can be held until they reach a certain age where they are capable of managing their financials. their wealth is managed and held by a trust fund until they are able to take full charge of it. charity zakat is the fourth pillar in islam, which makes it an essential part of islamic economic system. every muslim who has a predetermined threshold level of wealth called the nisab, is obliged to give zakat. besides zakat, charity is also greatly emphasized to help the less fortune and keep wealth in circulation when it changes hands, from rich to poor. in shari’ah, we are giving away from what he has bestowed upon us and everything that is intrusted to us from allah. therefore, charity is also one of the best way to keep money in circulation, giving to those deserving and need it the most. best evidence of this circulation is the annual collection and transfer of the 2.5% zakat. poor are with the highest propoensity to spend in any society, for example if we give £2 to a wealthy person, he will just put it in his pocket for later use, whereas if we give the same £2 to a less fortunate, they will spend it shortly, as they have more immediate and pressing needs. hinderance of growth of wealth – an overview from the perspective of protection of wealth, below are the issues that threaten the preservation and permissible growth/development of wealth. prohibition of hoarding and miserliness hoarding doesn’t realize the intented use of wealth, the circulation to benefit as many people as it can, though one might think that hoarding can protect and increase the wealth. the difference between miserliness and hording should be noted here. an attribute where one simply does not want to spend his wealth is called miserliness where as hoarding is trying to litterally concentrating wealth in hands. that makes the rich more richer and hence increases the gap between the rich and the poor. concentration of recources, industries and wealth, giving the power to few indivitials in a scociety, leading to monoplies, can also be a kind of hoarding, something undesirable in shariah. prohibition of being extravagant extravagence is discouraged in islam. muslims are not allowed to do wasteful consumption and asked to be moderate in everything in their life. there is no monetary limit to separate moderation from excess. however, there are some obvious factors we should keep in mind while spending. the main reason behind this discouragement is to minimize the income gap between rich and poor. something that can lead the scoiety to envy and unhealthy differences. prohibition of interest ribaa comes from the verb ra’baa that means ‘to grow’ or ‘to increase’. today, the entire global financial system is based on the lending money on interest ,for example, a return on a loan, and that implies earning at no risk or zero effort. hence, keeping oneself away from such a serious transgression is never easy. rich people earn interset is from the less fortune society members. and that’s how wealth become concentrated in hands of rich people. interest undermines the risk based nature of trade and investment whereas, real profit is a result of effort and risk both. ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 prohibition of theft stealing someone’s assets or wealth is always considered a crime. in islam, stealing is a crime by consensus a major crime and the punishment is severe. act of taking someone’s belongings without consent of the owner is categorised as theft. the main objective of this prohibition is to protect the rights of the owners and to protect their property, possessions or wealth. maqasid al shariah in wealth circulation islam encourages wealth circulation and highly discourages wealth concentration to few hands. that is why it also serves the objective of protecting the financial transactions and encourages circulation so that a large number of people can have access to finances. shari’ah does not deem the accumulation of wealth impermissible as long as one is fulfilling its obligations to allah, mankind and to the society through philanthropic activities and zakat. ibn-e-ashur quoted that legitimate circulation of wealth among the bigger portion of the society will bring prosperity and happiness. to further enlighten this concept of wealth, shari’ah has made the permissibility in all the financial contracts and activities unless stated otherwise to empower the people and to help the society to flourish and prosper. all excessive wealth held beyond one's legitimate needs sho uld be held as a trust (amanah) and surrendered to the members of the society. the shari'ah has provided several measures for spending wealth on the society. these i nclude  zakat, endowment (waqf)  voluntary charity (sadaqat),  inheritance (faraid),  will (wasiyyah),  donations and grants, and  social security (altakaful al-ijtima'i). investments can be carried out by firms, governments or even by individuals. in islamic banks, deposits are public money thus they must be directed for public or social interest as a whole for real needs of economy. circulation of wealth by right approach is obligatory and not just a choice by itself. for example, islamic banks in sudan are required by law to contribute to community development projects. so indeed, state or governments in islamic state plays vast a crucial role in regard to usage of wealth. such roles of provision of basic needs arrange provisions for social security, foster equitable distribution of income, wealth and fulfilment of social obligations. investment – sukuk investing as an entrepreneur or being supplier of capital enjoins spending investing behaviour among economies as truly encouraged by shari’ah. savings in modern time goes through financial markets to different channels. through capital markets, investors can be a small or large part of this circulation process through proper regulated channel. securities in islamic capital markets should represent ownership preferably. sukuk which is a modern and relatively new innovation in shari’ah literature. islamic finance industry which is lacking the link of real economy development can effectively serve the goals of wealth circulation, leading to infrastructure building, more employment and thus more income earning opportunities. sukuk structuring with the suitable embedded islamic finance contract can mobilize capital to the necessary resources or sectors of economy a) deposit in banks through sukuk by those who have accumulated wealth, through channelled markets would allow surplus to be invested to deficit portions and also small investors can participate through mutual funds and other pooled instruments. b) for private and public-sector projects, sukuk can be used with the support of mature secondary markets for increasing liquidity and dynamism in the economy. investments in major and in fact needed sectors like infrastructure, education, developments projects public and private both can be induced through sukuk which in turns channels the surplus funds to these sectors in a formalized way. c) cost of intermediation can be reduced and economies of scale in financing can be enjoyed through efficient capital markets to provide vital link for the allocation of wealth and facilitating surplus to the right place. but sukuk in order to fulfil the above plans should be asset backed not asset based with an ownership style and equity based structure. awareness about maqasid of shari’ah in terms of wealth circulation and its protection can be utilized not only by proper allocation and preservation of them but also by avoiding unhealthy concentration of it and thus ushering in to the new level of prosperity. the economic system of islam demands clearly equitable mobilization and distribution of resources. funds should never be misused or even managed unprofessionally. basically, any fund or accumulated wealth should be circulated through zakat and charity channels which ultimately reduces the size of the idle money in the society for the wellbeing society members. so, zakat is an institutional mechanism which provides the continuous circulation of wealth micro and macro dimensions in wealth circulation shari’ah has macro aspect of it’s as wealth circulation while transparency in dealings and justice in the system are its micro goals. marketability as fair circulation of wealth according to ibn e ashur, the maqasid of wealth have five broad headings including marketability, transparency, preservation, durability and equity. marketability requires fair contribution of wealth in society. quran mentions ‘the qur’an says: “he knows that in time there will be among you sick people, and others who will go about the land in search ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 of god’s bounty” (73:20). it means transferring wealth to as many hands as possible by means of trade and in exchange of compensation ‘lawfully’ through financial contracts recognized by islam. by giving rights to people to use their wealth efficiently, set of rules covering deceased estate, maintaining women in part of will and recipient of wealth. in contemporary time, link of domestic and international trade is vital due to the fiat money system of economy. promoting maqasid al-shari’ah in new products development a maqasid driven product or approach indeed should be wholly observant to shari’ah requirements and other than this, customer satisfaction or society advantage broadly should be the main concern in the product development process. customer oriented products benefits the society individuals as a whole and thus comes under umbrella of maqasid of shari’ah. doctrine of maslahah can be embedded within maqasid to take care of society’s interest in banks or firms operations as well as stakeholders. many literatures have related the issue of maqasid observation in product development process [3]. iii.commercial and financial transactions to institute the objectives of shari’ah in a society, muslims are strongly encouraged and facilitated to participate in different types of commercial and transactional activities. in commercial activities, the underlying principle is ibadah. and quran and sunnah don’t invalidate any new transactions unless they are contradicting shari’ah. if fairness of maqasid al shari’ah is not annihilated, freedom of contract is allowed [4]. a. legality vs permissibility there are contradicting views on the legality and permissibility of a contract, some of the shariah scholars urge the permissibility of the structure of the product while some emphasize on the objectives and intentions of the contracting parties. the base of difference in the views of shariah scholars is the hadith, “matters are determined by intention.” intention should be the base when determining the legality of a contract, not merely looking at the structure of the product alone. however, imam shafi’i is of the view that it is never reasonable to decide whether a contract is legal or not, on the intentions of the parties because it very complex to tell about the intentions of a party. besides that, some shari’ah indications show that assessing such things should be based on their design and manifestation. shari’ah scholars look into this and bring together the two conflicting views by introducing the two types of ruling, namely, hukmqada’i and hukm-diani. hukm-qada’i this hukm is to analyse whether the contract is complying with all the shari’ah requirements relating to its form and structure. this is mainly concerned with form and structure of the product, if the for and structure of the contact is shariah complaint, it is not conflicting with shari’ah law and there is no element that can deem a contract invalid then it is declared as shariah-compliant and valid. hukm-diani on the other hand, this hukm analyses if the objectives of a contract are shariah complaint, only then a contract is permissible. thus, if a contract meets all the legal and contractual conditions and requirements then the transaction is valid. however, the validity of a contract doesn’t necesserily make a contract halal/permissible. it is noteworthy to mention that shariah scholars are not indifferent on the permisibilty of a contract over the matter and the intentions of the contractivng parties and the conflicting views are only on the validity of a contract. shafi’i scholars expressed the examples where the intention of the contracting parties actually nulify the contract, for example, selling of grapes or other fruit products to the parties making alcohol or sellings arms to murderers. this tells us that when the intentions are hard to establish, the form and structure is more alid important.the contract must be valid and permissible to be classified as shariah compliant by the shariah scholars. today the question is, is contemporary islamic finance follwing the same principles? one of the most controversial product in islamic finance is bai-al-inah which is widely used in malaysia. the product where bank provides financing without exposing itself to any risks. some have mentioned it as “playing with the documents.” bai-al-inah is also criticized being a legal device to avoid riba based loans, however, although they are differet in form, the nature of this bai-alinah is not different from conventional loan. b. facilitating benefits over minor harms shari’ah has facilitated the transactions as much as possible to provide more benefits over minor harms. for example, for the validity of the sale contract, the two items of exchange (iwadayn) should not necessarily be available at the time of contract, to avoid harms on the transaction. c. facilitating financial contracts shari’ah facilitates and strongly encourage participation in commercial and financial contracts and undertaken various kind of activities and investments for that. the underlying principle of ‘permissibility’ is used normally for commercial activities in if. the approach in islamic commercial dealings in not only formal but substantial. freedom of contract is allowed as long as it doesn’t invalidate or conflict with maqasid principles. contracts are mainly classified into subsets according to their nature including partnership, exchange or sale, voluntary, reward based etc. not only facilitation of contracts whether commercially or financially is vital for maqasid but also fair and transparent dealings along with reciprocal objectives and equality is important. therefore, in the maqasid approach, values and practices, ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 form and substance should integrate and not contradict one another. in commercial and finance activities, for example, the shari’ah injunctions should be integrated in the operational activities with genuine concern for fair and transparent practices that contribute to the development of society and human wellbeing along with facilitation which is the true example in practical cases like sukuk, microfinance and even the new emerging concept of crowdfunding in context of islamic finance. d. social responsibility in if and maqasid al shariah many prominent scholars like muhammad chapra and naqvi have urged commercial and financial transactions of if industry to be embedded in fair, just environment and overall society to be envisioned deeply in maqasid al shari’ah, as they asserted if to be a subset of islamic economics. lack of ethics and low morality not only damage industries but overall societies as consequences of total greed and misbalance in ethical practices can be referred from recent financial crisis. it brought into limelight the if industry and its commercial and financial practices as if industry was less affected by crisis, though not unscratched. the distinguishing factor of if industry is indeed the underlying principles and robust foundations of maqasid, without which the means and ends will not be achieved [5].institutionalizing social values in commercial and financial contracts and also adopting maqasid al shari’ah as an indispensable framework or corporate strategies will provide directional guidelines for this industry for meaningful future along with not just focusing on minimum shari’ah compliance in product and research development. the more a company leads to social improvement, the more it has economic benefits [6]. some practical examples like ftse and dow jones islamic index offering volunteering and involving in charities schemes, cause related marketing strategies linking contribution to charity sales, bank brunei berhad’s computers for educational institutions or banks dealing with welfare issues etc. but not limited to. these socially responsible are not conflicting to corporate objectives but rather connected. and according to shari’ah there is no harm in improving competitive market or business along with making sincere commitments to a better society (which is the jest of maqasid al shari’ah). if can contribute towards society through its commercial and also financial activates to overall society and particularly by specializing in environment friendly product development, empowering sme’s, support from large known firms etc. e. maslahah (public interest) a basis of law, ruled according to a certain necessity and/or a particular circumstance, it can be of either prohibiting or permitting nature. shariah scholars declare something permissible or prohibited on the above-mentioned basis only if it serves the public interest and it does not contradict with islamic teachings. it is used to promote public benefit and avoid social evils from a society. maslaha is from the word ‘masalih’ which means welfare or interest/benefit. it can be defined as seeking the benefit and avoiding harm [7]. hence, the activities of ensuring economic justice with wealth circulation are encouraged. wealth should not be limited to the rich, fair share of returns and profits should be distributed among the contracting parties and fair pricing should prevail while avoiding benefits that burdens the public [8]. the wealth in the hands of individuals and the governments are trust from the allah and it should be used for common societal goals. distribution and redistribution of wealth is not a favour by the rich to the poor but it is a right of the poor. there is a due right for deprived and less fortunate. thus, not every product in islamic finance is fully embracing objectives of shariah. if the islamic financial institutions (ifis) are focusing on the streucture of the product instead of focusing on the underlying objective of the contract or product, ifis are not really striving to achieve the objectives of shariah. objectives of shariah are used as rationalized for the application in bai-al-inah. it is questionable transaction even though observing objectives of shari’ah should be the first factor to allow the transaction. the harms that are resulted by practicing bai’al’inah are more worse than public interest (maslaha). firstly, the bank is literally creating a debt in the economy, that will eventually lead to higher speculation which will result in uncertainty and an unfair risk-bearing conditions. secondly, it is only paper work, there is no sale or purchase in real terms, which allows the parties to have financing without any real trade. this activity hinders the objective of equal distribution of wealth and income. thirdly, as discussed before, bai-al-inah is a form of validation of interest using legal device or channels. fourthly, this contract does not need the bank to hold the asset for a long time to sale it as the bank normally holds it for few minutes. holding the asset will imply that bank is liable for the asset held. the benefit and income, the bank is gaining out of this transaction, is opposed to the rights of profit and the principle, ‘al-kharaj bil-dhaman’, a shari'ah legal maxim which bases the entitlement to revenue on corresponding liability for bearing losses. this implies profiting from the transaction without taking any liability. since bank is not the owner, bank cannot claim the asset in case of default. lastly, only because the asset brought to be sold to get some case, the price of the asset offered by the bank for purchase is never same as the market price, which is not fair to the customer. majority among the shariah scholars are of the view that bai-al-inah is not valid and permissible and it is a way to legalise riba. the harms of such debt based-financing transactions at include:  it results in creation of debt  leads to a chain where money will be exchange for more money in future, which is unjust, risky and uncertain  this debt proliferation will result in gambling and speculative transitions  debt-based transactions result in greater instability https://www.investment-and-finance.net/islamic-finance/s/sharia-maxim.html ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6  leads to inequitable distribution of income and wealth  inefficient allocation of resources  it raises the anxiety level of the society concluding the above discussion, it is suggested that debtbased financing like bai-inah and tawaruq, both should be thought over once more before sanctioning it for the public. moreover, getting funded from ifis for developing huge structure does not comply with shari’ah if there is no proper care of the environment and not proper care of stakeholders. it is the need of time to incorporate the socio-economic developments as necessary factors while financing such projects. shari’ah does not encourage the developments on the cost of human lives and that makes their life more difficult and hard. iv. conclusion maqasid al shariah plays a very important role for a society in achieving prosperity. the shariah teachings strongly emphasise on preserving one’s wealth. one of the main objectives of shariah is the protection of wealth. the jurists argue that the concept of protection of wealth is beyond its literal meaning, it encourages to generate, accumulate, preserve, protect as well as distribute the wealth with justice. in financial industry, maqasid have also a very important part. since it has a major role in islamic finance, discussing protection and distribution of wealth, it is obvious that we can see a greater change in the results and goals if we aim to achieve objective of shariah. islamic financial institutions are recommended to integrate policies that also achieve maqasid alshari’ah. endnotes and references [1] abubakar ys (2016) corporate social responsibility of islamic financial institutions: a look from the maqasid al-shariah (purpose of shariah) approach. bus eco j 7: 255 [2] islahi, a. a., & ghazanfar, s. m. (1998). economic thought of al-ghazali [3] a. ahmed, habib. 2011. “maqasid al-shariah and islamic financial products: a framework for assessment.” isra international journal of islamic finance 3 (1): 149–60. b. al-suwailem, sami. 2011. “financial engineering: an islamic perspective.” in islamic capital markets: products and strategies. vol. 9. c. lahsasna, ahcene, and m. kabir hassan. 2011. “the shariah process in product development and approval in icm.” in islamic capital markets: products and strategies, 23–68. d. muda, muhamad, and abdullah jalil. 2007. “islamic financial product development: shariah analysis.” iium international conference on islamic banking and finance, no. 606: 1–16. e. suwailem, sami al. 2007. “financial engineering: an islamic perspective .” sinergi kajian bisnis dan manajamen vol. 9 (no. 1): 87–102. [4] kamali, hashim. 2000. “issues in the legal theory of usul and prospects for reform.” 69-70. iium . [5] dusuki, a. w. (2008). “understanding the objectives of islamic banking: a survey of stakeholders’ perspectives.” international journal of islamic and middle eastern finance and management, 1, no. 2 132-48. [6] abul hassan, hjh salma binti abdul latiff,. (2009). “ "corporate social responsibility of islamic financial institutions and businesses: optimizing charity value",.” emerald insight, humanomics, vol. 25 iss: 3 pp.177 188. [7] vejzagic, m., & smolo, e. (2011). maqasid al-shariah in islamic finance: an overview. in 4th islamic economic system conference. kuala lumpur, malaysia, october (pp. 4-5). [8] mohammed, m. o. (2009). the objectives of islamic banking: a maqasid approach. iium institute of islamic banking and finance. references atmeh, wasim k. al-shattarat & muhannad. t.t. “profitsharing investment accounts in islamic banks or mutualization, accounting perspective .” www.glofin.org. diakses march 26, 2014. bank negara malaysia. 2006. capital adequacy. diakses march 20, 2014. http://www.bnm.gov.my/guidelines/01_banking/01 _capital_adequacy/06_psia.pdf. bnm. 2009. guidelines on musharakah and mudharabah contracts for islamic banks. diakses march 18, 2014. http://www.bnm.gov.my/guidelines/01_banking/04 _prudential_stds/15_mnm.pdf. ghafoor, a.l.m abdul. 1995. interest free commercial banking. iqbal, mohammed arif and munawar. 2011. the foundations of islamic banking-theory,procedure and educaton. macmillan, palgrave. 2009. “profit-sharing investment accounts in islamic banks: regulatory problems and ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 possible solutions.” journal of banking regulation 300-306. rosly, saif ul azhar. 2008. critical issues on islamic banking and finanial markets. siddiqui, dr.muhammad nejatullah. 1981. “rationale of islamic banking.” yahya, ismail oriyomi. 2013. “profit sharing investment accounts: implicationsfor liquidity risk management.” academia. may. diakses february 2014. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 community foudations: main characteristics and trends – a comparison between islamic republic of iran and italy i. the ethical and cultural roots of foundations «community», «civil economy» and «territory» are the three key words inspiring the principles and values of the foundations. «community» (“communitas” in latin) means “reciprocal gift”, and they exist when people are willing to offer reciprocal aid. the word “civil” placed alongside the term “economy” refers to inclusion, such as civitas, which included everyone in roman culture. civil economy is inclusive; it includes everyone notwithstanding their public roles so they can make their contribution within the social-economic fabric. otherwise, the individualist economy of the homo oeconomicus would prevail be-cause «economic life undoubtedly requires contracts, in order to regulate relations of exchange between goods of equivalent value. but it also needs just laws and forms of redistribution governed by politics, and what is more, it needs works redolent of the spirit of gift»1. finally «social innovation» to rectify the negative criticalities in post modernity and recover what has been lost, as the social doctrine of the church teaches us. the economic basis that inspires foundations, such as micro credit, non-profit, and the principle of subsidiarity, are not modern inventions as they originated in the middle ages to make the sense of communitas a tangible notion and to meet the needs of people in the local are-as. on a political level, their actions have turned civil society into a protagonist, as american sociologist jeremy rifkin anticipated at the turn of the nineties when he spoke of the white economy, namely the sector of the economy focusing on social assistance and help to individuals: «work, as we know it, at a certain moment will end, because there will be a series of technological innovations, the third industrial revolution (and today we are at industry 4.0) and so the way we under-stand work will change»2. the economy of welfare and of social innovation comes from the meeting of people determined to add value to their capabilities in a horizontal network logic revolving around the “relationship asset”. this differs from the “goods asset”, not so 1 benedict xvi, caritas in veritate, n. 37. 2 jeremy rifkin, the end of work. much for its intangible nature but for possessing a value that is infinite and not convertible into cash, be-cause relationships have been intentionally put aside by the economy, which becomes «a sad science of numbers and statistics» in this way. civil economy has the merit of putting a logic of community welfare, associations, foundations, social cooperatives alongside the traditional welfare provided by the state. from this new viewpoint, welfare be-comes a generative system where the individual citizen is an active entity because on the one hand he receives, while helping to produce services on the other. a process driven by the principle of gratuity, of “giving without losing and taking without removing”, of sharing an individual’s experience and know how made available to all3. 3 relations based on care and no charge represent the typical development of voluntary work, since learning to “take care of others” stimulates capabilities that would otherwise remain dormant. encouraging volunteer work, namely “care of others”, brings the anthropological dimension to the surface forming our existence, and generates the model of “circular subsidiarity” where the private sector, civil society and the public sector work together for the good of collectivity inspired by a new model of cooperative culture. davide maggi, noemi rossi, mazdak faiznia, hirad housmand ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ii. the mission of foundations over the last 20 years, many local authorities have been supported and aided by an «anomalous political player», still relatively unknown in italy: community foundations. they are non-profit agencies driven by a new sense of philanthropy founded on solidarity and the culture of giving. it is not a new model but it was previously linked to the english speaking world. the first community foundation was founded by frederick goff, the owner of the cleveland trust company, on january 2nd 1914 in cleveland, ohio. this has since become one of the leading names in community philanthropy in the united states4. in the 1970s, this model of philanthropy also started to gain ground in europe, especially england. in italy, community foundations were founded after a law was issued to reorganize the italian banking system that brought about a major change in how banking foundations were structured, as banks were now required to make a clear distinction between their lendings and charity work5. there are currently 32 community foundations in italy, concentrated mainly in the north of the country, that aim to recreate a network of communitas along with all the others operating in the territory6. their aim is to collect donations and reallocate them with the ultimate purpose of improving the quality of life of all the people located in a given area. their goal is not to simply accumulate or disburse funds but to collect them and gather resources and expertise in order to promote operations targeting local needs, actively involving public and private actors for the execution of projects useful for society: «they operate both as financial intermediaries and social intermediaries at the same time (ferrucci 2010), and the focus of their work is the donation from and for the same community they intend to develop»7. in circumstances where politics is no longer able to organize itself due to a lack of funds, or sense of community, or for other reasons foundations build a common good thanks to the generosity of the general public. social relations and a sense of solidarity for one’s own local territory enable the building of networks consisting of donors, investors, institutions and third sector organizations based in the area. 4 in 2011, it reported assets worth over 1 billion 800 million dollars and disbursements worth approximately 80 million dollars. 5 the law in question is n. 218/1990, also known as the amato law. 6 these entities were founded in response to an invitation made by fondazione cariplo to the territories: to accumulate assets worth 5 million euros in ten years, by way of an initial input in order to receive a subsequent donation of 10 million euros from fondazione cariplo itself to add to these assets. 7 l. bandera, «le fondazioni di comunità: una nuova declinazione della filantropia», in f. maino, m. ferrera (ed.), primo rapporto sul secondo welfare in italia, turin, centro di ricerca luigi einaudi, 2013, 1. community foundations are established and flourish in environments where a territorial humus is created which is willing to put innovative welfare policies in place. they support themselves thanks to a charity trust fed by donations from the community (bequests, for ex-ample), from private businesses, religious organisations, or other institutions that choose to support the development of these specific entities. this is a type of philanthropy that grows inconspicuously and is by no means outdated; in fact, there is a comeback of this type of approach founded on gifts. italy had always had a longstanding tradition in philanthropic actions that was intentionally destroyed and uprooted after its unification. over the passing years, community foundations have created a democratization process for philanthropy, making it accessible to everyone, even if each foundation has its own specific goals 8 . their principal characteristics include: their wealth is not accumulated thanks to a single, large donation from a single or limited number of players, but is gradually built up thanks to many small and medium donations from members of the public who choose to support specific funds within the foundation itself. respecting the wishes of the donor is a guarantee of security and flexibility in order to encourage donations, to safeguard the philanthropic purpose, and guarantee transparent policies for the protection of donors, foundations offer benefits from the point of view of bureaucracy: any administrative charges and obligations associated with the donation (costs, taxes, documentation, feasibility, etc.) are borne by the foundation and do not fall on the donor. second, the foundation certifies and guarantees the trustworthiness of the beneficiaries, relieving the potential donor of any risk of making contributions to beneficiaries that fail to live up to expectations. third, community foundations allow the donor to change the manner and the beneficiary of their donation at any time, thus avoiding the risk of losing or wasting resources. iii. community foundations in italy: an overview there are an estimated 1,800 foundations based in over 46 countries, with 60% in the usa, canada, australia, and south africa. in italy, these institutions are an expression of civil society and started to gain ground in 1999 as a result of an intuition by fondazione cariplo, which sponsored 15 out of the current 32 community foundations in just 8 years9. 8 l. bandera, «le fondazioni di comunità: una nuova declinazione della filantropia», in f. maino, m. ferrera (ed.), primo rapporto sul secondo welfare in italia, turin, centro di ricerca e documentazione luigi einaudi, 2013, 2. 9 the first italian community foundations to be founded were: fondazione della provincia di lecco and fondazione della comunità comasca in 1999; fondazione della provincia di mantova, fondazione di comunità del novarese, fondazione della comunità bergamasca and fondazione della comunità di monza e brianza in ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 fondazione della comunità veronese was founded in 2010 and is the only one not linked to a banking foundation, as it is the result of the ongoing coordination of its six founder members: the diocese of verona, banca popolare di verona, cattolica assicurazioni, ucid (unione cristiana imprenditori dirigenti), fondazione segni nuovi, and fondazione beato tovini. the general public regard them as supporting local government and acting as a lifeline for the policies in their areas. the sense of affection for one’s own area is what enables foundations to grow and remain in touch with what the territory needs, working with people who are aware of the needs of civil society and are capable of promoting its involvement in order to find the solution for such problems. in this way, a local community marked by lots of different elements, such as its economy, history, and culture, has the possibility to express itself through an institution whose focus is primarily on the territory where it operates. fondazione cariplo has supported more than 30,000 projects offering social benefits, and currently operates in four distinct areas: environment, art and culture, scientific research, and services for people. these foundations are based on the principle of endowment, the initial ad hoc funds provided by fondazione cariplo in order to structure its internal organization in a professional manner. in 2012, the overall assets of the 15 foundations established as part of the community foundations project reached 227 million euros, the equivalent of approximately 3 percent growth compared to the previous year. as well as the first 15 ventures into community philanthropy, other entities have been founded over the years that are worth mentioning on account of their commitment and their operations conducted in favour of social inclusion in their local area. fondazione di comunità del novarese was founded on april 19th 2000 and is the largest in italy with assets worth approximately 23 mil-lion euros divided into 70 funds, consisting of donations from businesses, families, individuals, religious organizations and public agencies that have chosen to give their donations to this foundation alone. the governing body reflects the most significant players in the area: the committee consists of the president of the province, the mayor, the prefect, the bishop, the presiding judge of the court, the presidents of several professional orders 2000; fondazione della provincia di cremona in 2001; fondazione di comunità del varesotto, fondazione della comunità di brescia, fondazione della provincia di pavia, fondazione della provincia di lodi and fondazione pro valtellina in 2002; fondazione comunitaria del ticino olona, fondazione comunitaria del verbanocusio-ossola and fondazione comunitaria nord milano in 2006. (accountants, notaries, and lawyers), the area commissioner for fondazione cariplo, and the president of the chamber of commerce. its powers are limited to appointing the members of the board of directors once every three years, consisting of thirteen directors, three auditors and a general secretary. in general, calls for applications are the preferred tool for supporting projects and safeguarding transparency of delivery to the non profit agencies stipulating this. community foundations have adopted a tool known as “calls for funding”, enabling not only transparency in the delivery of resources but also the multiplication of the amounts. over the last five years, fondazione di comunità del novarese has become less frequently identified for its “money approach” but for taking a line based on a “community approach” instead, similar to the sys-tem in canada where «local difficulties are approached through the creation of community and leadership skills, helping the community to improve how it handles problems». raising funds is not seen as a fundraiser but as a landraiser, a creator of communitas whose efforts are focused on gathering resources in favour or local projects. the virtuous experience consists of identifying difficulties in one’s local environment and of offering concrete projects to overcome them. similarly, fondazione comunitaria del ticino olona invests in education for young adults and in social aid linked to microcredit in support of families at risk of poverty; the “famigliamoci” project promoted by fondazione provinciale della comunità comasca connects non profit organisations in order to produce a single programme at provincial level in support of families in hardship; the “sostenere la genitorialità” project promoted by fondazione di monza e brianza encourages the culture of dialogue in the relationship between parents and children, involving representatives of private social aid, educators, teachers, psychologists and parents. iv. non-governmental and non profit organisations in iran’s history mosques, takaya, religious bodies and cafes are considered by traditional afghan non-governmental organizations, and after that, the funds for borrowing money, charities, islamic associations and even graduation courses in later periods, and then unions, guilds and trade and engineering systems, etc., are more recent forms of civil institutions. the regulations for the establishment and activities of ngos and foundation on february 29, 2005, during the last days of the government of seyyed mohammad khatami, were approved by the ministry of intelligence on the basis of article 138 of the constitution, and were adopted on the basis of article 138 of the constitution. organizations can be ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 networked or join international organizations with the subject of their activities and objectives, in accordance with the rules. obviously, in terms of private non-profit social nongovernmental initiatives before the revolution existed as charity or in a more traditional way related to religious communities. nonetheless, nonprofit organizations with proven social and cultural character remained in quantitative terms in the minority. but instead after the revolution and especially after the law of 2005 and in particular the last 10 years social and cultural commitment on the part of private and non-governmental organizations in many areas from health to education, social finance and charity are growing strongly. numbers show that there are 3049 non-profit organizations which 41% of them are financial institutions of islamic finance, 22% are charity, 14% health, 10% for rehabilitation, and 13% for education and culture. even today, this topic at an organizational and structural level has a long way to go in iran even if it is in a situation of strong growth and development. v. cultural foundations and non-profit organizations in iran. before the islamic revolution non-profit foundations controlled by royal family organizations headed by farah pahlavi has presided over a number of medical, cultural, sports, educational and social welfare organizations. the farah pahlavi specialist office has had forty employees and four sections until 1979, which included: education, healthcare, social welfare and culture and art. obviously, the will of farah pahlavi and her cultural background and her attention to art and culture, coincided with shah’s interests of waking the long and ancient history of the country and restore its power and pride at the international level. also, the socio-cultural situation of iran in that time, and above all the economic position of the country, and the growth of the oil price have created a great atmosphere of the modernization of the country in all aspects, especially through foundations and non-profit cultural organizations, still supervised by the royal family and in particular farah diba. these organizations had a complementary function of the government and with the sovereign control of royal family could achieve their goals faster than the governmental and ministerial organizations that had to go through bureaucracy and… below is a list of some of the art and culture foundations and non-profit organizations that were created or directly related to farah pahlavi's office. the center of intellectual development of young children and adolescents. is a non-profit organization founded in 1965 institute for the intellectual development of children and young adults better known as kanoon is an iranian institution with a wide range of cultural and artistic activities in the field of mental and cultural development for children and young adults. the organization was at the center of the vanguard of cultural production in the late 60s and early 1970s and is the platform through which many of iran's most regarded artists and filmmakers, launched their careers. the program, led by one of farah's close friends lili amir-arjomand, involved building a network of both permanent and traveling libraries across the country in order to pro-mote culture and literacy. during this period, kanoon's publishing consisted only of translating and importing western classics such as hans christian andersen. eventually, kanoon began producing and publishing its own books and soon after grew to be not just a social organization, but also a prolific producer of many kinds of materials for children. many these materials toured with the traveling libraries. within the walls of kanoon, there was an unprecedented amount of freedom and support provided to the artists involved. under these circumstances kanoon turned into a sort of quasi-utopian hub, or incubator or laboratory for an incredible group of artists, many of whom worked across several media (most of the major protagonists were designers and also illustrators and would experiment with animation or filmmaking if they chose to). to have this type venue available at this pivotal moment when iran is transitioning into modernity in terms of its visual culture was absolutely crucial. after the revolution the institution has become a public company, first supervised by the ministry of culture and higher education and then transferred to the ministry of education. the iran cultural foundation. 1964 the iranian culture foundation was a research institution founded to protect, expand, and advance the persian language. the iranian culture foundation was a nonprofit organization with legal personality. parviz natal khanlari was the general secretary of the iranian culture foundation. it was also stated in the foundation's constitution that the iranian culture foundation was founded to promote and expand the persian literature and chestmaster's "cultural heritage of iran. after the islamic revolution, in 1981, the iranian culture foundation and eleven other cultural and scientific institutes merged together, and from all of them, an institution called the institute for cultural studies and research, affiliated to the ministry of culture and higher education, which is now the institute of humanities and cultural studies called. the tehran philharmonic society founded in 1953, nonprofit organization and from 1963 to the supreme chairman farah pahlavi to sup-port the philharmonic tehran income. the tehran philharmonic society was a nonprofit and popular institution and all its revenues were used to expand and popularize scientific music through organizing concerts of the tehran philharmonic orchestra. the tehran philharmonic performed concerts with world-famous musicians and music leaders such as herbert von karajan , jewish manohin, zubin mehta and isak sternan . after the islamic revolution, the philharmonic society of iran, with the support and follow up of dr. abdolhossein mostofi, has been reopening since 1994, and subsequently the tehran philharmonic orchestra, with the determination to create an entrepreneurial and efficient environment for graduate students in music schools and music education centers. ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 the imperial society of philosophy. in 1974, nonprofit organization, farah pahlavi empress of iran commissioned her personal secretary hossein nasr, head of the empress's private bureau, to establish and lead the imperial iranian academy of philosophy. it was the first academic institution to be founded upon the principles of philosophical traditionalism. nasr was a professor of history of science and philosophy at university of tehran. after the revolution of 1979, the activities of the association were suspended until 1982. in 1982, the society of philosophy of iran and 12 other institutes under the supervision of the ministry of science and the institute for cultural studies (institute of humanities and current cultural studies). other and cultural nonprofit foundation under the patronage of farah pahlavi office have been the touss festival (epic traditional arts) the cultures dialogue organization the isfahan festival (popular art) the asian institute of pahlavi university the shiraz/persepolis festival of arts the national association of cultural relations the shahbanou farah cultural society the book publishing and editing foundation the national iranian folklore organization. vi. after the 1979 revolution and the birth of the islamic republic as we mentioned in the previous paragraph part some of the foundations and non-profit organizations after the revolution of 79 have no longer worked but instead most of them with no changes have continued their lives but with a quite radical change. before the revolutions these foundations and non-profit organizations worked in parallel and the complementary part of the government with the partial participation, and supervision of the office of farah pahlavi (royal family), which was quite independent from the government and had a more feasible and quick managerial character, after the revolution of 79 most of these organizations have held the non-profit character at the governmental level, they have become an integral part of the government under the guidance of ministries of their business sector. they have thus become para governmental organizations with the same managerial characteristics of the government that is bureaucratic, less feasible and fairly linked to governmental changes. but considering this para governmental aspect of foundations and non-profit organizations, after the revolution of 79 other art and culture foundations have been stablished, that in some periods they have managed to achieve good results. below are some examples the farabi cinema foundation founded 1983 is governed by the statute of a non-governmental, non-profit organization under the auspices of the ministry of culture and islamic guidance and acting as the executive arm of the ministry in the field of cultural and artistic policy and orientations. in addition to producing and distributing films at home and abroad, the foundation also provides investment and production support, technical services (including lab, editing, sound studio, dubbing, etc.). about 30 percent of the annual production of iranian cine-ma is the product of the foundation. farabi cinema foundation festival office is the organizer of the fajr international film festival, the international festival of children and young adults, and in general any professional film festival held under the guidance of the ministry of guidance in iran. the iranian youth cinema association is the largest filmmaking association in iran, the iranian youth cultural society was established on 1977as a nonprofit organization. it was not officially active before the victory of the islamic revolution, and it has been inactive for some time since the revolution. in 1985, with the changes that took place in the cinema and audiovisual department of the ministry of islamic guidance, in order to promote the national cinema and gain experience in the activities and effects of amateur cinema and in the establishment of the islamic center for film education, the cinema center experimental, farabi cinema foundation and the iranian youth cine-ma association were set up as a platform for the development of a national cinema with a specific mission in the form of consolidated duties for each organization to explore the bright talents of humanity among the youth of islamic countries. rudaki's cultural and art foundation started its activities in november 2003 with the approval of the islamic consultative assembly in the form of non-governmental and nonprofit public institutions. the activities of the rudaki foundation began with the merger of two sets of which the people of tehran and iran became acquainted with these collections for many years. rudaki hall is one of the most equipped and the largest opera houses in iran's musical and theater, which was built by yogiya aftandilians, based on the opalin of vienna in 10 years, and opened in 1965. on the other hand, azadi tower is one of the most memora ble monuments in the world, dating back to 1964 ad. this year, the designation of the symbol of iran was put in place between the architects of our country and eventually the design of engineer hossein amanat, this tower was exploited in 1972, and after the islamic revolution, the ministry of culture and islamic guidance was entrusted. vii. some preliminary findings in conclusion, in an era marked by an economic downturn like now, spreading the experiment of community foundations represents an important driver of development towards innovative forms of second welfare, capable of providing a tangible response to new needs. nevertheless, if banking foundations are capable of playing an important role, politics must retain the precedence of decision-making. not just because their resources are marginal compared to public and private re-sources, but because the funds distributed by foundations can be used for strategic investments, such as interventions in emergency situations, the experimenting of innovative solutions, the deployment of additional resources, ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 raising awareness and advocacy, development of non profit agencies and the promotion of the collective impact. their role must remain ancillary so as not to create “a form of plutocracy”. facilitators but not fixers; change must be guided by politics, which is not measuring up to its duties at the moment, and by civil society and non profit organizations in particular, which concentrate mainly on their operations and are lacking in this point of view. references [1] l. bandera, le fondazioni di comunità in italia: uno sguardo di insieme, percorsi di secondo welfare, may 2012. [2] d. carrera, a. messina, economia e gestione delle aziende non profit, aracne, 2008. [3] b. casadei, “le fondazioni di comunità, valore del dono e funzioni della filantropia”, la rivista delle politiche sociali, n.4, pp. 271-283, 2012. [4] m. franzon, e. pezzi, “le fondazioni comunitarie in italia: sviluppo e tendenze”, queste isti-tuzioni, 158-159 (luglio-dicembre), pp. 136-157, 2010. [5] r. judith, m. brandenburg, the power of impact investing: putting markets to work for profit and global good, rockefeller foundation, wharton digital press 2014. [6] m. meneguzzo, d. carrera, a. messina,“incubatori di impresa sociale, volano di sviluppo”, impresa sociale, 77(1), pp.191-224 2008. [7] oecd, social impact investment: building the evidence base, 2015. [8] world economic forum, from the margins to the mainstream. assessment of the impact in-vestment sector and opportunities to engage mainstream investors, 2013. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 future trends and finance approaches in islamic banking 1 university of turin, italy, sepideh.khavarinezhad@unito.it 2 university of turin, italy, paolo.biancone@unito.it abstract briefly, islamic banking refers to financial activities that are governed by the teachings of the islamic law (quran, sharia) and essentially prevent payments and receive interests. islamic banking today attracts muslim and non-muslim market player. while the global financial tension has created new weaknesses in the international financial system around the world, islamic banking demonstrate symptoms of relative resistance to these shocks. it is even argued that if islamic principles were implemented, it would prevent a financial crisis. despite the fact that the growth of islamic banking in recent years has promising a bright future in this area, it is imperative that islamic financial institutions and islamic banks do many things. islamic banks, which are now focusing on strategic options and basic operations and infrastructure, will be in a more powerful position in order to achieve the intact market excellent opportunities and manipulate the changing dynamics of their industry. keywords islamic banking, conventional banking, market strategy, operational efficiency, finance approaches i. introduction in brief, the existence of islamic banks in the second half of the 20th century came as an offshoot of the newly rediscovered islamic economics [1]. the purpose of islamic banking is to finance activities that are governed by the doctrine of the islamic principle of islam and essentially prevent payments and receive interests [2]. islamic banking today attracts muslim and non-muslim market players. the global market for sharia-compliant financial products is estimated at $ 800 billion to $ 1 trillion. according to international financial services london, by the end of 2008, sharia (religious l-owned assets have risen to $ 951 billion that increase of 25 per cent from $ 758 billion in 2016 and 75 per cent from $ 549 billion in 2018 (the islamic finance industry has grown at an annual rate of 15-20%, much larger than the growth of the traditional financial industry (conventional). islamic financing mechanisms have different alternative forms and transactions from the conventional financial institutions in which they do not deal with interest [1]. while the global financial crisis has created new weaknesses in the international financial system around the world, islamic financial showed an indication of relative resistance to shocks. it is even argued that if the islamic principles were implemented, it would prevent a financial crisis [2]. these sharia principles have a fundamental concept that god is the owner of the whole world as well as the whole wealth. muslims have the right to enjoy their wealth providing that it is realized or invested in a way that is adhering to sharia principles [1]. islamic financial instruments should all follow the sharia dictates.[3] however, some of the effects of the crisis were felt in the industry and exposed vulnerabilities that need to be quickly identified in order to sustain the growth of islamic banking [3]. in spite of the fact that there is no consensus about the causes of the global financial crisis, there are a number of different authors who have made a lot of guesses. some argue that the complex and excessive use of structured finance products, derivatives and other unreliable assets in the wake of the financial crisis is to blame. others argue that monetary policy, financial supervision and easy regulation combined with surplus leverage and credit growth are fundamental factors that triggered the crisis. all of the above items require prudential regulation and supervision. the lack of supervision and regulation in the financial sector played an important role in the financial crisis, which led to poor liquidity management. islamic banking, as a solid industry, faces many challenges. for example, the lack of effective regulatory frameworks, standards and guidelines, decent manpower, effective government support, regulations and prudential supervision, risk management and external auditing for islamic banks are challenges facing the industry for future growth. the methodology of this study is documenting analysis with a comparative approach. secondary data has been collected through manuals, religious texts, islamic finance related websites, guidelines issued by various regulatory bodies, guidance note suggested by various institutes, legal provisions in the legislation of several countries and various research papers were reviewed and their findings were used as a secondary data to expand this paper [4]. sepideh khavarinezhad1, paolo pietro biancone2 ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 this paper is organized as follow: we conduct in section ii, according to the mentioned comprehension, the growth trend of islamic banks has been investigated from the profitability factor. in section iii, scrutiny the challenges faced by islamic banks. in section iv, proposed the most important markets that operate are in accordance with islamic law; in section v, competition between these banks and conventional banks is examined in terms of customer-centric approach; in section vi, presented derivatives islamic instruments and its challenges have been raised and some examples of islamic banks have been mentioned. in section vii, presents prospects and opportunities for better efficiency and solutions to improve the performance of executive management, create opportunities, and achieve effective efficiency. at the end of the paper in section viii, we have collected and concluded the discussed issues. the strategy of this paper focuses on finding a position and attaining sustainable growth through more efficient use of opportunities and opportunities. ii. islamic banking dynamics a closer look reveals that dynamics and market forces are changing, and two key indicators in the islamic banking industry indicate the need to review strategies in this industry: figure 1: the difference between growth in islamic banking and banking assets (%) source: bank negara malaysia (2018) figure 2: cost to income ratio source: bank negara malaysia (2018) islamic assets of conventional banks are considered in the level of conventional banks because they are considered to be the yield of the conventional bank[4]. 1. slow growth current after several years of rapid growth in which islamic banking surpassed many of the conventional banks, the growth of asset differentials in key geographic districts, including saudi arabia and the united arab emirates, was stopped. soon, growth in islamic banking can be reduced due to the full market, and islamic banks will lose their "normal" share[5]. although current data are non-deterministic, they can be considered as a primary indication. 2. reduced profitability although islamic banks have surpassed conventional banks in terms of growth in recent decades, they are not higher to profitability. for example, many small islamic banks in the gcc have been struggling to profitably for many years; some have also suffered from a regional economic crisis that is mentioned in the "islamic banking challenges" section [6]. most importantly, some important islamic banks, especially gcc, have seen a drop-in margin in the last five years. in order to maintain profitability, the ability to increase the capacity of islamic banking, especially those that have not yet been exploited, is essential. from a strategic point of view, this means that islamic banks, which so far only imitated conventional banks, need to rethink their position [7]. from an operational point of view, islamic banks need more efficiency over their value chain. iii. the challenges of isl1amic banking considering the slow growth and the reduction in the profitability of islamic banking, we will address some of the major challenges facing this industry. 1. the size it has been observed that many islamic banks are smaller than their usual rivals in their domestic markets. so that even the major’s islamic banks are usually compared to conventional international competitors. [8]. in fact, there is no islamic advance bank in the world that has a particular islamic or broad-based business model [9]. 2. competition although the growth of the market is declining, the number of islamic banks and financial institutions is on the rise. for example, the only new banking licenses issued in the united arab emirates in recent years have been for islamic banks, while conventional banks are opening up and providing islamic instruments. consequently, it is not a significant distinction only in accordance with the sharia[10]. 3. standardization and legislation standardization and legislation are the constant challenges of islamic banks. different perceptions of accepting various products from the sharia perspective make standardization difficult. for example, an islamic financial instrument can be accepted by a group of angels and rejected by another group, because the sharia and jurisprudence decrees issued by these ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 jurists are based on their personal perception and jurisprudential rules[2]. moreover, there is a difference in the admission of products and services between southeast asia and the middle east and now, an approach has emerged. as the bank of nigeria (the central bank of malaysia) avoids selling gcc-denominated banking products to increase standardization in the industry; legal issues could also arise from the absence of specific islamic banking laws in some countries[11]. 4. cost structure most islamic banks, despite the dramatic growth, have not been continuously profitable, especially after the global banking crisis. part of this defect is the structural factors. because islamic instruments are usually more complex than conventional tools, which increases the cost of providing and producing these services[12]. banks' specific weaknesses, for example, risk management and operational efficiency, also contribute to this issue. iv. overview of the market islamic banking financial activities in accordance with sharia and jurisprudence and islamic law have become part of the global financial services industry, which has seen rapid growth both in size and in terms of structure[2]. the total islamic assets in 2016 are estimated at around $ 1200 billion. islamic bank assets account for about 90 per cent of this figure, while islamic capital accounts for 10 per cent of the remainder. the main geographic markets are iran, saudi arabia, united arab emirates, malaysia, kuwait, qatar and turkey (figure 3). figure 3: the eight core markets are the growth engine for global industry and require tailored strategies. sources: central banks, ey analysis (2018) in recent years, islamic banking has had a significant growth rate. for example, the combination of the annual rate of growth (cagr) in saudi arabia was 21% between 2006 and 2010, and in malaysia, it was 24%. markets in the form of the influence of islamic banking (the number of islamic banks' assets as a percentage of total bank assets) can be divided into three main categories: fixed, emerging and intact (table 1). the consolidated category of islamic banking in the middle east and southeast asia comes with some of the most active global markets like kuwait, saudi arabia, the united arab emirates and malaysia. emerging markets such as pakistan and indonesia have a large muslim population and with this in mind, it is expected to have a good perspective in the future. similarly, large and untapped markets like india are considered to be a tremendous asset for courageous investors. sources: company financial reports, ey universe, ey analysis (2018) at present, there has been no effective step in promoting the expansion of islamic banking. from a strategic point of view, markets like india are a great opportunity to develop. the three main types of actors in the islamic banking industry are noteworthy: islamic banks and islamic financial companies. all islamic banks or institutions are entirely independent or are under the umbrella of conventional banks, with islamic instruments, are abandoned and isolated in islamic banking, which are placed within conventional banks.[13] islamic financial institutions focus on providing financial instruments based on jurisprudence and religious law, such as housing and automobile financing, and are not allowed to receive interests. 1. is there a market or niche market? basically, islamic banks have two strategic options ahead: the exploitation of the islamic banking niche market in full contrast with conventional banks before moving on any of these paths, by adopting a mixture of both strategies, we present concepts from each of them[8]. 2. exploitation of the niche market the full exploitation of the niche market is intended to target segments of customers who are heavily involved in financial transactions in compliance with religious law. as well as the provision of products and services that not only address public financing but also the specific needs of muslim customers. while islamic banking services are plentiful in banking (for example, auto loans and credit cards), while there are vacancies in some more complex and advanced areas (for example, asset management and wealth management), such products that are ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 appropriate to the specific needs of muslim customers, provide a ground for actual distinction [14]. in microfinance, target customers can consist religious conservatives, clerics, endowment organs, or members of the islamic ministries of justice. an example case of a microfinance product that is specific to muslims is the financing of pilgrimage to hajj pilgrimages. this service is also suitable for clients who commonly consider less importance in their finances to comply with religious law. such products are now existing in some muslim countries; for instance, the tabung banking in malaysia and brunei[15]. in personal banking, the objective sectors may comprise the holders of halal industries. providing expert consultation to people with great particular worthwhile sketching for the endowment can be a various and specific service in this section. in corporate banking, the target sectors could include islamic philanthropy foundations and the halal industry[16]. asset management for endowments, funded by western organizations, purchased by private companies based on religious law, can be considered as an essential service in the field of islamic banking. in institutional banking, other financial institutions can serve the purpose of providing specialized banking services to support the development of islamic financial activities. on the other hand, the full exploitation of islamic banking requires attention to pricing. since target customers are less willing to accept conventional banking products, islamic banking products can be priced at a higher price than conventional products, provided they remain competitive among islamic products.[15, p. 04] maintaining a personal relationship in gaining "loyalties to islamic banking is important, and this means providing bricks and cement (physical) branches where the line staff can faceto-face meetings with customers[17]. at the same time, non traditional methods to reach customers through alternative ways, like the phone bank, should also be taken into consideration[18]. in addition, the social responsibility of the organization, for example, to support local community associations and the establishment of islamic philanthropy foundations, can be strongly requested by islamic banking customers. some international banks have islamic effects in many countries, for example, hsbc annual in malaysia and some islamic banking communities that are resident in the gcc have significant geographical envelopment[19]. although some banks focus on the same country, geographic extension is considered an opportunity for growth for centralized banks on niche market. there are good markets outside malaysia and the gcc, including emerging markets with a majority of muslim populations, like indonesia and iraq, and rich and developed markets with muslim minorities like germany and france. in these two countries, venture cooperatives can be the best entry strategy [18]. market vacuums are very diverse so that opportunities to meet the specific needs of muslim customers with special banking outcomes consistent with fundamental islamic values are still not developed and provide adsorbent areas for development and profit for those who are keen on exploiting niche market [20]. 3. face-to-face competition with conventional banks it is the obvious that many islamic banks challenge versus their competitors. at the same time, everybody does not notice that the face-to-face strategy is essentially different to the strategy of exploiting the niche market islamic banking. competition against conventional banks means attracting customers who are less important in their financial activities to comply with religious rules and pay more attention to competitive products and effective services in the banking market[21]. there are three key principles in targeting the customer segments. first, identifying the segments of the customers who have the least openness to islamic banking (to prevent). second, identifying sectors that are not fully compliant with religious law (to understand the shortcomings) and third, identify the sectors open to ethical banking (to reach muslim and non-muslim audiences [17]. v. increasing competition and the need for customer-centric approaches in islamic banks the attraction of these customers’ needs to satisfy a wider range of customer needs and, therefore, due to the ease of use and reasonable prices compared to conventional banks. to achieve this goal, product innovation in the form of expanding services using existing islamic structures and the design of new islamic structures has a special priority [22]. financial services and products for small and medium-sized enterprises appear in emerging islamic banking and moral banking products, investment in sustainable energy, are an opportunity to expand the range of services provided. the structures of new islamic banking products do not easily fit with religious rules. these include covert funds (a speciality of alternative assets for individuals with a net asset value and derivative instruments for corporate and institutional customers. although some islamic banks provide islamic derivative instruments, such tools, in general, they are not accepted as products based on religious law [12]. islamic banks are usually at a disadvantage in competing with their conventional counterparts because they usually have smaller sizes (figure 4). for example, in microfinance, the extent and scope of the network are more dramatic [20]. to compete successful, focusing on two areas is essential. first, islamic banks should pay attention to using alternative ways likewise, internet banking and mobile banking to attainment market contribution. applying these as a sales channel is superior to focusing on services that are already customary. second, the use of ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 different branch patterns should be investigated according to the needs of target customers. these patterns include a range of service delivery, focusing on a wider range of customers, to complete branches that cover all customer segments. alternative subsurface patterns have other advantages, which include reducing investment costs, operating costs, and deployment times and, if combined with alternatives, will be very powerful. a new and customer-focused illustration that emphasizes ethical and social values or environmental efforts will reach the largest collection of muslim and non-muslim audiences [23]. therefore, training programs on islamic banking products and structures are also needed. when facing with the conventional banks, the first step before the international expansion is to build a strong domestic foundation. integration and ownership provide intriguing opportunities for achieving synergies related to scale from wider operations. [24] strategic integration and ownership of islamic banks allows the expansion of their branch networks, the exploitation of synergies operational and financial penetration is more effective than conventional banks[10]. figure 4. the size of conventional banks compared to islamic sources: central banks, ey analysis (2018) vi. derivatives islamic instruments combination tools are very common in islamic banking. some experts in the islamic banking industry condemn these tools because they consider these tools to be incompatible with religious principles [25]. they believe that a delay in bilateral commitments to future time is implied in the debt swap ruling without the transfer of an initial asset, which is considered to be the probability of a transaction speculated. this is the most important reason for the rejection of derivatives instruments in the muslim world, especially the gulf states. at the same time, some of the leaders of the islamic financial functions industry need to understand the need to manage the potential risks and potential benefits of their tools to cover. for example, the central bank of malaysia (negara), which has always been the defendant of mentioning and providing derivative instruments in islamic banking, assigns that with the juridical, regulatory and corporate governance framework, the islamic finance system can be reclaim and expanded[26]. the bank presented the first islamic international instrument settlement to document islamic transactions in 2007. the malaysian bank also introduced the first islamic-derived yield in 2005 (the exchange rate for islamic interest). another milestone is for tahawwat's islamic derivative instruments, which were presented by the islamic international financial market in 2010 (a bahraini standardization standard for islamic money and capital markets and the international association of swaps and derivatives instruments) [25]. contracts, including modaraba, mosavama, indicate which of the parties can obtain into risk management adjustments for covert funds, standard anatomies and documentation[2]. these new standards, if broadly accepted, could strengthen the market for islamic derivative. presently, malaysian banks and main international banks present islamic derivatives. the most comprehensive of these instruments is the swap of the islamic interest, exchange swaps, exchange rate swaps, futures contracts and structured products of shares of islamic instruments, unlike traditional instruments, cannot be traded because their goal is only to cover and not speculative tools. reducing development and profitability shows that the time has come to exploit the potential of islamic banking. in this regard, islamic banks should inspection their tactical position and increment their functioning efficiency[27]. over the years, multitude of islamic banks have experienced a two-digit growth rate that surpassed their rivals in conventional banking. at first sight, everything looks good for banking. there is abundance of circumstances for growth and advancement, as islamic banking, even at the gulf cooperation council (gcc) and malaysia, seldom soars a third of the universal market quota. many potential markets that are full of muslim populations (such as india and the commonwealth of independent states (cis) from the former soviet union remain intact[22]. in addition, the general influence of banking on multitude grand industry markets are still slight. for example, the gcc countries have not yet attained the level of banking in countries such as france and britain. meanwhile, several emerging markets have been opened up to islamic banking [22]. vii. opportunities for improving efficiency an islamic bank pursues any strategic position, requires more efficiency for processor activities to adding value. like other gcc banks, crucial areas include sales advantage, operational efficiency, and efficiency management. 1. focus on the customer the number of banking products and income per client in the gcc remains comparatively low compared to developed markets. customer euphoria is a vital element in expanding the market share of banks, while studies have shown that gcc ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 banks do not care about customer satisfaction as a priority. the three main areas for improving customer focus can be:  workers: line staff (sales staff have a very limited knowledge of the services and products they provide), which is more common in islamic banking, while that islamic banking customers need additional explanations for sharia-based structures and products. there is also a need to improve responsiveness, for example, customer contact at the right time.[2]  information: when customers have important information about a product before do not buy, usually leads to serious and lasting damage to brand loyalty (for example, awareness of additional costs after purchase)  contact facilities: customers usually have a limited number of calls centres or services and often go from part to another. there are only a few islamic banks that have a many-sided client relationship perspective. improving client service begins with a framework in which consistent with all features of the institution (people, culture, performance metrics, processes, and infrastructure). when the rivalry escalates, a more intelligent, complicated and customer-centred approach to islamic banks is needed. redesigning sales staff and shifting the focus from product to customer segments, improving skills and sales techniques, and deploying multi-channel delivery through organizational coordination will maintain costs down and increase customer satisfaction. preserving a viewpoint towards the customer in all aspects has a specific advantage. 2. operational efficiency most of banking processes in the gcc are still handy, with numerous paper documents and layers of decision making. this issue is very difficult in islamic banking because there is always a transfer of an asset in islamic banking[28]. redesigning processes can bring significant improvements and, even in some cases, reduce resource requirements by up to 50%. in spite of the fact that automation is very significant, it is not consistently obligatory, especially considering the low cost of working in the gulf cooperation council. targeted it investments are significant because they align the all organization with respect to the strategy and recapitulation of the structures and can dramatically improve performance. outsourcing offer options for focusing on business processes, developing service surfaces, and raising controls. despite the fact that is a relatively new concept in the gcc, many regional banks have successfully outsourced their relatively simple processes to india and egypt. a structured approach to product design and offering (cost analysis and cost savings identification for strategic and functioning costs can decrease costs in some cases by up to 30 %.) 3. performance management supervising and rewarding the most successful people are the clue to improving performance surfaces. remunerations can be financially, career progression, or introduction of people in an organization[23]. an appropriate and structured motivational system can be a powerful tool for maintaining employees, especially in islamic banking, which has a deficiency of experienced human resources. the key factor here is the direct linking of rewards to implement actions that have already been defined at employee level (so that improvements can be made at a high cost). viii. summary and conclusion this study, however, focused on the islamic banking segment only; and noted that there are also new instruments for financing and capital market products, islamic banks were among the first categories of financial institutions that emerged in islamic financial services industry. as this industry expanded, and as the conventional financial sector in mena countries diversified into capital markets and other segments, many islamic non-bank financial institutions and services also emerged in islamic finance. now the islamic financial services industry is not only composed of islamic banks but also includes investment and mutual funds, project finance companies and takaful institutions.[26] the growth of islamic banking in recent years has promising a bright future in this area. but along with increasing competition and some recent signs of this growth has declined, so it is necessary for the financial institutions and islamic banks to do many things. in islamic banking, with any strategy that a strategy focuses on locating in the context of, or competing with, conventional banks either face-to-face or a combination of both, sustaining growth requires more efficiency along the supply chain. the islamic finance industry is in the midst of a phenomenal expansionary phase, exhibiting average annual grown rates of about 15 per cent in recent years. this rapid growth has been fueled not only by surging demand for sharia-compliant products from financiers from the middle east and other muslim countries but also by investors around the world, thus rendering the expansion of islamic finance a global phenomenon[8]. new product innovation is also driven by domestic banks’ interest in risk diversification. with a large number of new islamic banks across the middle east and asia especially, diversification of products enables banks to offer the right product mix to more sophisticated clients. a few banks are already active across different jurisdictions, and this trend is certainly going to continue in the near future with possibly some consolidation. infrastructure plays an important role in supporting a nation's economic growth [29-31]. islamic banks, which are already focusing on strategic and basic operations and infrastructure, will be in a more formidable 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[9] muhammad ridhwan ab. aziz, introduction to islamic institutions in economics and finance. bandar baru nilai: usim publ, 2012. [10] t. beck, a. demirgüç-kunt, and o. merrouche, “islamic vs. conventional banking: business model, efficiency and stability,” p. 44, 2010. [11] m. a. el-gamal, “a basic guide to contemporary islamic banking and finance,” p. 49. [12] y. abdul-rahman, “islamic instruments for managing liquidity,” vol. 1, p. 7. [13] “world islamic banking competitiveness report 2016,” p. 68. [14] p. imam and k. kpodar, “islamic banking: how has it expanded,” emerging markets finance and trade, vol. 49, no. 6, pp. 112–137, nov. 2013. [15] a. samad and m. k. hassan, “the performance of malaysian islamic bank during 1984–1997: an exploratory study,” ssrn electronic journal, 2006. [16] a. m. bohari, c. w. hin, and n. fuad, “the competitiveness of halal food industry in malaysia: a swot ict analysis,” no. 1, p. 9. [17] m. amin, z. isa, and r. fontaine, “islamic banks: contrasting the drivers of customer satisfaction on image, trust, and loyalty of muslim and non‐muslim customers in malaysia,” international journal of bank marketing, vol. 31, no. 2, pp. 79–97, feb. 2013. [18] m. rezaei, “islamic accounting laws or islamic laws in accounting,” p. 8, 2018. [19] m. h. kadri, “islamic financial reporting: evidence from malaysia,” ssrn electronic journal, 2016. [20] h. ahmed, “financing microenterprises: an analytical study of islamic microfinance institutions,” islamic economic studies, vol. 9, no. 2, p. 38, 2002. [21] h. amin, a. rahim abdul rahman, s. laison sondoh, and a. magdalene chooi hwa, “determinants of customers’ intention to use islamic personal financing: the case of malaysian islamic banks,” journal of islamic accounting and business research, vol. 2, no. 1, pp. 22–42, apr. 2011. [22] s. a. srairi, “cost and profit efficiency of conventional and islamic banks in gcc countries,” journal of productivity analysis, vol. 34, no. 1, pp. 45–62, aug. 2010. [23] m. f. akhtar, k. ali, and s. sadaqat, “liquidity risk management: a comparative study between conventional and islamic banks of pakistan,” vol. 1, no. 1, p. 10, 2011. [24] s. a. metawa and m. almossawi, “banking behaviour of islamic bank customers: perspectives and implications,” international journal of bank marketing, vol. 16, no. 7, pp. 299–313, dec. 1998. [25] o. i. bacha, “derivative instruments and islamic finance: some thoughts for a reconsideration,” p. 34, 1999. [26] s. s. ali, “islamic banking in the mena region,” p. 45. [27] w. poon, “users’ adoption of e‐banking services: the malaysian perspective,” journal of business & industrial marketing, vol. 23, no. 1, pp. 59–69, dec. 2007. [28] h. s. a. mokhtar, n. abdullah, and s. m. al-habshi, “efficiency of islamic banking in malaysia: a stochastic frontier approach,” p. 34, 2006. [29] p. p. biancone and m. radwan, “sharia-compliant financing for public utility infrastructure,” utilities policy, vol. 52, pp. 88–94, jun. 2018. [30] biancone, p., & secinaro, s. (2016). the equity crowdfunding italy: a model sharia compliant. european journal of islamic finance, 5, 1-10. [31] secinaro, s. (2017). equity crowdfunding sharia compliant (vol. 1). g giappichelli editore. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) the taxation of sukuk in the italian context: is italy’s tax system ready for islamic financial instruments? (*) university of turin, italy alberto.franco@unito.it (**) ughi e nunziante law firm, italy – csallustio@unlaw.it abstract— this article is focused on the tax treatment of sukuk, one of the most important financial instruments compliant with shariah principles. in the first part, the authors make a brief analysis of eu countries that have adopted specific legislative or regulatory measures to solve some tax critical points that usually discourage the use of the sukuk. in the second part, these financial instruments are examined from an italian income tax standpoint. the analysis is conducted not only in light of current tax legislation and praxis but also with reference to possible future developments. in this perspective, the authors examine some critical issues such as the lack of guidelines coming from the italian tax authorities and the uncertainties on the application of the italian general anti avoidance rule. keywordssukuk; taxation; financial instruments; italy i. introduction among the islamic finance, sukuk undoubtedly constitute the “crown jewels”, because such instruments create a framework for participation of a large number of people in financing project in public and private sectors according to various models and structures [1]. in general terms, sukuk (which is the plural form of sakk, certificate) are islamic financial certificates that complies with shariah principles and laws. investment sukuk, as defined by aaiofi, are the certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity. even if sukuk are often defined as “islamic bonds”, it must be pointed out that their structure differs from a typical bond structure. in fact, the definition above includes two important points: a) sukuk holders must have the ownership of the asset of the specific project, and b) the project and the sukuk issuance procedure must be consistent with shariah principles. furthermore, in order to understand the basic functioning of sukuk at least five shariah principles must be taken into account [2]: 1. the prohibition of riba interest, i.e. any added amount paid, as cost of borrowing, by the borrower to the lender more than the principal amount. this principle implies that a sukuk cannot have the “typical” bond structure, because of the prohibition of interest repayments to the lender; in fact, according to shariah, money is just a mean of exchange and has no intrinsic value, so an individual or an institution should not be able to generate income from money; 2. the prohibition of gharar, i.e. uncertainty or speculation. the trading under uncertainty in financial transactions is not allowed, but risk-taking is allowed when all terms and conditions are clearly stipulated and known to all parties; 3. the use of asset-backing, i.e. each financial transaction must relate to a tangible and/or identifiable underlying asset, ensuring that islamic banks remain connected to the real economy. in this perspective, sukuk can be divided in two main categories: asset-based sukuk and debt-based sukuk. only the former can be tradable, while the latter are not tradable (except on par value, with no profit for the seller); 4. the prohibition of haram investments, i.e. any transaction that involve alcohol, pork, prohibited drugs, and pornography; 5. the prohibition of maysir, i.e. all transactions that have the element of gambling and are based merely on chance are not allowed. according to recent information, italy would soon enter in the islamic finance (if) market, and the italian parliament is going to discuss a proposed legislation on sukuk that might allow a significant development in the use of such instruments, which at the moment are limited by the financial legislation (and by some tax issues, as described below) [3]. as a consequence, it is particularly important to examine the italian tax framework potentially applicable to sukuk, also in connection with the systems of some eu member states which have already implemented guidelines or rules concerning such instruments. in the following paragraphs the aforementioned aspects are be examined, firstly with a brief analysis of eu countries that dr. alberto franco* and dr. carlo sallustio** http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) have been adopted specific actions (legislative or regulatory) in order to set out a general perspective for the taxation of sukuk, then particular attention is paid to the italian situation, also with reference to possible future development1. ii. taxation of sukuk among the eu: a “conditioned” substantial approach from a tax standpoint, the analysis of the sukuk treatment mainly concern two aspects: a) the taxation of the sukuk remuneration in the hands of the holder, and b) the deductibility of the sukuk remuneration paid by the sukuk issuer. in fact, from a tax perspective, the treatment of interest and dividends is very different, due to the fact that, in general terms, the former are deductible from the taxable income of the payer and taxed in the hands of the recipient, while the latter are not deductible for the payer and they are taxed (even if with particular mechanisms in order to avoid double economic taxation, such as total or partial exemption) in the hands of the recipient. nevertheless, for some hybrid financial instruments there is also a mismatching problem. in fact, in case an instrument is considered by the legislation as a share for the issuer and as an obligation by the holder, it is possible that the remuneration would be non-deductible (as it is considered similar to a dividend) for the former and taxed as an interest from the latter. on the contrary, there would be also the non-taxation case, e.g. a remuneration that is deducted as an interest by the payer, and it is fully or partially tax exempt (as a dividend) in the hands of the recipient. in light of the cases above, it is crystal clear the reason why some countries have issued specific rules and criteria in order to clarify the tax treatment of sukuk, also because the uncertainties in the taxation of such instrument could represent a significant obstacle to their development. in this respect, it is noteworthy to remark that two approaches can be recognized among european countries that have explicitly addressed the taxation of islamic finance. the first approach consists in providing only some clarification by the tax authorities, without issuing or modifying the relevant legislation on taxation of financial instruments, such as in luxembourg and france. with reference to luxemburg, tax authorities admit that, if an income is substantially an interest, such income may be taxed according to its economic nature, i.e. as an interest, despite its legal form, only if certain conditions are met2. 1 please note that the following analysis relates only to direct taxation aspects from an italian and comparative standpoint. also, cross-border issues are not considered. 2 in particular, this approach is allowed only if all the following conditions are met: france has also adopted tax measures to promote islamic finance. in 2009 french tax administration issued five guidelines [5], which tend to make sukuk comparable to conventional bonds, and the remuneration paid to the holder comparable to interest, if certain conditions are met3. after this first guidelines, the french tax administration has put in place an industry consultation and has updated the criteria provided with the aforementioned document in 2010 4; some further clarifications have also been provided in 2012 [8]. the second approach consists in adopting an ad hoc legislation on islamic finance and sukuk, with significant innovations and modifications to the relevant tax rules. this approach has been followed by countries such as united kingdom and ireland. the contract between the parties must clearly demonstrate that the financier acquires the property to resell it, concurrently or within a period not exceeding six months, to his client; the contract must show separately the remuneration of the financier as a result of his intermediation, the benefit of the financier constituting the consideration for a deferred payment, the purchase price by the customer and the purchase price of the asset by the financial resources; the benefit of the financier must be clearly explained, known and accepted by both parties to the contract; the benefit of the financier must be expressly designated as the consideration for the service rendered by the financier to the customer and which results from the actual deferral of payment made to the investor. for example, it may be a clause presenting the profit as "the consideration for the deferred payment granted to the buyer by the seller, the buyer undertaking to pay the seller the profit until the date of final reimbursement "; as for the accounting and tax treatment, the profit must be spread by the financier on a straight-line basis over the deferred payment period, regardless of the repayments made [4]. 3 more in detail, if all the following conditions are met, sukuk could be considered to be debt instruments and t the remuneration could be deductible the taxable income of the issuer: (i) sukuk should entitle their owners to be reimbursed before the shareholders of the issuer; (ii) sukuk should not grant any voting right or any right in the liquidation profits to them; (iii) the amount of the remuneration paid to investors should be based on the underlying asset and remain limited to a market rate with a markup; (iv) the reimbursement of sukuk may be partial [6]. 4 guideline 4 fe/s2/10 of 24th august 2010. the 2010 guidelines analyze a specific type of sukuk, the sukuk ijara (i.e., the sukuk involving the lease of an asset), and they adopt the same approach of the 2009 guidelines. more in detail, according to the 2010 guidelines the income distributed to sukuk ijara holders is considered interest income if the sukuk ijara qualifies as a debt instrument under french tax law, and a sukuk ijara will qualify as a debt instrument for french tax purposes only if the holders are repaid in the event of liquidation or insolvency proceedings before the partners/shareholders and equity holders of the issuing entity; the holders do not benefit from the rights generally attributed to shareholders and as such have neither voting rights nor rights to a liquidation dividend in the event of the liquidation or winding up of the issuing entity (except in the event where the sukuk ijara would be converted into equity rights); the income received by the holder depends on the revenues generated by the financed assets or the results of operations of the issuing entity, but this income must be capped at a recognized market rate (euribor, libor, etc.) plus a determinable margin. the income distributed to the holders may be nil depending on the profits of the issuing entity or the return on the assets. however, an income target may be specified to the holders; and the principal of the sukuk ijara may be repaid only in part in the event where the value of the financed assets has fallen, but the right to the repayment of the principal may only be reduced proportionally to this decline in asset value. on the contrary, if one or more of the previous conditions were not met, the sukuk ijara would qualify as an equity instrument, and consequently the remuneration paid to the holder would be deemed be a dividend [7]. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) as for united kingdom, the uk legislation has adopted ad hoc tax rules generally based on the substance, rather than on legal form. an update of the legislation was necessary due to the absence of a doctrine on substance-over-form in uk tax law: in fact, such country generally taxes transactions according to their legal form “so the legal manner in which a transaction is structured and documented determines the taxation of that structure, unless there is a specific statutory provision to the contrary” [9]. such rules establish a category of transactions called “alternative finance arrangements” which embraces sukuk and several other transactions (murabaha, mudaraba, musharaka and other financial structures). in order to avoid abuses, these provisions are used in duly substantiated cases, in which the borrower effectively receives financial funding from a bank or by a person duly authorized to carry out lending activities. the corollary of this substance-over-form principle entails that the proceeds from the islamic finance transactions are treated, for tax purposes, in the same way as interest paid in consideration of a loan5. in fact, also in the uk tax system, provided that certain conditions are met a sukuk is treated as a security for corporation and income tax purposes6 . 5 changes in the uk legislation have been implemented by stages. the first significant change happened in 2003: the finance act 2003 introduced some reliefs in order to prevent multiple payment of stamp duty land tax on islamic mortgages. afterwards, the finance acts 2005 and 2006 have been implemented further measures directed to put other islamic products on the same tax footing as their conventional counterparts. moreover, the finance act 2007 has clarified the tax framework of sukuk. in particular, the section 53 of the finance act 2007 provides that the payments made by a customer to a sukuk issuer, other than the amounts paid for the customer’s gradual acquisition of the beneficial interest in the property, is treated as an alternative finance return and consequently taxed as interest. this puts this financial instrument in the same position of a classical securitization, because the withholding tax is not applicable. in particular, the proceeds deriving from murahaba operations shall qualify as income assimilated to the interests (and subjected to the same tax regime), as fruits resulting from commissioning available to an economic capital, rather the same way as capital gains. same treatment is provided to income arising from operation of mudaraba, which, although resulting from a form of joint venture, are not treated as dividends or profits from investments, but also fall between the income and similar interests. the tax assimilation is now complete, because to incomes from islamic finance are subjected to the same provisions concerning similar financial instruments and involving withholding taxes, transfer pricing, etc. [10]. 6 in particular, those provisions apply to arrangements if: – they provide for a person (the holder) to pay a sum of money (the capital) to another (the issuer); – they identify assets, or a class of assets, that the issuer will acquire to generate income or gains directly or indirectly (the bond assets); – they have a specified life (the bond term); – the issuer undertakes to: dispose at the end of the bond term of any bond assets which are still in the issuer’s possession; make a repayment of the capital (the redemption payment) to the holder during or at the end of the bond term (whether or not in instalments); and pay to the holder other amounts on one or more occasions during or at the end of the bond term (additional payments); – the additional payments do not exceed a reasonable commercial return on a loan of the capital; – the issuer arranges for the bond assets to be managed with a view to generating income sufficient to pay the redemption payment and the additional payments; ireland has also introduced a specific legislation concerning sukuk and other transaction (murabaha, musharaka, and mudaraba). more in detail, the finance act 2010 has provided that, with reference to sukuk, the investment return will be treated for purposes of irish tax law as if it was interest on a security, and the investment return will be charged to tax accordingly, only if certain conditions are met [12]. in light of the above, both with reference to the taxation of sukuk in the hands of the holder and to the tax deductibility of the sukuk remuneration paid by the issuer, the main issue in all the countries which address this topic seems to be whether, and under which circumstances, the economic substance or the juridical form prevails. in the above-mentioned countries, the prevailing approach seems to be a “conditioned” substantial approach. in other words, those countries generally allow a substance-based taxation of if instruments (also because a taxation based merely on the legal form is seen as potentially distortive) but only if certain condition are met, in order – mainly – to prevent possible tax avoidance by the abuse of this approach and to avoid (positive or negative) discriminations among financial instruments. from an italian standpoint, bearing in mind that no clarification has been given so far on if instruments (neither from the tax administration nor via ad hoc legislation), the general rules on taxation of financial instruments would apply. as a consequence, in the next paragraphs the italian tax treatment of financial instrument issuers and holders is examined, in order to point out some considerations about the taxation of sukuk in such context. iii. the italian tax framework for financial instruments as mentioned above, while several european jurisdictions, as described in the previous paragraph, have taken actions to encourage the development of shariah-compliant transactions also by means of a non-discriminating tax framework7, italy has not adopted so far neither specific legislative provisions nor explicit clarifications (in form of circular letter or resolutions) by tax administration, even if a law proposal has been recently filed with the italian chamber of deputies [14]. therefore, from an italian perspective the tax treatment of sukuk must be determined according to the general rules applicable to financial instruments [15]. while other tax systems (such as anglo-saxon and northern europe countries) provide for a unique income category of financial income, without any further division or partition [16], under the italian income tax code (testo unico – the holder is able to transfer its rights under the arrangements to another person (who becomes the holder as a result of the transfer); – the arrangements are listed on a recognized stock exchange; and – the arrangements are treated in accordance with international accounting standards, wholly or partly, as a financial liability of the issuer [11]. 7 different jurisdictions have taken action in order to enable the execution of transactions in line with the dictates of shariah through the preparation of a favorable regulatory framework, both in legal and tax. the uk was the first european jurisdiction to adapt its tax legislation in order to allow the execution of transactions in line with the precepts of shariah [13]. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) delle imposte sui redditi, tuir) taxation of financial income for non-business subjects is based on two income categories, depending on the “static” or “dynamic” use of capital. more in detail, the first is considered “investment income” or “income from capital” (redditi di capitale), and it includes all the income derived by a mere “static” use of the capital, as interest and dividends, in which the remuneration is the consequence of the productivity of the capital. on the other hand, the “dynamic” use of capital refers to those cases in which the emersion of positive or negative differences in dependence on an uncertain event is possible, such as capital gains and losses (art. 44, par. 1, letter h, tuir). on the contrary, for business entities income from capital and capital gains/losses are generally included in the determination of the taxable income, as all the income derived in a business activity is considered business income and it is subject to corporate income tax. in light of the considerations made above, the main issue seems mostly related to the investment income category, due to the fact that from tax purposes it is crucial to ascertain when, and under which conditions, a sukuk remuneration is considered as a dividend or as an interest, and the criteria for the deductibility of the sukuk remuneration from the issuer’s taxable income. a. taxation of investment income: interest versus dividends this category includes both income from investment in companies and other entities (such as dividends) and interest and other income arising from loans and other forms of capital deployment (obligations, bonds, certificates, etc.). the determination of the taxable income for such category is based on two main principles: non-deductibility of the production expenses (e.g., bank fees) or capital losses, and taxation at the time of the receipt and not on an accrual basis (i.e., income is taxed only at the time of the payment in the hands of the securities holder). however, apart from the two general principles above, it is worth noting that, even if interests and dividends are included in the same income category, they are subject to tax according different rules. more in detail, dividends derived by individual shareholders are subject to tax depending on whether the participation is held in a business capacity or not. in the first case, such dividends are exempt for 50.28%, and they are subject to individual income tax (imposta sul reddito delle persone fisiche, irpef) at a progressive tax rate8 only for the 49.72% of the amount, irrespective to the percentage of the voting power or of the capital owned in the company. on the contrary, in the second case (i.e., individual shareholders not holding the participation in a business 8 the irpef rates are the following (art. 11, tuir): up to eur 15,000: 23% from eur 15,001 to eur 28,000: 27% from eur 28,001 to eur 55.000: 38% from eur 55,001 to eur 75,000: 41% over eur 75,000: 43% capacity) the tax treatment depends on the percentage of voting power and/or the capital owned by the shareholder: a) if the shareholder owns more than 20% of the voting power (2% for listed companies) or 25% of the capital (5% for listed companies), the same regime of partial exemption above described would apply; b) if the shareholder owns less than the percentages mentioned in the previous point, dividends distributed are subject to a 26% final withholding tax. as for interests arising from loans and other forms of capital deployment, they are generally subject to a 26% final withholding tax (article 26 of the presidential decree n° 600/1973 and law decree n° 66/2014)9. furthermore, specific rules apply to hybrid securities. from a tax perspective, it must be ascertained if a hybrid security can be included into one of the following type: a) financial instruments similar to shares, if their remuneration is totally linked to participation to the economic results of the issuer. in that case, the proceeds are treated as dividends in the hands of the recipient, while for the issuer the remuneration paid would be non-deductible as it is considered similar to a distribution of profits to shareholders (article 44, par. 2, letter a, tuir); b) financial instruments similar to bonds, if the issuer has an unconditional obligation to pay at maturity an amount not less than that amount received for the subscription, and if the holder has no direct or indirect participation in the management or control of the business or the deal for which such securities have been issued (art. 44, par. 2, letter c, n° 2, tuir). in case a hybrid security cannot be included in one of the two categories above, it is classified among the so-called “atypical securities” (titoli atipici), if the dependence on the financial results of the issuing company is partial, and so they are neither shares (or similar to shares) nor bonds (or similar to bonds) (article 5 of law decree 30 september 1983 n° 512). the proceeds deriving by such financial instruments are subject to a 26% final withholding tax. furthermore, for corporation and business entities, interest and dividend received are included in the determination of the taxable income, as according to article 81, tuir all the income derived in a business activity is included in the business income and it is subject to corporate income tax (imposta sul reddito delle società, ires, whose current rate is 24%). however, while interest expenses are fully taxed (on an accrual basis) in the hands of the recipient, dividends and other income from financial instruments similar to shares 10 that are not 9 moreover, a reduced rate (12.5%) would apply to bonds issued by the italian government, eu member states or states that allow an adequate exchange of information with the italian tax authorities. 10 this treatment also applies to remuneration on securities, financial instruments and contracts of silent partnership or joint ventures, limited to 95% of their non-deductible portion; remuneration on securities and financial instruments, even not similar to shares but to the extent they are not deductible in the hands of the issuer, http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) considered equity-like securities for tax purposes, and to the extent that they are not deductible in the hands of the issuer, are 95% exempt, and so they are generally subject to tax (at the time of the payment) only on 5% of the amount received (article 89, tuir). b. the deductibility of the remuneration paid by the issuer as mentioned in the previous paragraphs, also in the italian tax system dividends are not deductible from the taxable income, while interests are in principle deductible, even if certain limitations would apply. to this extent, tuir provides that is not deductible any kind of remuneration due on securities and financial instruments, for the portion of it that directly or indirectly involves the participation to the economic results of the issuer or other companies in the same group, or the specific business activity for which the financial instruments were issued (article 109, par. 9, letter a, tuir). on the contrary, interest expenses are in principle deductible from the payer’s taxable income, although some limitations apply. in particular, for corporate entities interest expenses are fully deductible up to an amount equal to interest income accrued in the same tax period, but the excess over that amount is deductible, in brief, to the extent of 30% of the company’s earnings before interest, taxes, depreciations and amortizations (ebitda). any excess of interest expenses over the 30% of ebitda may be carried forward for deduction in the following tax periods, and it would be deductible if interests in such tax periods are less than 30% of ebitda (unless some cases in which happens a change of control and/or the company’s business purpose)11. furthermore, it is important to remark that interest paid by banks and other financial institutions are fully deductible, while interest paid by insurance companies, parent companies of insurance groups and qualifying investment fund management companies are deductible up to 96% of their total amount. iv. the tax framework for sukuk holders in the italian context in light of the italian tax framework for financial instruments described above, it is possible to point out some considerations on the tax treatment of sukuk based on the aforementioned general principles and rules. in this respect, a sukuk can produce in principle two types of income: a) income from capital, as for the remuneration (periodic or not) derived by the capital contribution made by the sukuk holder; limited to 95% of the (possible) quota corresponding to the participation to the economic results of the issuer. 11 for taxpayers subject to irpef (individuals acting in a business capacity and partnerships) such limitation does not apply, while interest are deductible only if they are related to the business activity and to the extent of the ratio between taxable revenues and total revenues. b) capital gain/loss (as “miscellaneous income of financial nature”) as for the proceed deriving from the sale, the disposal or the redemption of sukuk12. the main tax issues of sukuk seem to be related to the qualification of their remuneration among the investment income category, so it is noteworthy to focus on the letter (a) above, i.e. if the remuneration of the capital contribution can be qualified as an interest, as a dividend or as a profit from “atypical security”, as defined by the italian tax rules. as briefly mentioned before, the prohibition of riba imply that interest is necessarily replaced with a profit and a losssharing principle, so it means that any remuneration must be earned from an effective commercial trading. furthermore, there is no guarantee on the return, because risk and profit must be shared equally between the parties of the transaction. it is noteworthy to remark that the italian rule described above consider as non-deductible those proceeds paid in connection with a (direct or indirect) participation to the economic result of the issuer and/or a specific activity carried out, because such proceeds are considered as dividends for the issuer. this criterion can be a serious obstacle to the deductibility of the remuneration paid with reference to the sukuk in the italian context, because, to the extent that sukuk do qualify as “undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity”, as defined by aaiofi, the proceeds paid in connection with sukuk could be considered non-deductible because they represent a participation to the issuer’s results or in a specific activity. in this perspective, such remuneration would be taxed as a dividend in the hands of the sukuk holder, and so it can be partially (or almost fully, in case of intercompany payments) exempt for the recipient. however, it must be also taken into account that in some cases even financial instruments linked to the economic results of the issuer are not considered similar to shares and consequently their remuneration is deductible as an interest for the issuer (and taxed accordingly for the recipient). this is the case, for example, of those instruments whose yield is predetermined at a certain rate, but the perception of the remuneration depends on the existence of profits or on the actual distribution of dividends by the issuer. also, it must not be a priori excluded that, even if the legal form of some islamic finance structures does not allow the payment of an interest to the lender, from a substantial standpoint the remuneration could be structured in order to be a de facto interest, at least from a tax standpoint, and so it would be subject to tax accordingly. therefore, as a conclusive remark, even if at first glance – due to their definition itself – sukuk seem to be included among the financial instruments similar to shares from an italian tax standpoint, a deeper analysis is required in order to 12 in case this gain cannot be regarded as an income from capital, as for instance in a zero coupon bond structure. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) determine the correct qualification of such instrument in the tax legislation applicable to the issuer and to the holder. v. conclusive remarks in light of the analysis made in the previous paragraphs, it is clear that in order to classify a sukuk as similar to shares or not, it must necessarily be taken into account not only the legal form of the financial instrument, but also the economic and financial effects for the issuer and the holder. in this perspective, it can be said that italian tax legislation has already a rather substantial approach for all financial instruments, so the introduction of sukuk as a “new” (at least, for the italian system) category of financial instruments should follow the same criteria provided for the other financial instruments. this does not necessarily mean that a possible introduction of sukuk would be “plain vanilla” for the italian tax context. even if the substantial effects of the financial instruments are considered in order to determine the appropriate taxation, it is worth noting that several classification problems for hybrid financial instruments still remain in the italian tax system, due to, for example, the lack of sufficient official guidelines. this uncertainty can constitute an obstacle to the if development in italy, also because the italian tax administration could have the power to recharacterize one or more transactions (including sukuk) in case it does not agree with the qualification given by the sukuk issuer/holder (e.g., the issuer considered that the remuneration is not linked to its economic results, while tax authorities considered that it is). moreover, tax authorities can also recharacterize one or more transactions when they fall within the scope of the general anti avoidance rule contained in article 10-bis of law 212/2000, according to which one or more transactions can constitute “abuse of law” if they are formally consistent with tax law but there is no economic substance, i.e. they don’t generate significant effects other than tax savings and they are not justified by valid and non-marginal non-tax reasons. in this perspective, it would be interesting to determine if non-tax reason different from economic reason, such as the compliance with shariah’s principles and laws, could be considered nonmarginal reasons which are suitable to justify a deviation to the “normal” juridical form and consequently do not lead to an “abuse of law”. with reference to possible future developments from a tax standpoint, as mentioned in the first paragraph, a law proposal on islamic finance has recently been presented to the chamber of deputies; such proposal considers the tax treatment of certain transactions (in particular, murabaha, ijara and istisna’a) and also addresses the tax issues related to sukuk. if the aforementioned proposal will be approved by the italian parliament, it is undoubtedly going to remove some uncertainty in the field of the taxation of these financial instruments. in the meantime, or in case the future legislation on sukuk will not explicitly address all the relevant tax aspects, in order to clarify the italian tax treatment for a possible sukuk transaction and remove all the related uncertainties, one possibility for the parties involved in a sukuk transaction can also be the submission of a tax ruling request to the tax administration, also because the interpretation provided is binding on tax authorities and consequently all the tax issues could be solved in advance13. references [1] p. p. biancone and m. z. shakhatreh, “using islamic finance for infrastructure projects in non-muslim countries”, in ejif – european journal of islamic finance n° 2, april 2015, p. 2. [2] p. p. biancone and m. z. shakhatreh, “using islamic finance for infrastructure projects in non-muslim countries”, in ejif – european journal of islamic finance n° 2, april 2015, p. 2. [3] s. filippetti, “l’italia stringe per il debutto del btp “islamico””, in il sole 24 ore, 8 march 2017, p. 27. [4] in this respect see gouvernement du grand-duché de luxembourg, administration des contributions directes, circulaire du directeur des contributions l.g.-a n° 55 du 12 janvier 2010, par. 2.2. for the luxemburg islamic finance tax framework see also n. muller, j. van den berg, “clarification of tax treatment of certain islamic finance products”, in derivatives. & financial instruments ibfd n. 2/2010; a. barbiero, “lussemburgo islamic bond e fisco”, in commercio internazionale 12/2010, pp. 43 ss. [5] guidelines fe/09, entered into force on 25th february 2009, and especially title 2 of guideline 4 concern the tax aspects of sukuk. [6] b. delaigue, a. reillac, “france adopts tax measures to promote islamic finance”, in european taxation, may 2009, p. 287 [7] a. de brosses, f. burnat, “france – islamic finance”, in derivatives & financial instruments, september/october 2010, p. 38. [8] document boi-djc-fin-20-20120912 [9] j. cape, “general legal framework applicable to the taxation of islamic finance”, derivatives & financial instruments ibfd, september/october 2010, p. 40. [10] a. mashayekhi, r. hicks, a. rahman, a. ravalia, “islamic finance in the uk: regulation and challenges (vol. 9)”, london: financial services authority, 2007. [11] j. cape, “general legal framework applicable to the taxation of islamic finance”, in derivatives & financial instruments ibfd, september/october 2010, p. 43. [12] p. maher, p. mcqueston, “ireland tax treatment of islamic finance products”, in derivatives & financial instruments ibfd, september/october 2010, p. 49. [13] p. p. biancone, “finanza islamica e impatti fiscali, lo stato dell’arte in italia”, in amministrazione & finanza n° 8-9/2016, p. 25. [14] g. ursino, “l’italia si gioca la carta del btp sukuk”, in plus24 – il sole 24 ore, 6th may 2017, p. 23. [15] for a detailed analysis in english language of italian financial income taxation and deductibility rules see g. gallo, “italy-individual taxation”, country surveys ibfd (www.ibfd.org), and g. gallo, “italy corporate taxation”, country surveys ibfd (www.ibfd.org). [16] a. marinello, “i regimi di tassazione dei redditi di natura finanziaria”, in f. marchetti (editor), “i redditi finanziari. determinazione della categoria e prospettive di riforma”, aracne, canterano (rm), p. 87. 13 the answer from the italian tax authorities generally takes 90 days. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, portsmouth university, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france i. introduction ii. taxation of sukuk among the eu: a “conditioned” substantial approach iii. the italian tax framework for financial instruments a. taxation of investment income: interest versus dividends b. the deductibility of the remuneration paid by the issuer iv. the tax framework for sukuk holders in the italian context v. conclusive remarks references editorial_board.pdf editor in chief editorial board paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 european companies: evaluation for sharia compliance “opportunities and challenges” paolo pietro biancone a and maha radwan b a university of turin, italy. paolo.biancone@unito.it b university of turin, italy. maha.radwan@unito.it abstract— the continuous growth of islamic finance investments and the innovation in its various financial instruments make it an attractive financial system especially for the western countries. islamic finance is currently introduced in some european countries however the rest of the continent is studying the idea of having dual financial system (i.e. islamic system and conventional system). attracting islamic investors to europe requires the compatibility of the investments with sharia. the aim of this paper is to evaluate european companies for being sharia compliant. qualitative and empirical approaches are used in the research methodology to test the european companies’ eligibility using a sharia compliant methodology screening. the results should be a key element in understanding the nature of those companies and figuring out if it will be a win -win situation; in one hand those companies can be financed through islamic financial instruments and on the other hand examine the profitability of those companies. keywordssharia compliant, islamic finance, european companies, sharia compliant screening, and sharia indices i. introduction and literature review islamic finance is as old as islam and its roots go back to almost 1500 years ago, and its practices have been really used throughout those years across the muslim world. however, it has moved recently from a mere old theoretical concept to a practical reality. a natural consequence of this progress is the opening up of new means for its growth and development worldwide. islamic financial products, while they are derived from islamic ethical laws, are not limited to muslims population only but they are available to everybody (warde, 2000; usmani and taqi, 2002; el-gamal, 2006; and ayub, 2009) [25, 24, 8, & 2]. from a western prospective; it is a technical financial system that is operating on an ethical basis that is very similar to the social responsibility investments that promotes for an ethical finance; and this makes of it an attractive system for the western countries. the recent global financial and economic crisis has brought to evidence many issues concerning the stability of the conventional financial system. this has prompted an extensive global re-evaluation by the international community on the adequacy of the existing international economic and financial system. there was a need to establish financial transactions that add value to the real economy and that avoid speculative investments. this could be represented in islamic finance, which is based on the ethical sharia principles (askari, iqbal, & mirakhor, 2010) [1]. these principles have socioeconomic goals like sustainability and poverty alleviation where it encourages muslims to maximize their wealth as long as they do not create a situation that is creating a social distortion or violating the norms of islamic justice (dusuki, 2006) [7]. sharia provides guidelines for aspects of muslim life, not only religion but also politics, economics, finance, and social life (silva, 2006) [22]. there are two sources of knowledge in islam; primary and secondary (siddiqi, 2004) [21]. primary sources comprise the quran and sunna revealed/divine knowledge from allah to his prophet mohammad. secondary sources are the derived knowledge through ijtihad “exertion” of scholars to accommodate new and contemporary issues, through agreed upon methodologies, such as ijma “consensus” and qiyas “analogy. the most important principles of islamic finance that are derived from sharia include a prohibition for riba “usury/interest”, prohibition of gharar “uncertainty/speculation”, prohibition of maysir “gambling” and prohibition on investment in a nonhalal activity that is equivalent to haram “unethical” businesses products or services (such as alcohol, tobacco, pork, adult entertainment, and weapons). sharia compliant products must be backed by or based on an identifiable and tangible underlying asset; it is also important that the investor and investee adhere to the concept mailto:paolo.biancone@unito.it mailto:maha.radwan@unito.it ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 of profit and loss sharing which is in other terms sharing the risk of all financial transactions. last but not least is the obligation of zakat “charity/ purification” for poor and needy (biancone, & radwan, 2015) [4]. islamic finance industry in europe has an increasing trend in terms of growth rate and this can be related not only to that europe is searching for attracting arab investments for liquidity but also for the growing muslim population in europe. islamic funds domiciled in europe accounted for 16.3% of the global aggregate sharia compliant assets under management in september 2014 up from 11.8% at the end of 2012. [11] european companies no matter their size are seeking the high solvency of the islamic investors. it is a diversifying source of funding for large companies through sukuk, but also for financing small and medium enterprises (smes) through different equity or debt financing mechanisms. equity-based mechanisms are based on the profit and loss sharing. musharaka “joint venture or partnership of equity participation” and mudaraba “partnership” are famous examples for this type of financing mechanism. while debtbased mechanisms are based on mark up cost plus concept that can be applied easily in purchase and sales operations. murabaha “cost plus mark up”, ijara “leasing”, salam and istisna are the most well known used contracts in the debtbased mechanism. the islamic financial markets have developed rapidly as new investment instruments over the last two decades. over the past decade, the global capital market scene has witnessed the introduction of islamic indices, which are designed to filter out the stocks in conventional indices in accordance with the islamic principles. some of these indices are: financial times islamic index series (ftse), dow jones islamic market index (djim), standard & poor shari'ah index (s&p) and morgan stanley capital international islamic index (msci) (ho, rahman, yusuf, and zamzamin, 2014) [9]. in their analysis for the performance of the global islamic indices they found that islamic indices outperformed their conventional counterparts during crisis periods. accessing islamic funds and financing instruments needs a full compatibility with the sharia principles, since sharia compliance of the underlying equities is a pre-requisite for being eligible for investments by islamic financial institutions. the european companies are facing a real challenge especially in their current debt structure that represents the highest factor for their exclusion from being a sharia complaint due to the high loans and interests. there is a very little literature that focuses the islamic indices and funds and in specific for the western companies eligibility for accessing sharia compliant financing mechanisms. we propose to fill the gap by providing analysis for the different islamic indices and evaluation of the european companies for being a sharia compliant through studying and applying the sharia compliant screening methodology. this is to understand the impact of the screening for eligibility on origin, size, and profitability of the companies and what would be the opportunities and challenges in their compliance. and answering the question of those companies can be financed through islamic financial instruments or not as well as examining the profitability of those companies. the paper is organized as follows; section ii is an explanation for the sharia compliance screening methodology, section iii clarifies the differences among the different islamic indices, section iv discusses the debatable issues in the sharia screening methodology, while section v is the empirical study for evaluating the sharia compliance of the european companies, and finally section vi concludes. ii. sharia compliance screening methodology within the sharia concept; the ownership of some shares in a company is considered a partial share in the company itself. so in order to get a muslim investor in a company; this company should be a sharia compliant. there are technical steps applied for classifying a company as a sharia complaint as well as there are several worldwide current indices for the screening process that provide confidence to muslim investors that the profit is permissible according to islamic sharia ethical principles. for conducting the screening process the criteria are divided into qualitative criteria and quantitative criteria. by controlling the qualitative and quantitative criteria the companies would be screened for their typology of business activities and investments on one hand and for their resources “assets”, profit and financial structures on the other hand. this screening process is supervised and controlled by the sharia supervisory board that should be totally independent committee composed of specialized islamic jurist and islamic finance expertise who are assigned by the islamic indices provider and its role is to verify, control and assure that the business is done according to sharia principles. such expertise raises the attractiveness of sharia compliant financial intermediaries to investors considering islamic investments (sole, 2007). [23] qualitative screening qualitative screening represents the classification of the business of each company. companies must have their activities within the permitted activities “halal” and avoid all non permitted activities which are referred as to haram activities. activities should of course include also all of the production and sales process of their products. disallowed activities are; alcohol, pork related products, pornography, tobacco, gambling, conventional financial services, weapons and defence, biological human and animal genetic engineering, and media and advertising companies with exception to news channels, newspapers, and sports. the companies that are excluded after this screening do not qualify for quantitative screening. ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 quantitative screening after companies had passed through the qualitative screening they should pass to the second phase of screening which is quantitative screening. in this screening phase the financial rations of the companies should be tested for not exceeding specific thresholds that are different among the different global indices. not only the percentage thresholds are different but also the calculation formulas in some instants are different. however the levels that are subject for testing are the same which are: the leverage level (debt level), interest level, and the liquidity levels. it is worth mentioning that in some indices there is the dividend purification and in some others revenues purification which is a measurement for the portion of revenue that is generated from non compliant operations in which minimum level of tolerance is accepted as long as the business sector is sharia compliant. iii. differences among sharia compliance indices there are some differences among the major worldwide indices for sharia compliant. regarding the qualitative criteria there are not too many differences as what is permissible and what is not but only in few points. for example, in the s&p 500 shariah index it is not excluded the company that has activities in weapons /defence but it is excluded the company that has business activities in the hedging of gold and silver or that has activities in cloning. on the contrary according to dow jones islamic market indices; it is not excluded the hedging in gold and silver and considered excluded any activity related to weapon and defence and hotels. some others are more flexible as in the case of morgan stanley capital international (msci) islamic index series, ftse sharia global equity index and the shariah advisory council of malaysia (sac) that are accepting some impermissible activities as long as the core business is permissible. on the contrary to the s&p and dow jones that exclude companies that have any involvement with impermissible activities. moving forward to the quantitative criteria we can figure out that there is a lot of differences among the worldwide indices whether in the calculation method (where one is using the market capitalization and another is using total assets) or in the threshold limits (e.g. one is setting 49% threshold for the liquidity ratio and another is setting it to 33%). mentioning again the same five major indices; the following table explains the difference among them in the three used financial ratios: table i. quantitative criteria s&p dow jones ftse msci sec level of debt total debt / market capitalizatio n(avg 36 months) < 33 % total debt / market capitalizatio n(avg 24 months) <33 % total debt / total assets < 33 % total debt / total assets < 33.33 % total debt / total assets < 33 % interest ratio cash & interest bearing securities / market capitalizatio n (avg 36 months) < 33 % cash & interest bearing securities / market capitalizatio n (avg 24 months) < 33 % cash & interest bearing securities/ total assets < 33 % cash & interest bearing securities / total assets < 33.33 % liquidity ratio accounts receivables / market capitalizatio n(avg 36 months) < 49 % accounts receivables / market capitalizatio n(avg 24 months) < 33 % accounts receivable s & cash / total assets < 50 % accounts receivable s & cash / total assets < 33.33 % cash / total assets < 33 % non permissible income (npi) npi (excluding interest) / total revenues < 5 % npi (including interest) / total revenues < 5 % npi / total revenues < 5 % two classes of npi / total revenues class 1 < 5% class 2 < 20% iv. debatable issues in sharia screening methodology the global different indices disagree among themselves and there is no unique unified index that can be a reference point for both companies and investors to rely on. standardization of islamic finance regulations has been of increasing interest in the industry. sharia is open to interpretation and islamic scholars are not in complete agreement regarding what constitutes sharia compliant. islamic finance laws and regulatory practices vary across countries. the lack of concurrent viewpoints makes it difficult to standardize islamic financing (shameen, 2005) [19]. who set the rules and thresholds? there is an absence of a unique universal framework among all sharia indices (derigs & marzban, 2008) [6]. every index provider has a sharia supervisory board that set the framework in which the index would work on. the dilemma is that; we have a different set of indices with two same main criteria qualitative and quantitative but with different basis, formulas, and thresholds under those two main criteria. not only sharia supervisory board is not unified in one framework but also some of them are already members in some financial ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 institutions which strongly hits the credibility of the set of rules they put to regulate each index. another point is that some of the indices rules are rigid and some are flexible, some excluding totally any involvement of non halal transaction and some accept and permit if it is not the core business (khatkhatay & nisar, 2007) [12]. some set a rigid threshold for financial ratios of 33% and some set more loose and flexible one up to 50% (mahfooz and ahmed, 2014) [13]. a third issue is the frequent changes of the set of rules as some indices every now and then change their set of rules and their thresholds applied for the financial ratios as well as the formula of calculation like the modification of the threshold for one item which is the liquidity ratio to be up to 33% instead of previously was up to 45%. this problem also strongly hits the stability of the position and classifications of the companies, i.e., one company could be classified as sharia compliant and then after changing the ratios and formula could be excluded and considered a non sharia compliant one. another debate is the non permissible income ratio that is related to the total revenue in some indices with a tolerance level of maximum 5% to be purified. in this issue scholars also did not agree about it as they claim it should be taken out from dividends not from revenues and others say if distributed (mohamed donia and shehab marzaban, 2010) [14]. some indices ignore it totally because in order to specify the amount that need to be purified is difficult enough as it is easy to sort out the generated income from interest bearing investments but it is infeasible to know the information regarding all non sharia compliant transactions that could occur occasionally if the main primary business is sharia compliant simply because companies report revenue , rate of return, and dividends but without specifying any details about any non permissible transaction. challenges from a western prospective in western countries since the existence of the islamic banks and sharia compliant investments are still not widely spread, and companies in their financing instruments and debts rely upon conventional banks and institutions. due to this fact they seek a level of tolerance for the interest bearing debts and for the interest bearing securities. on the other hand, many scholars debate and argue about this fact as they debate that the tolerance level which is 33% is too much and that riba cannot be tolerated by any mean. as a result this represents a challenge as many western countries are still studying how to introduce the islamic finance along with the conventional one. this is not an easy process as most of them need a harmonization of the local laws and regulations of each country with the regulations of sharia. another challenge is that sharia requires an asset based investments and tangible assets so this means that is not very much appreciated the high liquidity, and this has raised some claims saying if we exclude companies of high liquidity level or in case of imposing low level of tolerance then this could lead to insolvent pool of companies. v. evaluation for sharia compliance of european companies “empirical study” this paper aims for evaluating the european companies; for their compliance to sharia, and therefore the possibility of opening up to islamic investments opportunities. another objective is to figure out what are the european countries that have more sharia compliant companies and also analyzing the findings to understand the available information as regards the size, sector, and profitability of those companies. research tool and assumptions this empirical research is conducted based on several assumptions to be tailored and applied on to follow the sharia compliant screening methodology for all european union companies. the assumptions that had been used are covering both the qualitative and quantitative criteria for sharia compliant screening. the used search database bank for reaching information regarding all european union (eu) companies is amadeus. the pool that is to be examined is the eu companies in specific the unlisted ones since indices are referring to the listed companies and this paper tries to understand the chances that those unlisted companies have to be financed with an islamic finance investments. assumptions: a) unlisted companies only; to evaluate the companies that are not previously evaluated or traded in a stock exchange. moreover, those companies mostly are smes and have weak access to financing means. b) excluding all haram (non halal) business industry and activities that are considered not permitted according to sharia to fulfill the qualitative screening. the criteria of exclusion were done taking into consideration the most rigid parameters among all the above mentioned indices. c) as it was mentioned before that we are testing assumption for the unlisted companies so there is no available market capitalization (like what is used in s&p or dow jones). as a result the formula was set to measure relatively to the total assets (like ftse, msci, and sec) but instead we choose the most rigid threshold which is 33%. the used formulas are as follows:  liquidity ratio: total accounts receivables / total assets “threshold: < 33%”  interest ratio: cash & interest bearing securities / total assets “threshold: < 33%” ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5  debt level ratio: total debts / total assets “threshold: < 33%” d) no non permissible income was considered like the dow jones index. this choice was done also based on the difficulty to sort out details referring to impermissible transactions. e) eu countries only (austria, belgium, bulgaria, croatia, cyprus, czech republic, denmark, estonia, finland, france, germany, greece, hungary, ireland, italy, latvia, lithuania, luxembourg, malta, netherlands, poland, portugal, romania, slovakia, slovenia, spain, and united kingdom). f) ultimate owner: it was imposed to select companies that are owned by ultimate user and by imposing this we assured that companies are not a controlled by another company. research findings the whole sum of the european companies that were the starting pool was 3,100,308 companies. then the number was reduced by limiting it to the unlisted companies to be 2,901,048 companies. this number was the initial pool for applying qualitative criteria that then was reduced after exclusion of haram businesses activities to be 2,634,716. the set of assumptions fulfilling the qualitative criteria showed that there is no real challenge in that aspect as excluding 266,332 companies which represents 9% is very acceptable percent. however, moving to the quantitative criteria reflects the real problem. this can be clearly seen especially when the debt ratio was applied as the number of compliant succeeded to pass this threshold were 472,632 only. this figure represents only 16% out of the original pool and 18% out of the qualified companies from qualitative sharia screening. that result reflects the most significant challenge for the european companies is their debt structure and that is naturally done through conventional financial instruments. the same was revealed after applying the interest and liquidity ratios as the number of companies passed these thresholds were reduced again to be 372,492 companies. this last reduction has decreased the qualified percent of companies to be only 13%. moving to the last two assumptions where limiting it to the eu countries which has not decreased the number a lot, but then the ultimate owner imposition has heavily decreased then to reach a final total of 9,286 companies. as it is clear from the previous sequence; 9286 companies had resulted to be sharia compliant out of a pool of almost 3 million companies. an analysis for the full data for the research findings to figure out the details by country regarding their percent out of the total number of sharia compliant companies that were found in each of the eu countries can be demonstrated in the following pie: figure 1. sharia complint companies by country as we can see that it was specified the first highest 12 countries then for the rest of the eu countries that represents 16 countries were summed collectively since they represent a small share. according to the known classification of smes regarding the number of employees that is classified as follows: micro: 1 – 9 employees, small: 10 – 49 employees, medium: 50 – 249 employees, and finally large: > 250 employees. analyzing the three countries that had a share higher than 10% which are spain (14%), germany(13%), and uk (11%), we found that in spain 77% of the companies are micro size companies (i.e. employees’ number is between 0 and 9), with good results in terms of profitability where 67% have a positive roe. while in germany; the size of the companies is so different from those of spain and is divided as follows; 18% are large companies (i.e. employees’ number higher than 250), 32% medium size companies (employees’ number is between 50 and 249), 26% small companies (i.e. employees’ number is between 10 and 49), and finally 24% micro sized companies. almost half of the german companies operate in the services sector and second half is divided between retail and wholesale trading, and manufacturing sector. regarding the united spain 14% germany 13% uk 11% czech republic 9% netherlands 9% sweden 8% italy 5% belgium 4% denmark 5% bulgaria 4% poland 4% france 4% rest of eu 10% sharia complaint companies empirical research outcome ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 kingdom companies that are mostly operating in the services with small and medium sized companies; however the significant thing that was seen in their high profitability values. the four countries that had a share between 5% to 10% out of the total final sharia complaint companies were as follows; czech republic (9%), netherlands (9%), sweden (8%), and italy (5%). in czech republic around 74% of the companies are small and medium size while on the contrary is the netherlands where the majority is micro sized. in sweden what is really different from all previous countries is that half of the companies are large companies and the other half is small and micro sized companies and very few medium sized companies. their profitability is relatively high in comparison to others and with a majority operating in services sector. on the contrary is italy where the majority is micro sized companies (84%), small sized (12%), the rest were medium sized and no large sized companies almost but with more than 80% of positive profitability. looking for the rest of the countries whose share was below 5% of the total companies; the most observable was bulgaria that most of its companies are large and medium sized. after analyzing the outcomes in both the qualitative and quantitative screening, we have found that the challenge that could face the european companies on the level of qualitative for example for the food and beverage sector could be reduced by providing full details about the nature of activities that could be evident to investors or to the screening measures by acquiring halal label or certificates from authorized recognized entities for their line productions. acquiring the halal would implicitly mean that their production operations and business activities are qualified as a qualitative screening. on the other hand, the challenge that they face on the quantitative level is all correlated to two points; first is that the european companies’ debt level is too high and this could be solved through working on the debt structure through decreasing the debts and consequently increasing the equities through the tools of the islamic equity-based mechanism musharka and mudaraba, and second is the used financial institutions for financing and investing which are the conventional banks and this could be solved through dealing with islamic financial institutions instead using debt-based mechanism of murabha, ijara, or istsnaa. looking with a future scope after the qualification of the companies and their success to pass the sharia compliant screening and find the suitable financing mechanism we have to think about the corporate governance problem. since the resulted companies are mostly small companies and in europe it is probably family businesses which have many corporate governance measures problems. according to a recent survey about family businesses in europe (2014) [15]; the problems could be seen in the composition of the board of directors’ members where 50% of the board seats are given to family members with really few independent seats and in the board efficiency where 39% of those boards do not have an “audit and risk” committee while 43% of them have “nominating/remuneration” committee. another problem could be seen that many of them have no ceo succession plan (russell reynolds associates, (2014), “survey of corporate governance practices in european family businesses” russell reynolds associates). in the case of financing those companies there must be corporate governance model applied for controlling and assuring investors’ rights and this needs a board of directors for managing those companies and an independent supervisory board for monitoring and controlling. limitation of the research this empirical research was limited to the registered companies in the used database, also with the some limited transparent information provided by the companies. another limitation was faced in the qualitative screening since there were some companies not explicitly specifying in details their activities and just were stating food sector so it was set to exclude them since we had not enough information to choose if they are halal activities or not. one last limitation was the difficulty of comparison between countries since they are unlisted companies so many of them use their local accounting standards and not a unified accounting standards like the ifrs. vi. conclusion the potential growth of the islamic finance in europe is really high for several reasons; the emerging need for an alternative finance that is more stable and does not depend on speculation, the several serious initiatives that were taken by eu countries toward accommodating and promoting islamic finance (e.g. uk, germany, ireland and luxembourg), the growing muslim population in europe, the huge interest in europe to attract investors from islamic markets consequently boost the economy and increase liquidity, and finally the geographic location of europe and the strong trade agreements with the major islamic markets. no doubt those factors will enhance the opportunity for the islamic finance to grow however this should be supported by creating the suitable environment for promoting that finance. this empirical research has reflected an evaluation for the european companies for their compatibility with the principles of sharia and consequently compatibility with islamic finance. the research findings had revealed a good opportunity for a basic moving step toward islamic finance and this was seen in the qualitative criteria with a challenge related to certifying activities and production with halal labeling is needed sectors like food and beverage, cosmetics, medicine, and tourism sectors. the other real challenge is in the quantitative criteria since the financing model in europe depends heavily on debt and that was the main reason behind eliminating almost 80% of the companies. this challenge could be resolved if those companies changed their debt structure or their financing financial institutions using islamic equity-based or debt-based mechanisms. another challenge is that for avoiding the debt s and interests from conventional banks this requires the existence of the islamic banks to support and finance those companies. one of the major opportunities in that most of the ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 economies depend heavily on the smes for their important role in capital accumulation and creation of employment opportunities but on the other hand those companies suffer from the inability to access finance and limitation of international exposure; the islamic finance represent a real opportunity for then in resolving those problems. however, this needs a well defined corporate governance model to be applied in those companies where the paper pointed out that this could represent a future problem since those companies really lacks it. however, taking all threats and challenges into consideration and working on them is feasible and benefiting from the islamic finance investments is a possible target. references [1] askari, h., iqbal, z., & mirakhor, a. (2010). globalization and islamic finance: convergence, prospects and challenges (vol. 778). john wiley & sons. [2] ayub, m. (2009). understanding islamic finance (vol. 462). john wiley & sons. [3] biancone, p. p. (2012). il bilancio della banca islamica e la rappresentazione dei principali contratti finanziari. [4] biancone, p. p., & radwan, m. (2015). sharia compliant “possibility for italian smes”. european journal of islamic finance, (1). [5] biancone, p. p., & shakhatreh, m. z. (2015). using islamic finance for infrastructure projects in non-muslim countries. european journal of islamic finance, (2). [6] derigs, u., & marzban, s. (2008). review and analysis of current shariah-compliant equity screening practices. international journal of islamic and middle eastern finance and management, 1(4), 285–303. doi:10.1108/17538390810919600 [7] dusuki, a.,w., (2006)‘corporate governance and stakeholder management of islamic financial institutions’, national seminar in islamic finance, kuim, nilai, aug. 20th -30th, 2006. [8] el-gamal, m. a. (2006). islamic finance: law, economics, and practice. cambridge university press. [9] ho, c. s. f., rahman, n. a. a., yusuf, n. h. m., & zamzamin, z. (2014). performance of global islamic versus conventional share indices: international evidence. pacific-basin finance journal, 28, 110-121. [10] iqbal, z., & mirakhor, a. (2011). an introduction to islamic finance: theory and practice (vol. 687). john wiley & sons. [11] kfh research (2014). global islamic finance: propositions to europe. kfh research ltd. [12] khatkhatay m.h., & nisar, s. (2007). shariah-compliant equity investments: an assessment of current screening norms. islamic economic studies, 15, 47–76. [13] mahfooz, s., & ahmed, h. (2014). shariah investment screening criteria: a critical review. jkau:islamic econ., 27(1), 111–145. [14] mohamed doni, shehabmarzban, 2008. shariah-compliant equity investments: frameworks [15] russell reynolds associates, (2014), “survey of corporate governance practices in european family businesses” russell reynolds associates. [16] s&p shariah indices methodology, s&p dow jones indices: index methodology, march, 2014. [17] sani, n. a., & othman, r. revision of shari’ah screening methodology: the status of shari’ah compliant companies in malaysia. [18] securities commission, list of shariah-compliant securities by the shariah advisory council of the securities commission malaysia, http://www.sc.com.my/eng/html/icm/sas/sc_syariahcompliant_101126.p df. [19] shameen, a. august 8 2005,“islamic banks: a novelty no longer”. business week. [20] shariah screening methodology: adapting two tier approach, insights reports shariah screening (www.mifc.com). [21] siddiqi, m. n. (2005). riba, bank interest and the rationale of its prohibition. markazi maktaba islami publishers. [22] silva, m. (2006). islamic banking remarks. law & bus. rev. am., 12, 201. [23] sole, j. a. (2007). introducing islamic banks into conventional banking systems.imf working papers, 1-26. [24] uusmani, m. t., & taqī ʻusmānī, m. (2002). an introduction to islamic finance(vol. 20). brill. [25] warde, i. (2000). islamic finance in the global economy. edinburgh university press. [26] wilson, r. (1997). islamic finance and ethical investment. international journal of social economics, 24(11), 1325-1342. [27] wilson, r. (2001). the economics of mutual funds: an islamic approach. university of durham, 1-25. [28] zainudin, n. b., miskam, s. b., & sulaiman, m. b. revised shariah screening methodology for shariah-compliant securities: new standard to meet global expectation websites [29] aaoifi standards and membership body information (http://www.aaoifi.com/). [30] amadeus, information on companies across europe (http://www.bvdinfo.com/en-gb/our-products/companyinformation/international-products/amadeus). [31] dow jones: (http://www.djindexes.com/). [32] ifsb standards and membership body information ( http://ifsb.org). [33] morgan stanley capital international (msci) official website. (http://www.msci.com/). [34] pew forum’s, size and distribution of world’s muslim population, october 2009 report (www.pewforum.org). [35] securities commission of malaysia, (http://www.sc.com). [36] standard & poor. s&p shariah indices methodology. (http://www.standardandpoors.com). [37] the world bank official website. see (http://www.worldbank.org/). http://www.mifc.com/ http://www.aaoifi.com/ http://www.bvdinfo.com/en-gb/our-products/company-information/international-products/amadeus http://www.bvdinfo.com/en-gb/our-products/company-information/international-products/amadeus http://www.djindexes.com/ http://ifsb.org/ http://www.msci.com/ http://www.pewforum.org/ http://www.sc.com/ http://www.standardandpoors.com/ http://www.worldbank.org/ ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 issues and challenges in financing the poor: lessons learned from islamic microfinance institutions abstract— islamic microfinance institutions (imfis) play a very important role in contributing towards higher financial inclusion among the poor, especially in the muslim countries. despite their importance, the imfis face wide ranging issues especially in the operational and regulatory aspects, and these issues hinder the effective development of the imfis. by examining the experience of two major imfis in indonesia and malaysia, namely baitul maal wat tamwil (bmt) and amanah ikhtiar malaysia (aim), this study offers a new perspective by making a comparative study between the two imfis with the aim of understanding the peculiarities facing each institution, unlike the earlier studies which commonly focusing on a particular institution only. the study finds that sustainability and human resource are the main issues facing both imfis. while structural issue such as reliance on subsidies could jeopardise the sustainability in the long run, human resource is highly critical in ensuring smooth functioning of the imfis as well as their sustainability even in the short run. findings of this study contribute to highlight the critical factors to be emphasized in ensuring sustainability of imfis. keywords-component; microfinance, baitul maat wat tamwil (bmt), amanah ikhtiar malaysia (aim), islamic finance i. introduction islamic microfinance plays a crucial role in improving financial inclusion among the poor especially in the muslim nations by serving the financial needs of the poor who are commonly categorised as the “unbankables”. in the south-east asian region, islamic microfinance has grown rapidly particularly in indonesia and malaysia, where the muslimmajority populations have created a great demand for shari’ahcompliant microfinance products that can cater for the sociocultural peculiarities of the poor in these countries. the islamic microfinance institutions (imfis) continue to expand their services to provide a variety of financial services to the poor segment of the community in the form of micro-credit, microsavings and micro-takaful. efforts are continuously taken to integrate the islamic third sector, namely zakat, waqf and sadaqah into the islamic microfinance to help fully mobilise the financing capacity of islamic social finance. in essence, the objective of islamic microfinance is to fulfil the financial needs of the poor and as a means of poverty alleviation efforts to achieve equitable distribution of wealth and income with full adherence to the islamic values. over time, this tool has become undoubtedly very effective in securing sustainable financing supporting the expanding needs for impact investment [1]. the “unbankables” require small amount of financial support over a period of time so that they can eventually break away from the poverty chain. the nature of imfis certainly fit into the financial requirements of this group of people as specific financial assistance can be structured with back-up trainings, follow-ups and consultations. different countries have different social structures and financial gaps among the citizens. depending solely on the government via public spending to boost income is not always the only successful remedy. therefore, tapping into islamic social finance such as zakat and donations is the alternative that should be selected to combat poverty. socially-related problems due to increased level of poverty can possibly be addressed by enterprises that focus on dual objectives of generating social impact and financial benefits [2]. developing countries such as malaysia and indonesia that continuously strive to improve the socio-economic status of the less fortunate have creatively invented financial institutions to cater for the issues. it is worth looking into the two institutions to learn the good aspects that can be replicated and refined. in malaysia, amanah ikhtiar malaysia (aim) is the largest microfinance institution established in 1987 offering various micro financial services. reflecting its commitment and excellence in the effort of alleviating poverty, aim received “best microfinance institution award” from global islamic finance awards for four consecutive years from 2013 to 2016. this institution has been mandated to alleviate poverty and increase the household income under the malaysian economic transformation plan. meanwhile in indonesia, baitul maal wat tamwil (bmt) is one of the successful imfis that has grown significantly in numbers for the past twenty years and improved the lives of thousands of poor people in indonesia. despite the success story, these two imfis face different internal and external issues in their operations. while aim is established as a non-governmental organisation (ngo) receiving grant from the government, bmt is established as a cooperative and being more independent in terms of sources of funds. being a private trust body mandated to reduce poverty, aim has a clearer governance structure, thus has a more stable source of funds compared to bmt. consequently, a number of n. satar and dr. s. kassim ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 bmts have been shut-down due to financial problems. in view of the different models, if these two microfinance institutions were to be scrutinised, there are issues that are unique as well as common to both. this study aims to highlight the issues faced by aim and bmt and discuss how the issues can be tackled by complementing the best practices of each imfi. in comparing the issues and challenges facing aim and bmt, greater emphasis is given to aspects that could possibly jeopardize the smooth running of their operations as well as the long-term survival of the institutions. in this study, qualitative comparative analysis method is used with extensive article reviews. aim and bmt are chosen because these two institutions are the leading examples of the imfis in the world and therefore, the issues that they are facing are of important interest to be shared so that relevant stakeholders are equipped with important input to make further improvement in the future. ii. a review of issues faced by islamic microfinance institutions the noble intention of microfinance in improving the economic status of the unfortunate segment of the society needs no further introduction. different microfinance institutions with different operating models and locations would naturally face different issues. in the context of aim and bmt, despite their achievements in combating poverty, there are still some issues and challenges they face in providing financial access to the poor. this section discusses the issues and challenges faced by aim and bmt in delivering the conscience-based financing services. the success of bmt is dependent on determinants such as capability of financial management, characteristics of clients, capability of risk management, familiarity among clients and managerial team, and suitability of information technology (it) and network. however, due to the nature of bmt being heterogeneous in its nature of operations, different locality will have different sets of determinants [3]. this renders the determinants to be very difficult to be generalized into standard forms and therefore, assessing the performance and effectiveness for comparisons between different bmts is difficult. in actual practice, each bmt is given the liberty to run the institution given the peculiarities brought before them as well as the availability of resources that they have. bmt is able to maintain its sustainability through the fund received from the social and religious collection, and the deposit from saving facilities offered by the institutions [4]. however, sometimes, bmt runs out of their deposit fund due to financing. undoubtedly, fund raising is one of the core activities as reliance on the government for financial allocation is not possible. dependency on social and religious collection on the other hand, hinges on the responsibility awareness of the surrounding communities; the more charity-minded people around could mean more funds coming in for financing activities. to achieve sustainability from method other than religious collection, cash waqaf system is an ideal option [5]. the cash from donor is channelled to cash waqaf institution before being distributed to microentrepreneurs involved in a musyarakah mutanaqisah partnership. a slightly different model of cash waqaf for bmt was suggested by ascarya and sukmana [6] where it is suggested that the cash waqaf is managed by bmt so that income generation activities can be created, and subsequently more socially beneficial programmes can be funded. through this way, the microfinance institution is expected to be more independent and have more ownership over their operations. internal factors such as lack of capital and innovation in marketing products, shortage of sources of funding, employees’ underperformance, and facilities and technologies that are not up to date also affect the operational efficiency of bmts [7]. meanwhile, the external issues are stiff competition among the bmts, low level of public trust towards bmt performance, lack of networking and co-operation among other financial institutions, as well as lack of supervision and guidance from government and majlis ulama indonesia. however, despite the issues, bmt is still capable of connecting with the bottom of the economic group in the society [8]. on the other hand, aim, being subsidized by the government, offers limited microfinance products and has standardized the lending contracts [9]. as of today, there are only three types of services offered, namely financing, compulsory savings and charity fund. more diversified products would enable customers to choose based on their needs and extend the deliverability of the objectives of aim. for instance, products should be extended into using other islamic contracts such as musyarakah (partnership) and ijarah (lease). musyarakah in particular would encourage and drive the clients to work harder because of the profit and loss sharing element involved whereas simple loans really mimic the conventional method only. this contract gives honourship and higher sense of responsibility for the clients to execute their small scale business undertakings. with the small financing given, many aim clients utilise the financing to embark on small businesses, even though these clients are capable to self-employ. however, the income from the small businesses may not be higher than the wage income. there must be a way to further increase their income for them to graduate from the low wage especially for women clients who enjoy flexible hours so that they can manage their families at the same time [10]. iii. issues and challenges facing the imfis the issues and challenges facing both aim and bmt in providing financial access to the poor can be divided into several categories. this section discusses these issues and challenges faced by aim and bmt in delivering the conscience-based financing services. ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 a. human capital performance the challenges of human capital performance in bmt come in several dimensions. firstly, the staff lack spirits in developing islamic financial services. in addition, there is insufficient human resources with good managerial skills to manage the performance of the institutions. low understanding in economic principles and islamic financial transaction aggravate the performance of the human capital. shari’ah compliance is the key feature of doing business in islamic microfinance but in practice, many officers and employees of bmt have low financial literacy. this situation is very upsetting because it will impact the perception of the community towards the image of bmt. the members of bmt are dependent on the institution to educate and support them in understanding and distinguishing between bmt and its conventional counterpart. when this issue with human resources are not addressed accordingly, people assume that financial products and services offered by bmt are similar with other conventional financial institutions. in reality, most of administrators and management of bmt also have no background in finance and economic. according to the research conducted by universitas islam indonesia, majority of bmt administrators lack knowledge and experience in managing islamic finance institution, therefore in practice, bmt often deviate from islamic principles and cannot be efficient in business management. in general, bmt started as a small business unit initiated by the public. having a limited business scope with limited human resources capacity, human resource capability management skill in bmt has difficulty to grow. due to budget constraint, human development training cannot be done that leads to the poor performance of human resources in bmt. this issue causes many bmts to suffer bankruptcy problem because of operational failure [11]. focusing on the case of bmt in pekan baru, the study supports that lack of quality human resource and absence of specific regulations affect its performance. the study also states most of employees in bmt do not have competency as shari’ah practitioners and do not have understanding about the concept of business [7]. little or none has been written on aim in terms of human resource performance based on the review carried out. this is a research gap that can be focused by future researchers. there seems to be many articles written on bmt which is applaudable because it shows that there are concerns with bmt and they want to see improvement due to the big potential that could benefit so many. b. cost of fund and perception of interest cost of fund in bmt is higher than the cost of fund in islamic and conventional banks. this is because bmt has to put in more effort to invite customers to save and deposit their fund in bmt by giving higher profit rate to depositor. at the same time, to offset that cost, bmt transfers the cost to other products which makes other products to cost more. this situation influences perception of the people that bmt is conducting financing scheme based on riba although bmt claim that they operate their product and service based on shari’ah principle [12]. it is understood that the basic of islamic finance is the avoidance of riba. however, the perception of indonesian muslims on banking interest is still divided even though majlis ulama indonesia has produced fatwa no. 1 in the year 2004 to forbid interest rate. it is important to note that the perception of indonesian muslims on interest is classified into three groups: a) interest is riba, thus it is haram, b) interest is halal as long as there is no islamic bank, and c) interest is halal. this position restricts the opportunity of islamic finance institution to make ordinary muslims as their target market because of the different perception on interest [12]. in the case of aim, there is zero cost of fund because financing is offered based on qard. however, a 10% service fee called ujrah is charged to the members. this rate is unusually high due to the unique operation of aim and is suggested to be waived or kept to minimum to honour the spirit of qard hassan and offered to the hard core poor only [13]. offering loan in the form of qard by charging service fee resembles conventional loan to the eye of the public. therefore, aim as an imfi should consider introducing islamic microfinance products based on equity based financing such as mudharabah and musharakah to the poor customers. by introducing islamic microfinance products, aim will not only become credit provider but more importantly, a business partner to its clients to foster their businesses and provide guidance to the clients to elevate themselves from the vicious chains of poverty c. legal or structural problem and standardization on establishment and operations to date, there is no specific act or regulation on bmt in indonesia. the existence of bmt is based on act of cooperation and ministerial decree about kjks (koperasi jasa keuangan syariah /cooperation for shari’ah finance services). this means that bmt is still governed by the conventional system. the act of cooperation only regulates cooperations in conventional structure. in indonesia, islamic banks are regulated by a specific act (act. no. 21 year 2008). there is no formal standardized regulation for bmt. this problem affects the stability of bmt presence because it gives opportunity for many “blind passengers” to manipulate the noble aims of bmt for their own interest such as accumulating wealth, getting higher benefit and misusing depositor fund for their own business. the conduct of the business of bmt become unethical and opposite to shari’ah and practical principle. since there is no act, regulation or standardization for bmt’s establishment and operation, fraud cases cannot be taken into court of law and punished. the consequence of their activity is that the reputation of bmt in the society is damaged and compromised [12]. there is also lack of legal support from government to bmt. some of the issues are bmt in indonesia is not governed by legal provisions and there is no suitable supervision and guidance system. this legal support issues become important considering the fact that bmt is the ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 organization that administers and manages society’s funds. banks have deposit insurance agencies in the event of liquidation but bmt does not have this kind of support. the absence of a clear legal framework may also lead to the inaccessibility of deposit insurance agency. thus, public savings collected by bmt is not properly protected [14]. aim, on the other hand, is a private trust body that was established on 17 september 1987 and has been registered under trust act 1952 amendment 1981 (act 258). the establishment of aim is an effort of “ikhtiar project” which was a research project led by professor david s. gibbons and professor sukor kassim [15]. as a registered private trust body, aim is being governed by lembaga amanah ikhtiar malaysia mainly by the board of trustee in which the membership consists of economic planning unit and implementation coordinator unit from the prime minister department, ministry of finance malaysia, ministry of rural and regional development, state representatives and some other members that were appointed based on individual capacity. the members of the board of trustee have the responsibility to ensure the administration, operation, distribution of fund and the implementation of project initiated for sahabat of aim conducted with due diligence without any misappropriation. the operation of aim is based on the mandate given by the government. in 2013, this institution was entrusted with rm 300 million to benefit over 500,000 borrowers by 2015 [16]. d. standardization of shari’ah supervisory board authors and affiliations on the topic of the shari’ah compliance monitoring, dewan shari’ah nasional majlis ulama indonesia (dsn mui) has appointed shari’ah supervisory board (ssb) in each islamic financial institutions (ifis) representing dsn mui to supervise and ensure that the ifis operate according to islamic principles. however, the presence of ssb in every ifis does not make the general public feel reassured because people still see the gap between theory and practice. this could imply that, either the suggestions by ssb are not implemented or the general public does not really understand the shari’ah law to be able to discern the whole matter. whatever it is, the responsibility lies with bmt to implement shari’ah law in their daily operations and ensure the general public are aware that they are implementing it. bmt carried out standardization on three major aspects which are the standard operating procedures, human resources and financial statements. even though ssb is an independent institution whose main function is to supervise compliance of shari’ah in the operations, ifis need to be aware not to overlook compliance on islamic principles s to avoid the risk of reputational damage. research on bmt yogyakarta found that bmt in general has implemented internal control, but there are still weaknesses in the authorization procedures. from 19 samples, only 11 bmt has ssb [17]. aim has its own shari’ah advisory board (panel penasihat syari’ah) that carry out standardized supervision. this ensures homogeneity across the products and services offered. no sources are found to criticize or claim the functions of the advisory board of aim so far. e. high operating cost and reliance of subsidy the islamic microfinance providers face the issue of high operating costs in order to maintain financial sustainability. the cost of financing incurred by bmt is the same regardless of the size of the loans provided to the poor. besides, high margin between the loan value and repayment reflects the problems of high transaction cost in loan processing. in addition, the issue of high cost will reduce financial inclusion. bmt, on average, distributes around us$80-us$400 in loan which is considered small. the administration cost that must be covered by bmt is around 50 percent from the nominal funding. this effectively means that, if there is no support in terms of subsidy for bmt, they must charge high margin to borrowers. therefore, the role of subsidy is very important for bmt to ensure its sustainability. reduction in transaction cost is a key issue that should be resolved for bmt in the long run. this issue is tricky due to the nature of the environment bmt is operating in. offering financing to small entrepreneurs in rural areas in small amount can be very costly. subsidy has a direct influence on microfinance. subsidized lending will have a positive impact on reducing financing rate or margin especially in bmt. many bmts search for private donors because the administration is easier than public subsidies. the problem that occurs in bmts is that many bmts can only sustain in the first two years without subsidy. after that, many of them collapse. external subsidy is crucial especially for the small-sized bmts. maintaining bmt performance by maintaining subsidy stability is a challenge for bmt. the government, national private companies and international donors have to keep providing subsidized financing sources for the poor using bmt and the importance of subsidy is unquestionable [4]. customers prefers islamic bank financing because of the steadier and more stable flow of fund compared to bmt. increasing asset and drastic liability mismatch lead liquidity risk and the less resilient bmt is prone to external shocks [6]. delegated with the task of alleviating poverty in malaysia, aim receives strong financial and non-financial support from the malaysian government and its agencies, which is critical to its sustainability. financial support comes in the form of interest-free government financing, grants and soft loans through allocations made under various malaysia plans. similar to conventional microfinance institutions, aim unavoidably experience high transaction costs due to asymmetric information problems. these costs relate to monitoring and searching costs and the cost of administration, which are all directly associated with the information problems in the rural financial markets. small loans are expensive because of high overhead costs, which usually have a large ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 fixed cost attached. aim must find a mechanism to reduce transaction costs as added costs are often passed onto clients. aim still depends heavily on the support from the government and related agencies for funding. the operational cost of aim is relatively high and salaries and administrative cost from the major proportion of operation cost, nevertheless creating only a small portion of assets. by means of a fixed administrative charge of 10%, it does not cover its operating costs and could not be sustainable and self-dependent. aim should look again on their fundamental principles because of the loss of direction in focusing on the not so poor or non-poor and giving larger loans and better-off borrowers. therefore, there is no incentive from such institutions to offer any other microfinance products apart from microcredit loans to finance their operation. this theory also occurred in bmt which many of them searching for private donor because the administration is easier than public subsidies as mentioned earlier [18]. if costs are not covered, the capital will be depleted and continued access to financial services will be difficult. therefore, aim should seek financial funding from variety sources other than government to maintain their sustainability in the long-term. f. repayment problem among members geographical distance is important because it will lead to islamic microfinance efficiency. the higher distance will cause more credit rationing problem. one of the features for the people at the bottom of the economic pyramid is that, they live in remote areas which are far away from financial institutions including bmt. people who live near to bmts have lower incidence of credit rationing and one of the difficulties facing the poor borrowers in accessing credit is the distance between their homes and the bmts. in practice, bmts need to include the distance between the bmts and the borrower to help in deciding whether they should get financing or not. this is because short distance will make the monitoring process easier and the application would have a greater chance of being approved. the distance of a borrower’s house from bmt is also a determinant of credit rationing. financial services nearness is described as poor people who live nearer to microfinance institutions and can be contacted. people who live closer to bmt will have easier access to financing since it will reduce the cost of monitoring because it does not require bmt staff to take public transportation that would acquire a cost. a greater risk will be faced by bmt if they give funding to far away borrowers [4]. furthermore, the long travel time from home to bmt cause customers to get less access to information and updates. it also makes the frequency of customers’ meetings with bmt employees getting smaller so the chances of bad repayment rate increase and also smaller participation of the customer of bmt to borrowing. for example, in bmt khairu ummah located on jalan raya leuwiliang, leuwiliang, kabupaten bogor, as well as two branches of bmt khairu ummah located in the cigudeg and puraseda village, leuwiliang have a bad repayment rate and one of the reason are the customers’ home are far away from the bmt agency [19]. aim members also have repayment issue but the cause of the issue is different and related to client selection procedure of aim that starts with measuring potential clients’ average monthly household income. households with average monthly household income below the poverty line income (pli) has been calculated by the malaysian government since the year 1976. it was estimated based on the necessity of food and other basic needs and would be considered as absolute poor, while households with average monthly household income below half of the pli would be categorized as hardcore poor. therefore, households whose average monthly household income falls below the pli, including both poor and hardcore poor households, are considered to be eligible to obtain microcredit from aim. based on a survey in kelantan, terengganu and kedah, more than 50% of the total respondents reported that they used credit in non-income generating activities, which increases the chance of encountering repayment problem. repayment problems can lead clients to leave the program or become inactive borrowers. when hardcore poor households’ income streams are interrupted, which is commonly the case, the clients may have to sell their fixed assets to repay the loan. aim therefore has to consider a flexible loan policy to allow poor and hardcore poor households to reorganize the loan when clients encounter any financial crisis. aim should also focus on appropriate training and development programs in order to enable the hardcore poor households to use credit in income generating activities, grasp employment generating opportunities as well as find and invest in new income generating activities, which eventually reduce their repayment problem [20]. g. lack of business knowledge and technical skills bmt is faced with the lack of entrepreneurial development in the community [14]. when potential members do not have the skill to run a business, upward social mobility cannot be achieved in the event of the members fail. the lack of exposure and education also contribute to the non-delivery of the financing granted with the intention to assist the poor to increase their income. pbmt institute is one initiative to provide training program related to managerial aspect of bmt in order to produce competent and high quality staff and deal with human resources problem. however, not many bmts are interested to send their staff for the programme since it requires some fee payment [21]. in the malaysian environment, entrepreneurship culture does not blend well amongst the malays and bumiputera as compared to the chinese. for chinese, most of their businesses succeed and they transfer down their skills through generations. hence, knowledge in business management and related technical skills have to be transferred to all microfinance borrowers since majority of them are malays and bumiputera. realizing this issue, aim provides business and financial management course to the borrowers but only ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 selected borrowers are chosen to attend the course. aim also does not have a standardized module of training specially to handle different level of borrowers. for example, the level of understanding financial and business management topics may vary from each borrower. the trainer or the speaker needs to make it easy and simple for the information and knowledge to be understood because the audiences lack education. based on the research, many aim borrowers lack knowledge on how to manage their business income. most of them do not know how to separate between their business and personal consumption. many borrowers allocate a large portion of their income for personal consumption and only the least amount for their businesses. many use the income to financially support their daily living expenses and make little effort to expand their businesses. this is one of the many reasons, why some of their businesses are unsuccessful even after continuous microcredit loans. the major constraints for the poor have always been the dependency on a single economic activity and the lack of skills to vary their sources of income to supplement their daily living [22]. the success of microfinance depends largely on the skills and understanding of the people managing the microfinance programme given the unbankable nature of microfinance clients themselves, namely low literacy level, having little knowledge about business, and having no physical assets. iv. conclusion facing different operating situations and unique peculiarities, both aim and bmt have their own shortfalls. they have almost similar categories of issues, being formed having the objective of poverty alleviation, most issues stem from criteria of the members as well as the staff of the institutions. members with no background in business and imf staff with no shari’ah training and exposure are among the most serious potential factors for failure. therefore, human capital, from the members and the imfs, play pivotal role in ensuring the success of the social financing. another glaring issue is the reliance on subsidies of aim and dependency on donors by bmt. inevitably, the nature of profit maximization is not the modus operandi, hence, these imfs need to find other source of funding such as sri sukuk that has been gaining ground over the recent years. this can be further looked into in future research. while aim is blessed with the support from the government, the bmt lacks this legal support. some amendment to the laws pertaining imfs would accommodate their growth. shari’ah issue is not seen as a stumbling block for the operations of aim but for bmt, it is more serious. the role of shari’ah supervisory board is still minimal and the mixed perception of the indonesian public on riba puts restriction for bmt to widen its market. between the two institutions, credit is due to bmt for its non-dependency on government grant for source of funds. bmt fits the description of imfis that can stand on its feet to offer financing to the poor without the government having to dig deeper into their coffers. they actually help the government by serving the customers who are unbankable and live in different types of difficult geographical settings that cannot be reached by the normal financial institutions. in summary, internal issues can be managed by the imfs and government but external issues that concerns the mindset of the members need intervention from more parties. bmts issues are more complex to be solved because of the nonstandardization elements in the operations as compared to aim. a special task force looking into each and every bmt for improvement is ideal but difficult to be executed due to its heterogeneity and resources to fund the task force. references [1] biancone, p. pietro, & radwan, m. (2018). social finance and unconventional financing alternatives: an overview. european journal of islamic finance,, (10), 1–6. https://doi.org/10.13135/2421-2172/2818 [2] biancone, p. pietro, & radwan, m. (2019). social finance and financing social enterprises: an islamic finance prospective. european journal of islamic finance, 0(0). https://doi.org/10.13135/24212172/3176 [3] hosen, m. n., & sa ’roni, l. s. (2012). determinant factors of the successful of baitul maal wat tamwil (bmt). international journal of academic research in economics and management sciences, 1(4), 2226–3624. retrieved from www.hrmars.com/journals [4] wulandari, p., & kassim, s. (2016). issues and challenges in financing the poor: case of baitul maal wa tamwil in indonesia, international journal of bank marketing, vol. 34 issue: 2, pp. 216-234 [5] asmy, m., mohammed, m. o., & abdullah, m. a. (2016). developing cash waqf model as an alternative source of financing for micro enterprises in malaysia article information. journal of islamic accounting and business research, 7(4), 254–267. retrieved from www.emeraldinsight.com [6] ascrya, a., & sukmana, r. (2017). cash waqf models of baitul maal wat tamwil in indonesia. in international conference and call for paper: waqf and economic growth [7] hamzah, rusby, z., & hamzah, z. (2013). analysis problem of baitul maal wat tamwil (bmt) operation in pekanbaru indonesia using analytical network process (anp) approach. international journal of academic research in business and social sciences, 3(8), 215–229. https://doi.org/10.6007/ijarbss/v3-i8/138 [8] possumah, b. t., & baharuddin, g. (2012). governing baitul mal towards 2020; issues and challenges: indonesia experiences. international journal of business and management tomorrow, 2(10), 1– 10. retrieved from www.ijbmt.com [9] mokhtar, s. h., nartea, g., & gan, c. (2012). the malaysian microfinance system and a comparison with the grameen bank (bangladesh) and bank perkreditan rakyat (bpr-indonesia). journal of arts and humanities, 1(3), 1–18 [10] almamun, a.-, abdul wahab, s., & malarvizhi, c. a. (2011). examining the effect of microcredit on employment in peninsular malaysia. journal of sustainable development, 4(2), 174–183. https://doi.org/10.5539/jsd.v4n2p174 [11] nurasyiah, a., utami, s. a., & mahri, a. j. w. (2016). the challenges of human capital performance in developing baitul maal wat tamwil in indonesia, 15, 599–604 [12] kholis, n. (2012). the prospect of islamic microfinance institutions in indonesia. episteme, 7 [13] saad, n. m. (2012). microfinance and prospect for islamic microfinance products: the case of amanah ikhtiar malaysia. advances in social http://www.hrmars.com/journals http://www.emeraldinsight.com/ https://doi.org/10.6007/ijarbss/v3-i8/138 http://www.ijbmt.com/ ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 science,1(1). retrieved from http://irep.iium.edu.my/27269/1/possible_islamic_products_for_microcr edit_scheme.pdf [14] rusydiana, a. s., & devi, a. (2013b). challenges in developing baitul maal wat tamwiil (bmt) in indonesia using analytic network process (anp). business and management quarterly review, 4(2), 51– 62. retrieved from https://core.ac.uk/download/pdf/83283333.pdf [15] https://www.aim.gov.my/maklumat-korporat-aim [16] http://edbizconsulting.com/publications/isfire_11_2013.pdf [17] mediawati, e., & agustami, s. (2016). sharia compliance on murabaha financing. advances in economics, business and management research, 15, 161–162 [18] abdul rahman, r., & dean, f. (2013). challenges and solutions in islamic microfinance. humanomics, 29(4), 293–306. https://doi.org/10.1108/h-06-2012-0013 [19] effendi, j., & utami, a. r. (2016). the effect of social capital on customer’s repayment rate at islamic microfinance institution. aliqtishad: journal of islamic economics, 8(2), 227–242. https://doi.org/10.15408/aiq.v8i2.2631 [20] abdul wahab, s., almamun, a.-, malarvizhi, c. a., & mariapun, s. (2011). examining the critical factors affecting the repayment of microcredit schemes in amanah ikhtiar malaysia (aim) in malaysia. international business research, 4(2), 93–102. https://doi.org/10.5539/ibr.v4n2p93 [21] pbmt. (2015). haluan bmt 2020 bmt sebagai sokoguru perekonomian indonesia [22] mason, c., wan azmi, w. n., & madden, r. (2015). aiming for greater financial inclusion through sustainable development: the story of aim (amanah ikhtiar malaysia) https://www.aim.gov.my/maklumat-korporat-aim http://edbizconsulting.com/publications/isfire_11_2013.pdf https://doi.org/10.5539/ibr.v4n2p93 ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 developing an islamic bosnian diaspora mutual fund: islamic finance, diaspora philanthropy and the economic development of bosnia and herzegovina abstract — this paper analyzes the potential of diaspora philanthropy in an islamic economic context specific to the development of bosnia and herzegovina. the bosnian war in the late 1990s created a large bosnian diaspora population that resulted in significant increases in the country’s remittance inflows, which continue to account for a large percentage of bosnia’s gdp. while some financial remittances are invested, most are used towards consumption and contribute very little to the country’s economic development, oftentimes leading to negative long-term effects including a significant youth brain drain. however, islamic finance presents a potential revolution in the role remittances, as a form of diaspora philanthropy, play in economic development and poverty eradication within bosnia. namely through the creation of an islamic bosnian diaspora mutual fund which pools remittances in the form of investments. the aim would be to primarily mobilize remittances, which individually have very little economic potential, and invest them in shari’ah compliant instruments and endeavors in bosnia. return on investments could then be pooled into philanthropic funds which would be used towards supporting small and medium business growth and combat issues related to unemployment. thus, this paper discusses the potential of islamic finance in organizing and revolutionizing diaspora efforts (financial remittances) in detail. it presents a case for islamic finance and its role in effectively strengthening diaspora philanthropy in order to contribute to the economic development of bosnia and herzegovina while presenting a potential model for the mutual fund. keywords islamic mutual fund, remittances, diaspora philanthropy, economic development, youth brain drain i. introduction philanthropy has a long presence and tradition in history with examples of its practice in all major civilizations. its ideological presence in nearly all of the world’s major religions as well as societies, not to mention the arguably innate human tendency toward philanthropic activities, make philanthropy a key component in any system. philanthropy looks to solve issues at their origin in order to alleviate them completely over time, as oppose to providing immediate solutions that do not last. it is considered that the most effective philanthropy is organized or institutionalized philanthropy as this form of giving tends to be more effective. diaspora philanthropy, as a form of organized philanthropy, is playing an increasingly important role in global philanthropy as a whole. its potential in providing aid particularly to developing countries is discussed in detail in this paper. examples of foundations which have effectively taken advantage of diaspora philanthropy include the ireland funds and turkish philanthropy funds, who have successfully provided billions of dollars of aid to their home countries over the years by mobilizing their respective diaspora worldwide. one of the key areas which diaspora philanthropy and philanthropy in general, can affect is economic development. since the projects which are funded by these foundations are always of a social or economic nature, they successfully provide outlets for economic development whether in the form of poverty alleviation, employment opportunities or similar. they are also not hindered by political factors as philanthropy in its nature should be free of any politics. this means that the external aid diaspora philanthropy foundations offer could be more effective than any government aid the recipient country is currently receiving. bosnia and herzegovina, as a nation with a significant diaspora population, could very well take advantage of this form of diaspora philanthropy. already a high remittance receiving nation, bosnian diaspora could re-evaluate their current giving schemes in order to better answer the current economic issues. not only could the creation of a bosnia diaspora philanthropy foundation reform the way remittances are used, therefore eliminating the already negative long-term amela trokic ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 effects of their inflow in bosnia and herzegovina, but it could also directly work towards answering some of the greater socio-economic problems such as the youth brain drain and unemployment. but the potential of a bosnian diaspora philanthropy is heightened when considered from an islamic economic context. namely by establishing an islamic bosnian diaspora mutual fund which pools remittances in the form of investments. the pooled funds would be invested in islamic financing schemes concerned with eradicating poverty, increasing economic development and reducing the unemployment rate, and turning the youth brain drain into a brain gain. primarily, the potential of schemes such as takaful products, mudarabah and musharakah schemes and qard hasan are encouraged. therefore, this paper attempts to present the potential of diaspora philanthropy in an islamic financial context. it presents the argument for the benefits of establishing an islamic bosnian diaspora mutual fund particularly in encouraging economic development in bosnia. it will discuss how the creation of such a fund would effectively promote economic development in the country by mobilizing remittances, which individually have very little economic potential, and investing them in shari’ah compliant instruments and endeavors. it also presents a potential model for an islamic bosnian diaspora mutual fund aimed at supporting small and medium business growth and combating issues related to unemployment, with specific consideration of the youth demographic. ii. bosnian migration and formation of bosnian diaspora population the migration of balkan populations, including those of bosnia and herzegovina, have a long tradition. while migration flows can be traced back to pre-world war times, all migration prior to the second word war will be considered insignificant to the contribution of this research. with that in mind, all recent migration flows from the region can be grouped into three categories representing the major reasons for why individuals migrate. these include; (i) voluntary migration; (ii) economically driven migration; and (iii) forced migration. the latter is not necessarily a recent phenomenon considering the numerous wars and violent unrests which characterize the balkans. however, the bosnian war of the early 1990s specifically contributed to this category [1]. in fact the bosnian war period, including the pre-war and post-war periods, resulted in the most relevant migration flows for the purpose of this analysis since they contributed to the majority of the bosnian diaspora population which exists globally today. therefore, these migration flows can be individually analyzed by breaking the migration flow into three major time periods:  pre-war migration  migration during the war; and  post-war migration a. pre-war migration migration prior to the bosnian war was mainly the emigration of the labor force in the 1960s and 1970s. at the time, the territory that constitutes bosnia and herzegovina today was under the rule of the former socialist federal republic of yugoslavia (yugoslavia). during the aforementioned period, yugoslavia was experiencing slowdowns in economic development resulting in unemployment and an ultimate ease in emigration restrictions [2]. this is widely considered the first large migration flow of bosnians from the country to various parts of the world including, but not limited to, australia, the united states, canada and countries in western europe such as germany, switzerland and austria. the education level of emigrants of bosnia during this period was characterized as low and medium-educated [3]. b. migration during the war the war in bosnia and herzegovina, which lasted between 1992 and 1995, saw the rise of a large migration population. migration occurred due to the violent conflicts that arose during this period with voluntary migration occurring when people moved in order to seek asylum in safer areas or avoid potential danger, and forced migration occurring when territories were overtaken by the opposing side. this migration flow can be broken into two groups of migrants; those who were internally displaced and those who were externally displaced. nearly 2 million people, or about half of the country’s population at the time, forcefully migrated from their homes [1]. for the purpose of this paper, only those migrants who constitute the externally displaced population are of relevance to our research as they make up a portion of the current bosnian diaspora population. the resulting externally displaced migrant population ranged from low to highly-educated bosnians due to the nature of the situation. as individuals were forced to migrate, the incentive was purely one of safety and survival, therefore, producing a wide range of different types of migrants. the countries to which bosnians migrated varied depending on where asylum was being offered at the time but generally constituted countries of the european union, the united states, canada and australia [4]. c. post-war migration the migration flows during the post war years to the present date are generally categorized as voluntary and driven by economic reasons. bosnia and herzegovina’s economic situation is less than desirable, illustrated by its low activity rate (one half of the eu average), leading to people looking for labor opportunities elsewhere [1]. the countries to which bosnian migrants mainly move to during this post-war period include neighboring countries such as croatia, serbia and montenegro as well as eu countries within the vicinity, mainly germany and austria [3]. migration today is not limited to the labor force as students are increasingly leaving bosnia in pursuit of better educational prospects. according to data compiled by unesco, a large number of students from bosnia and herzegovina pursue their ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 studies outside of the country. according to this same data, 12,452 students from bosnia studied abroad during the 2011/12 school year, an equivalent of 11.8 percent of all students enrolled in bosnia at the time [3]. it is also interesting to note that bosnia has a large tertiary educated migrant population, the second largest out of all european and central asian countries in the year 2000 at a staggering 23.9 percent of the total tertiary-educated population [4]. the number of educated physicians in bosnia and herzegovina that emigrate each year is also significant. since the end of the war, the percentage of the medical brain drain has steadily been increasing and reached a high of 12.2 percent in 2004 (table 1). that is an estimated 772 physicians out of a total 5,541 physicians in bosnia and herzegovina leaving the country, a significant loss to the system. table i. emigration of physicians from bih year physician brain drain # of physician emigrants # of physician in bih medican brain drain (%) 1995 487 5,062 8.8% 1996 513 5,165 9.0% 1997 553 5,260 9.5% 1998 607 5,371 10.1% 1999 670 5,426 11.0% 2000 705 5,656 11.1% 2001 754 5,430 12.2% 2002 736 5,503 11.8% 2003 756 5,541 12.0% 2004 772 5,541 12.2% today, the world bank estimates a total bosnian diaspora population of 1.461 million emigrants worldwide which only takes into consideration the foreign-born population [5]. the ministry for human rights and refugees of bosnia and herzegovina, on the other hand, has measured the stock of diaspora at 1.669 million emigrants. their estimate includes descendants of second and third generations so even those not born within bosnia but who carry its citizenship/nationality. either way, it can be concluded that bosnia has a large diaspora with a considerable potential if tapped into appropriately. iii. remittances in bosnia and herzegovina as mentioned earlier, officially recorded remittance flows to developing countries were estimated at $401 billion (usd) in 2012. not only was this an increase from remittance flows in 2011, but the expected future growth is estimated to be an average of 8.8 percent annually in the period of 2013 to 2015 [6]. generally in developing countries, remittances are used for consumption purposes and in such are considered to help alleviate poverty by positively impacting income distribution (diminishing economic inequality) and individual welfare [4]. remittances can also affect the economy of a developing country as a whole by covering deficit while also promoting employment, productivity and overall growth [7]. table ii. remittances from bosnian emigrants to bih year remittances (in million usd) 2001 1.521 2002 1.526 2003 1.749 2004 2.072 2005 2.043 2006 2.157 2007 2.700 2008 2.735 2009 2.167 2010 2.228 bosnia and herzegovina, with its impressive diaspora population, has been one of the top remittance receiving countries in the world for the past decade. in 2004, bosnia and herzegovina had a remittance inflow of $2.072 million (usd) making it the second highest receiver of remittances in eastern europe and the former soviet union that year [4]. by 2007, remittances accounted for 18 percent of bosnia’s gross domestic product (gdp) and in 2010, despite the effects of the economic recession, remittances still accounted for an impressive 12 percent of the country’s gdp [1]. that is a total inflow of $2.228 million (usd) in remittances to bosnia and herzegovina (table 2). figure 1. gdp and remittances for bosnia and herzegovina [4] although there is minimal data on the exact use of remittances in bosnia and herzegovina, it is assumed that the primary use is towards consumption as with other developing economies know for significant remittance inflows. also, seeing as both gdp and remittances show yearly increases, and consumption is a main component of gdp, it can be assumed that the remittances were in fact used mainly towards ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 consumption hence boosting the gdp (figure 1). in a country where nearly 50 percent of the gdp is absorbed by government bureaucracy and the average monthly wage is only about $450 usd, [8] remittances come as a much needed boost to household incomes, even if only used towards consumption. therefore, remittances do have apparent advantages to the economic development of a nation, particularly one whose development was hindered and in many ways reversed due to years of violent conflict. a. negative long-term effects of remittances despite contributing heavily to gdp and providing an initial boost to the war-traumatized economy, remittances have had negative long term effects on the economic development of bosnia and herzegovina. although remittances are meant to alleviate poverty and economic inequality, in the case of bosnia they tend to have the opposite effect. with regards to poverty alleviation, remittance inflows have not been pro-poor but instead it has been shown that a larger number of non-poor households receive remittances than poor ones in bosnia [9]. the average amount of these remittances has also been nearly twice the amount of those received by the poor households. as far as economic inequality is concerned, remittances seem to attribute to widening the economic gap as oppose to minimizing it since the average amount of remittances received steadily increases from the poorest to the richest deciles [4]. furthermore, seeing as remittances are primarily used for consumption the multiplier effects are not as effective as they would be if these funds were saved or better yet invested. sadly, only between 4 and 6 percent of remittances are invested in businesses and/or entrepreneurial ventures [1]. consumption in itself poses a greater threat seeing as remittance inflows are steadily decreasing, so people accustomed to higher spending habits will suddenly be faced with the reality that they cannot maintain these habits within their diminishing financial means. a financially-dependent population relying on outside funding left to fend for themselves in a country with high unemployment and very few opportunities is a dangerous threat. it is also one of the reasons why a large number of youth are leaving bosnia and herzegovina and remittances may just be helping the process along. b. youth brain drain the term brain drain refers to the permanent emigration or outflow of highly trained or qualified people from their home country. bosnia and herzegovina is a country which is definitely experiencing a brain drain, but particularly one pertaining to their youth population. there are many factors which contribute to the youth brain drain occurring in bosnia today. employment among the youth aged between 15 and 29 is staggeringly low with an unemployment rate of 57 percent, the largest in the region as can be seen in figure 2 [6]. considering this demographic group makes up nearly one quarter of the country’s total population, bosnia and herzegovina maintains one of the highest youth unemployment rates in all of europe [6]. figure 2. unemployment rates by age group. (lfs data) remittances also promote the youth drain in the sense that they offer the financial means to leave bosnia and herzegovina. seeing as education is highly subsidized in bosnia, youth can complete their education in the country and use the remittances they receive from family abroad to leave. with family members living outside of bosnia setting the example, why wouldn’t youth want to leave and join them, after all they too could help their family in bosnia by inevitably sending remittances back as well. however, this may spur a chain reaction where remittance inflows become the main financier of the youth brain drain. in light of recent protests erupting in many cities around bosnia and herzegovina over unemployment and government corruption, it is clear that the population is becoming more restless. the first riots began in tuzla early february 2014, and quickly spread to other major cities in bosnia including the capital of sarajevo. several of the demonstrators were youth who call for change to the entire system, in some cities getting quite violent [10]. what is already being referred to as the bosnian spring is proof enough that change is necessary and the last thing a country in this state of revolution and transformation needs is for its youth to leave since it is they who will best bring about the desired change. remittances can provide the means to help spur the appropriate development that bosnia is looking for, that is turn the brain drain into a brain gain, but reforms are necessary. iv. diaspora philanthropy and the case of bosnia and herzegovina a. the significance of diaspora philanthropy in the changing face of global philanthropy, where new techniques and strategies are being sought out in order to increase the impact of philanthropy, diaspora philanthropy can be a significant player. considering the increasing number of international migrants, a value that today stands at approximately 214 million people versus 150 million in 2010 [11], there is a strong potential for significant impact. diaspora offers a unique opportunity for their homelands, not only are they as a group not constrained to the language and cultural barriers of their homelands but they have the ability to utilize foreign approaches and technology, which they better understand, in their homeland [12]. they are the link between their current country of residence and their country of origin, ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 transferring knowledge and creating new opportunities. as such, their contributions can take on a significant philanthropic potential. specifically, remittances can be the basis of effective philanthropy in developing countries and/or economies. the term remittance is often used in varying contexts to represent different economic transactions. with regards to the research presented in this paper, remittances refer to the transfer of money from foreign–born individuals living abroad (outside of their country of origin) to family left behind in their homeland. the world bank estimated that officially recorded remittance flows to developing countries reached approximately $401 billion usd in 2012 [6]. keeping in mind that this figure represents formal remittance flows only, that is remittances that were recorded, and does not take into consideration all informal flows which include hand-to-hand delivery, the exact value and potential of remittances can be considered far greater. in order to take advantage of diaspora potential, it is necessary to mobilize the contributions into philanthropic activities. currently diaspora contributions, pertaining to remittance flows, are mainly used towards consumption which does not necessarily create a significant, desired economic (or social) impact [4]. mobilizing these contributions into a philanthropic fund could procure more desirable results for the developing country and its economy. consider the impact organizations such as the ireland funds has had on the economic development of ireland, having raised over $370 usd million for worthy causes in ireland to date [11]. keeping in mind that such organizations transfer not only funds but human and social capital, whose value can represent a significant aspect in the way financial markets are measured, the possibilities are endless and deserve further consideration. with remittance flows expected to steadily increase every year, despite the current unfavorable economic situation, reaching an estimated $534 billion usd in 2015, action should be taken immediately [11]. b. diaspora philanthropy in other countries as mentioned earlier, global philanthropic funds are emerging as the new face of global philanthropy. their potential lies in the large number of diaspora looking to help their homelands and bosnia can take advantage of this as well. when considering successful examples of such diaspora philanthropy funds, the worldwide ireland funds are definitely worth mentioning as they are a leader in this phenomenon. the irelands funds are a philanthropic network whose main activities include supporting causes they deem worthy in ireland and around the world. they support a wide range of programs in various fields in an attempt to be the largest network of friends of ireland [13]. it is widely agreed that their efforts over the past 40 years have contributed to boosting ireland’s economy specifically by helping develop ireland’s local businesses and by creating new options for the country’s economic recovery [11]. similarly, the turkish philanthropy funds (tpf) seeks to maximize the impact of philanthropy or giving, in this way attempting to ensure the effectiveness of philanthropy to turkey and other countries. they work towards analyzing which projects will provide the greatest, most measurable impacts in order to deduce where donations are best invested. tpf understands that individual giving can be most effective when pooled and invested in causes that promise potential change [13]. thus, in this way they can ensure that donations are maximized and that they are contributing to projects that will provide real reform to the country and its people. c. developing bosnia’s diaspora philanthropy that diaspora efforts and philanthropic aid to bosnia and herzegovina exists cannot be denied, the impressive value of remittances being sent every year is proof of this. however, the effectiveness of these diaspora efforts have fallen short in recent years, even creating negative long term effects as was discussed earlier. remittances can still be effective and provide appropriate aid if certain reforms are taken in the way bosnian remittances are collected and used. it is important to remember that remittances are personal and those who receive them decide how they are used. so the key is to convince those who send remittances that the potential of their donations is far greater once pooled into funds. if diaspora mobilizes together and pools remittances into funds run by a global bosnian diaspora philanthropy foundation comprised of responsible and skilled individuals, this could have a significantly greater effect on the state of bosnia, economically and socially, today. table iii. the data on the number of emigrants from bih host country number of migrants from bih usa 350,000 germany 240,000 croatia 300,000 serbia 150,000 austria 150,000 slovenia 150,000 sweden 80,000 switzerland 60,000 australia 60,000 canada 50,000 italy 40,000 denmark 23,000 norway 16,000 total 1.669,000 not only does bosnia have a significant diaspora population to mobilize in the first place, but the dispersion of bosnian diaspora is an essential factor as well (table 3). the number of bosnian emigrants living in north america for example, which includes the united states and canada, is approximately 400,000. compared to approximately 120,000 emigrants in the northern (scandinavian) european countries, ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 these two geographical locations could in themselves provide great support to a global bosnian diaspora philanthropy foundation and constitute the two main areas of mobilization for the foundation. not to mention the fact that the countries within these geographical areas, specifically canada and sweden, are considered very social nations who offer significant welfare. the further assistance and support that could be harnessed from the opportunities offered in these countries could also be directed towards the effective development of a global bosnian diaspora philanthropy foundation. looking to the philanthropy funds established by other diaspora groups, like the irish and turkish funds mentioned earlier, bosnian diaspora can learn a lot. the most important step would be to mobilize skilled individuals with the expertise to establish and run a diaspora foundation, with branches in key geographic areas such as north america and scandinavia. the foundation would then research and prioritize core areas which are in need of particular assistance in bosnia and herzegovina. focus areas will most likely include, but are not limited to, alleviating unemployment (and therefore poverty) by creating more job opportunities, funding the education and health sectors, improving the quality and standard of living and similar. funds would then be established to finance projects which attempt to provide solutions to the problems within these aforementioned areas. the basic mode of financing these funds could well be the remittances that are being sent today. v. the role of islamic finance in developing a global bosnian diaspora fund extending from the concept of a global bosnian diaspora fund, islamic finance plays a crucial role in making this idea more effective. while the bosnian diaspora fund itself is the foundation, representing the group of potential investors, islamic finance can ensure the very essence of the fund is maintained, that being to contribute to the economic development of bosnia and herzegovina. in that respect, the global bosnian diaspora fund can be designed as an islamic mutual fund. examples of diaspora mutual funds already exist, such as the rwanda diaspora mutual fund (rdmf), but none which incorporate aspects of islamic finance as well. therefore the potential of an islamic bosnian diaspora mutual fund are significant. aside from the arguments already presented earlier about the size and potential of bosnia’s diaspora and remittance giving, it is important to note that the majority of bosnian migrants living abroad identify with the islamic faith. the model for an islamic bosnian diaspora mutual fund could then be created, with bosnian diaspora from around the world representing the investors and remittances constituting the investment capital, as can be seen in figure 3. figure 3. islamic bosnian diaspora mutual fund the fund would invest in islamic financial models aimed at contributing to the economic development of the country. this would be organized in three main models:  takaful – investments in micro-insurance policies for low-income individuals, primarily in rural parts of bosnia and herzegovina, with the intent to contribute to poverty alleviation.  mudarabah and musharakah contracts – contracts specifically aimed at domestic small and medium enterprises intended towards their growth and development. in special cases, mudarabah contracts can also be allocated to entrepreneurs in order to provide them with seed capital to encourage the initiation of more start-ups in bosnia.  qard hasan – support for youth in bosnia with entrepreneurial endeavors to help reduce youth unemployment. also, scholarships for further education abroad with the condition that the youth return to bosnia and implement their foreign education in the country to its benefit. this will help combat the increasing youth brain drain. a. takaful and its poverty alleviation potential in bosnia and herzegovina in terms of insurance, it has increasingly become recognized for its potential and contribution to poverty alleviation. studies have shown that individuals living in poverty have a desire to save and safeguard themselves against possible future risk but often lack the opportunity or support to do so. insurance can provide the poor with coverage, reducing their vulnerability in terms of disease, theft, disability and other threats [14]. yet, providing insurance to the poor is a difficult feat particularly due to the unfavorable circumstances associated with it such as high costs, corruption, and low collateral, uncertain profitability and similar. not to mention the high start-up costs and need for an economically and politically stable environment [14]. consequently, the responsibility of providing insurance to the poor has been left to the informal sector with minimal success. ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 the cooperative insurance structure is perhaps the best option for providing insurance to the poor. a cooperative is an autonomous association of individuals who voluntarily cooperate in order to achieve mutual benefit whether of a social, economic or cultural nature [14]. takaful is very similar to the cooperative and mutual insurance schemes and can, therefore, be effective in contributing to poverty alleviation [15]. this can primarily be conducted through the creation of micro-takaful products as a part of a larger poverty alleviation strategy, as takaful alone cannot solve the poverty problem. therefore, as a product in which the islamic bosnian diaspora mutual fund invests in, takaful can be a very effective tool in helping bosnia’s economic development as part of the fund’s overall aim. its potential in bosnia is also significant. there are many insurance companies currently working within bosnia, however, none of them are offering takaful products. in that sense, the market potential is large because any organization to start offering takaful would be the first. other factors which create a favorable market for takaful in bosnia include the large muslim population of nearly 2 million and a stable insurance market growth in the last few years. this eradicates some of the risk associated with takaful products. b. mudarabah and musharakah contracts for sme development bosnia and herzegovina suffers from limited sme support services making them heavily dependent upon donor support. similarly, while the country has a relatively well-established and developed network of start-up business incubators, about 13 in operation around bosnia, their legal status is questionable [16]. this puts into question their ability to assist aspiring entrepreneurs and the extent to which their assistance can go. the need for more assistance and support is therefore quite clear. not only because it is lacking but because bosnia requires strengthened entrepreneurship in order to create potential growth in the private sector, especially with regards to the development of smes. the banking sector, however, does little to encourage this growth as very little is invested in startups since they are considered high-risk [17]. an islamic bosnian diaspora mutual fund could fill the gap the government has left and provide further assistance to sme development as well as for individual entrepreneurs, particularly those which fall into the youth demographic. investing in smes is crucial for bosnia’s economic development because it will contribute to enhancing the country’s overall productivity by creating new jobs that reduce unemployment. in turn this will help reduce poverty and spur future innovations [18], particularly if youth-led ventures are sponsored. the issue of high-risk which other banks fear in bosnia would not be an issue for mudarabah and musharakah which allow islamic banks to lend over a longer period of time to projects with higher risk profiles [19]. therefore, not only would the fund help solve financing problems faced by smes in bosnia, but it would again contribute to the fulfillment of their main aim which is to contribute to the economic development of bosnia c. qard hasan and the youth brain drain as mentioned, bosnia faces a significant youth brain drain problem mainly as a result of its poor economic situation. youth look for any opportunity to leave the country which significantly diminishes bosnia’s major and arguably most valuable resource, its human capital. action needs to be taken to limit the further migration of youth by encouraging them to stay. creating more employment opportunities for youth is one major step and it can be done by providing support for youth entrepreneurial ventures. while this was discussed as a possibility with mudarabah and musharakah financing scheme, qard hasan is another option which may be more attractive to less experienced but ambitious youth. similarly, since many bosnian youth are limited in their education as a result of poorer access to modern resources and learning opportunities, qard hasan can be used to provide scholarships to support foreign education of bosnian youth. while at first this may seem contradictory since it would mean that more youth leave the country, the scholarships would carry conditions that require the individual return and work in bosnia. the fund could not only invest in these scholarships which would be an investment in the human capital itself, but could also help employ the youth who return upon completing their education, most likely in the companies and endeavors they financial support through their other investment schemes. what’s more, a heightened diaspora involvement in providing sustainable aid could not only slow down the brain drain, but it could also contribute to a brain gain. as oppose to simply sending money in the form of remittances that have no specific purpose, an islamic bosnian diaspora fund would make use of the diaspora human capital. this means that the knowledge and skills that diaspora has would be exploited for the benefit of bosnia and herzegovina – networking, bridge building, information exchange and connecting global markets are a few examples of the advantages a mobilized diaspora force could provide through philanthropic engagement conclusion it is very important that the diaspora potential be understood and targeted in bosnia and herzegovina. the increasing success of other countries in mobilizing their diaspora through philanthropic activities presents a perfect example for bosnia. also, the role of diaspora philanthropy in global philanthropy is growing as researchers, institutions and even governments are beginning to take notice. philanthropy has always played a significant role in social development and its role in economic development continues to increase. in a time of economic unrest and insecurity, it is important to turn to philanthropy in order to not only ensure economic success but to provide economic equality for all. for bosnia and herzegovina, years of war and conflict have made growth difficult and now, 20 years later, the process is still very slow. yet, with protests raging over the political corruption and mass unemployment, perhaps now is the best time to consider the alternatives. diaspora philanthropy could well be the new approach this nation has been looking for to boost economic (and therefore social) development free from political ties. ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 the creation of a bosnian diaspora fund could significantly contribute to the nation’s economic development. by mobilizing bosnia’s significant diaspora population, particularly in north america and scandinavia, their potential could be exploited in order to meet the needs of bosnia’s developing economy. diaspora offers many benefits including networking, bridge building, information exchange and connecting global markets, all of which could greatly benefit bosnia. furthermore, the current power of diaspora giving, mainly in the form of remittances could be re-evaluated. the potential for islamic finance is important at this point. at present, bosnia receives high levels of remittance inflows which initially provided a much needed boost to the war-torn economy but which have more recently had negative effects in the long run. by pooling these remittances into a fund which would be run by an islamic bosnian diaspora mutual fund, their effect would be notably more effective. also, seeing as how individually remittances are low and mainly used towards consumption, by pooling them not only would they have a greater financial affect but they would provide wide-spread national aid as oppose to the individual aid the currently provide to incomes. islamic financial schemes would be ideal for the fund to invest in because they would contribute most to bosnia’s economic development. considering the role takaful plays in poverty alleviation, and its current market potential in bosnia, it present the first possible investment scheme for the mutual fund. the second scheme would be mudarabah and musharakah based as they have a great potential in supporting sme growth while also avoiding one of the main issues with sme financing in bosnia today, which is high-risk. finally, qard hasan could be of particular importance for youth and encouraging entrepreneurial growth as well as supporting further education. considering bosnia’s brain drain, particularly the youth brain drain, the fund could reverse the effects by turning this into a brain gain. the mobilized potential could directly target youth and provide them with greater opportunities in bosnia and herzegovina giving them less incentives to leave. furthermore, by combining the knowledge which diaspora will provide with the youth potential currently residing in bosnia, the exchange and resulting effect could be promising for the nation’s economic development. in this way, unemployment would also decrease both among youth and other demographic groups seeing as the fund could help establish new jobs and provide the youth it supports with positions in the projects it supports. references [1] z kacapor-dzihic, and n. oruc, social impact of emigration and ruralurban migration in central and eastern europe, brussels: european commission, 2012. [2] m. valenta, and s. ramet, the bosnian diaspora. surrey, england: ashgate, 2011. [3] bosnia and herzegovina migration profile. sarajevo: minsitry of security bh, sector for immigration, 2012. [4] a. trokic, “the negative long term effects of remittance inflow in bosnia and herzegovina”. analytical, vol. 5, pp. 58-73, november 2012. [5] world bank, migration and remittances factbook. washington dc: world bank publications, 2010. [6] world bank, improving opportunities for young people in bosnia and herzegovina. washington dc: world bank publications, 2013. [7] n.n., international migration outlook. paris: oecd, 2006. [8] d. bilefsky, “war’s lingering scars slow bosnai’s economic growth”. the new york times, february 2009. [9] n. oruc, “remittances and development: the case of bosnia”, unpublished. [10] a. smale, “furious bosnians shut down central sarajevo”. the new york times, feburary, 2014. [11] c.g. wescott, and j.m. brinkerhoff, converting migration drains into gains: harnessing the resources of overseas professionals. phillipines: asian development bank, 2006. [12] p.d. jonson, diaspora philanthropy; influences, initiatives, and issues. boston: harvard, 2007. [13] d. ancien, m. boyle, and r. kitchin, “exploring diaspora strategies: an international comparison”, unpublished. [14] z. abdulrahman, “takaful: potential demand and growth,” islamic economics, vol. 22, pp. 171-188, 2009. [15] a. elrbeck, m. altuntas, and t.r. berry-stolzle, “microtakaful: field study evidence and conceptual issues,” department of risk management and insurance, university of cologne, 2011. [16] z. dzafic, a. rovcanin, and n. klopic, “development of small and medium enterprises: b&h compared to other western balkan countries,” economic analysis, vol. 40, pp. 88-103, 2008. k. newland, and e. patrick, “beyond remittances: the role of diaspora in poverty reduction in their countries of origin,” migration policy institute, 2004. [17] n. ellahi, t. bukhari, and e. naeem, “role of islamic modes of financing for growth of smes: a case study of islamabad city.” international journal of academic research, vol. 2, pp. 161-171, 2010. [18] a. huda, “the development of islamic financing scheme for smes in a developing country: the indonesian case,” procedia – social and behavioral sciences, vol. 52, pp. 179-186, 2012. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 the potential of innovative financial tools: social impact bond (sib) and sustainable and responsible investment (sri) sukuk, towards the sustainable growth of the islamic finance industry abstract— the purpose of this paper is to explicate the congruence of innovative financial tools: social impact bond (sib) and sustainable and responsible investment (sri) sukuk with the principles of islamic finance, and explore their potential contribution towards the sustainable growth of the islamic finance and societal wellbeing. using various literature, the paper takes a comparative approach in explaining and relating the two innovative tools with the development of islamic finance. the paper finds that there is a growing interest in innovative tools such as sib and sri sukuk globally. furthermore, these tools exemplify the spirit of risk-sharing and social responsibility which are the major essences of islamic finance that are currently missing in practice. the paper provides a reference towards understanding the mechanism and concepts of sib and sri sukuk. it also provides insight to the emerging interest in these innovative tools, and assesses the current innovative efforts in the islamic finance industry. additionally, it highlights the potential of these tools towards the sustainable growth of the islamic finance industry through risk-sharing and societal impact. the paper is exploratory and conceptual in nature therefore further empirical studies can be done. keywords social impact bonds; sri sukuk; risk-sharing; innovative financial tools; social responsibility. i. introduction the islamic finance industry has seen significant growth since its emergence in the 1970s where it started as a nascent sector mainly focusing on shari„ah compliant banking, and later grew into a comprehensive financial system which includes banking, capital market, and takaful. the growth of the industry has been consistently upward, growing a compound annual growth rate (cagr) of 17% from 2009 to 2013 [1]. currently, the industry‟s assets are estimated to be worth usd 2 trillion and are set to become usd 5 trillion in 2020. these growth figures are a result of improved infrastructure, robust and comprehensive industry, broader customer and issuer base, and interconnected cross-border transactions [2]. overall, the industry is concentrated in the middle east and asia with the gcc region accounting for the largest proportion of islamic financial assets (37.6%), followed by the middle east and north africa (mena) region (34.4%), while asia has 22.4% of the share from the total global islamic financial assets. although there is significant interest from other regions, the contribution from regions such as europe remains low. nonetheless, the future growth remains promising with a number of developments and initiatives taking place [1]. despite the encouraging progress, the full potential of the islamic finance industry is yet to be realised. more needs to be done to enhance islamic financial institutions (ifis) and expand innovative financial tools in order to maintain and achieve sustainable growth of the islamic finance industry. furthermore, there have been calls to bridge the gap between islamic finance theory and practice by developing more sustainable tools that also embody principles of islamic finance such as risk-sharing and social responsibility [3]. therefore, this paper aims to highlight two relatively new innovative financial tools, the social impact bond (sib) and the sri sukuk, which have the potential to be further utilised and developed in the islamic finance industry. these tools can add to the diversity of islamic finance instruments and provide the much needed social impact that is currently lacking from the industry. this paper is conceptual in nature but may have some practical relevance for ifis and parties interested to innovate shari„ah compliant and socially impactful tools. essentially, the paper will fill an important gap within the literature of sib, sri sukuk, risk-sharing and the practice of islamic finance. the structure of this paper is as follows: the following sections explain the concepts of sib and sri sukuk, then compare and contrast these innovative tools. this will be followed by a section that explains their congruence with islamic finance principles and a section that provides arguments why they can become the new frontier for the sustainable growth of the islamic finance industry. finally, several suggestions and a conclusion will be provided. ii. social impact bond (sib) in recent years, there has been a growing global interest in sib, especially from western governments that are seeking syed marwan 1 , prof. dr. engku rabiah adawiah engku ali 1 1 institute of islamic banking and finance (iiibf), international islamic university malaysia (iium) ejif – european journal of islamic finance no 4, march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 additional funds to help cover their dwindling resources amidst global financial constraints. quite a number of countries including the uk and the us have implemented sib for a variety of social programmes that address the issues such as recidivism, homelessness, education, unemployment, and care for troubled children. albeit being a relatively new financial tool that does not have sufficient track records, early pilot sibs have shown promising results and “proof of concept” [4]. therefore it is no surprise that other countries such as australia, new zealand, and canada are developing sibs for their respective countries. the following section explains and defines the sib model. a. definition a review from various literature shows that the sib does not have a fixed definition. kohli, besharov [5] define sib as “an arrangement between one or more government agencies and an external organization where the government specifies an outcome (or outcomes) and promises to pay the external organization a pre-agreed sum (or sums) if it is able to accomplish the outcome(s)”. henderson [6] defines sib as a financial instrument where investors pay for a set of interventions to improve social outcomes that are of financial interest to the government commissioner. if the social outcome improves, the government commissioner will repay the investors for their initial investment, plus a return for the financial risk that they have undertaken. however, if the results do not improve above the pre-agreed threshold, then the investors will lose their investment. according to costa, shah [7], sibs can be understood as contractual relationships between the government and private enterprises with the aim to deliver positive social outcomes. there are various versions of its name, where “social impact bond” is generally used in the uk and canada, while the term “pay for success bonds” and “human capital performance bonds” is used in the us, whereas in australia it is called the “social benefits bond” [8]. in this paper, “sib” will be used to represent this tool due to the more common usage in literature. b. mechanism the sib model intersects the public, private, and the social sector by encompassing a multi-stakeholder partnership approach. the following figure illustrates the mechanism of sib and the relationship between the stakeholders: figure 1. sib process flow as shown in the above figure, there are a number of stakeholders involved in a sib. firstly, the commissioner identifies the social area of interest. the commissioner then contracts with a financial intermediary where certain objectives are determined. the intermediary raises initial capital by issuing bonds to private investors. these investors invest by buying the bonds in exchange for future payments plus additional returns which are dependent on the success of the programme. the funds obtained from the bonds are then used by the intermediary to pay non-profit organisations (npos) who will provide the social services for the targeted population. in order to assess the degree of success for the programme, independent-evaluators are hired. they will do the necessary appraisal and report the success, or failure of the programme to the stakeholders. the evaluations are undertaken with a high degree of scientific accuracy, usually involving control groups [9]. once the report is received, the necessary funds can be paid to the investors. however, if the programme is not successful, the investors may not get any return at all. c. sib structure despite its “bond” name, sib is distinct from a conventional bond or any other type of fixed-income tool in the financial market. in general, a typical bond would have a guarantee on the capital and rate of return. on the other hand, the sib‟s capital and return are not guaranteed as they are contingent upon the success of the social programme. the guarantee element in conventional bonds also prevent total loss towards investors (risk-shifting), while in a sib, the outcome risks is shared amongst stakeholders (risksharing). from another perspective, sibs share features of both equity and debt. sib has a fixed term and capped upside, but similar to an equity, the return vary depending on the performance of the programme/project while the investments are not secured by real assets or cash flows [10]. it is also said to be a composite of a loan, equity, and fixedincome instrument – there may be the risk of total loss such as in an investment; returns based on the degree of success seen in dividends in an equity; and returns based on pegged rates like in a fixed-income instrument [11]. this makes the sib model an innovative and very unique form of financially engineered tool that is built upon social impact. d. benefits of sib there are a number benefits that can be realised from sib. so much so, that a mckinsey & company report by callanan, law [12] concluded that “sibs have potential as a tool to help solve america‟s societal problems at scale”. from literature, the benefits that can be anticipated from implementing sib are that: 1) it increases the pool of capital that can be made available to fund social intervention programmes by tapping into private sector funds [13-15]. 2) it encourages multi-stakeholder collaboration between the diverse organisations involved in the social services programmes by aligning incentives among stakeholders [3, 13, 15, 16]. ejif – european journal of islamic finance no 4, march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 3) it creates better market discipline and offer stable revenue streams for service providers, enabling the effective ones to thrive [13, 15, 17]. 4) it aligns government funds directly with improved social outcomes. in other words, it allows for funding to shift towards effective approaches. [5, 13, 16, 18]. 5) sib helps improve performance and effectiveness of social programmes as it focuses in achieving results in a transparent manner for taxpayers. the structure also has an inherent "check and balance" mechanism with the involvement of various stakeholders. [5, 16, 18]. 6) sib helps accelerate adoption of new solutions and innovations: with the sib, government agencies would have an incentive to invest in new strategies that have potential as opposed to funding the same old approaches that are not effective [15-17, 19]. 7) faster learning about what works: the sib model approach incorporates rigorous and continuous evaluation of programmes, accelerating the way we learn about which approach actually works and which do not [16, 20]. 8) it encourages risk-sharing between stakeholders from the public and private sector. the mechanism is somewhat similar to equity investment where each stakeholder hold their respective risks. however, the stakeholders are also rewarded for these risks if the programme succeeds [3]. 9) it is an innovative financial tool that can become an alternative investment asset class that is not tied to the conventional financial market. as such, sib is not subject to market volatility as its returns are driven by outcome of the social programme, rather than business cycles, economic shocks or market speculation. this also offers diversification benefits for investors [3]. 10) sib programme’s success may result in considerable cost savings as it focuses on preventative intervention measures that solve the social problem at its core, rather than treating the symptoms. public funds are shifted towards early intervention which will reduce the need to spend on treatment programmes [8, 21]. the figure below provides a simple illustration on how public savings can be realised through sib: figure 2. cost saving from successful sib e. global trends the world‟s first sib was launched in the uk in 2010, addressing the issue of recidivism (reoffending). £5 million was raised by social finance (intermediary) from charities and private organisations to fund intervention services for short term prisoners (less than one year) at her majesty‟s prison (hmp) peterborough. the sib programme provided the target group the much needed supervision and assistance upon their release from prison which was not adequately provided by the uk‟s probation service [4]. from its assessment in 2014, it was shown that the programme has successfully reduced reoffending by 8.4% from its first cohort (1000 prisoners) of the target population [22]. as of september 2015, the uk has launched almost 30 other sib projects ranging from social issues such as homelessness to youth employment [23]. in the usa, the white house established the office of social innovation and civic participation to develop grant programme to help npos to scale up effective programmes. in 2011, the white house endorsed the idea of pay-forsuccess (pfs), encouraging government agencies to look into new funding models including the sib. $100 million was asked from the congress to implement the idea of pfs at state and city level [14]. consequently in 2012, goldman sachs partnered with the city of new york, bloomberg philanthropies, and mdrc to initiate the first sib in the us. it managed to raise $10 million to fund adolescent behavioral learning experience programme which aims to reduce juvenile recidivism at rikers island correctional facility [3]. in california, projects are currently underway for a health impact sib targeting chronic asthma and reducing children‟s hospital visits related to the disease. the harvard kennedy school has also set up a sib technical assistance lab that offers assistance to governments considering the model. while in 2014, the obama administration again asked congress for $195 million discretionary funds for sib market development, and proposed a $300 million pfs incentive fund within the department of treasury to pilot projects for areas such as education, housing, training, and incentive funds for local governments [14]. currently, there are 7 sib projects in implementation in the usa and more are yet to come [23]. australia has launched two sibs in 2013, both focusing on foster care avoidance and child protection system. other sibs are being developed especially in the areas concerning family building and recidivism. finance for good [23] reports in its sib tracker, as of september 2015, there are currently 50 sib programmes globally, including from india, portugal, germany, ireland, belgium, and netherlands. the total size of sib contracts currently underway is estimated to be approximately cad190 million (usd143 million). the figure below shows the breakdown of the social issue areas and the sib values currently in implementation. ejif – european journal of islamic finance no 4, march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 figure 3. value of sib market social issue areas (cad mm) surprisingly, this innovative and promising tool has not gained as much interest from islamic or muslim majority countries, despite its fund raising capabilities, risk-sharing advocacy and social impact. nonetheless, there are some encouraging developments in the form of sri sukuk, which will be discussed in the following sections. iii. the sustainable and responsible investment (sri) industry sustainable and responsible investment (sri), sometimes also referred to as “socially responsible investment”, is a generic term that covers any type of investment process which combines investors‟ financial objectives with their concerns regarding environmental, societal, and governance (esg) issues [24]. as with the islamic finance and sib industry, the area of sri investing has gained traction and showed upward trend of growth over the past decade. in the us alone, the estimated total assets under management using sri strategies expanded from usd3.74 trillion in 2012 to usd6.57 trillion at the start of 2014, a 76% increase [25]. while as of 2010, 28% (more than £900 billion) of assets under management in the uk are under the sustainable and responsible investment (sri) segment [26]. however, according to the uk government, the market is still embryonic and is way below its potential scale. there are £95 billion of uk charitable income and endowment assets for social investment and the government are looking at ways to unlock this area. uk investors are also very keen on the social investment market. the uk government is also constantly seeking to improve its legal and administrative environment for social innovation by looking into its “charities act”, and reviewing its financial legislations [27]. it hosted the g8 social impact investment event in 2013, which discussed the role of social finance in economic development. additionally, a social investment bank, “big society capital”, was launched by the uk government to encourage the growth of the social investment market [26]. the growing awareness for sustainable and environmentally friendly development has led to more interest in sri and “green” projects from the likes of european commission (eu) and the world bank – which has led the issuance of a green and socially responsible bond since 2008. as of september 2015, the world bank has issued approximately usd8.5 billion equivalent in green bonds [28]. encouragingly, the development of sri investing has also caught the interest of one of the largest islamic finance and sukuk market in the world, malaysia. a. malaysia’s sri sukuk framework malaysia took the lead in issuing guidelines for the sustainable and responsible investment (sri) sukuk. the sri sukuk framework was first mentioned in the malaysian 2014 budget speech by the prime minister [29] and consequently launched by the securities commission malaysia (sc) in august 2014 as an extension to the existing guideline. this framework is part of the sc‟s capital market masterplan 2, which aims to promote socially responsible financing and investment [30]. the masterplan sets the agenda to develop a conducive environment for investors and issuers who are interested in sustainable and responsible investments, and facilitate the growing trend of new innovative financial tools such as green bonds and sibs [31]. the guideline covers a broad range of eligible projects which include projects that aim to: (a) preserve and protect the environment and natural resources; (b) conserve the use of energy; (c) promote the use of renewable energy; (d) reduce greenhouse gas emission; or (e) improve the quality of life for the society. existing projects under several categories are deemed to be eligible to be categorised as a sri project. this includes community and economic development projects relating to: (i) public hospital/medical services; (ii) public educational services; (iii) community services; (iv) urban revitalisation; (v) sustainable building projects; or (vi) affordable housing. islamic trust and endowment (waqf) assets or any projects that undertake the development of waqf assets are also deemed eligible to be categorised under sri [32]. furthermore, the framework details out the disclosure requirements for the issuer which includes details of the sri project and its impact, as well as a statement affirming that the issuer has complied with the relevant environmental, social, and governance standards, or recognised best practices relating to the eligible sri project. an independent party must also be appointed to undertake an assessment of the sri project and issue a report to be included in the prospectus or disclosure document. this adds transparency, boosts investor confidence, and encourages the sri market to grow, which is evidenced in the first sri sukuk issuance by khazanah recently [33]. b. khazanah sri sukuk: ihsan sukuk the first sri sukuk in malaysia was launched by khazanah malaysia berhad (khazanah) in may 2015 [34]. the sukuk programme (ihsan sukuk) led by a special purpose vehicle (spv) called ihsan sukuk bhd (ihsan), has a rm1.0 billion nominal value with a tenure of 25 years from its first issuance. the first issuance was fully subscribed in june 2015 with a value of rm100 million, and has a 4.3% return per annum over a 7 year tenure [35]. it was assigned a rating of aaa(s) by ram rating service berhad (ram). the rating reflected khazanah‟s role as the credit obligor under the sri sukuk structure [34]. the sole lead arranger of the sukuk is cimb investment bank berhad (cimb) while the joint shari'ah advisors are cimb islamic bank berhad and amanie advisors sdn bhd. the sukuk is ejif – european journal of islamic finance no 4, march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 structured according to the islamic principle of wakalah bi al-istithmar. the figure below shows the structure of the sukuk in further detail: figure 4. ihsan sukuk structure the proceeds from the sukuk issuance is channelled to yayasan amir, which is a non-profit organisation (npo) that manages khazanah‟s trust schools programme a public-private partnership with the government. the objective of the programme is to improve accessibility to quality education in malaysia. the sri sukuk follows a “pay for success” structure which measures impact through several key performance indications (kpis) throughout a 5year period. prior to its maturity date, an independent auditor from either ernst & young, kpmg, pricewaterhousecoopers, or deloitte, shall evaluate the kpis of the sukuk and provide a kpi evaluation report for the sukuk trustees, facility agent, and sukuk-holders [36]. c. is sri sukuk a form of sib? looking at the structure, characteristics, and aims of sri sukuk, one cannot run from associating it with the sib model, especially when sib itself does not have a standard definition. therefore it should come to no surprise that ram ratings [33] categorised sri sukuk as a form of sib. this is because, similar to sib, in sri sukuk the issuer‟s obligation to pay will depend on the performance of the sri project with regards to its kpi. the notion that sri sukuk is a form of sib is further strengthened by looking at the definition of sib as provided by the centre for social impact bonds [37] which defines sib as an arrangement with four necessary features: 1) a contract between a commissioner and a legally separate entity ‘the delivery agency’; 2) a particular social outcome or outcomes which, if achieved by the delivery agency, will activate a payment or payments from the commissioner; 3) at least one investor that is a legally separate entity from the delivery agency and the commissioner; and 4) some or all of the financial risk of non-delivery of outcomes sits with the investor. accordingly, reeder, khalid [11] and ng, mirakhor [3] have both proposed several shari'ah compliant sib structures, which are based on contracts such as jualah (performance-based fee), musharakah (profit-and loss sharing partnership), mudarabah (investor-entrepreneur model), as well as the wakalah bi istithmar (agency to invest). the khazanah ihsan sukuk structure fulfils the four necessary features of sib as defined by centre for social impact bonds [37] and applies the wakalah bi istithmar structure in its contract. hence it can be said to be a shari'ah compliant sib. this is in line with the research by ronicle, stanworth [38] which finds that sibs can take a number of forms as long as it shares the fundamental features, with new varying structures emerging as the sib concept develops. therefore, we agree with the proposition by ram ratings [33], sri sukuk is a form of sib. iv. congruence of sri and sib with islamic finance the areas of islamic finance (if), sri, and sib have been among the most rapidly growing areas in the finance industry over the past decade [24, 39]. during this period, their growth rates have grown far beyond the financial markets as a whole and the trend appears to continue upwards. the parallel growth of these areas are not coincidental as they are catalysed from the relative rise of awareness of moral values, ethics and social responsibility in certain segments of the finance industry. there are several commonalities shared by if, sib, and the sri concepts. firstly, similar to if, sib and sri have their roots from religious doctrine, specifically the objective of many practitioners of many religions to use their money in ways that are compatible with their religious beliefs [3, 39]. for example, christian theology gives focus on the individual‟s moral responsibility to use their wealth consistent with one‟s faith [john wesley, in 39]. likewise in the jewish faith where the passages from the talmud support the use of investment as a means to promote ethical activities and social good [40], while islamic finance is guided by the principles of the shari‟ah which acts as its authority on ethical and legal reference [24]. undeniably these religious values have influenced investment decision-making for centuries, only to be overcome by greed and individualism as seen in reoccurring financial crises. these religious values shaped what we call “moral and ethical” investment behaviours today. early forms of moral and ethical investing activity include the avoidance of investing or supporting “sinful” industries such as gambling, guns, and alcohol. this ethical and moral investing behaviour grew in the 1960s and 1970s to encompass a wider range of objectives such as boycotting companies that were involved in the vietnam war or traded with apartheid-south africa [39]. secondly, if, sib, and sri share the principal of using money or wealth in a way that conforms to certain moral standards and beliefs. this is opposed to the traditional conventional finance practice that is mainly driven by the aim to maximise risk adjusted returns. this is not to say that if, sib, and sri ignore the effort to achieve strong returns on investment, but rather they take into consideration not only the pure economic returns, but also social returns gained from the practice that is compliant with their beliefs and ethics. in the modern era, moral and ethical investment ejif – european journal of islamic finance no 4, march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 concerns include human rights, labour rights, environment, and corporate governance. the most common type of strategy employed by moral and ethical investors has been “negative screening” – which is the practice of not purchasing securities or financial tools that do not meet the moral and ethical standards set by the investor. this practice screens out securities that are involved in the industry of tobacco, alcohol, gambling, weapons, and high pollutants. the new investment practice involves a more proactive form of investment usually referred to as “impact investing” [39]. the impact investing practice practices a “positive screening” method that looks at funding efforts that can achieve positive and measurable social and economic outcome. this method is commonplace in sib and sri and should become the norm in if practice as well. thirdly, sib and sri embody the principle of risksharing, an element that is an essence of islamic finance [3]. in a sib and sri sukuk, the risk of the programme failing to reach its targeted outcome, is shared amongst the stakeholders involved. this involves not only the financial risk towards investors, but also the reputational risk the government suffers causing loss of trust in executing its duty as the caretaker of social welfare. the society also risks losing the potential benefits that could have been gained from the sib succeeding and creating better social outcomes. furthermore, sib and sri encourage corporate social responsibility, and protecting and preserving the benefits and interests of the society, which is in line with the principle of maqasid al-shari'ah embedded firmly in islamic finance theory [33, 41]. sib and sri sukuk also intend to finance measurable social outcomes which appeal to the islamic finance principle of social justice [3]. lastly, another commonality seen is that the growth of if, sib, and sri has been mainly demand-driven [39]. as such, financial institutions have devoted their resources into these areas as a response to the increasing demand from individual investors and community. v. sib and sri sukuk as new frontiers for sustainable islamic finance growth there are two main reasons why this paper argues that sib and sri sukuk have the potential to become the new frontiers of sustainable islamic finance growth. firstly, in the current global market there is limited overlap between conventional and islamic financial market. many muslim investors invest in both conventional and shari'ah-compliant products, yet few non-muslims invest in shari'ah compliant products despite the growing interest [39]. the intrinsic nature of islamic financial products themselves does not cause this, but rather the unfamiliarity of the non-muslim investors towards the terminology and structure of the products. nonetheless, according to bennet and iqbal [39] the products can still be attractive if they offer reasonable risk-adjusted return as compared to the market – especially for western investors that do not have enough exposure to islamic finance. the shari'ah-compliant products may take some time to be accepted by non-muslim investors, but the enduring growth of sri philosophy among conventional investors may help accelerate this acceptance. this is because muslim and non-muslim investors alike are increasingly looking for investments that can make positive social impacts [39]. hence shari'ah compliant products that focus on creating positive social impact can be an innovative tool to bridge the gap between conventional and islamic finance. these types of sri products can tap into the demand and appetite of the non-muslim investors who are sri driven. products such as shari'ah-compliant sibs and sri sukuk can most likely appeal to this appetite. secondly, to date if products have been criticised for being too skewed towards fixed income or debt-based instruments. however, the prevalence of equity-based or risk-sharing arrangement is more evident in the shari‟ah approved equities. the investment in equity is more easily made compatible with the principles of if that emphasises on equitable risk-sharing and the prohibition of interest. the main mechanism in ensuring shari`ah compliance is by applying various activity and financial screening techniques to confirm conformity to islamic religious and ethical standards. both sib and sri in the conventional capital market have focused on equity rather than on fixed-income. similarly, shari`ah compliant sib and sri sukuk can be structured to use equity and risk-sharing contracts as well. hence, financial intermediaries have found that creating shari'ah compliant and sri equity products is much easier and straightforward as compared to fixed-income ones [39]. as a result, if and sri practitioners are turning their attention to the development of risk-sharing tools. the “kuala lumpur declaration” in 2012 is an example of this [3]. the declaration was a result of a strategic roundtable discussion by scholars and economists, jointly organised by the international shari‟ah research academy for islamic finance (isra), the islamic research and training institute (irti), and durham university. among others, it declared that risk-sharing is a salient characteristic of islamic financial transactions. it recommended governments to endeavour towards risk-sharing systems and move away from interest based systems by levelling the playing field between equity and debt. furthermore, it recommended governments to “issue macroeconomic instruments that could provide their treasuries with significant source of non-interest-rate-based financing while promoting risk-sharing, provided that these securities meet three conditions: (i) they are of low denomination; (ii) are sold on the retail market; and (iii) come with strong governance oversight” [42]. the move towards risk-sharing products that have focus on ethics and social responsibility creates a clear opportunity for the sustainable growth of the islamic finance industry. this demand for shari'ah compliant risk-sharing products can be conveniently filled by products in the like of shari'ah compliant sibs and sri sukuk. the potential development of innovative risk-sharing products such as sri sukuk and sib is very encouraging but needs to be developed further. therefore efforts to facilitate the development of sib and sri sukuk tools need to be established in order to address the challenges and risks involved. for example, sheng [43] highlights the need for professional benchmarking and measurable impact on ejif – european journal of islamic finance no 4, march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 societal issues and development. while ng, mirakhor [3] suggests the need for a special taskforce with authority and working groups to be set up by the government in order to catalyse and strategies the development of social impact investment market. a social investment bank or foundation can be established by the government to underwrite issuance of sib without the need of further credit enhancement (as with the case of khazanah aaa rating by ram). tax incentives to reduce the cost of capital can also be offered. examples of these can be seen from the tax vouchers in the case of khazanah sri sukuk, the social investment tax relief in the united kingdom, and the new markets tax credit in the united states. vi. conclusion the islamic finance industry has shown tremendous growth and development over the past few decades. however, it can be argued that despite this progress, the full potential of islamic finance industry has not been realised. additionally there are calls to bridge the gap of islamic financial theory and practice, and also growing demands for shari'ah compliant risk-sharing tools. this can be done through two innovative tools: the sib and sri sukuk, which are relatively new, but have shown promising results from sib and sri programmes that have been implemented. in addition to their congruence with islamic finance principles of risk-sharing and social responsibility, the development of these products can further diversify islamic financial tools and attract investors with sri appetite. however, much more effort is needed especially from the governments in order to facilitate the development of sib and sri sukuk. finally, the ideas and principles within of sib and sri need to be promoted to a wider audience in order to create greater awareness and interest in the market. references [1] ifsb, islamic financial services industry stability report 2015. 2015, islamic financial services board: malaysia. 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[43] sheng, a., islamic finance as social impact investing. 2013, fung global institute. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 islamic accounting laws or islamic laws in accounting university of turin, italy – mojtaba.rezaei@edu.unito.it abstract— in the academic and professional circles in accounting, the issue of islamic accounting has always been challenging and controversial. a group of accountants believes that traditional accounting, based on western philosophy, cannot meet the financial reporting needs in islamic countries. therefore, muslim scholars should provide a definition for accounting in islamic countries and clarify the reporting requirements by simplifying the goals and characteristics of islamic accounting. this group believes by defining an islamic framework, a new branch in accounting, that is called islamic accounting, is created. another group of muslim accountants insists that there is no islamic accounting or western accounting, and any change in accounting in order to standardize it should be in line with the needs and demands of users in the country or region and even specific religious groups. proponents of this theory say that if there is an independent islamic accounting, then there may also be christian accounting or jewish accounting. the final opinion of islamic accounting opponents is that accounting is accounting. keywords; islamic accounting, riba , ribh, zakat, culture. i. introduction islam, like other religions, has its own world-view and system of beliefs but is not confined to individual domains. islam is a coherent system for human life in the political, economic, cultural, and religious and all other significant and influential aspects. therefore, for muslims, the separation of science and religious guidance is not admissible. many muslim scholars believe that the accounting system, which itself is part of human knowledge, should be linked with the doctrines of islamic religion, and this is what islamic accounting is called. since there are some aspects in of islamic economics, which are largely different with western economics so accounting techniques based on western economic theory cannot be easily applied in an environment of islamic economics. on the other hand, a number of accounting researchers believe that the need to use islamic foundations in islamic countries is unavoidable, but it is not necessary to codify a completely different standard with the international accounting standards and call it the islamic accounting standard. this group states that these differences are part of cultural and environmental influences on accounting that should be considered a part of the accounting and not essential as a new science. another important issue in islam, that can affect the economic system, is the differences between concepts and, in some cases in principals, in two main branches in islam, sunni, and shia. despite the fact that most islamic societies follow the sunni religion, but there are remarkable and powerful nations in the islamic world, follow the teachings of shi'a. in this paper, has been tried to address the issue by considering the needs, differences, contradictions, and similarities to find a reasonable answer for this question "is there a serious conflict between islamic accounting and international accounting rules that create a completely new science as islamic accounting? better expression, islamic accounting standards, or should islamic accounting be recognized as a complementary part for accounting? this issue is also considered that "the coherence and harmony between the various islamic ideas and branches are such that the islamic accounting standard can be developed for all islamic countries or not"? ii. theoretical framework accounting is defined as an integrated dynamic system for assessing and measuring corporate activities in the field of business, collecting, processing of data to convert into information that is appropriate for reporting and making the findings available to decision-makers. the result of this systematic process is the presentation of the documents that are called financial statements in the terms of accounting. usually, the best and complete definition of accounting is this simple statement "accounting is the language of business". however, business is not only its financial aspect and there are other nonfinancial aspects but a proper way to realize accounting definition could be to call it as "the international language for financial decisions". accounting affects many aspects of human life. certainly, everyone has personal financial planning. investments and taxes are just a basic element of life today. in all of these, there is a trace of accounting. accounting knowledge has helped to improve the daily lives of humans. on the other hand, the notion that accounting is only methods, methodologies, numbers, and financial statements is also wrong. accounting includes regular rules and precise standards that preserve the profession’s purpose and protect the core objectives. however, this is also wrong, that accounting is an independent island in the sea of science. many internal and external factors are effective in accounting formation. among the many studies that have been done in the field of financial and accounting in different societies, a series of these studies have provided frameworks and models for studying the impact of environmental factors on accounting. the results that are based on two deductive and inductive approaches approve that accounting development and evolution are affected by various environmental factors, and the most important elements are culture and beliefs. therefore, this is suggested that in mojtaba rezaei ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 structuring of accounting of each country, should be considered the culture and beliefs of that country. the function of international standards is formed by angloamerican accounting thought and most of the standards are based on the western perspective of accounting. but over the past 30 years, a social and political change and complex network of interlinked economic have contributed to the wealth owned by muslims and also to their need to make the most of this wealth in accordance with the principles of islam[1]. moreover, this is correct that the existing standards, which have been developed according to a conventional framework, are insufficient to guide islamic financial organizations absolutely. islamic finance has been experiencing a rapid growth in banking, capital markets, insurance, and asset management. iii. the footprint of culture in accounting the influence of culture on financial accounting has been a significant issue in accounting research as far as the importance of culture on accounting practices have been a long debate, especially in the area of international accounting [2]. the existence of different patterns in accounting systems is shown in many attempts. environmental factors are the best example in this field that their considerable influence over the development of national systems is noteworthy. many scholars have tried to recognize and found the environmental elements involved [3], [4]. violet [5] is the one of first researcher who thoroughly scrutinized culture as an effective drive of variances in international accounting. in his review, accounting system was considered as a social task (a product of its culture) that is restricted by cultural variables because cultural belief exists even in the most basic of societies. however, he did not categorize different patterns of culture-specific causes that allow a better realizing of the influence of environmental factors on accounting development. gray [6] promoted the viewpoint that culture might have influence on accounting practices. he used the societal values dimensions of hofstede [7] as cultural elements that are effective in accounting practices based on the accounting values and to test this idea he examined specific hypothesis about this relationship [8]. the viewpoint accepted by some researchers about accounting practices is that the specific needs of each country are the main reason for the type of accounting in that particular society [9]. cohen, pant & sharp [10] argue that the management and accounting of each country is a result of the feedback of the cultural needs of the country, thus changing requirements will change accounting practices as well. the effects of environmental factors on accounting systems in different countries is such that sometimes the usual accounting practice in one country in another country is illegal. for example, one of the most striking differences can be found in china. socialist principles and the influential role of government have made accounting practices in china different from what is seen in western accounting. control over society in china is very strong, and this control includes accounting and the way it is applied. therefore, based on the type of needs and demands that the government has, and not based on the need for investors to make decisions, financial statements are prepared. the government also owns many companies directly or indirectly, which it is another reason for the difference in how the financial statements are prepared. to adapt environmental conditions, the training of managers based on the culture in china and its effects on performance is vital for foreign companies who want to have a branch in china [11]. another example about the role of environment and culture on accounting is germany. flexibility in the germans is less than to what is seen in americans. this inflexibility has made the accounting and management system in germany as highly structured and rigorous. the result of this system is the adoption of long-term policies for the organization and the predictability of future performance. the other thing about the germans is their precise monitoring. in the united states, unlike germany, having a high degree of flexibility has caused the accounting system to be varied from a company to another and also being more adaptable to changes made in the business [12]. iv. conceptual framework of islamic accounting new accounting issues about the impacts of religion raised in the 1970s by the combination of religious principles with economic activities initiated by islamic banking. at first and in the absence of authoritative guidance, islamic banks (as the first islamic institution) had to develop their own accounting policies .these policies were to some extent different with western approach. financial statements of islamic banks reflect different revenue recognition methods and different classification and disclosure practices [13]. with the boom of the economy in the middle of the twentieth century, the implications of sharia compliance with accounting and auditing of islamic financial institutions received greater attention and became more important. the sharia is an arabic word that literally means “the way” or “the path to the water source”. in islam, achieving prosperity is the ultimate goal and it has been interpreted as al-falah happiness in this world and in the hereafterin the context of islam. to achieve this goal, a path has been identified, which is called the sharia. whit the passage of time, it seemed vital to develop the conceptual framework to guide users in their decision-making. the role and position of sharia in the development and growth of accounting can be reviewed by analyzing the researches made in this area. in the early 1980s, the initial english-language scholarly article about the accounting problems in islamic financial institutions provided abdel-magid [14] examines the principles of sharia, which are directly involved in banking affairs, and expresses his assessment of specific accounting treatments needed for these transactions. the main concept of this paper was an essential need for differentiation between islamic accounting and western accounting. however, he identified the ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 possibility of imposing economic and political factors on corporate reporting and accounting standards. over time and by an increase in demand for islamic banking, it was necessary for those banks which offering sharia-compliant transactions to develop their own accounting policies and practices. these banks also had to prove their claims to the customers to comply with the sharia. this was a detailed explanation on how their transactions are actually complying with sharia principles. the role of religious advisers became more and more commonplace, and banks use them as a major part of their organization chart to plan transactions and provide religious decisions to ensure conformance with sharia principles. in 1991, with the increasing desire of the islamic private islamic finance sector to new markets, especially the global markets, the need for an islamic framework that develops sharia-based standards were expanded. therefore ,the first private standard-setting structure was set up in bahrain. this structure, originally known as the financial accounting organization for islamic banks and financial institutions (faoibfi), later became the accounting and auditing organization of islamic financial institutions (aaoifi). its committee consisted of bankers, accountants, academics, sharia scholars and members of regulatory bodies. special attention to socioeconomic justice (al-adl) and its relationship with accounting standards has presented in a published essay in 2002 by hudaib and haniffa [15]. they describe for all aspects of life, a general horizon of the fundamental rules and values of sharia. in the paper, the term “islamic perspective of accounting” is defined and the issue that "how islamic accounting can help to improve the socioeconomic justice indicators" has been discussed. authors seriously criticized methods of aaoifi that are more technical and their suggestion was a theoretical framework for islamic accounting based on sharia. their main criticism was that the standards elaborated by aaoifi, are only fully compliant with bahrain and not outside [16]. v. relationship between accounting and social responsibility the best and plain definition of accountability can be summarized in a few words: accountability is a concept in morals that covers numerous ethical behaviors. it involves such concepts as a responsibility to implement an obligation, answerability of what has been done regarding the obligation, enforcement, and liability to do the commands, and blameworthiness in case of disobedience. in islam as a thorough and widespread religion, the essence of the relationship between the creator and his creations is a significant aspect. this nature is in the connection between humanity and the universe, human relations with their own society, different societies and humanity as a whole, and the relationship between humans and their souls. the conception of accountability in islam is rooted in the quran that is reference to the principle of accountability, directly. the most relevant word with accountability in arabic is the word "hesab" according to the quranic verses. this word is repeated more than eight times [17] .to account, in its generic sense, counts as one’s obligation to god in everything that muslim is accountable and in all matters relating to human attempt, generally .the existent resemblance between hisab in islam and account lies in the responsibility of every muslim to conduct their religious and non-religious duties referring to the holy quran. in the research of nahar and yaacob [18] it is described that the word "account" in islam conceptually relates to humans ’obligations as allah’s representatives on earth (khalifah vicegerent) and they are responsible directly to allah in the hereafter on all matters pertaining to their worldly endeavors”. cardinal dogma in islam is rooted, as mentioned above, in the relationship between human and god, and human accountability to god for their actions and omissions [19]. western viewpoint emphasizes that accountability is limited to law only. consequently, there are no ethical principles such as decency, truthfulness, and honesty underlying a man’s acts and consciousness. the individual attempts to pursue his benefits and interest by deceiving and breaking the established rules. conversely, islamic perspective highlights the different concept of accountability. judgement in the hereafter is identified in terms of weighing one’s good and evil deeds in a balance. the linguistic stem of the term (taklif – arabic) includes the meaning of having to do difficult and burdened things generally named obligation. muslims are obliged to do what allah asks and avoid what he forbids. accountability and liability refer to the aspects of duty and obligation, whereas blame also involves sanctions [20]. alam [21] considered the subject of accountability to god and lewis [22] particularly persevered this consideration by discussing two major ethical concepts for islamic accounting: god’s absolute ownership of all resources and humanity’s role as god’s representative (khalifa) on earth, granted stewardship of god’s possession. the significance of this these concepts are so much that are known as the root of the contemporary view of sustainability. mortuza [23] addressed how financial accountability and social justice can be reached by adhering to the sharia principles. he discussed the concept and the roles of "riba", "zakat" and "hisbah" and their contemporary relevance to social responsibility. gambling’s [24] societal accounting as a basic source influenced on the emerging literature on social accounting. gambling and karim [25] and tomkins and karim [26] emphasized the necessity for islamic accounting sharia-based and stress that accounting and business ideas and methods developed in a western environment influenced by judeochristian ethical notions would not necessarily operate effectively in a muslim environment . they distinguish an obligation for organizations to be accountable to the muslim community (the ummah) and discuss the two elements, which are considered as influential tenets in muslim users’ needs connecting to financial reporting. two key factors are the ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 prohibition of riba, sometimes interpreted as usury, but more usually as all forms of interest, and the fundamental obligation of all muslims to pay the religious levy zakat. vi. riba perhaps the prohibition of riba, is the most effective and controversial aspect which has influenced many issues in the islamic economics and even western accounting and financial economics. chapra [27] has defined riba in this way: "in sharia, riba technically is recognized as the extra payment (premium) by the borrower that must be paid to the lender along with the principal amount, as a condition for taking a loan". there is no doubt about the forbidden (sharia: haram) riba from the point of view of the qur'an and sunnah in both of the important branches of islam, shi'a, and sunni, as far as some jurists consider it as one of the essential necessities of religion. another definition for riba is presented by siddiqi [28] "riba is defined as pressure imposed on the debtor at the maturity of the debt to pay more specified amount in case that there is no ability to repay the principal amount and added interest. chapra [27] in his article has said, "there are various opinions about riba, but in general, and according to most religious scholars, riba is an unjustified earning that a person could obtain a monetary advantage without giving a just counter-value. riba is prohibited in islam and this injection distinctly implies that money that use in this forbidden system can be, for example, lent legally for either charity aims and even in managing lawful business based on the partnership in profit and loss [29]. in sharia, nevertheless, there is a distinct different between doing business and riba. the trade risk is apportioned equally among all the participants involved in a deal or trade, but in riba, risk is connected heavily and directly to the borrower. perhaps this simple definition provided by ighbal [30] is the most comprehensible definition of riba "in its widest general implication, riba signifies any increase of capital not justified by a risk taken". scholars in islamic countries have broadly sorted interest "riba" into two major types; the first category is "riba al-fadl" that is represented as an extra in the exchange of two things or goods that have the same value, unlawfully [31]. therefore, as to be lawful, the exchange of identical commodities must occur immediately (on the spot) and there must be no difference in amount. most muslims and most non-muslim observers of the islamic world believe that islam forbids interest on loans. in islam, unlike other society, the issue of interest is very important. as far as, the second category is directly related to this subject "riba al-nasi'ah" that is associated to extend a repayment period of a loan for another payment of money, artificially [32] vii. ribh the best translation of the word "ribh" is profit, as a result, ribh is a reasonable, and legitimate gain is obtained from a sale of goods or doing services. this profit, which is an added amount on the cost, is normally known as mark-up. this "extra" represents a kind of compensation that a trader expects in exchange for all expenses that he\she has paid for the product or buy a good or service such as making the effort and taking the risk to bring a product or a service to market. in riba, by contrast, added amount is to a loan and not to a cost of a product. generally, the difference in ways that they (riba and ribh) are earned is the most important aspect of the distinction. the most important difference about the environment in which the "riba" occurs with the environment in which "ribh" occurs, is defined in a simple word "reality". trading, investing take place in a real economy. in this real economy, people do real buying and selling. they (buyers and sellers) experience real risks. profit achieves in a real economic activity, but riba does not happen in a real activity. in many cases, there is no deal. the goods are not actually traded. the actual sale and delivery do not occur. the main differences between riba and ribh is shown in below table, briefly. viii. zakat god possesses all wealth and private property, this is the fundamental principle based on the holy quran in islam, and the property has a public meaning and it should be spent on the usefulness of the islamic community. therefore, there must be a powerful mechanism for the turnover of the wealth in islam in order to realize the issue of social justice. for this circulation of wealth, islam has established instruments as a law of sharia. the most important is a mechanism called zakat. zakat is a strong device that inherently cause redistribution of income and wealth is in islam. the qur'an has interpreted zakat as a tool for the purification of wealth. if we want to compare it with a financial term in the west, we can say that zakat is an islamic tax. a religious tax, which is deducted from the wealth of those parts of the community who pay and assign to the poor people and is an obligatory charge, one of the five basic practices that muslims perform mandatory (in shia is one of ten). ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 zakat is payable based on real ownership of productive and excess assets that have been controlled for a year. as a result, temporary acquisitions, impermanent and occasional assets, and perishable and corruptible goods are not the basis for calculating zakat [33]. another important issue is complete ownership. that means, a person own a property entirely and nobody else has any claims. in other words, the asset should be genuine and without any claim from others. productive assets are considered as cash in hand and/or at the bank, stocks, shares, bonds, inventories of finished goods intended for sale, earnings from rented fixed industrial assets and net receivables (in shia zakatable assets are limited and this issue is discussed below(. there are a few exceptions to zakat's payment, for example, assets held for daily consumption are not zakatable. generally, in islamic law, conventional amount of the zakat is 2.5% of cash or other kind of wealth, which reaches, or exceeds "nisab", the minimum amount one has to own. nisab, as a criterion, identifies that how much the sum of property is required that paying zakat for a muslim become mandatory in islamic point of view. on the other hand, this means that if the amount is below the "nisab" muslims do not have to pay [34]. ix. accounting practice and zakat in 1997, adnan and gaffikin [35] explored the use of financial statements to calculate one’s liability for zakat scientifically. in this study, they examined most of the personal aspects of paying zakat as a debt. they have studied the issue of how these standards can be applied to the rules and methods used to calculate zakat, based on concepts such as the going concern, historical cost, and periodicity concepts, which are existed in the accounting standards. although they pointed out that in islamic accounting, there is a strong realization principle; witch must assets held on are to be recorded at historical cost. clarke, craiig, and hamid [36] reached to this conclusion that when accounting statements are suitable for calculating zakat that to be prepared based on current market values. the obtained results about current value in a model that is presented by baydoun and willett [37] in the "islamic corporate reports" research between 1994 and 2000 were comparable to those witch clarke and colleagues argued. the most important investigation witch was carried out in order to find a comprehensive mechanism for paying, collecting and distributing zakat among the persian gulf countries ) members of the gulf co-operation council (gcc)). this research reveals that the role of the government in organizing the process of collecting and paying zakat is crucial due to some problems that arise in absence of proper organization. x. differences between zakat in shia and sunni there are differences in the zakat rulings between shia and sunni religions, and these differences are such that the question about the need for islamic accounting or islamic accounting standards is raised. the most important difference can be found in the cases of zakat. zakatable assets in shia jurisprudence, unlike sunni jurisprudence, are limited in certain cases. this restriction is to such an extent that, in order to include a particular asset that is zakatable, it must also possess its own inherent conditions. in the case of zakat accounting, the most important difference is about the wealth -trading capital in shia jurisprudence zakat on wealth is not mandatory but in the sunni belief, it is. below table (table1) presents some major differences in this issue. table1: title shia1 sunni2 maliki shafi'i hanafi hanbali is maturity as a criterion for paying zakat? yes no no yes no is zakat mandatory for nonmuslims? yes yes no no no is it necessary to pay zakat despite having a debt? yes yes (with some conditions ) yes no (with some conditions) no banknotes not zakatable zakatable (if it is more than nisab*) zakatable (if it is more than nisab) zakatable (if it is more than nisab) zakatable (if it is more than nisab) gold bullion not zakatable zakatable zakatable zakatable zakatable capital not zakatable zakatable zakatable zakatable zakatable *in sharia (islamic law), nisab is the minimum amount that a muslim must have before being obliged to zakat. 1 hosseini sistani, sayed ali (2016) , tauzih al-masail, available from :http://www.sistani.org/english/ . also it can be found on http://fa.wikishia.net/view/%d8%b2%da%a9%d8%a7%d8%aa 2 juzairi, abdul rahman (2006) fiqh 'ala al-madhahib al arba'ah https://archive.org/details/islamicjurisprudenceaccordingtothefoursunnischoolsalfiqhalaalmadhahib alarbaah/page/n1 . also it can be found on http://fa.wikishia.net/view/%d8%b2%da%a9%d8%a7%d8%aa xi. conclusion the demand for an islamic accounting system in societies and the global economy has increased dramatically. noticeably, this need is vital for those institutes and companies that operate in the islamic realm and want especially fulfill the socio-economic aims according to sharia [38]. as is said in this paper, a clear historical presence of islamic accounting is seen from revelations in the quran and the practices of the prophet. although it is difficult to identify the historical influence of islamic accounting on accounting, particularly due to the loss of archives over the centuries, but evidence suggests that islamic accounting has been influential in the development of western accounting, including the double-entry system still used today. however, the need for the revival and reformation https://en.wikipedia.org/wiki/maliki https://en.wikipedia.org/wiki/shafi%27i https://en.wikipedia.org/wiki/hanbali https://en.wikipedia.org/wiki/sharia https://archive.org/details/islamicjurisprudenceaccordingtothefoursunnischoolsalfiqhalaalmadhahibalarbaah/page/n1 https://archive.org/details/islamicjurisprudenceaccordingtothefoursunnischoolsalfiqhalaalmadhahibalarbaah/page/n1 ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 of islamic accounting is vital. "how to do this revival in accounting?" this was discussed. is it need for new accounting as a new science or add new standards as needed? it is essential considering environmental issues in muslim countries. the american accounting standards board (fasb) as a pioneer in the development of theoretical concepts stated that these concepts have been developed for the american economic, political, and social environment. environmental conditions affect accounting and in a muslim country, so the economic environment is based on observance of islamic values, this economic environment would be effective. the accounting and auditing organization has developed an accounting standard for islamic contracts [39]. because international standards are not enough in this issue. for example, accounting for islamic transactions (uqud, sing. aqd) can be raised. the former secretary general of the organization believes that these standards are complementary to international standards, not a completely separate and independent sector [40]. from a global perspective, accounting development cannot be attributed to a specific region or culture, but accounting is a process that has been influenced by different cultures in different periods of history. as islamic societies have historically contributed significantly to what has been repeatedly called the western scientific innovations today. there is nothing in the name of western accounting and islamic accounting. the practice of accounting in different regions is different because of various historical, legal, religious, and cultural factors, just like the differences in scientific innovations that vary from country to country due to cultural and historical reasons. in many cases, these differences have helped to improve accounting jit (just-in-time) and kaizen (continuous improvement), two of the most important ways to increase productivity, have been invented by the japanese, but today they are considered as a part of accounting rather than japanese accounting. likewise, it is not doubtful that some of the top islamic accounting researchers have a significant contribution to the development of accounting in west, but it should be noted that this important and influential role has been contributing to the improvement of accounting science, and not just western accounting. on the other hand, the main essence of the discussion is that in the muslim countries, the information needed by users is varied, and they are asking for information on issues such as observing the religious law and calculating zakat. nevertheless, and based on the internal point of view in islamic society, there are some cases that do not require converting accounting to islamic accounting to reflect differences . 1) the purpose of financial accounting is to provide information for external user needs, and these requirements are partly environmentally. therefore, environmental issues are effective in accounting, and if there is a need for more information in addition to the usual international information, it can be provided. 2) in most islamic countries, trade and business are the same as in other countries, and in many cases the principles of commerce are the same, too. therefore, since coincidence is noteworthy, this similarity must also exist in accounting to cover all firms. 3) the goal of maximizing the profit, if it is in the framework of the islamic law, is not an anti-sharia act for a muslim. in practice, the motivation to earn profit for muslim with non-muslims do not seem to be different. 4) in the case of muslim-specific transactions, it can develop a standard for the completion of common standards, such as those related to islamic contracts (uqud (sing. aqd). (as it is done in most muslim countries) 5) the zakat payable by a muslim consist in the quantity and the sort of assets the individual owns. there is not provided specific recommendations about which kinds of wealth are zakatable and is not specified percentages to be given. therefore, there is no consensus on this issue, the extent and type of zakat vary from one islamic country to another, depending on the type of religion, and sometimes these differences are contradictory. therefore, these contradictions impede the creation of a single islamic accounting system. in other words, these kinds of differences arise from the impact of social influences and not only in the type of religion. 6) accounting goals can also be based on the utility of both decision-making and accountability. in many cases, the information needed to decide on a response may also be appropriate. because the information is necessary for decisionmaking and for accountability, both theoretical concepts must be covered. therefore, the emphasis on islamic response or accountability in the current business environment is not accountable. the undp (united nations development program) states that the gap in knowledge has increased between arab countries and the rest of the world. this is explained by the fact that the sum of one year's translation of a book in spain is equivalent to the same sum of translation in arab lands in the millennia .so ,any challenge to prove the separation of accounting required in islamic countries with existed accounting, not only does not lead to the advancement of this science in islamic lands, but also results in the isolation and weakness of islamic accounting [41]. accounting should remain the same accounting and there is no need to add the word "islamic" to accounting for the reflection of this need. because financial accounting mission is, the provision of information and this information are defined according to the needs of the users. hoodbhoy (1991), by expressing a statement by nobel laureate mohammed abdul salam, states: "there is only one global science. science is an international issue and there is nothing in the name of islamic science, as hindu science, jewish science, and so on." references ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 [1] dima s. david d., paiusa l. 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(2007). “book review on interest in islamic economics”,review of islamic economics, 11(1), pp. 149– 153. [32] hassana, m. kabir (2017), "a contemporary survey of islamic banking literature " journal of financial stability. [33] clarke f., craig r., hamid s. (1996), physical asset valuation and zakat: insights and implications, advances in international accounting, vol. 9. [34] dusuki, a. w., & bouheraoua, s. (2011). the framework of maqasid al-shariah (objectives of the shari'ah) and its implications for islamic finance. isra research paper, (no: 22/2011). [35] adnan, m. and gaffikin, m. (1997), "the shari'ah, islamic banks and accounting concepts and practices", the accounting, commerce and finance: the islamic perspective international conference, university of western sydney, macarthur, february 1997. [36] clarke f., craig r., hamid s. (1996), physical asset valuation and zakat: insights and implications, advances in international accounting, vol. 9. [37] baydoun, n. and r. willett. 1997. islam and accounting: ethical issues in the presentation of financial information. accounting, commerce & finance: the islamic perspective. vol.1, no.1 [june]: 125. [38] biancone, p. p., & radwan, m. (2018). sharia-compliant financing for public utility infrastructure. utilities policy, 52, 88-94. [39] aaoifi, ‘aaoifi structure about aaoifi’. retrieved 22 may 2016, from http://www.aaoifi.com/en/about-aaoifi/aaoifistructure.html [40] abdulaziz, a. (2010). al-dhara’i and maqasid al-shariah: a case study of islamic insurance. intellectual discourse, 18(2), 261-281. undp report avialable from: http://hdr.undp.org/sites/default/files/2016_human_development_repo rt.pdf ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 real estate, usufruct right and the issue of the waqf assets in egypt. abstract— in the last decade, egypt became more and more integrated with the global economy starting from its participation in the union for mediterranean (ufm), a partnership with the goal of creating a european mediterranean free trade area (emfta). nevertheless, egypt has been and still is an islamic state still retaining some of the characteristics of the traditional islamic legal system. this coexistence of western practices and values of islamic tradition makes it a fascinating case study in the field of economy and law. in this paper we will pay particular attention to the development of the law of real estate and land property in egypt; specifically, we will illustrate how the islamic character of egyptian traditional law, attempts of international openness and egyptian nationalism has combined together during the years. firstly, we will summarise the key points in the process of reforms that have been put into practice starting from the prime ministerial decree 350/2007 establishing that companies and enterprises have the right to own real estates and lands regardless of their nationality or the nationality of their partners and shareholders. this opening to foreign companies was strongly discourage in 2012, by law no. 14 which gives the minister of the defence the responsibility of setting regulations concerning land attributions in the sinai peninsula. minister of the defence banned any foreigners land ownerships (so called ‘sinai law’), this decision severely affecting the real estate market in the sinai area, where foreign investments had been a key factor. in 2015 amendments to law no 14 have been introduced, loosening the restrictions on investors that wish to acquire land rights in the area on the sinai peninsula. it extends the scope of persons that are outside the range of the sinai law allowing nonegyptians that receive title to a land by inheritance, testament or gift to keep the right of usufruct under certain conditions. we will then focus on the crucial role of the usufruct right. we point out that due to the above-mentioned legal innovation, the usufruct system in egypt also upholds national security, and guarantees that land–especially that of a special nature like the sinai peninsula–will not fall into the hands of foreigners. a particular case of usufruct is the “waqf” or religious endowment, consisting of income-producing property whose usufruct is assigned by its original owner to a mosque or to carry out charitable works (e.g. building schools, orphanages and hospitals). the original owner of an endowed property retains his or her ownership in it, but the usufruct right is conveyed to an endowment authority. in egypt, the endowments authority, established since 1971, is affiliated with the ministry of religious endowments: it is the sole competent authority empowered to manage and invest in endowment assets. such investments can have an impact in real estate system and in the usufruct right scheme in the name of a more pervasive state involvement in this field of investments. all these aspects will be broadly analysed in this paper. keywords—egypt; real estate; usufruct right; waqf i. the public procurement system in egypt and his impact for the social reforms. during the first half of the twentieth century and so on, the egyptian economy’s dependence on land ownership and property law as crystallizes in the egyptian civil code [1] (ecc) meant that other sectors of the economy and commerce as the industry contributed only in minor part of gross domestic product (gdp) [2]. indeed, foreign capital contributed to the growth and the industrialization of egyptian economy in the decade 1960-1970s [3]. the role of foreing capital investment in the economy of the country also appears quite evident. therefore, since 1960 with several different statal-plans for the development and the growth of the economy, egyptian authorities relied massively on foreign capital [4]. put it differently, foreign investment on land property defined the principal social, economic and political system. according to the ‘sociological approaches’ of the early twentieth century, circuleted through different models and patterns and as manifested in numerous civil codes, such the swiss code, the soviet code or the proposed franco-italian code of contracts [5] (where was evident a tension between nationalism interests and an orginal modern view of comparison of different european models of codification that appears clearly also in the political debate between two eminents legal scholars such vittorio scialoja and emilio betti [6] about the socio-economical function of a juridical notion as the negotio), property laws were permeated with a prominent social purpose as a tool for securing social objectives and social solidarity. ‘abd al-razzāq al-sanhūrī, renowed legal scholar and professor who drafted the revised egyptian civil code of 1948 1 (al-qānūn al-madanī), sought in vane [7] to 1 g. bechor, the sanhuri code, and the emergence of modern arab civil law (1932 to 1949), brill, 2007, pp.99-101; n. saleh, civil codes of arab countries: the sanhuri codes, arab law quarterly, vol. 8, no. 2, 1993, pp.161-167; f. castro, il modello islamico, giappichelli, torino, 2007, pp. 186-218 and f. castro “abd al-razzaq ahmad al-sanhuri (1895-1971): primi appunti per massimo papa, eugenio santostasi ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 include immediately in the new code the term ‘social function’2 (al-waẓifat al-ijtimāʿīah) as regards to property law3. nevertheless, the flexible social function of property law in egypt, as regulated in article 802 and 8064 of the civil code, was able to adapt itself during the political change from the period of the monarchy, when the civil code was written, to the arab socialism regime 5 beginning with the nasserite revolution of 1952 6 . therefore, the situation appears clear simply considering the words of guy bechor regarding the ductility of the sanhūrian civil code model, which would be able to be interpreted and adapted according to the mutable necessities (aḍ-ḍarūra7) of society: una biografia”, in ‘studi in onore di francesco gabrieli nel suo ottantesimo compleanno’, roma, 1984, passim. j. n. d. anderson, the shari'a and civil law, in islamic quarterly, 1954, pp. 29-46; y. linant de bellefonds, le droit musulman et le nouveau code civil egyptien, in annales economiques et sociales, 1965, p. 4; e. hill, al-sanhuri and islamic law. the place and significance of islamic law in the life of and work of ‘abd al-razzāq al-sanhūrī, egyptian jurist and scholar 1895-1971, arab law quarterly, vol. 3, issue 2, pp.182-214. 2 a. shalakany, between identity and redistribution: sanhuri, genealogy and the will to islamise, islamic law and society, volume 8, issue 2, 2001, pp. 201-244. the original civil code proposal, article 1162 made by al-sanhūrī says: “the owner of a thing may use it, enjoy it and perform disposition (taṣarruf) in it, provided he acts within the limits of the law, without any inervention by another, on condition that this take place in accordance with the social function of property” in g. bechor, p. 101; ibid. “the right of property is both individual (ḥaqq fardī) and a social function (waẓīfa ’ijtimā‘iyya)”, p.103. 3 art. 802 of the egyptian civil code of 1948: “the owner of a thing has alone the rights to use it, enjoy it and undertake disposition of it, within the limits of the law”. 4 art. 806 of the egyptian civil code of 1948: “the owner is obliged to obey the rules, orders and regulation, relating to public good or the good of a given individual”. it also appear quite evident a relation between this dispositions and the islamic tradition with the notions of “ḍarar” and “taʿaddī” (‘abuse of right’ and ‘ousting’), see d. santillana, istituzioni di diritto musulmano mālikita con riguardo anche al sistema sciafīta” vol. ii, ipo, roma, 1925, pp. 266-280. 5 “the soviet union was a major and stable supplier of foreign loans to egypt during 1960-1972 (…) from 1968 throught 1972, the u.s.s.r disbursed $319 million to egypt which amounted to about 37 percent percent of foreing loans received by the egyptian governemnt.”: see n. abdalla, p.87. 6 as pointed out by zohny, pp. 169-183: “both presidents gamal abdul nasser (1956-1970) and anwar sadat's (1970-1981) (…) administrations were not successful in importing, or developing locally, the state-of-the-art technologies necessary to satisfy local consumers and build an export oriented economic and development goals of their respective administration. (…) both nasser and sadat's legislators gave low priority to this vital area of law that is "procurement law”. see also on this point r.a. hinnebusch, the politics of economic reform in egypt, third world quarterly, vol. 14, no.1 (1993), p.160. 7 see ‘ḍarūra’ by y. linant de bellefonds in encyclopedia of islām, edited by b. lewis, ch. pellat and j. schacht, vol ii, leiden, brill, 1991, pp. 163-164: “necessity (also “iḍṭirār”), in works of fiqh has a narrow meaning when it is used to denote what “in 1967, sanhūrī (…) published the eighth volume of alwasīṭ8, (…) he was obliged to adapt the purpose of social function as manifsted in the code in order to respond to the changes that had occurred in the meantime in what was now an authoritarian regime. he extended (…) the flexibility of the concept of social function in order to enable it to absorb the socialist ideas (…). while during the 1940s sanhūrī had emphasized the relativity of individual property rights vis-à-vis society, the enphasis now shifted to their relativity vis-à-vis the state9”. several decades have gone from this initial arrangement. however, we can deduce the importance of legal concepts such as those mentioned above, as they are affected by a widespread and often uneven network of legislative reforms. this regulations have often innovated the legal system of the country in terms of individual property rights, investments and social policies. especially, it is interesting to analyze the social impact of the various and layered ordinary laws (qawanīn) related to the investments of foreign private subjects for the purchase of real estate: these laws were able to influence the ability to attract foreign capital to egyptian banks and other financial operators in the country, with a primary role in investment and welfare policies10. ii. foreign investment and property law in egypt during the 20th century. a briefly overview since the half of last century, foreigners, individuals and companies, have been entitled to own real estate in egypt subject to certain conditions and some restrictions. along the twentieth century, the regulation of foreign ownership of real estate spreads across several laws and regulations [8]. the nature of the real estate (e.g., residential, investment, agricultural) and its location 11 (e.g. the proximity of the property to egypt’s borders, lands in strategic areas, such as those adjacent to the western, eastern and southern borders; islands located in the red and mediterranean seas; and the may be called the technical state of necessity, and a wider sense when authors use it to describe the necessities or demands of social and economic life, which the jurists had to take into account in their elaboration of the law which was otherwise independent of these factors”. 8 “al-wasīṭ fi sharh al-qānūn al-madanī”, litt. “the explanation of the civil code”. 9 g. bechor, p. 109. 10 about the idea of a ‘islamic welfare’ (al-takāful al-ijtimāʿī) in the classical sources see m.h. kamali, the right to education, work, and welfare in islām, islamic text society, cambridge 2010, pp. 189-260. 11 its crucial here to note that drawing up laws on foreign ownership and investment, the identification of the specific characteristics of a particular geographic area appears an essential part. clearly, it denote the peculiar political program of a government and the strategies for the future development. ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 suez canal area and the so called “free zone”12) they are the two essential factors around which, during the decades, the principal regulatory and legislative interventions have been organized by the state. more specifically about the pivotal importance of the location in the development of notable areas of the country, there are two species of ‘free zones’ in the country. ‘public free zones’ are established in specific locations by general authority for investment and free zones (gafi)13 including, alexandria, suez, port said, damietta, ismailia and cairo. ‘private free zones’ are established exclusively for a specific project or company, subject to the approval of gafi14. the types of activities permitted in the free zones are mixing, blending, repackaging, manufacturing, assembling, processing and repair operations. public free zones are usually located adjacent to seaports and airports to facilitate import/export procedures. private free zones are established exclusively for specific projects that either need to be located near the sources of their raw materials services, or which, by their nature, are located outside the public free zones. private free zone status is more difficult to obtain due to the requirements set out by gafi, determines the scope of the ownership rights and any applicable restrictions15. more in details, until 1951 foreigners investores had been entitled to own land in egypt but in that year, law no. 37 was enacted prohibiting the ownership of agricultural land by nonegyptians. agricultural lands were exclusively reserved to egyptians16. after that firstly restrictions, law no. 15 of 1963 12 according to investment law no.72 of 2017 section i: general provisions, chapter (1), “definitions” a free zone area is: “a part of the state territory located within its borders and is governed by its administrative authority, and where the dealings are conducted in accordance with special customs and tax provisions” (cf. art. 1, law no.72 of 2017). 13 for the composition and jurisdiction of this authority cf. section iv, chapter (2) of law no.72 of 2017 “the general authority for investment and free zones (“al-hayʾat al-ʿāmat li-lstiṯmār”, ة ئالهي .(العامة لالستثمار 14http://www.globalsmes.org/news/index.php?func=detail&detailid=6 30&catalog=35&lan=en&search_keywords=. 15 http://www.gafi.gov.eg/english/startabusiness/investmentzones/pag es/freezones.aspx. according to art. 1 of law no.72 of 2017 an ‘investment zone’ is: “a geographic area with defined size and borders, allocated to conduct one or more specialized and specific investment activity and other complementing activities, and the development infrastructure thereof are conducted by the developer of such zone”. 16 on this subject see: s. margold, agrarian land reform in egypt, in the american journal of economics and sociology, vol. 17, no. 1, oct., 1957, pp. 9-19; r. bush, politics power and poverty. twenty years of agricultural reform and market, in third world quarterly, vol. 28, no. 8, 2007, pp. 1599-1615; o.c. kirsch, agricultural cooperatives as an instrument of agricultural policy. experience with cooperative promotion of production in egypt, in verfassung und recht in übersee / law and politics in africa, asia and latin america, vol. 10, no. 2 (1977), pp. 255-267; d.e. wahdan, planning imploded. case of nasser physical on the prohibition of foreign ownership of agricultural lands prohibits the acquisition of agricultural lands by foreigners both individuals and companies, whether by way of freehold ownership, usufruct or any other type of real property right [9]. in the ground of this law, no foreigns, whether natural persons or juridical persons, might acquire agricultural or desert land [9]. transitional provisions were included in the law whereby foreigners who held such lands at the time lost their title which by way of nationalization. they were compenseted by government bonds. foreigners who inherited agricultural lands likewise lost their right to the land and were compensated by the state [9]. the nature of ownership forbidden to foreigners istated to be “full ownership” (“ḥaqq al-raqaba”), bare ownership (“milk al-raqaba”) and “usufruct” (“ṣāḥih ḥaqq alintifā‘”: the islamic concept of “ḥaqq al-intifā” 17 , i.e. the ownership of “manfa‘a” is wider than “usufruct” in its modern sense). in contemporany legal doctrine and terminology the term “manfa‘a” or its ownership, i.e. “milk almanfa‘a” is replaced by “usufruct”; “raqaba” is still used in the sense of bare ownership and this distinction was well preserved in the “murshid al-ḥayrān of muhammad qadrī pascia, artt. 4-5 “alintifā‘ al-jā’iz” art. 13 of egyptian civil code: “usufruct is the right to use and enjoy a thing of which the bare ownership belongs to another”18. the linguistic specifications appear to be fundamental for better understanding the link between the classical islamic law categories concerning real rights or contracts and the substance of the individual rights and they relationships in the field of foreign capital investments in egypt. thus, from 1960 to 1972, foreign capitals mainly in the form of loans came to egypt from government and private sources. however, with heavily nationalization measures of 1957-1963, foreign private investment was discourages, “with the exception for the italian fiat automobile company which, in conjunction with egyptian public capital, produced nasr planning, in economic and political weekly, vol. 42, no. 22, jun. 28, 2007, pp. 2099-2107; r. bush, an agricultural strategy without farmers. egypt's countryside in the new millennium, in review of african political economy, vol. 27, no. 84, jun., 2000, pp. 235-249 17 s. horii, pre-emption and private land ownership in modern egypt: no revival of islamic legal tradition, islamic law and society, vol. 18, no.2, 2011, pp. 186-187. about the intifā program under sadat government see r.a. hinnebusch, pp. 159-161 where the author highlighted the “(…) the inherit of sadat’s legacy of intifā. intifā sought to replace étatism with foreign, arab, and private capital as the engines of development but, in failing fully to roll back nasser’s heritage, it did not create the necessary investment climate”. 18 see f.j. ziadeh, property law in the arab world, london: graham & trotman, 1979, pp. 61-62: “the right of usufruct is real right or “ḥaqq ʿayn” (e.g. it can be mortgaged) for the use of and exploitation of a thing that belongs to another, and this right lapses with the death of the usufructuaris, “muntafi‘in” (…). the right to usufruct, as it were, diminishes the rigth of the right of the owner over his property. of the three elements of the right of ownership, namely, user, exploitation and disposal, only the last is retained by the owner. but the owner recovers these elements with the expiration of the period of the usufruct or with the death of the usufructuary”. see also s. horii, pp. 193-194. ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 cars”19: one of the company’s facilities was located in the city of helwan. in 1974, law no. 43 on “investment of arab and foreign capital and the freezone”[2] established that companies created under this law are permitted to own urban land, but in 1976, law no. 81 forbided, with certain exceptions 20 , the acquisition by foreigners of urban land wheter it is vacant or wheter it as been upon. this proihibition is also stated to apply to foreigners, wheter natural persons or legal entities. however, in this law, a legal entity is deemed to be non-egyptian, even if it is constituted in egypt, in the event that more then onethird of its share capital is owned by foreigners21. this law further provides that a lease for a term exceeding a period of fifty years will be deemed to be ownership as forbidden by the law22. in contrast with the impasse of the 1980s23, from the ‘90s and so on egypt “appears in the process of a major break with the past which will produce a mixed, less étatist and more market-cetred economy” 24 . law no. 230 of 1996 on the 19 n. abdalla, p. 90. the author also specified here that in this period: “however, large amounts of the capital inflow to egypt were in the form of loans, which have to be repaid (…). as early as 1965 and 1966 egypt became unable to fulfill contractual debt service obligations.” p. 94. 20 m.h. davies, pp. 69-73. 21 article 1 of law no.81 of 1976. this constitutes an exception to the rule that companies established in egypt are of egyptian nationality. 22 m.h. davies, pp. 70. 23 about the ‘80s we can register law no. 230 of 1989 on ‘investment guarantees and incentives’ (mentioned in a.y. zohny, p.179 as a symbol, among others specifics laws, of a turning point for the so called ‘egyptian procurement regime’, providing “a variety of incentives for investments in egypt, including protection from expropriation, tax holidays, and the establishment of free trade zones”), however repleced by law no. 8 of 1997: see t.f. riad [10]. furthermore, provisions like those developed in paragraph (3), article (20) of that investment law enacted in 1989 about the status of profits distribution system applicate to the companies and their employees, will remain untouched with the law no.72\2017 (cf. art. vii,). see law no. 143 of 1981 on “desert lands” with whom egypt government regulates ownership of this particular kind of territories. this law restricts ownership of desert land to egyptian nationals and to egyptian companies owned by at least 51% of egyptians; certain limits are placed on the number of feddans that may be owned by individuals, partnerships and corporations (e.g. joint stock companies are permitted to own 50,000 feddans; partnerships and joint stock companies may own “desert lands” within this limits even if foreign partnership or shareolders are involved provided that at least 51% of the capital is owned by egyptians, see m.h. davies, p.71). law no. 159 of 1981 on joint-stock companies is specifically cite in artt. 48, 49, 52 and 53, of law no.72\2017, concerning the provisions of the incorporation of companies and facilities and post-incorporation services. 24 r.a. hinnebusch, p. 159. the author specified that: “the 1992 ‘reform’ of the agrarian relations law eliminates the security of tenure enjoyed by tenants since 1952 revolution (…), the superiority of property over labour rights is believed to be necessary to give investors confidence”, see p. 161. regulation of ownership of built properties and vacant land by non-egyptians (“law no. 230 of 1996”) governs the ownership by foreigners of property for residential purposes. in applying law no. 230 of 1996, a company is deemed a ‘foreign company’ if the majority of its capital is not owned by egyptians, regardless of whether the company is incorporated and registered in egypt or elsewhere. law no. 230 of 1996 applies to all kinds of real property disposals by foreigners except inheritance. for purposes of this law, ownership rights include freehold ownership and usufruct rights. pursuant to article 2 of law no. 230 of 1996, the number of lands or built properties which a foreigner may own must not exceed two properties for residential purposes (for the owner and his immediate family) and the area of each real estate must not exceed 4,000 square meters. once acquired, a foreigner must hold on the residential real property for 5 years before he is able to dispose of it to others, unless otherwise permitted by virtue of a special resolution issued by the prime minister25. the council of ministers has the authority to relax these restrictions and issue special conditions on the ownership of real estate located within touristic areas, designates from time to time. the law also allows the council to add fields of activities in which foreign joint stock company can invest [10]. additionally, ownership of residential lands is conditional to the development of the land. pursuant to article 4 of law no. 230 of 1996, a foreigner who acquires a residential land must start construction works to develop the land within 5 years from the month in which registration of such land with the notary public is recorded. in the event the five-years period lapses without commencing construction works, the prohibition to dispose of the vacant land would be extended to a period to the delay period in commencing construction works. more of less we can find the same regulations in law no. 8 of 1997 of investment guarantees and incentives [10]. this new law, that can be seen as an unicuum with the previous one, offer incentives for egyptians and foreigners for investment in certain fieldof activities as: reclamation of barren or desert lands; oil service and delivery gas infrastructures; housing projects, as well as in the finance and economy field with investments program in risk capital and project funded by the social fund for development, management, purchase and liquidation of debts26. this law also includes a favoreble tax exemptions of five or ten years from revenues on commercial and industrial activities of individuals or the tax on profits in the case of corporations [10]. to summarize: the principles regarding foreign investments developed in the country during the twentieth century remain in force today. this is possible because the combination of the nature of the property with its territorial localization remains of fundamental importance. this resulted in modulated legal solutions. the nature of property is essential to determine the type of real rights that can be insisted upon and activated by private individuals, whether they are foreign investors or 25 art. 5 of law no. 230 of 1996. 26 ibid. pp. 117-118. ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 nationals. therefore, it is evident that on a strictly political level, the property regime is able to respond to the policy needs of the various governments that have succeeded in leading the country. iii. foreign investment in the twenty-first century. the so called ‘sinai law’ of 2012 and his emendaments of 2015. the problems (but above all the opportunities) related to the social function of property in the egyptian legal system have been the pivot around which the stratified regulatory framework for domestic and foreign investments has been revolved. even nowadays large amounts of capital in the form of investments from abroad, collected by an attractive and convenient internal legislation, strongly affect the policy and economic strategies put in place by the governments in the last few years 27 . the state tried to find a solution through the reforms providing a new law on investments capable of overcoming the earlier regulatory stratification. although foreign companies can not access any kind of investment, many of the restrictions are slowly disappearing. prime minister resolution no. 548 of 2005 states that foreigners shall enjoy equal rights with egyptians for acquiring freehold title to units in hurghada and the red sea and usufruct rights for up to 99 years for residency purposes, subject to obtaining the approval of the ministry of defense, ministry of interior and the national security authority [8]. units acquired in those areas are exempted from the 5-years restriction on disposal and accordingly may be disposed of at any time after their acquisition [8]. obviously, geographical location of area where investment are possible is still a central issue in two regulatory interventions reviewing the domestic and foreign investment sector in the country, culminating in the new law no. 72 launched in june 2017. the first intervention, law no. 17 of 2015 revision of the previous law no. 8 of 1997, provides that foreign companies and establishment which investment projects fall within the list of commercial activities defined by the legge no. 8 del 1997 (art. 1) and its executive regulations, may own land buildings and develop real estate as necessary for the purposes of establishing their commercial activities, except lands and properties in areas designated by the council of ministers from time to time (art. 2). a company must be incorporated in egypt in the form of a joint stock company, limited liability company or limited partnership; however, there are no restrictions on the nationality of the shareholders, their residence and their shareholding percentage in the company: “the companies and establishments shall have the right to possess and own land for building and built premises as required for the excercise of their activities and to expand the same regardless of the nationality or domicile of the partners, or the percentage of their shareholding”.28 the second regulatory intervention actually was not unique but from 2012 the egyptian legislator, in two times, has dealt with the peculiar situation of the territories of the sinai 27 see artt. i, ii, iv and vii of law no. 72 of 2017. 28 article 12 of the investment law of 1997. peninsula, strategically and geographically decisive for the political, economic and defensive fate of the country. at first, with law no. 68 of 2015, the egyptian government imposed that ownership of land in these areas is limited to the state for public security reasons 29 ; secondly, the presidential decree issuing law no. 95 of 2015 (that introduces amendments to the decree of the supreme council of armed forces no. 14 of 2012 on the integrated development of the sinai peninsula or ‘sinai law’), loosens the restrictions on investors who wish to acquire land rights within sinai peninsula, widening the scope of persons exempted from the ‘sinai law’ 30 . this law had exempted existing projects at the time (19 january 2012) from its application. the new decree extends the exemption to projects that were still in the process of establishment, if they had preliminary agreements with the government. the decree allows non-egyptians who receive title to a land in the sinai peninsula by the mean of inheritance, testament or gift to retain some rights over this land 31 : they can keep the right of usufruct32 over the land as well as title to immovable properties established on that land. however, they have to dispose the title of the land itself to an egyptian within six months from the date the foreigner acquires the land’s ownership33. iv. the social function of the investment. article 15 of law no. 72 of 2017. following this initiative of reform started with the law no. 95\2015 and with the aim of overrun the previous and disorganic legislation 34 , a new investment law, no. 72 of 2017 (or ‘new law’) was officially published on 31 may 2017 and came into effect on 1 june 2017 35 . this law aims to promote foreign investments: in particular, art.2 dictates the ultimate aim towards which the new investment regulations will have to tend, according to the environmental law 36 (a "comprehensive and sustainable development"). it takes into consideration several aspects, such as: the growth of national economy, the reduction of the unemployment rate, increasing of both exports and foreign investment 37 , reducing bureaucracy, simplifying 38 and enhancing processes 39 . the 29 https://www.tamimi.com/law-update-articles/foreign-ownershipof-real-estate-in-egypt/ 30 eces-egyptian center for economic studies reform bulletin, september 2015, p.7. 31 http://sharkawylaw.com/stay-informed/september-02-2015-issue61/. 32 ibid. the maximum period for usufruct rights is extended from 30 to 50 years and can be renewed to another 25 years. 33 ibid. 34 https://youssrysaleh.com/investment-in-egypt/new-egyptianinvestment-law/. 35 http://www.riad-riad.com/en/publications/egypts-new-investmentlaw-2017#corporatesocialresponsibility. 36 see law no. 4 of 1994 promulgating the ‘environment law’. 37 art. 2 l. no. 72 of 2017. 38 see the “investor service centre”, part of gafi’s organization, regulated by art. 21 l. no. 72 of 2017. ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 provisions of investment law no. 72 shall not affect the benefits and tax exemptions40, guarantees and incentives for existing companies and establishments 41 . these companies shall retain their privileges, guarantees and incentives42 until the end of the related investment periods43. according to the welfare statal plans44 as well as the relocation and social reuse45 of part of the generated revenues46, the legislator established art. 15 law no. 72 \ 2017: this article introduces some original points compared to law no. 8 of 1997. for instance, the “social responsability of the investor” clearly states: “toward achieving the goals of the comprehensive and sustainable development, the investor may dedicate a percentage of his annual profits to create a social development system”47. a devolution of part of the revenues set at 10% calculated on the amount net of expenses and taxes paid to the treasury 48 according to article 23 of the income tax law no. 91 of 2005. the executive regulations (approved in october) has detailed49 a composite indication of projects that the investor can choose to finance, according to the goals 50 set by the ministries 51 and (above all) the "supreme council for investment" (“al-maǧlis al-āʿlāh li-lstiṯmār”, in arabic الستثمارل .( المجلس األعلى the latter is a new institution “established under the chairmanship of the president of the republic”52 created for: “3adopt the policies and the investment plan which prioritise the target investment projects, in line with the state’s 39 art. 3 l. no. 72 of 2017; https://youssrysaleh.com/investment-inegypt/new-egyptian-investment-law/. 40 artt. 4-6 l. no. 72 of 2017. 41 art. 9 l. no. 72 of 2017, with a specific regulation for the free zones areas. 42 artt. 10-13 l. no. 72 of 2017. 43 http://www.shandpartners.com/the-new-investment-law-of-2017in-egypt/. 44 ministry of finance, financial statement of the state budget for fiscal year 2015/2016 (in arabic), june 2015 (http://www.mof.gov.eg/mofgallerysource/arabic/pre%20budget%20final%20version%2018-3-2015-ii.pdf). 45 art. 2 l. no. 72 of 2017, no. 3: “consideration of all aspects with social dimension, protection of the environment and the public health”. 46 see the eces-egyptian center for economic studies reform bulletin, september 2015, pp.1-3 (http://www.eces.org.eg/mediafiles/uploaded_files/c2e2aa39.pdf). 47 art. 15 l. no. 72 of 2017, § 1. 48 ibid., § 2. 49 see part i of executive regulations of law no. 72 of 2017. 50 art. 15 l. no. 72 of 2017, § 1. in particular: “1. take the necessary action to protect and enhance the environment; 2. provide programs in the areas of healthcare, social care, or cultural care, or other development areas; 3. support the technical education or the funding of research, studies, and the awareness campaigns aiming at improving the production; and 4. training and scientific research”. 51 ibid., § 3. 52 art. 68 l. no. 72 of 2017. general policy, the economic and social development plan, and the applicable investment regimes (…), 5follow up the updating and execution of the investment map across the various specialized sectors and geographic locations in line with the national economic plan”.53 the goals of technologies development related to the telecommunications sector and technological innovation in agricultural sector54 appear as pivotal. obviously, even if the article in question is short, it is possible to deduce how the freedom of choice regarding the destination of such devolution by the investor is not completely free of barriers or prohibitions. on one hand we find a timely reminder to the gafi intervention55 as a body responsible for inspection and supervision on the companies over the companies activities56, on the other hand the reference to the supervision of the minister of investment affairs (moi). even more stringent seems to be the closing statement of article 15, which provides that: “in all cases, it is prohibited to use the projects, programs, or services delivered under the social responsibility umbrella to pursue political, party-related, or religious purposes or which entail discrimination among the citizens”57. the control system of this particular activity to which the investor is called receives an equally precise clarification by the law. references to the bodies responsible for overseeing investor activity are contained in the same l. no. 72 of 2017 regarding the resolution of disputes58, negotiable out of court, relating to the application and interpretation of the law itself: “without prejudice to the right to litigation, any dispute arising between the investor and any one or more government bodies in relation to the investor’s capital or the interpretation or enforcement of the provisions of this law may be settled amicably through negotiations among the disputing parties”.59 53 id. 54 see part iv of executive regulations of law no. 72 of 2017. 55 art. 69 l. no. 72 of 2017. 56 art. 71, no. 11, l. no. 72 of 2017. gafi is also a monitoring organization deeply tied with the government, seeing as: “gafi is a public economic authority with a public legal personality that reports to the minister of investment (art. 69)”; “the authority shall have a board of directors that shall assume the development of its general policy (…); the board of directors shall be formed by a decree issued by the prime minister” (art. 73); “the board members shall disclose all of their funds and such disclosure shall be audited on an annual basis by an independent entity to ensure there are no violations (…). a report of such auditing shall be submitted to the supreme council through the competent minister” (art. 73). 57 art. 15 l. no. 72 of 2017, § 4. 58 see section v, l. no. 72 of 2017. 59 art. 82 l. no. 72 of 2017. it should be noted that a plethora of new committees arise within the gafi and regulate by articles 83 (the grievance committee), 85 (ministerial committee on investment dispute resolution), 88 (ministerial committee on investment contracts dispute resolution) and 91 (the egyptian arbitration and mediation center), could produce the opposite effect to the ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 finally, provisions concerning the supervision of investors, specifically contained in title v of the executive regulations, sanction disciplinary measures for companies that act in violation of the limits imposed by investment law and “following the approval of the board of directors of gafi”60; in particular we highlight: “ii) shortening the duration of the enjoyment of incentives and exemptions; iii) ending the enjoyment of incentives and exemptions, with the consequent effects on decisions and licenses issued to the company or establishment; iv) cancellation of the license to practice the activity. in case of violations that threaten the public health or the security of citizens or national security (…). if the company or establishment continues to commit the offense or commit another offense within one year of the first offense, the license will be canceled”61. as a conclusion, we wish to point out that the waqf (pl. ʿawqāf) institution has not only an economic predominance, but it is strictly connected to the welfare policy of egypt. the new law on private investment in the country would be capable of attracting foreign capitals and generating a profit; part of these profits will be addressed to sustain welfare strategies (ex art. 15 l. no. 72 of 2017), thus affecting the ʿawqāf 62 system. an economic and also political strategy 63 leading to the opening to foreign investment has indeed the advantage of sustaining the indigent part of the popolation in the less developed regions of the country. given its critical importance for development over the next years, social responsabilty appears to have been the leitmotif of the recent electoral campaign and part of the political agenda of the reelected egyptian government. references [1] r. a. debs, islamic law and the civil code. the law of property in egypt, new york, columbia university press, 2010, pp. 116-144; g. baeh, a history of landownership in modern egypt, 1800-1950, oxford: oxford university press, 1962, pp.71-146. [2] a.y. zohny, egypt's procurement regime and building an export oriented economy, in arab law quarterly, vol. 18, no. 2 (2003), p.174 [3] n. abdalla, the role of foreing capital in egypt’s economic development: 1960-1972, international journal of middle east studies, vol. 14, no.1 (feb.,1982), p.96. desideratum of l. no. 72 of 2017 (a rationalization of the entire system), if not adequately specified in their areas of jurisdiction. 60 art. 124 of executive regulations of law no. 72 of 2017 (only arabic text available at: http://www.nib.gov.eg:8091/media/45cb79905440476b9236fc93ec5c d042.pdf). 61 id. 62 r. a. debs, pp. 137-140. 63 http://english.ahram.org.eg/newscontent/3/12/300126/business/eco nomy/the-egyptian-economy-cautious-outlook-on-reform.aspx [4] ibid., p.87-90. [5] g. alpa, g. chiodi, il progetto italo francese delle obbligazioni (1927). un modello di armonizzazione nell'epoca della ricodificazione, giuffrè editore, 2007. [6] m. brutti, vittorio scialoja, emilio betti: due visioni del diritto civile, g. giappichelli editore, 2013. [7] a. r. al-sanhūrī, al-wasīṭ fi sharh al-qānūn al-madanī, vol. viii, cairo, dār al-naḥda al-‘arabiyya, 1967, p. 492. [8] http://www.tamimi.com/law-update-articles/foreign-ownership-of-realestate-in-egypt/. [9] m.h. davies, business law in egypt, kluwer law and taxation publishers, deventer\netherlands, 1984, p. 69. [10] t.f. riad, the legal environment for investment in egypt in the new millennium, arab law quarterly, vol.15, no. 2, 2000, pp. 117-130. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 an evaluation of dana gas’s mudarabah sukuk from shariah and legal perspectives muhammad salahuddin hekmatyar*, ebrahim parkar*, *institute of islamic banking and finance, international islamic university of malaysia abstract-dana gas’s proclamation that its sukuk is unlawful under shariah and uae law, garnered the attention of prominent business publications in the summer of 2017. the unprecedented move by dana gas could potentially instigate wider ramifications for the sukuk industry. the purpose of this paper, is to investigate whether dana gas provided valid grounds to justify their sukuk as being unlawful under shariah law. it highlights the key claims of dana gas about the prevailing market conditions at the time of the sukuk issuance and the legal challenges involved. the methodological approach of this paper focuses on key documentation, which includes the sukuk prospectus and company statements. based on the analysis of the sukuk features, there are a few infringements of shariah rulings in the profit distribution and purchase undertaking practices, when benchmarked against aaoifi (accounting and auditing organization for islamic financial institutions) standards. keywords – sukuk, shariah compliance, default i. introduction over the years, the sukuk market has enjoyed tremendous growth and spearheaded the islamic finance industry. global sukuk issuances in 2016 reached $88 billion, representing a 44% increase over 2015 issuances of approximately $61 billion. new sukuk issuances from etihad airways, oman telecom, government of jordan amongst others, gave the market great momentum in 2016 (iifm sukuk report, 6th edition). however, shock and controversy enshrouded the islamic capital markets in the following year, when dana gas released a company statement asserting their sukuk issued in 2013, contravenes uae and shariah law. consequently, the company refused to pay sukuk holders profit payments due, claiming that the obligation no longer existed due to the sukuk being no longer shariah compliant. even more boldly, dana gas declared that previous profit payments should be returned to them in light of the sukuks invalidity. the wider ramifications for the industry are as of yet unknown, although if the courts rule in favour of dana gas, it may set a precedent for other sukuk issuances to follow suit. dana gas stated their sukuk is unlawful under uae and shariah law. this paper seeks to examine those claims and determine whether dana gas has adopted a valid stance, based on aaoifi (accounting and auditing organization for islamic financial institutions) guidelines and legal directives. the methodology of this research adopts a qualitative approach, utilising a case study method. instances whereby sukuk issuers declare their own sukuk as unlawful are rare. shariah compliance forms the backbone of the islamic finance industry and violating it poses a key risk to the involved parties. thus, examining such a case can contribute to an area of research that can facilitate the sukuk market to become more resilient to potential future occurrences of similar issues. ii. literature review a. definition and features of mudharabah sukuk with the growth of the islamic finance industry, sukuk is deemed as an alternative to avoiding interest-bearing bonds. defined as participation securities, they contrast compared to conventional bonds in terms of the structure of the product. in addition, the underlying asset also plays an important part in the sukuk structure, unlike conventional bonds, which utilize interest rates as the core mechanism for transactions (hasan & lewis, 2007). specifically, aaoifi has defined sukuk as certificates that are of equal value, representing undivided shares in ownership of tangible assets, usufruct or services (aaoifi 17, 2. p. 468. 2013). through its evolution, various types of sukuk structures have emerged such as murabaha, musharakah, ijarah, wakalah, and mudharabah. sukuk are further subdivided into two types, asset-based and asset-backed. according to isra (international shari’ah research academy), the primary difference between them; are that in an asset-backed sukuk, the investor gains benefit from an underlying asset, which was funded by their own money. thus, any anticipated gains depend on the asset performance. on the other hand, the gains for investors in an asset-based sukuk does not necessarily derive from the asset itself. in this case, sukuk holders have no special right to the asset and rely wholly on the originator’s creditworthiness. regarding the profit distribution, asset-based sukuk will often be determined by a fixed profit rate for distribution to its investors. in other words, an asset-based sukuk attempts to emulate the behaviour of a conventional bond (isra, 2015). this paper will only concentrate on mudharabah sukuk, due to it being the type of sukuk dana gas employed in its sukuk issuance. essentially, the nature of mudharabah is a partnership contract, whereby the partners share the same profit and risk. thus, in the context of sukuk, aaoifi described it as the certificate which represents a project or ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 activities managed on the basis of mudharabah, by appointing one of the partners or another person as a mudharib (aaoifi, 3/6/2, 2015). to ensure transparency, both partners must determine the profit and loss ratio in the agreement. therefore, the partners will be aware that the results of the partnership will be borne together. frequently the contract also stipulates a specific percentage of the mudharib’s profit share, which is paid periodically to the sukuk holder, to withdraw their investment in stages (hasan & lewis, 2007 & el-gamal, 2006). another crucial aspect when establishing a sukuk is the spv (special purpose vehicle). the spvs primary role, is to be the third party between the issuer and the sukuk holder, thereby confirming every transaction pertaining to the sukuk. hence, the role of the spv is similar to the role of a trustee firm. there are several ways to setup the spv, one way being a professional trustee company to oversee the position of a trustee. another option is an spv is established by the company, acting as trustee as well as an issuer. the final option is by having a different trustee for asset acquirement and sukuk issuance (isra, 2015). in the context of dana gas, we will focus on the second approach, which was how dana gas handled their sukuk issuance before 2013 (dana gas prospectus). b. previous instances of sukuk default despite its growth in the capital markets, sukuk has encountered numerous problems, one of which is the risk of default. the default risk has a variety of causes, from liquidity, legal, economic conditions and mismanagement issues. consequently, these issues require scrutinising to address the core factors that result in a sukuk default, beginning from restructuring until liquidation of assets. the first paradigm comes from the kuwait investment firm dar tidk.kw. in 2009, this sukuk was declared as a default, with $100 million owed to investors. the management argued that the main causes for the default, was that the market default rate had increased. furthermore, during that period, it was only one year prior to the global financial crisis of 2008 2009, subsequently affecting many financial markets across the world. in this case, the company was trying to seek another refinancing deal totalling $1 billion to settle all their debts. the company also had to liquidate some of their assets to support this course of action (thomson reuters, 2009). the next example is the golden belt sukuk, issued by saad group company in saudi arabia worth $650 million. the sukuk was issued in 2007 and matured in 2012, however in 2009 this sukuk was declared as a default. some controversy occurs due to the intervention of the saudi government at the time of restructuring the sukuk. in addition, a committee established by the saudi government, was prioritising local investors and refused to protect the rights of foreign investors. thus, according to robert j shapiro this case could be a catalyst to leading saudi into future difficulties, whenever the government desires to deal with the international market (shapiro, 2013). another similar case is with the east cameron gas company. they defaulted in their sukuk which ended up in us courts during 2007. the restructure undertaken for that sukuk was worth $10.9 billion in the middle of 2011. according to oseni, as part of the restructuring plan, the company issued a $32.94 million sukuk on 7th january 2013, representing the third tranche in the restructuring process (oseni, 2014). based on the previous cases, although sukuk has been categorised as the islamic equivalent of a bond, sukuk is not completely devoid of risk. especially the market risk, which is comparable to the same conditions found in a conventional bond. c. dana gas company background established in 2005 and headquartered in the state of sharjah in the uae (united arab emirates), dana gas classes itself as the first and largest regional private sector natural gas company. publicly listed on the adx (abu dhabi securities exchange), dana gas has sizeable production assets in egypt, the kurdistan region of iraq and uae (dana gas overview, 2017). crescent petroleum is dana gas’s largest shareholder with a 19% stake of the company (4-traders, 2017). in 2016, gross profit was $103 million with assets worth $3.8 billion (dana gas annual report, 2016). dana gas initially launched their sukuk in late 2007 for $750 million. after strong demand, an additional $125 million was raised taking it to $1 billion (dana gas annual report, 2008). the sukuk matured in october 2012, with a fixed profit rate of 7.5%. sukuk holders comprised of major global firms including blackrock and ashmore group. dana gas missed a deadline to pay accrued profit due on 30th october 2012. subsequently, they became the first company in the uae to falter on sukuk repayment. reasons cited as the catalyst for the default, predominantly point to liquidity difficulties triggered by payment delays from egypt and iraq’s kurdistan region (“uae's dana gas misses”, 2012). specifically, 729 million dirhams was outstanding from egypt gas deliveries and 1.2 billion dirhams in the kurdistan region (“uae's dana gas won't ”, 2012). dependency on clients in political troubled regions will inevitably lead to cash flow inconsistencies. law firm latham & watkins were hired in the restructuring deal and stated dana gas had a strong desire to implement the restructuring through a sharia’ahcompliant method. (lw, 2015). concentrating on the changes in the aaoifi standards that relate to mudarabah sukuks, the purchase undertaking price is among the most vital issues. according to aaoifi standards and other studies, after the issuance of the new standard, it is not permissible to purchase the asset based on nominal value. the price of undertaking must be on the market value, fair value or the rate that is agreed at the redemption date (aaoifi shariah standard 12(3/1/6/2)) (naim et’al, 2013) and (lahsasnas, 2008). ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 d. shariah rulings and advisory in uae similar to other gulf cooperation council (gcc) countries, uae follows a decentralised model for shariah compliance matters in the islamic finance industry. article 6 of the uae islamic banking law states ‘that each islamic bank (ib), financial institution and investment company should establish its own shariah supervisory authority to ensure that its transactions and practices conform to islamic law. it also states the establishment of “higher shariah authority” to supervise ib, financial institutions and investment companies, art. 5, federal law no. 6 of 1985 (hamza, h, 2013). in reality, the higher shariah authority never came into existence and the shariah supervisory boards (ssbs) undertake the responsibility of shariah governance (ginena, 2015). articles 693 to 709 of the federal law no. (1) 1987, concerning civil transactions law of the uae (the civil code), deal with the uae law requirements relating to mudarabah. these articles fall under the section of “(3) mudaraba companies (where one partner places assets at the disposal of another to make a profit)”. the composition of the articles revolves around the core tenants of a mudarabah contract. shibeer ahmed, head of winston & strawn’s middle east banking and islamic finance practice commented: “on the basis of publicly available information, i understand that dana gas is relying on the provisions of the civil code to argue that certain expectations, which the sukuk holders may have in relation to their rights under the mudarabah agreement, are not enforceable because they contravene the civil code. dana gas has obtained an injunction from the uae courts to prevent any enforcement action by the trustee (acting for the sukuk holders) until there is a full hearing” (winston & strawn llp, 2017). dana gas state in their prospectus, that they utilised the advisory firm ‘dar al-shariah’ to obtain shariah compliance approval for their sukuk structure (sharif, a. ,2017, june 15). dar alshariah offer several shariah advisory services to entities within the islamic finance industry. they also have a prolific portfolio of clients, having been involved in sukuk offerings by etihad, dp world, dubai islamic bank (dib), government of pakistan and many others (dar alshariah brochure, 2017). e. governing law and jurisdiction the legal jurisdiction in the uae encapsulates an engaged approach, whereby the legal framework recognises islamic finance through the enactment of law. for both conventional and islamic global financial transactions, english law and courts are the preferred choice. the rationale behind this choice is primarily down to the enforceability of rights, obligations and remedies, the independence and reliability of judiciary. also, the flexibility offered through the freedom of contract principle, thus enabling parties to incorporate particular rules or provisions that meet their requirements (ginena, 2015). terms in the dana gas prospectus stipulate that the governing law and jurisdiction are predominantly split between english and uae law. the declaration of trust, the agency agreement, the purchase undertaking, the sale undertaking, the security agreement, the security agency agreement, the ordinary certificates and the exchangeable certificates are governed by english law and subject to the non-exclusive jurisdiction of the english courts. whereas the mudarabah agreement, the uae share pledges and the uae mortgage will be governed by the laws of the uae. the courts of the uae have non-exclusive jurisdiction to hear all disputes relating to the mudarabah agreement and the uae share pledges, and exclusive jurisdiction to hear all disputes relating to the uae mortgage (dana gas final terms, pg 28). a question that arises, if the dana gas sukuk is partially or fully non-compliant with shariah, does this entail its unlawful under uae law. secondly, does this negate the obligation of profit payments, rescinding the terms of the contract and making it unenforceable legally? without a central shariah body to offer guidance and provide the final say on shariah matters, rulings regarding shariah remain somewhat subjective. while dana gas may disregard its sukuk as being shariah compliant, one may argue that it remains a legally enforceable fixed income instrument. more importantly, dana gas’s payment obligations as a result of non-payment (default) and the purchase undertaking is under the governance of english law and stipulates the dispute resolution in english courts (dana gas sukuk: a red herring or cause for concern ?, 2017). iii. research methodology the methodology used in this research adopts the qualitative approach, specifically using content analysis, a systematic reading of a body text, figures and tables. the technique has also been used in many scientific fields, including history, law and psychology. to be specific in this research we conduct a discourse content analysis, a type of analysis which focuses on how particular phenomena are presented (krippendroff, 2004). therefore, the explanation about phenomena here, is conducted chronologically to include scholarly opinions, shariah standards, country regulation and practical implementations. many documents were studied in the collation of this research including: the sukuk prospectus, country’s law and official company statements. iv. finding and discussion a. overview of the dana gas sukuk terms this section centres on analysing the practical implementation of the dana gas sukuk, beginning from the structure, subsequently moving to the shariah and legal issues. the details of the sukuk restructure that occurred in 2013, the revised terms that were agreed are as follows: table 1: overview of company’s sukuk ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 spv name: dana gas sukuk limited profit rate: 7% and 9% type: mudharabah issue size: $850,000,000 ($850m) maturity: 31 october 2017 country united arab emirates tenor: 3.5 years issue date: 08 may 2013 exchanges: irish stock exchange arrangers: barclays capital, citigroup, jp morgan source: sukuk.com b. dana gas mudharabah sukuk structure concept this section will highlight the parties involved in the dana gas sukuk (dana gas prospectus): illustration 1: sukuk structure overview source: dana gas sukuk prospectus (2013) highlights of the dana gas sukuk structure are as follows: dana gas (mudharib) conducts the mudharabah agreement with dana gas sukuk limited (trustee). subsequently, the trustee will create a declaration of trust, which later becomes the underlying asset for the trustee to issue the sukuk. in this case, the mudharabah asset is worth $1 billion and dana gas contributed 14.992 percent. pursuant to the mudharabah agreement, the trustee will issue the sukuk consisting of two different types of sukuk. they are: exchangeable sukuk and ordinary sukuk. those sukuk are worth $850,080,000, which is the residual percentage of asset from the mudharib contribution. next, the cash obtained from the certificate holders by trustee, is transferred to the mudharib, in this case the trustee will become the rabul-mal. the company (dana gas) as the mudharib, prior to receiving the cash from the trustee, will invest the money to several shariah compliant investments. regarding the profit distribution, before the investment was conducted, the company (dana gas) will distribute the profit periodically. this action is called ‘periodic required amount’. the amount will be paid quarterly. there are some conditions in case of a shortfall when: a) the amount of profit distributable to the trustee on such date. b) the periodic amount required is payable immediately on the following periodic distribution date. in that case, the mudharib will transfer to the transaction account, an amount equal to the shortfall from the reserve account. finally, at the time of redemption, the mudharib shall liquidate the mudharabah assets (by way of constructive or actual liquidation) and shall pay into the transaction account. . c. shariah issues in dana gas mudharabah sukuk 1) fixed profit rate mudharabah is known as partnership contract with both parties sharing the same profit and risk profile. mufti taqi usmani, a prominent scholar in islamic finance argued that in terms of profit distribution, it is not permitted to take a percentage from the lump sum of capital (usmani, 1998, p.33). furthermore, el-gamal puts forward that in this situation, there are still several disputes between the jurists. however, there is some leniency if the share is not known explicitly, then the profit can be fixed. nonetheless, he opined that the vast majority of jurists have unequivocally rejected the mudharabah contract, whenever a partner promises to fix the return, likening it to interest (el gamal, 2006). aaoifi has also stated some conditions pertaining to the fixing of profit, concluding that the profit cannot be fixed. according to shariah standard no 13: 8/1. it is a requirement that the mechanism for distributing profit must be clearly known in a manner that eliminates uncertainty and any possibility of dispute. the distribution of profit must be on the basis of agreed percentage of the profit and not on the basis of a lump sum or a percentage of capital. 8/5. if one of the parties stipulates that he should receive a lump sum of money, the mudharabah contract shall be void. this rule does not apply to a situation where the parties agree that if the profit is over a particular ceiling then one of the parties will ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 take additional profit and if the profit is below or equal to the amount of the ceiling the distribution of profit will be in accordance with their agreement. the profit distribution of the dana gas sukuk is a peculiarity. in july 2017, dana gas declared their sukuk is no longer shariah compliant. subsequently, the company approached a sharjah court to support their opinion just a few months before the maturity of the sukuk (bloomberg, 2017). the prospectus verily confirms the use of a fixed the profit rate since its inception, at a rate of 7.0% for exchangeable certificates and 9.0% for ordinary certificates (dana gas prospectus, p.1). to maintain its capability for repayments, the company also promised to keep the reserve account. furthermore, for ensuring that the company will meet its obligation, the company promised to allocate 99% from the profit of the mudharabah asset, to be placed in the trustee account. hence, at the time of payment, they can pay it in accordance to the profit agreement stipulated in the terms (dana gas prospectus, 2013, p. 71). to further expand on the breakdown of how the company can pay a fixed profit rate to the sukuk holders without breaching shariah law, the following illustration expands upon the concept: illustration 2: the profit distribution concept source: adapted from dana gas prospectus 2007 and 2013 citing the sukuk prospectus, if the rabul-mal has exceeded in the nominal ratio from the pre-determined profit rate, the rabul-mal will forego the amount as an incentive for the mudharib. whereas, if there is a shortfall during the time of payment, the mudharib will transfer an amount equal to the shortfall from the reserve account (dana gas prospectus, 2013). by looking at these practices, the action for ratio, exceeding profit and shortfall are in line with aaoifi standard no 13 8/1 and 8/5. however, when we examine the last output of the product, it is mimicking to some extent, the conventional bond output, contradicting both standards. 2) fixed purchase price at time of redemption although the nature of the mudharabah is a partnership contract, the underlying mechanism differs in an asset-based sukuk. it shares similar characteristics to a bond, in terms of output, resulting in a lower risk. thus, paying back the principle to certificate holders is one of the obligations for the mudharib (dana gas). to ensure the company has the capability to payback their investors, with the same amount of money invested, a few approaches are adopted. one such tactic is by fixing the price of asset repurchase to the face value price. according to the dana gas sukuk prospectus, scheduled redemption is as follows: ……the calculation agent will calculate the amount payable in respect of any ordinary certificate by multiplying the standard redemption amount by a fraction of which the numerator is the principal amount of the relevant ordinary certificate and the denominator is the aggregate face amount on the scheduled (dana gas prospectus. 2013. p. 126). to expand further on “aggregate face amount”, dana gas has extended the meaning of this term by the principal amount of outstanding certificates. in this case, 425,040,000 usd in ordinary sukuk and the same amount in the exchangeable sukuk (dana gas prospectus. p.139). according to the prospectus, the term was created to avoid disputes at the time of redemption (dana gas sukuk prospectus. p.139). therefore, it can be implied dana gas needed to adjust to the nature of the market, whereby giving back the principle in an asset-based sukuk is customary practice. by looking to the originality form of mudharabah contract, all risks that occur from the investment, will be borne together and consequently the price of the asset must be sold on the selling price, fair value, or rate agreed in the event of liquidation (aaoifi s 13. 8/8 and 12. 3/1/6/2). in addition, even before the aforementioned standard was issued, mufti taqi usmani gave a clear fatwa about a similar purchase undertaking practice. he stated no such practice had been approved by a jurist (usmani, 2007). on this occasion, dana gas makes a valid point that the manner of purchase undertaking utilised was not consistent with shariah standards. therefore, questions now arise on which standards dana gas were referencing during the 2013 sukuk restructure. the new standard that overrules this issue was published back in 2008. another issue on purchase undertaking is bay’ al-inah (sale and buyback) due to a wa’d (promise) to purchase unilaterally, which is permissible according to aaoifi. they formulated a clear definition and reason for permissibility in shariah standard no. 49. the wa’d that the governing body prohibited is the bilateral promise, closing a potential avenue leading towards bay’ al-inah. in the case of dana gas, the company does not employ bay’ al-inah since the nature of the aqad (contract) in the first instance is not murabahah (sale contract). while the asset on this occasion was a “certificate of trust” created by the mudharabah contract (partnership). 3) maturity of the contract according to mufti taqi usmani, there are a few different opinions regarding the termination of a mudharabah contract. he mentioned that the hanbali and hanafi schools of thought have the same opinion of permitting the maturity of a contract, as long as both partners agree. on the other hand, the shafiis and malikis are of the opinion that mudharabah cannot be restricted to a particular time (usmani, 1998, p. 34 35). ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 however, in this specific case, aaoifi has taken the position as stated in the shariah standard number 13: 4/3/1. when the mudarib has already commenced the business, in which case the mudarabah contract becomes binding up to date actual or constructive liquidation. 4/3/2. when the contracting parties agree to determine a duration for which the contract will remain in operation. in this case, the contract cannot be terminated prior to the end of designated duration, except by mutual agreement of the contracting parties. as stated in the dana gas prospectus, the sukuk will mature on 31st october 2017. despite some scholarly opinions ruling against the inclusion of a maturity in a mudarabah contract, the company has already complied with the shariah standard as stipulated in the above aaoifi rules. 4) guarantee of the capital there are a few different opinions amongst the jurists regarding guaranteeing the capital from the entrepreneur to the capital provider, in the mudharabah business model. the hanbalis and hanafis opined that the partnership remains valid, but the losses will be shouldered by the capital provider, since the condition is nugatory. on the other hand, the malikis and shafiis argued that in this case, the contract will be defective due to the presence of excessive gharar. ibn qudamah also put forward that this kind of practice is no longer a partnership contract but rather a loan contract (zuhayli, 2001). despite the differing opinions amongst the scholars, aaoifi addressed this matter in shariah standard no. 13: the capital provider is permitted to obtain guarantees from mudharib that are adequate and enforceable. this is circumscribed by a condition that the capital provider will not enforce these guarantees except in cases of misconduct, negligence of contract on the part of mudharib (13 para 6). dana gas arguably using its assets in accordance of the egyptian assignment agreement, as a guarantee for the capital provided by the sukuk holders. those assets are: shares of dana lng venture, sajaa gas private, united gas transmissions company ltd, mortgage of sajaa gas share pledge, 66 % of danagaz w.l.l and receivable of dana gas egypt (dana gas, 2013, p 16). dana gas’s actions are certainly in-line with the current shariah standard issued by aaoifi, even though it is contrary to the views of ibn qudamah, malikis and shafiis. d. shariah certification irregularities within the dana gas circular offering, under the heading of ‘no assurance can be given as to sharia rules’ in the risk factors section, dana gas states the following: “the sharia advisory board of dar al-sharia have confirmed that the transaction documents are, in their view, sharia compliant. however, there can be no assurance that the transaction documents or the issue and trading of the certificates will be deemed to be sharia compliant by any other sharia board or sharia scholars.” dana gas explicitly states that dar al-sharia have endorsed the sukuk as being shariah compliant. however, upon further scrutiny, this statement is misleading. when dana gas issued their sukuk in 2007, it was aligned to the aaoifi standards of that time and was certified by dar alsharia. in 2008, the chairman of aaoifi, mufti taqi usmani proclaimed that about 85% of sukuks were not in-line with shariah principles. in light of these comments, aaoifi altered their guidelines in 2008. the sukuk issuance of 2007 by dana gas retained its shariah compliance, as retrospective action in shariah rulings is not the customary approach. a prominent shariah consultant who was involved in the initial dana gas sukuk issuance in 2007 commented, that when dana gas restructured their sukuk in 2012, they did not re-certify it for shariah compliance. rather the original shariah compliance certification that dar al-shariah issued in 2007 was reused. the problem here is that the guidelines were modified after 2007 and thus a sukuk restructure necessitates a re-examination for shariah compliance. tellingly on the dar al-shariah company brochure 2017, it only mentions the initial sukuk offering that matured in 2013 not the sukuk restructure maturing in 2017. e. assessing dana gas’s claims dana gas released a company statement dated 6th july 2017 to sukuk holders, outlining the reasons as to why the 2013 mudarabah sukuk was deemed to be unlawful under uae and shariah law. dana gas placed a strong emphasis on the changing sukuk market conditions from 2007 to 2017. the evolution of the sukuk market has meant that many features of the dana gas sukuk are no longer regarded as shariah compliant (dana gas company statement, 2017). dana gas makes several claims to support their position in declaring the sukuk as shariah non-compliant that require addressing, with the purpose of validating if they carry any substance. claim 1: “when the company’s mudarabah sukuk was first issued in 2007, about 90% of sukuk instruments then in existence were mudarabah in structure” the first edition of the international islamic financial market (iifm) report, offers an insight to the structural breakup of sukuks issued from 2001 – 2009. the report notes that the dominant structure until 2005 was ijarah-based sukuk. thereafter between 2006 and 2007, other participatory structures were more widely adopted such as musharakah, mudarabah and exchangeable trusts. table 1 illustrates that ijarah and musharakah are by far the dominant structures used with 39 and 18 respectively. while mudarabah issues over the same period of time only occurred in six instances. an israejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 bloomberg bulletin q2 2013 corroborates with the iifm data with similar results. table 2: structural break-up of international issuances (iifm report 1st edition) type of sukuk no of issues value (us mil) % of total value ijarah 39 15,964 44% musharakah 18 7,726 22% mudarabah 6 4,725 13% islamic exchange bond 9 6,340 18% hybrid 3 487 1% murabaha 2 340 1% wakala or investment 1 325 1% total 78 35,907 100% source: in-house iifm sukuk issuance database claim 2: “however, the further development and evolution of islamic finance concepts and jurisprudence since our original sukuk was structured in 2007, and restructured in 2012/13, has resulted in the discrediting and abandonment of many of the features of our current mudarabah sukuk. the sukuk market has simply evolved and no longer regards a pure mudarabah structure such as ours as being shari’a compliant and, in the case of the uae, lawful” using the same reasoning that evolving market conditions render a sukuk’s shariah compliance void, this would entail other similar sukuk issuances would endure the same fate. data compiled by bloomberg indicates six other mudarabah sukuks issued by uae that would be exposed to the same inherit shariah compliance problems: table 3: outstanding sukuk in uae sukuk issuer profit rate abu dhabi islamic bank 6.375% dubai islamic bank 6.75% and 6.25% alhilal bank 5.5% noor islamic bank 6.25% gems education 12% dp world 6.25% source: bloomberg (2017) interestingly the dubai islamic bank’s (dib) sukuk was also certified shariah compliant by dar al-shariah, the same organisation that gave the all clear for dana gas’s sukuk. dib also happens to be dar al-shariah’s parent company leading to signs that the outcome of the dana gas court case may have a bearing upon the dib sukuk. claim 3: “these terms make our current mudarabah sukuk contrary to shari’a and unlawful under uae law.” the legal system in uae is based on a mix of shariah and european concepts of civil law (nyulawglobal, 2017). on multiple occasions, dana gas state that their sukuk is unlawful under uae law. therefore, the articles of law that elaborate upon on mudarbah contracts require further examination to ascertain what is specifically being contravened within the legislative framework. laws relating to mudarabah contracts are contained within articles 693 – 709 in the uae civil code. datuk dr mohd daud bakar stated that the mudarabah contract is in principle still regarded as a debt instrument and thus the issuer is still obliged to fulfil payments in a timely manner (ram press release, 2017). a contract that has been certified as being shariah compliant at the time of ratification, is it open to retrospective action that can invalidate it? according to prominent scholars, this is not the case. sheikh yusuf talal delorenzo, author of a 1996 textbook on islamic banking, expresses that compliance is determined at the time of issue and the matter is closed at that point. mohamad akram laldin, executive director of international shariah research academy (isra), concurs adding that “sharia compliance is embedded in a document and cannot be voided even if some parts of a deal turn out to be faulty” (“hard to invalidate islamic contracts”, 2017). f. purchase undertaking examination as stated in the dana gas prospectus, the purchase undertaking is governed by english law (dana gas prospectus, pg 54). dependence on english law for the documentation of ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 financial transactions is a routine practice. primarily owing to the presumed weak local legislation, in this case uae and to enhance the credit rating from conventional ratings agencies (al-amine, 2008). the purchase undertaking embodied in sukuk bears a striking resemblance to promissory estoppel (a promise is enforceable by law) found in english common law. in the case of dana gas, one can argue that they have committed a tort, ‘an act or omission that gives rise to injury or harm to another and amounts to a civil wrong for which courts impose liability’. therefore, it can be enforced in an english court in the case of default by the originator (kamali & abdul karim abdullah., 2014). judgement in an english court, in essence, alters the outlook of the transaction from to a borrower and creditor relationship. indeed, in november 2017, the english court lead by mr justice leggatt, the decision was made. it is stated that the purchase undertaking contract is valid and enforceable under the english law. the dana gas opinion which rely on the ralli brothers principles and on article 9(3) of the rome i regulation is denied by the judge. the court then explained that this principle will be accurate if the purchase undertaking were executed in uae. however, in this case, both party has agreed that the purchase undertaking action will be done in uk and govern by uk law (royal court release, case no fl2017-000004, 2017). v. conclusion the positive growth of the sukuk market is also trailed by some risks that occurs in conjunction with its development. some of those risks are with regards to defaulting sukuk, which affected a number of instruments in the 2008 global financial crisis. this study has examined the mudarabah sukuk of dana gas, since the company has declared its own sukuk as shariah non-compliant. after looking to the current practices from a shariah and legal point of view, we found that the foremost problems in this case, stem not from the shariah side but arise more from the legal and management areas. for the shariah issues, the core problem that may have contradicted the aaoifi shariah standards, is the practice of profit distribution and fixed price in the purchase undertaking. as for other issues such as guarantee of the capital and maturity of contract, they are only contrary to some scholarly opinions. however, the decision to declare that the company’s sukuk as non-compliant to shariah, requires further disclosure of information to reach a more conclusive verdict. as for the legal issues, the underdeveloped legal framework within the islamic capital markets in several countries, present challenges to those involved. malaysia has led the way in this field, laying down the groundwork to facilitate the development of a more comprehensive system that can offer a stable platform for dispute resolution. in uae, the lack of an adequate regulatory system, from both the legal and shariah perspectives, has contributed to the uncertainty that has arisen from dana gas’s actions. a central shariah supervisory authority would have certainly helped in this issue, by proclaiming a definitive judgement on the shariah non-compliance claim. if such a proclamation occurred, it may have alleviated the need for the matter to be decided in the english courts. now that the matter rests in the hands of the english legal system, the judgement is not being decided based on shariah law but rather according to the terms in the purchase undertaking agreement. references [1] al-amine, m. a. b. m. “sukuk market: innovations and challenges. islamic capital markets”. islamic economic studies, vol 15, no. 2, 2008, pp 33. [2] aaoifi . shariah standard . kingdom of bahrain: dar alamaiman. 2015 [3] “a guide to united arab emirates legal system” globalex. (2017). nyulawglobal.org. retrieved from http://www.nyulawglobal.org/globalex/united_arab_emirates.html [4] bloomberg. (2017). retrieved from:http://www.bloomberg.com/ news/articles/2017-06015/dana-gas-move-to-void-sukuk-stunts-analystswho-question-motive [5] dana gas company statement, (2017). retrieved from http://www.danagas.com/enus/investors/companystatementtosukukbo ndholders.pdf [6] dana gas sukuk (2017): a red herring or cause for concern? | white & case llp international law firm, global law practice.whitecase.com. retrieved from https://www.whitecase.com/publications/alert/dana-gassukuk-red-herring-or-cause-concern [7] dana gas co pjs company : “shareholders, managers and business summary” | abu dhabi securities market: dana | 4-traders. (2017). retrieved from http://www.4-traders.com/dana-gas-co-pjs9059637/company/ [8] dana gas. (2013). “the sukuk prospectus”. retrieved from: http://www.danagas.com/enus/investors/tab%20006%20offering% 20circular.pdf#search=sukuk [9] dana gas. (2017). the company statement to sukuk holders. retrieved from: www.danagas .com [10] elgamal, m. “islamic finance: law economic and practice”. cambridge publisher, 2006. [11] exclusive: uae's dana gas won't repay bond-sources. (2017). u.s. retrieved from http://www.reuters.com/article/us-dana-sukuk/exclusiveuaes-dana-gas-wont-repay-bond-sources-idusbre89t10120121030 [12] ginena, k. “foundations of shari'ah governance of islamic banks” wiley-blackwell, 1st ed., p. 125, 2015. [13] hasan, k., & lewis, k. handbook of islamic banking. edward elgar publishing limited, 2007. [14] "hard to invalidate islamic contracts, scholars say amid dana gas dispute".(2017). retrieved from https://www.reuters.com/article/danagas-sukuk-scholars/hard-to-invalidate-islamic-contracts-scholars-sayamid-dana-gas-dispute-idusl8n1jh2mi [15] hamza, h. “sharia governance in islamic banks: effectiveness and supervision model. international journal of islamic and middle eastern finance and management”, 6(3), 226-237, 2013. [16] isra (international shariah research academy for islamic finance. “islamic capital market; principles and practices”. pearson, 2015. [17] isra (international shariah research academy for islamic finance. “islamic financial system; principles and operation”. milleniacomms, kuala lumpur, 2015. http://www.nyulawglobal.org/globalex/united_arab_emirates.html http://www.danagas.com/enus/investors/companystatementtosukukbondholders.pdf http://www.danagas.com/enus/investors/companystatementtosukukbondholders.pdf https://www.whitecase.com/publications/alert/dana-gas-sukuk-red-herring-or-cause-concern https://www.whitecase.com/publications/alert/dana-gas-sukuk-red-herring-or-cause-concern http://www.danagas.com/enus/investors/tab%20006%20offering%20circular.pdf#search=sukuk http://www.danagas.com/enus/investors/tab%20006%20offering%20circular.pdf#search=sukuk http://www.reuters.com/article/us-dana-sukuk/exclusive-uaes-dana-gas-wont-repay-bond-sources-idusbre89t10120121030 http://www.reuters.com/article/us-dana-sukuk/exclusive-uaes-dana-gas-wont-repay-bond-sources-idusbre89t10120121030 https://www.reuters.com/article/dana-gas-sukuk-scholars/hard-to-invalidate-islamic-contracts-scholars-say-amid-dana-gas-dispute-idusl8n1jh2mi https://www.reuters.com/article/dana-gas-sukuk-scholars/hard-to-invalidate-islamic-contracts-scholars-say-amid-dana-gas-dispute-idusl8n1jh2mi https://www.reuters.com/article/dana-gas-sukuk-scholars/hard-to-invalidate-islamic-contracts-scholars-say-amid-dana-gas-dispute-idusl8n1jh2mi ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 [18] kamali, m., & abdul karim abdullah. “islamic finance”. international institute of advanced islamic studies, kuala lumpur, malaysia, 2015. [19] krippendorff, klaus. “content analysis. an introduction to its methodology”.sage publication , thousand oaks: california, 2004. [20] lahsasna ahcene. “examination of the aaoifi pronouncement on sukuk issuance and its implication on the future sukuk structure in the islamic capital market”. 6th international islamic finance conference, 2008. [21] moscow law firm, winston & strawn llp. (2017). retrieved from http://www.winston.com/ru/where-we are/europe/moscow.html#!/en/thought-leadership/shibeer-ahmeddiscusses-sukuk-decision-with-bondsloans.html?aj=ov&parent=3265&idx=5 [22] naim et al. “the effects of new aaoifi standards on sukuk in choosing the most authentic islamic principles”. journal of islamic accounting and business research, 2013. [23] oseni, u. “dispute management in islamic financial institutions : a case study of near sukuk defaults”. journal of international trade law and policy, 2014 [24] overview. (2017). danagas.com. retrieved from http://www.danagas.com/en-us/about/overview [25] “ram rating held dialogue with experts to dissect dana gas risks. ram.com.my, 2017 [26] sharif, m. (2017). why everyone's talking about dana gas's sukuk. bloomberg.com. retrieved from https://www.bloomberg.com/news/articles/2017-0615/dana-gas-s-move-to-void-sukuk-stuns-analysts-whoquestion-motive [27] shapiro, r. j. (2013). the importance of international standards in managing defaults in islamic finance : saudi arabia, 2013. http://www.danagas.com/en-us/about/overview https://www.bloomberg.com/news/articles/2017-06-15/dana-gas-s-move-to-void-sukuk-stuns-analysts-who-question-motive https://www.bloomberg.com/news/articles/2017-06-15/dana-gas-s-move-to-void-sukuk-stuns-analysts-who-question-motive https://www.bloomberg.com/news/articles/2017-06-15/dana-gas-s-move-to-void-sukuk-stuns-analysts-who-question-motive ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 input efficiency of financial services sector: a non-parametric analysis of banking and insurance sectors of pakistan asyed alamdar ali shah, bprof.dr. omar masood ainternational centre for education in islamic finance(inceif), malaysia; bchair quaid-e-azam school of management sciences, pakistan abstract—in an attempt to enrich the literature of the efficiency of financial services sector with holistic perspective, this study aims to empirically investigate the input efficiency of banking and insurance sectors with further probe into islamic segments of these sectors in pakistan. this study measures the technical, allocative, cost, and scale efficiencies of banking and insurance firms in our sample using the non-parametric frontier method, data envelopment analysis (dea). the findings show that, on average, the allocative efficiency of the overall islamic financial services sector has increased during the period of study and has also remained well above their conventional counterparts. the study also revealed that, insurance sector is more technically efficient than banking sector. finally, the study also found that overall efficiency of financial sector can also be improved by exchanging experts between two sectors. the results of this research study provide empirical findings as to how two segments of financial services sectors had fared in the competitive environment from 2007 to 2015. key words: input efficiencies, banking, insurance, dea, financial sector jel classification: g21; g22; g32; l25 i. introduction since global crisis 2008, introduction of new basel based capital rules and increased islamisation has made financial services sector face continuous challenges all over the world [18]. regulatory authorities have introduced new regulations to improve their performance and resilience to guard against capital impairment. among many measures taken to improve the resilience of financial services providing institutions the ability of the respective financial services providing institutions to utilize their input resources has always been a question. there are two types of financial services sectors that are functioning around the globe at present namely islamic and conventional. with the rise of islamic nature of financial services the competition for conventional segment for market share has increased manifold which is leading both these financial services sectors to compete for better input and output efficiencies. the studies have shown that long term share and value addition is highly dependent upon various efficiencies [4]. conventional financial services sector has long roots and therefore enjoys expertise to run their systems; however their islamic counterparts are underprivileged somewhat in this regard. besides this handicap many studies have shown that islamic financial institutions have achieved better efficiencies in many segments [15,20]. studies undertaken so far have been independently for various segments of financial services sectors, for instance, for banking sector alone and for insurance sector alone. therefore it is quite necessary to fill in the gap of analyzing the performance of financial sector as a whole. following the same trend there is also a need to analyze the efficiency of financial services firms functioning in pakistan because like other parts of the world efficiency analysis using dea technique has been conducted in pakistan accounting for only banking and insurance sectors individually, not taking them collectively as a single financial services sector. this is the gap that present study addresses by taking data of pakistani banking and insurance companies from 2007-2015 with panel based comparative analysis further decomposing the financial services sectors further into conventional and islamic. taking an account of financial services with holistic perspective is important because international investors, global financial institutions and policy makers all make efficiency based decisions. the primary objective of our study is therefore to examine the input efficiency of banking and insurance sector by evaluating technical, allocative, scale and cost efficiencies using data envelopment analysis (dea) by taking data from the period 2007-2015 and also to find any difference of efficiency in islamic and conventional segments of these sectors. the remainder of the paper consists of following sections; section 2 consists of literature review; section 3 consists of methodology; section 4 consists of results and discussion and section 5 is the conclusion. http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ii. literature review a. literature review for insurance sector efficiency performing research on insurance the studies from the west including usa concentrate on conventional segment [12]. studies in europe about insurance efficiency include austrian insurance sector and elaborating impact of organizational structure on the efficiencies of firms [8]. almost all of the studies conclude that product innovation and technology improvement has improved the performance of insurance firms in their respective research samples. due to the emergence and growth of islamic takaful over the last one decade we found the studies in this area very few. studies conducted in this area e.g., [11,13,33] conclude that cost efficiency of takaful firm is similar with their conventional counterparts. from asian countries researchers from east asian region lead literature on islamic segment of finance, consequently researchers like [11] in their study on takaful and conventional insurance firms opine that takaful firms are operating at lower efficiency than conventional insurance firms. he suggested that takaful firms need to reduce their administration expenses and asset gains. saad doing the similar analysis in malaysia suggested that takaful firms need to increase their size to reap benefits of economies of scale[21]. in pakistan researchers opine that pakistani insurance firms irrespective of islamic or conventional have better technical efficiency and need to improve their input pricing strategies to improve their allocative and therefore cost efficiencies[3]. furthermore khan & noreen conducting dea analysis on the comparison of efficiency of pakistani insurance and takaful firms found that insurance firms achieve more technical efficiency as compared with takaful firms[15]. furthermore, takaful firms achieve more allocative and cost efficiency as compared with their conventional counterparts. they also opine that takaful firms are also attaining higher efficiency when it comes to scale efficiency. b. review of literature for banking sector efficiency conducting comparative analysis of islamic and conventional banks also using ratio analysis [19] indicated that conventional banks perform better when it comes to analyzing efficiency and liquidity however, the islamic banks perform better when to comes to analyzing solvency. following the methodology of ratio analysis augmented by t-test found that during the period 2000-2009 islamic banks were more liquid and lower on risk than their conventional counterparts. however, they opined that the performance of both banking system was the same[16]. cengiz doing the comparative analysis of turkish banking sector using logistic regression and camels approach found that islamic banks in turkey perform better in terms of profitability and asset management however their market risk management performance is inferior[7]. in another study while analyzing the efficiency comparison of turkish banks using dea and other measures between the period 1990 and 2000 found that islamic banks achieve better revenue and cost efficiency as compared with their conventional counterparts [14]. sufian & noor in their work on islamic banks of asian and mena region using dea analysis found that islamic banks of mena region have higher level of technical efficiency as compared with asian islamic banks[27]. he also found that technical efficiency greatly contributes to profitability of islamic banks. lower level of allocative efficiency suggests the islamic banks need to work on their management skills and input price mechanism. usman using dea analysis on the data of conventional banks of pakistan from 2001 to 2008 found that foreign banks are more technically efficient as compared with their domestic counterparts. they also found that state owned and domestic owned banks are least efficient[29]. akhtar used data from 2001-2006 used dea analysis to calculate the efficiency of pakistani banks. his findings also suggest that the efficiency of foreign banks operating in pakistan is better than the efficiency of domestic banks whether they are public or privately owned. he also found in his study that foreign banks have been taken advantage in the utilization of domestic benefits and opportunities. he also suggested improving the internal performance and managerial skills[2]. nazir and alam in their study on 28 commercial banks from 2003-2007 to check the impact of privatization over operating income using dae technique found that privatization was not helpful for the banks to improve their operating income[17]. the reason for these contradictory findings they suggested included law & order situation, bad debts and increased competition. overall the study favored state owned commercial banks as distinct from all previous studies. still in another study a researcher using dea analysis to calculate the scale efficiency of five full fledged pakistani islamic banks found only dawood islamic bank efficient in terms of scale efficiency, while the most efficient year turned out to be 2007[6]. shah with his co-researchers in his study on banking sector using data on conventional and islamic banks found that islamic banks are performing better in terms of technical and scale efficiency however, conventional banks performed better in terms of allocative efficiency[23]. saeed also in their study on the comparison of islamic and conventional banking took data for the period 2007 to 2011 using dea analysis concluded that conventional banks are performing better than islamic banks which differs from previous studies on the ground that in earlier studies islamic http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 banks performed better in terms of allocative efficiency[22]. various researchers from pakistan in their study using data and on pakistani islamic and conventional banks for the period 2003-2008 and employing dea analysis also found that islamic banks are more cost efficient and less revenue efficient than their conventional counterparts[10,20]. taking an account of the studies as narrated hereinabove we find that so far studies undertake efficiencies of banking and insurance sectors independently. also we find that in the period before 2010 conventional banks had more technical and allocative efficiency, however after the in the studies undertaken after 2010 islamic banks are found to have more allocative efficiency. furthermore, from various economic reports undertaken to gauge performance of financial sector we understand that both the sectors contribute to development of financial sector collectively. therefore there is a dire need to take a collective efficiency analysis of banking and insurance sector. to accomplish our purpose we form following primary research question:  which sector out of banking and insurance is better employing inputs the in the financial sector? this main research question will be answered with the help of following sub questions:  which sector out of banking and insurance has better technical efficiency?  which sector out of banking and insurance has better allocative efficiency?  which sector out of banking and insurance has better scale efficiency?  the islamisation of which sector has input efficiency in financial sector? iii. methodology: a. what is data envelopment analysis contemporary dea measures are based on linear programming and relevant efficiency measures are bench marked according to best available practices of the industry[5,25]. various efficiency terms are used in dea analysis. firstly, by the term technical efficiency we mean the ability of a firm to convert physical input into output according to best available practices. accordingly a 100% technically efficient firm is the one that operates 100% at the level of industry practices [5,31]. technical efficiency is affected by expertise, efficiency and systems available to run an organization more than prices of inputs that do not have direct affect on technical efficiency. allocative efficiency is another measurement concept used in dea analysis. the use of this concept stems from the fact that an organization that is 100% technically efficient may not be using best available prices for the acquisition of inputs for its production process [5,28]. a third efficiency measure deployed in dea analysis is cost efficiency which is based on both technical and allocative efficiency. a firm can achieve cost efficiency only if it can achieve technical and allocative efficiency. it is measured by taking the product of technical and allocative efficiency [5,30]. the concepts have been explained in the figure 1 hereunder. figure 1. isoquant curve representing efficiencies the figure 1 above shows a curve which represents various combinations of inputs required to produce a unit of output. this curve is known as isoquant curve or efficiency frontier and represents expertise, efficiency and systems available to the enterprise for production. a firm can move along this curve for utilizing various combinations of input to produce given unit(s) of output. a firm is considered technically efficient only if it produces along this curve. in the figure 1 budget line is also drawn as a straight line drawn tangent to the isuquant curve. this shows combinations of inputs that have the same level of cost. the slope of the budget line is negative which shows the firm will have to reduce one input labor in our diagram to increase the quantity of other input capital in our case. closer to the origin “o” budget line shows lower overall cost and vice versa. the point of tangency “e” shows the combination which entails all three efficiencies i.e., technical, allocative and cost. the line oa in the diagram represents a technically inefficient point “a” because more inputs are required at this point to produce a unit of output as compared with point “b” which lies on the efficient isoquant. the point “b” is technically efficient but not cost efficient because it lies above the budget line which is tangent to the isoquant curve at point “e”. the point “e” therefore is a point of production that entails all technical, allocative and cost efficiency. http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 if an organization moves from point “a” and starts producing at point “e” it will increase its cost efficiency by (oaoc/oa). this improvement consists of improved technical efficiency by (oa-ob/oa) and improvement in allocative efficiency by (ob-oc/ob). apart from technical allocative and cost efficiencies many studies also analyze technical efficiency by taking another measure namely “scale efficiency (se)” [16]. this is ascertained by dividing technical efficiency on “constant return to scale (crs)” on “variable return to scale (vrs)” basis. if there arises difference in the technical efficiency at both the above two scales it proves that there exists scale inefficiency. se exists when a production unit maximizes its output at a given return to scale and operating at constant return to scale it increases or decreases its output. the result will be either increased scale efficiency or decreased. an explanation of “scale efficiency” has been given using figure 2 hereunder: figure 2. constant and variable returns to scale figure 2 has been drawn with the help of one input variable “b” on horizontal axis and one output variable “a” on the vertical axis. productivity under constant return to scale (crs) is shown as a straight line emanating from point “o” touching the top of the box rising gradually, while productivity under variable return to scale (vrs) is a curve that takes various slopes touches crs curve and moves further. under constant return to scale assumption the technical efficiency is between the point “e” and pc and under variable return to scale the technical efficiency is between the points “e” and “pv”. the distance between the two points which are also labeled as “c” and “d” in the figure 3, is due to “scale efficiency”. on the surface of figure 3 it is calculated as (gc/gd). b. operationalizing the concepts historically, the economists have used several ways to estimate the curve in figure 1 the most common of which consists of “least square” which is not practiced now and “best practices estimation” using dea and stochastic frontier estimation. for the purpose of our analysis we have focused on dea analysis which is too based upon linear programming [5]. c. using deap for calculating efficiencies . the mathematical model applied in the program is hereunder: (1) the u’s and v’s used in the problem along with the production variables x’s and y’s are constrained variables of the problem and are assumed to be greater than or equal to some small positive quantity for the purpose of ensuring the inclusion of all inputs and/or outputs for calculating all relevant efficiencies. the result h of the model is efficient if it equals “1” for an organization. but if the results are less than “1” it means some other organizations are more efficient. this mathematical expression is solved by converting it into a linear programming problem as under: (2) subject to the above formulation was first developed by ccr model and named as such in dea computer program. we can also construct a dual model by incorporating a dual variable in the above model. this has been shown hereunder: (3) subject to http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 the λ’s introduced as shadow prices in the model as dual variables limit the efficiency of each organization in sample of study to “1”. it also implies that the corresponding organization also has an efficiency of “1” which will also contain positive price and dual variable. accordingly, positive shadow price in the primary or positive value λ’s in dual represents and points the peer group of inefficient organization in the study sample. so far we have constructed this model on the basis of constant return to scale however, a similar model on the basis of variable returns to scale can also be constructed as known as bcc model. d. data and variables for the study asghar & afza discussing efficiency of insurance and takaful sector in pakistan indicated three approaches to identify output variables in financial sector, these consist of 1) the intermediation approach, 2) the user cost approach and 3) the value added approach[3]. following the same various studies have been conducted taking different variables into account to measure the efficiencies of insurance sector both in conventional and islamic financial services sector encompassing various variables based on different approaches for instance[8]. these studies indicate that for insurance industry capacity to bear risk and intermediation should form the basis of selecting outputs, following the same most of contemporary studies use “gross premium” in insurance sector as their first measure of output and investment income as second, that is used in our study as well. discussing variables selection in banking industry it was found that for analysis of banking industry generally two approaches are used to identify input and output variables namely the production approach and the mediation approach[1]. production approach involves inclusion of labor and capital resources as input resources whereas under intermediation approach deposits and loanable funds are used as inputs. the intermediation approach focused using three inputs; (1) total deposits and short term funding, (2) total expenses, and (3) total staff costs and two output variables (1) total (non) interest-bearing loans and (2) total revenues[1]. sufian following the same approach included total deposits and loan loss provision as two inputs; and total loans and investments as two variables as output[26]. apart from the two approaches a few researchers used a variation of intermediation approach also called asset approach. this approach is adopted for choice of variables in selection of variables for analysis of banks be it conventional or islamic[9,24]. following the asset approach this research has used two output variables, three input variables and the relevant prices of input variables. input variables consist of admin costs, deposit accounts and capital employed for all banking institutions; and admin costs, commission on premium, and capital employed for all insurance institutions. the output variables for this study include net interest income margin, and total loans & advances for conventional banking institutions; net spread earned and total financing for islamic banking institutions; and finally gross premium and net investment income for both islamic and conventional insurance institutions. the prices of input variables consist of average per employee admin costs for admin costs, average deposit rate for deposit accounts and weighted cost of capital (wacc) for capital employed for all banking institutions; and average per employee admin costs for admin costs, average per employee commission, and wacc for all insurance institutions. the prices have also been normalized as by dividing all the prices by the prices of physical inputs for instance p1* = p1/p3 and p2*=p2/p3 [31,32]. the data for this research has been obtained for the period 2007 to 2015 belonging to 20 islamic and conventional insurance and banking organizations each which represent about 80% market share in terms of deposit and 72% market share in terms of loans and advances in case of banking and 80% in terms of “gross premium” in terms of insurance firms. iv. results and discussion a. data analysis of insurance sector table i. efficiency of insurance firms year te se ae ce 2007 0.82 0.71 0.43 0.36 2008 0.87 0.74 0.47 0.41 2009 0.88 0.51 0.39 0.34 2010 0.94 0.83 0.45 0.42 2011 0.87 0.87 0.56 0.49 2012 0.92 0.86 0.55 0.51 2013 0.91 0.84 0.63 0.57 2014 0.92 0.86 0.64 0.59 2015 0.94 0.87 0.65 0.61 mean 0.887 0.766 0.498 0.443 sd 0.039881 0.128101 0.084424 0.08362 http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 table ii. efficiency takaful firms year te se ae ce 2007 0.88 0.42 0.72 0.63 2008 0.91 0.40 0.71 0.65 2009 0.89 0.44 0.69 0.61 2010 0.93 0.41 0.75 0.70 2011 0.92 0.45 0.70 0.64 2012 0.88 0.38 0.75 0.66 2013 0.95 0.45 0.71 0.67 2014 0.96 0.47 0.72 0.69 2015 0.96 0.48 0.72 0.69 mean 0.909 0.421 0.719 0.653 sd 0.026726 0.026726 0.023401 0.027415 table iii. efficiency insurance sector year te se ae ce 2007 0.85 0.58 0.56 0.47 2008 0.89 0.59 0.58 0.51 2009 0.88 0.48 0.52 0.46 2010 0.94 0.65 0.58 0.54 2011 0.89 0.69 0.62 0.55 2012 0.90 0.65 0.64 0.58 2013 0.93 0.67 0.67 0.62 2014 0.94 0.68 0.67 0.63 2015 0.94 0.68 0.68 0.64 mean 0.897 0.615 0.595 0.534 sd 0.02972 0.070887 0.049443 0.055702 the results in tables 1 to 3 above reveal that both takaful and insurance sector remain technically inefficient during the period 2007 to 2015 as the value of overall technically efficiency index is 0.897 which is below 1. however, the conventional insurance sector is lesser technically efficiency than takaful sector because the value of technical efficiency index of insurance sector is 0.887 as given in the first column of table 1 which is lower than the technical efficiency index of takaful sector which is 0.909. it can also be witnessed that the standard deviation of technical efficiency index of takaful sector is 0.0267 which is far lower than the standard deviation of conventional insurance sector which is 0.0399 showing takaful sector is more consistent in terms of efficiency. the results also show that takaful sector on the average requires approx 10% reduction in the input level to achieve better technical efficiency as compared with their conventional counterparts which require approx 12% reduction in input level to achieve the same levels of output respectively. tables above also reveal the scale efficiency of takaful and conventional sectors. this scale efficiency shows the level of optimal efficiency at which the insurance sector is operating. its value of 1 indicates constant return to scale which means the sector or firm under analysis is operating at optimum level; the level below the value of one indicates increasing returns to scale and level above 1 indicates decreasing return to scale which are both the level of operations deviated from optimality. the overall value of insurance sector presented in the table 3 above is approx 62% which indicates a significant expansion in insurance sector. following the value in tables 1 & 2 reveals that expansion in takaful sector is higher than expansion in conventional insurance sector because the value of takaful sector is approx 42% which is lower than the value of conventional insurance sector which is approx 76%. also it means that the sectors with lower value need to expand their scale to enjoy economies of scale. furthermore the tables one to three above also reveal allocative efficiency measures. table 3 reveals the value as approx 60% which shows the insurance sector had 40% allocative inefficiency. however, this inefficiency is more contributed by conventional insurance sector which is approx 50% inefficient as compared with takaful sector which is approximately 28% inefficient. cost efficiency of the firm is also affected by allocative efficiency. the overall cost efficiency of the insurance sector during the period under analysis is approx., 53% as depicted in table 2. an analysis of contributing tables 1 and 2 reveals that takaful sector is more efficient during this period as compared with conventional insurance sector as the average cost efficiency of takaful sector is recorded at 65% as compared with 44% of conventional insurance sector over the same period. this shows that takaful firms need to reduce their expenditures by about 35 percent as compared with 55% of conventional insurance sector to produce the same level of output. taking the overall perspective the insurance sector need to reduce expenditures by about 44% to produce same output level. http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 b. data analysis of banking sector table iv. efficiency of conventional banks year te se ae ce 2007 0.67 0.77 0.52 0.35 2008 0.64 0.79 0.51 0.33 2009 0.66 0.81 0.54 0.36 2010 0.69 0.82 0.53 0.37 2011 0.71 0.80 0.57 0.40 2012 0.72 0.83 0.59 0.42 2013 0.72 0.84 0.58 0.42 2014 0.73 0.85 0.59 0.43 2015 0.74 0.86 0.61 0.45 mean 0.698 0.819 0.560 0.378 sd 0.034561 0.029345 0.035707 0.037919 table v. efficiency islamic banks year te se ae ce 2007 0.59 0.70 0.73 0.43 2008 0.63 0.70 0.75 0.47 2009 0.64 0.72 0.77 0.49 2010 0.67 0.74 0.76 0.51 2011 0.69 0.73 0.79 0.55 2012 0.70 0.75 0.80 0.56 2013 0.72 0.74 0.79 0.57 2014 0.73 0.75 0.81 0.59 2015 0.73 0.76 0.82 0.60 mean 0.678 0.732 0.780 0.511 sd 0.049188 0.021667 0.02958 0.050281 table vi. efficiency banking sector year te se ae ce 2007 0.63 0.74 0.61 0.39 2008 0.64 0.75 0.62 0.39 2009 0.65 0.77 0.64 0.42 2010 0.68 0.78 0.63 0.43 2011 0.70 0.77 0.67 0.47 2012 0.71 0.79 0.68 0.49 2013 0.72 0.80 0.67 0.48 2014 0.73 0.81 0.69 0.50 2015 0.74 0.82 0.70 0.52 mean 0.677 0.772 0.646 0.438 sd 0.035981 0.02166 0.02815 0.041473 the results in tables 4 to 6 above reveal that both conventional and islamic banking sector remain technically inefficient during the period 2007 to 2013 as the value of overall technically efficiency index is 0.677. however, the conventional banking sector is more technically efficiency than islamic banking sector because the value of technical efficiency index of conventional banking sector is 0.687 as given in the first column of table 4 which is higher than the technical efficiency index of islamic banking which is 0.663. it can also be witnessed that the standard deviation of technical efficiency index of islamic banking sector is 0.045 which is far higher than the standard deviation of conventional banking sector which is 0.0314 showing that conventional banking sector is more consistent. the results also show that both islamic and conventional banking sectors on the average require approx 33% reduction in the input level to achieve better technical efficiency. tables above also reveal the scale efficiency of islamic and conventional banking. this scale shows the level of optimal efficiency at which the banking sector is operating. the overall value of banking sector presented in the table 6 above is approx 68% which indicates a significant expansion in banking sector. following the value in tables 4 & 5 reveals that expansion in conventional banking sector is higher than expansion in islamic banking sector because the value of islamic banking sector is approx 73% which is lower than the value of conventional insurance sector which is approx 81%. also it means that the sectors with lower value need to expand their scale to enjoy economies of scale. furthermore, tables 4 to 6 above also reveal allocative efficiency measures. table 6 reveals the value as approx 65% which shows the banking sector has 35% allocative inefficiency. however, this inefficiency is more contributed by conventional banking sector which is approx 45% inefficient as compared with islamic banking sector which is approximately 23% inefficient. the overall cost efficiency of the banking sector during the period under analysis is approx., 44% as depicted in table 6. an analysis of contributing tables 4 and 5 reveal that islamic banks are more cost efficient as compared with conventional banks sector as the average cost efficiency of islamic banks has been observed at 51% as compared with 38% of conventional banking sector over the same period. this shows that islamic banks need to reduce their expenditures by about 49% as compared with 62% of conventional banks to produce the same level of output. taking the overall perspective, banking sector needs to reduce expenditures by about 56% to produce same output level with major contribution from conventional banking. http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 c. data analysis for financial sector comprising banking & insurance table vii. efficiency of conv financial services sector year te se ae ce 2007 0.73 0.75 0.49 0.35 2008 0.73 0.77 0.49 0.36 2009 0.75 0.69 0.48 0.36 2010 0.79 0.82 0.50 0.39 2011 0.77 0.83 0.57 0.44 2012 0.80 0.84 0.57 0.46 2013 0.79 0.84 0.60 0.48 2014 0.80 0.85 0.61 0.49 2015 0.82 0.86 0.63 0.51 mean 0.764 0.792 0.529 0.405 sd 0.030 0.056 0.049 0.051 table viii. efficiency of islamic financial services sector year te se ae ce 2007 0.70 0.59 0.73 0.51 2008 0.74 0.58 0.73 0.54 2009 0.74 0.61 0.74 0.54 2010 0.77 0.61 0.76 0.58 2011 0.78 0.62 0.76 0.59 2012 0.77 0.61 0.78 0.60 2013 0.81 0.63 0.76 0.61 2014 0.82 0.64 0.78 0.63 2015 0.82 0.65 0.78 0.64 mean 0.7578 0.6081 0.7501 0.5689 sd 0.0349 0.0156 0.0183 0.0374 table ix. efficiency of financial services sector year te se ae ce 2007 0.72 0.68 0.59 0.42 2008 0.73 0.69 0.60 0.44 2009 0.74 0.66 0.59 0.44 2010 0.78 0.73 0.61 0.48 2011 0.77 0.74 0.65 0.50 2012 0.79 0.74 0.66 0.52 2013 0.80 0.75 0.67 0.54 2014 0.81 0.76 0.68 0.55 2015 0.81 0.76 0.69 0.56 mean 0.762 0.711 0.626 0.477 sd 0.031 0.035 0.034 0.044 the results in tables 6 to 9 above reveal that financial services sector consisting of firms from conventional and islamic banking and insurance sector remain technically inefficient during the period 2007 to 2015 as the value of their combined technically efficiency index is 0.762 . the level of productivity in both the sectors is also similar as the values of technical efficiencies are 0.764 and 0.757 respectively. however, it can also be witnessed that the standard deviation of technical efficiency index of islamic financial services sector is 0.0349 which is far higher than the standard deviation of conventional financial sector which is 0.030 showing that conventional financial services sector is more consistent. the results also show that both islamic and conventional financial services sectors on the average require approx 24% reduction in the input level to achieve better technical efficiency. tables above also reveal the scale efficiency of financial services sector. this scale shows the level of optimal efficiency at which financial services sector is operating. the overall value of banking sector presented in the table 9 above is approx 71% which indicates a significant expansion in financial services sector. following the value in tables 7 & 8 reveals that expansion in conventional financial services sector is higher than expansion in islamic financial services sector because the value of islamic financial services sector is approx 61% which is lower than the value of conventional financial services sector which is approx 81%. also it means that the sectors with lower value need to expand their scale to enjoy economies of scale. furthermore the tables 7 to 9 above also reveal allocative efficiency measures. table 9 reveals the value as approx 63% which shows that the financial services sector has 37% allocative inefficiency. however, this inefficiency is more contributed by conventional financial sector which is approx 47% inefficient as compared with islamic financial services sector which is approximately 25% inefficient. cost efficiency of any organization or sector is also affected by allocative efficiency. overall cost efficiency of the financial services sector during the period under analysis is approx., 48% as depicted in table 9. an analysis of contributing tables 7 and 8 reveal that islamic financial services sector is more cost efficient as compared with conventional financial services sector as the average cost efficiency of islamic banks has been observed at 57% as compared with 40% of conventional financial services sector over the same period. this shows that islamic financial sector need to reduce their expenditures by about 43% as compared with 60% of conventional financial sector to produce the same level of output. taking the overall perspective the financial sector need to reduce expenditures by about 52% to produce same output level. http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 v. conclusion the findings of our study suggest that insurance sector is far much superior when it comes to input productivity as the results of technical efficiency for them are higher than that of banking sector. this phenomenon exists in both islamic and conventional financial services sectors. however, the results are other way round when it comes to input price efficiency i.e., the allocative efficiency as the allocative efficiency of banking sector is better as compared with insurance sector. the cost efficiency of insurance sector again is better than that of banking sector. the results obtained from this study sufficiently support results from previous studies that were undertaken independently for measuring input efficiency of islamic and conventional financial insurance and banking organizations that islamic segment financial services organizations perform better in terms of allocative efficiency, for instance [15,20]. furthermore, in terms of scale efficiency although both the sectors individually and as a whole as well are operating at increasing returns to scale yet the results of banking sector are superior than that of banking sector. in terms of overall results both the sectors are conventional financial services is heavily underperforming in terms of their allocative efficiency. a. limitations this study has several limitations that require more research. for instance, we have calculated only input efficiencies of financial services sector whereas in order to complete the picture for overall efficiency we need to calculate output efficiencies as well. furthermore, choice of inputs for the study is another limitation because changing various inputs can make us calculate which inputs actually affect efficiency more than the others. the size of the sample for our research is another limitation as we can get more generalized results if we gather data across countries and longer period of time. b. policy implications our study has more macroeconomic implications because as the regulators in almost all of the islamic countries are pursuing islamic finance. our studies suggest that pursuing islamic finance should not be at the cost of penalizing the customers of conventional financial services because higher allocative efficiency means higher input costs and lower profitability which might ultimately affect the ability of the conventional financial services firms in terms of return to their shareholders. also this study has shown very healthy results for takaful firms as 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[33]. yusop, z., radam, a., and ismail, n., risk management efficiency of conventional life insurers and takaful operators. insurance markets and companies: analyses and actuarial computations, 2011. 2(4): p.58-68. http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, portsmouth university, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france editorial_board.pdf editor in chief editorial board microsoft word 1111-4694-2-ed.doc http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 conversion into islamic banks: jurisprudence, economic and aaoifi requirements * alexandria university (egypt) & doha institute for graduate studies (qatar) ** plymouth university (uk) abstract the objective of this study is to investigate the conventional banks conversion into islamic banks. it provides a significant opportunity to develop the understanding of the sharia requirement to conversion process and what the conventional banks have to do in order to be converted into islamic banks. in addition, it discusses the jurisprudential and financial motivations behind traditional banks converted into islamic banking. moreover, it discusses the accounting and auditing organization for islamic financial institutions (aaoifi) conversion standard. the study suggests that the conventional banks must commit with all conditions to successfully complete the conversion process and to be fully committed with sharia law. keywords: aaoifi, islamic banks, conversion, jurisprudence i. introduction islamic finance is not just increasingly attractive to the 1.6 billion muslims across the world but, there is a global explosion of activity in islamic finance ] 19[ . he argued that islamic finance and islamic financial institutions growing fast and will be the major global force. this enormous growth has attracted conventional banks to capture the huge market by creating a new islamic window or converted themselves into fully-fledged islamic banks or even just offering islamic products ]2[ . the accounting and auditing organization for islamic financial institutions (aaoifi) issued standard number (6) which represents the conversion issue and identifies its requirements and how the banks deal with it. this study tries to shed the light on the sharia requirement to the conversion process and what the conventional banks have to do to be converted into islamic banks. in addition, this study highlights the jurisprudential and financial motivations for traditional banks to be converted into islamic banks. moreover, the study also discusses the aaoifi conversion standard. the paper is organized as follows. section i is the introduction and section ii discusses the conversion process. section iii highlights the motivations of conventional banks to be converted into islamic banks. section iv discusses conversion forms. section v discusses aaoifi conversion standard. section vi is the conclusion. ii. conversion process islamic banking assets with commercial banks globally are set to exceed us$1.7t in 2013, suggesting an annual growth of 17.6% ]19[ . this huge growth of islamic banks is attracting large financial institutions such as hsbc, citibank, deutshe bank to keep up with this growth by providing islamic financial services, opening an islamic branch of the bank (or window within the banks), or even fully converted to islamic banking .]26[ the conversion process is different from bank to bank according to the motives of the transformation process ]4 [ . it is necessary here to clarify exactly what is meant by the conversion process? according to ]7[ ; it refers to the process of changing or causing something to change from one form to another (almost from a corrupted status, to the right way). this definition commonly includes that a conventional bank converts to work according to sharia law; thereby the entire bank’s activity is run according to islamic principles. iii. motivations for conversion into islamic banking: prior literature discusses the drivers of conversion into islamic banks. it identifies jurisprudential and financial reasons for the conversion process ]3[ ; ]4[ ; ]23[ ]5[ ; ]11[ ; ]21[ . the following paragraphs discuss these reasons in details. a. the jurisprudential reasons: the jurisprudential reasons refer to religious scruples that motivate a conventional bank to change its activity and work according to sharia law, especially dealing in “riba” (interest) that is prohibited in islam ]7[ . according to ]3[ the primary motivation of about 62% of converted banks is the adherence to sharia which includes that muslims should obey all allah’s orders such as the “riba” (interest) prohibitions and to intend to repent to allah. to fully understand the jurisprudential reasons, next section explains the following issues related three concepts: the inclusiveness in islam; the usury prohibition and the repentance to allah. 1inclusiveness in islam: the concept of inclusiveness in islam means that islam is for all times and places regardless of who a person may be or where he may be. islam should be his religion and his way of life. muslims must obey allah’s orders (islamic law or sharia law) which regulate all aspects of a muslim's life. islamic finance is based on sharia law. sharia depends upon the holly fatma ahmed* khaled hussainey** ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 book of allah (the quran) and the traditions (sunnah) of his prophet mohamed (peace be upon him). also, islamic jurisprudence (fiqh) is a source of sharia. it is developed by different schools of islamic thought over centuries which all agreed about the fundamental sharia principals (ejmaa) and sometimes hold different views on applications (ejtihad). there is not a problem in this life which has no solution in quran or sunnah. allah said in quran: ْلنَا َعلَْيَك اْلِكتَاَب تِْبيَانًا لُِكلِّ َشْيٍء َوھًُدى َوَرْحَمةً َوبُْشَرى لِْلُمْسلِِميَن سورة (َونَزَّ )89اآلية : النحل and we have sent down to you the book as clarification for all things and as guidance and mercy and good tidings for the muslims (quran 16:89). the faith in islam obliges believing in allah and his prophet and obeying all his orders. in the quran allah warns the human being against disobedience to his orders and from following our desires: ُ َوَرُسولُهُ أَْمًرا أَْن يَُكوَن لَھُُم اْلِخيََرةُ ِمنْ َوَما َكاَن لُِمْؤِمٍن َواَل ُمْؤِمنٍَة إَِذا قََضى هللاَّ َ َوَرُسولَ )36اآلية : سورة األحزاب (هُ فَقَْد َضلَّ َضاَلاًل ُمبِينًاأَْمِرِھْم َوَمْن يَْعِص هللاَّ it is not fitting for a believing man or a believing woman to have an option in their affairs when a matter has been decided by allah and his messenger and whoever disobeys allah and his messenger has indeed strayed into a clearly wrong path (quran 33:36). ِ َوَرُسولِِه لِيَْحُكَم بَْينَھُْم أَن يَقُولُوا َسِمْعنَا إِنََّما َكاَن قَْوَل اْلُمْؤِمنِيَن إَِذا ُدُعوا إِلَى هللاَّ ئَِك ھُُم اْلُمْفلُِحوَن )51اآلية : سورة النور (َوأَطَْعنَا ۚ َوأُولَٰ the only statement of the [true] believers when they are called to allah and his messenger to judge between them is that they say, "we hear and we obey." and those are the successful (quran 24:51). so muslims must return to quran and sunnah (guided by the righteous scholars) in all aspects of life and leave their lower desires. لَِك أَنَزْلنَاهُ ُحْكًما َعَربِيًّا ۚ َولَئِِن اتَّبَْعَت أَْھَواَءھُم بَْعَدَما َجاَءَك ِمَن اْلِعْلِم َما لََك َوَكَذٰ ِ ِمن َولِيٍّ َواَل َواٍق )37اآلية : سورة الرعد (ِمَن هللاَّ and thus we have revealed it as an arabic legislation. and if you should follow their inclinations after what has come to you of knowledge, you would not have against allah any ally or any protector (quran 13:37). يَا َداُووُد إِنَّا َجَعْلنَاَك َخلِيفَةً فِي اأْلَْرِض فَاْحُكم بَْيَن النَّاِس بِاْلَحقِّ َواَل تَتَّبِِع اْلھََوىٰ ِ لَھُْم َعَذاٌب َشِديٌد بَِما نَُسوا يَْوَم ِ ۚ إِنَّ الَِّذيَن يَِضلُّوَن َعن َسبِيِل هللاَّ فَيُِضلََّك َعن َسبِيِل هللاَّ )26اآلية : سورة ص(اْلِحَساِب [we said], "o david, indeed we have made you a successor upon the earth, so judge between the people in truth and do not follow [your own] desire, as it will lead you astray from the way of allah ." indeed, those who go astray from the way of allah will have a severe punishment for having forgotten the day of account (quran 38:26). ٰى َشِريَعٍة مَِّن اأْلَْمِر فَاتَّبِْعھَا َواَل تَتَّبِْع أَْھَواَء الَِّذيَن اَل يَْعلَُموَن ثُمَّ َجَعْلنَاَك َعلَ )18اآلية : سورة الجاثية ( then we put you, [o muhammad], on an ordained way concerning the matter [of religion]; so follow it and do not follow the inclinations of those who do not know (quran 45:18). islam is a holistic system for women, men and societies which organizes all aspects of human life politically, socially and economically. in some cases the sharia experts (ulama) disagree in some issues, ibn taymeya reported that the people must not forbid anything not forbidden in the quran or sunnah or legitimated anything except what allah legitimized without evidence from quran or sunnah. as it is also obvious from quran: ُسوَل َوأُولِي اأْلَْمِر ِمنُكْم ۖ فَإِن تَنَاَزْعتُْم فِي َ َوأَِطيُعوا الرَّ يَا أَيُّھَا الَِّذيَن آَمنُوا أَِطيُعوا هللاَّ لَِك َخْيٌر َوأَْحَسُن ِ َواْليَْوِم اآْلِخِر ۚ َذٰ َّ ُسوِل إِن ُكنتُْم تُْؤِمنُوَن بِا ِ َوالرَّ َشْيٍء فَُردُّوهُ إِلَى هللاَّ .)59اآلية : سورة النساء (ِوياًل تَأْ o you who have believed, obey allah and obey the messenger and those in authority among you. and if you disagree over anything, refer it to allah and the messenger, if you should believe in allah and the last day. that is the best [way] and best in result (quran 4:59). ُ ۚ َواَل تَُكن لِّْلَخائِنِيَن إِنَّا أَنَزْلنَا إِلَْيَك اْلِكتَاَب بِاْلَحقِّ لِتَْحُكَم بَْيَن النَّاِس بَِما أََراَك هللاَّ .)105اآلية : سورة النساء (َخِصيًما indeed, we have revealed to you, [o muhammad], the book in truth so you may judge between the people by that which allah has shown you. and do not be for the deceitful an advocate (quran 4:105). 2usury prohibition : usury or riba is an arabic word which means growth and it is a synonym for the term “interest” used in conventional banking ]20[ . islam bans usury because of its absolute injustice. ibn taymeya argued that the root of dealing with riba arises from the need. poor people who need money are often blackmailed by the rich people. hence islamic sharia seeks to build transactions based upon fairness and justice. many verses of the holy quran expressly prohibit riba. the first verse reveals a strong punishment for those dealing in usury. in sura al-baqarah allah said: بَا اَل يَقُوُموَن إاِلَّ َكَما يَقُوُم الَِّذي يَتََخبَّطُهُ الشَّْيطَاُن ِمَن اْلَمسِّ ۚ الَِّذيَن يَأُْكلُوَن الرِّ بَا ۚ فََمن َجاَءهُ َمْوِعظَةٌ َم الرِّ ُ اْلبَْيَع َوَحرَّ بَا ۗ َوأََحلَّ هللاَّ لَِك بِأَنَّھُْم قَالُوا إِنََّما اْلبَْيُع ِمْثُل الرِّ َذٰ بِِّه فَانتَھَٰى فَ ئَِك أَْصَحاُب النَّاِر ۖ ھُْم فِيھَا مِّن رَّ ِ ۖ َوَمْن َعاَد فَأُولَٰ لَهُ َما َسلََف َوأَْمُرهُ إِلَى هللاَّ .)275اآلية : سورة البقرة (َخالُِدونَ those who consume interest cannot stand [on the day of resurrection] except as one stands who is being beaten by satan into insanity. that is because they say, "trade is [just] like interest." but allah has permitted trade and has forbidden interest. so whoever has received an admonition from his lord and desists may have what is past, and his affair rests with allah. but whoever returns to [dealing in interest or usury] those are the companions of the fire; they will abide eternally therein (quran 2:275). ُ اَل يُِحبُّ ُكلَّ َكفَّاٍر أَثِيٍم َدقَاِت ۗ َوهللاَّ بَا َويُْربِي الصَّ ُ الرِّ : سورة البقرة (يَْمَحُق هللاَّ .)276اآلية allah destroys interest and gives increase for charities. and allah does not like every sinning disbeliever (quran 2:276). ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 the second verse in surah al imran where prohibition of interest (usury) is clearly declared. َ لََعلَُّكْم تُْفلُِحوَن بَا أَْضَعافًا مَُّضاَعفَةً ۖ َواتَّقُوا هللاَّ يَا أَيُّھَا الَِّذيَن آَمنُوا اَل تَأُْكلُوا الرِّ )130اآلية : سورة آل عمران ( o you who have believed, do not consume usury, doubled and multiplied, but fear allah that you may be successful (quran 3:130). the consensus view of muslims about the prohibition of riba based transactions a severe sin ]12[ . in addition of the previous mentioned verses of quran. there are many verses in quran strongly condemn riba and many ahadith (written sayings of the prophet muhammed saw) in sunnah pertain to various aspects of riba, like its prohibition, the severity of its sin and its different forms. لعن رسول هللا صلى هللا عليه وسلم " : عن ابن مسعود رضي هللا عنه قال وشاھديه، وكاتبه : زاد الترمذي وغيره . ) ) رواه مسلم ( ( " آكل الربا وموكله abdullah bin mas`ud (may allah be pleased with him) reported: the messenger of allah (pbuh) cursed the one who accepts al-riba (the usury) and the one who pays it. [muslim]. the narration in at-tirmidhi adds and the one who records it, and the two persons who stand witness to it. riba is not restricted to only interest. riba also applies to nonmonetary exchanges and includes sale/exchange transactions, which has important implications even today ]28[ . the term riba is used in the sharia in two senses; the first is riba al-nasiah and the second is riba al-fadl. riba alnasi’ah refers to the time that is allowed to the borrower to repay the loan in return for the ‘addition’ or the ‘premium’. hence riba al-nasi’ah is equivalent to the interest charged on loans while riba al-fadl: refers to an excess in weight/measure ]14[ . ، َعْن َمالِِك ْبِن أَْوِس أَْخبََرنَا إِْسَحاُق ْبُن إِْبَرا ْھِريِّ ِھيَم، قَاَل َحدَّثَنَا ُسْفيَاُن، َعِن الزُّ ِ صلى هللا عليه وسلم ْبِن اْلَحَدثَاِن، أَنَّهُ َسِمَع ُعَمَر ْبَن اْلَخطَّاِب، يَقُوُل قَاَل َرُسوُل هللاَّ لتَّْمِر ِربًا إاِلَّ ھَاَء َوھَاَء َواْلبُرُّ بِاْلبُرِّ ِربًا الذَّھَُب بِاْلَوِرِق ِربًا إاِلَّ ھَاَء َوھَاَء َوالتَّْمُر بِا " . ) صحيح البخاري"( إاِلَّ ھَاَء َوھَاَء َوالشَِّعيُر بِالشَِّعيِر ِربًا إاِلَّ ھَاَء َو ھَاَء umar bin al-khattab said: "the messenger of allah said: '(exchanging) gold for silver is riba unless it is done on the spot. (exchanging) dates for dates is riba unless it is done on the spot. (exchanging) wheat for wheat is riba unless it is done on the spot. (exchanging) barley is riba unless it is done on the spot."' from the above references from the quran and sunnah we can derive a number of results: • riba al-nasiah relates to loans while riba alfadl relates to trade ]15[ . • when the commodities of exchange are similar, excess and delay are prohibited, e.g. gold for gold or wheat for wheat, dollars for dollars and so on. the prohibition of riba is intended to prevent the accumulation of wealth in few hands ]12[ . 3repentance to allah: repentance ‘tawbah’ is to repent from the sins we commit. making sincere repentance or tawbah raises a muslim’s status with allah because the process of making tawbah involves the following steps: devotion to allah without showing it to people, recognizing ones mistakes and sins, feeling ashamed of violating allah’s trust of complete submission to his commands, quit wrongdoing by making a promise never to repeat such behaviour including reinstatement of rights and that repentance be at a time of repentance ]13[ . a number of verses of the holy quran refer to tawbah for example: َ يَْغفُِر قُْل يَا ِعبَاِدَي الَِّذيَن أَْسَرفُ ِ إِنَّ هللاَّ ْحَمِة هللاَّ وا َعلَى أَنفُِسِھْم اَل تَْقنَطُوا ِمن رَّ ِحيمُ )53اآلية : سورة الزمر ( الذُّنُوَب َجِميًعا إِنَّهُ ھَُو اْلَغفُوُر الرَّ “say: o my slaves who have transgressed against themselves (by committing evil deeds and sins)! despair not of the mercy of allah, verily, allah forgives all sins. truly, he is oft-forgiving, most merciful (quran 39:53). he also says in the quran: ابِيَن َويُِحبُّ اْلُمتَطَھِِّرينَ َ يُِحبُّ التَّوَّ .)222اآلية : سورة البقرة ( إِنَّ هللاَّ indeed allah loves those who repent and purify themselves (quran 2:222). and as the prophet (peace and blessings of allah be upon him) said: وعن أبي عبد الرحمن عبد هللا بن عمر بن الخطاب رضي هللا عنھما عن " بد ما لم يغرغرإن هللا عز وجل يقبل توبة الع " : النبي صلى هللا عليه وسلم قال . ) ) حديث حسن : رواه الترمذي وقال ( ( abdullah bin 'umar bin al-khattab (may allah be pleased with them) reported that: the prophet (peace be upon him) said, "allah accepts a slave's repentance as long as the latter is not on his death bed (that is, before the soul of the dying person reaches the throat)". (at-tirmidhi, who categorised it as hadith hasan). ِ : قَالَ رضى هللا عنه َوَعْن أَنٍَس { صلى هللا عليه وسلم قَاَل َرُسوُل َهللاَّ ابُوَن َوَخْيُر اَ , ُكلُّ بَنِي آَدَم َخطَّاءٌ , َواْبُن َماَجهْ , أَْخَرَجهُ اَلتِّْرِمِذيُّ } ْلَخطَّائِيَن اَلتَّوَّ َوَسنَُدهُ قَِويٌّ anas (raa) narrated that allah's messenger (peace be upon him) said: “all the sons of adam are sinners, but the best of sinners are those who repent often.” related by at·tirmidhi and ibn majah with a strong chain of narrators. the above verses and ahadith (written sayings of the prophet muhammed, peace be upon him) emphasized that it is important for conventional banks to get rid of usury deals and to give rights back to their owners. b. economic reasons: prior research ]23[ ; ]10[ ; ]24[ ) reported that islamic banks are more profitable than the conventional banks.recent study like ] 24[ investigated the differences between islamic and conventional banks in the gcc region on the basis of financial characteristics alone. according to roe islamic banks are more profitable and therefore, reward shareholders with higher returns than conventional banks also the operating expenses to assets are higher for islamic banks while islamic banks are less risky than conventional banks because of their ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 reliance on shareholder capital. hence the conventional banks seek to maximize their profit. in this context ]3[ reported that the main motivation toward the conversion process is the desire of conventional banks to achieve maximize their profit. in addition ]3[ identifies two motivations for the conversion to the islamic banking industry. these include the potential benefits from the expansion by working in islamic banking activities and the weak and the poor levels of competitiveness of the conventional banks. furthermore ]27[ revealed that conventional banks have a motive to offer services to a growing muslim population and to benefit from the growing number of international investors which are attracted to sharia-compliant products. moreover ]4[ argued that the work in the banking sector according to sharia is very profitable so it is axiomatic that conventional banks resorted to tap into it as much as possible. other study ]24[ investigated the most important motives behind the conversion process. he found that conventional banks converted to islamic banks to (1) keep their customers; (2) because of the believe in the prohibition of usury; (3) the competence to attract the sharia product customers and (4) to emulate the success in islamic banking and achieve a higher rate of return. most recently ]2[ investigated traditional banks conversion motivation into islamic banks using two banks in kuwait, one of them fully shifted to islamic banking and the other national bank of kuwait opened an islamic division (or window within the banks). the results also found the motivation of conventional banks conversion to islamic banks is two-fold: on the one hand, there is a religious scruple; but there is also a vital success of islamic banking role that is equally important. many traditional banks like hsbc, city bank, deutsch bank and chase jp morgan established islamic branches to cope with the islamic banking growth. this phenomenon proved feasible and resulted in a significant presence of islamic banking. iv. conversions forms: conversions forms, according to ]4[ are referring to the way that conventional banks choose to enter into the islamic finance world. prior studies ]26[ ; ]4[ ; ]3[ ; ]2[ ; ]16[ show that there are several forms of conversions. in the simplest sense ]23[ divided the conversion forms as follows. the full conversion: in this case the conventional banks are converted into to islamic banks. this might be caused because of a legal conversion of a country (such as iran, pakistan and sudan) or because of the decision of the conventional banks to be fullfledged islamic banks. the other way is the micro conversion which takes many shapes such as (1) establishing an islamic window in the conventional bank; (2) providing some islamic products, instruments or investment funds and (3) converting a branch or more of conventional banks into islamic branches. a. the main forms of conversion from jurisprudential point of view: some conventional islamic banks are seeking to increase their capacity of islamic banking services because of its higher profitability (or for ideological reasons). the conversion forms are different according to the conversion motivation. every bank has a different goal and plans ]9[ . by keeping track of the views of many of the sharia scholars and economists, it is clear that there is a divergence of views on whether the conversion is compatible with sharia principles or not ]23[ ; ]9[ ; ]7[ . before explaining the jurisprudential requirement, we will discuss the forms of conversions. 1full-fledged islamic banks: prior studies ]6[ ; ]23[ ; ]3[ ; ]2[ consider this form the most compatible with sharia law. ttradition banks which choose a full conversion consider it the wisest choice because it helps the bank to build a confidence and trust with their customers. he gives examples of full converted banks like aljazerah bank in the kingdom of arabia saudi and national bank of sharjah, united arab emirates ]2[ . the main features of this form are the full adoption of sharia principals and the existence of sharia supervisory board. the full convertor bank did not deal with usury (riba) ]3[ . sharia scholars state a number of conditions to deal with converted conventional banks: firstly, the commitment to sharia principals. secondly, the independence from the parent traditional bank in terms of (1) accepting money and investing, (2) working according to islamic sharia in contracts, regulations, and (3) not to apply any systems or perform transactions that violated sharia. finally, working under sharia supervision and it must have a sharia supervisory board ]6[ . the sharia scholars agreed about that it is permissible to deal with these banks if it conforms to the terms of sharia ]8[ ; ]9[ . 2islamic windows (units) and branches: the citibank bank (1996), dresdner kleinwort benson bank (1988) and new zealand and australia anz group were the earliest conventional banks that opened islamic units. opening windows / islamic units in traditional branches or islamic windows means that traditional banks allocate part or space to provide islamic banking services ]9[ while islamic branches is a conventional branch of conventional bank transformed to offer islamic banking services ]2[ . conventional banks generally turn to this form to avoid losing their customers who want to deal according to sharia and to attract customers interested in islamic products by opening new windows or transfer branch, or offer more islamic products ]7[ . there is a debate between sharia scholars and islamic banking experts regarding jurisprudential views. there are three groups; the first group encourages establishing islamic branches and windows and the other groups are against it. firstly, the view favouring the establishing of branches /islamic windows in commercial banks; argued that muslims can deal with the islamic subsidiaries of banks if these branches have a full commitment to the provisions of islamic sharia law in all their dealings ]6[ . they pointed out some reasons supporting their view. first; the islamic branches will stop usury which is considered as one of the most important islamic rules ]6[ . secondly, in some countries it is so difficult to obtain permission to establish islamic banks; therefore, islamic windows or branches are the sole alternative. in addition, the success of these branches may tempt conventional banks to be fully converted into a full-fledged ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 islamic bank ]9[ . moreover ]27[ argued that islamic branches are a primary step to apply the islamic banking system until such time to shift the entire bank into an islamic bank. finally islamic windows or branches can benefit from an accumulated experience of conventional banks and that of hundreds of years to support and develop islamic banking and increase its effectiveness. a chairman and executive member of the fatwa and sharia supervision for a number of islamic banks, insurance companies within islamic qatar, ]27 [ states that it is permissible to deal with these branches if they adhere to the conditions of islamic banking. in addition it reflects a real commitment to the provisions of sharia in order to get rid of the riba gradually (aljazeera programs, religion and life, 2005). on the other hand; the view that disagreed with islamic units or branches argued that the islamic branches are a new way to deceive muslims and drain money without a real conviction in islamic approach ]9[ ; ]7[ . they tend to an inadmissibility of dealing with islamic subsidiaries deduced from verses in sura albaqara: بَا إِْن ُكْنتُْم ُمْؤِمنِيَن ۝ فَإِْن لَْم يَا أَيُّھَا الَّ َ َوَذُروا َما بَقَِي ِمَن الرِّ ِذيَن آَمنُوا اتَّقُوا هللاَّ ِ َوَرُسولِِه َوإِْن تُْبتُْم فَلَُكْم ُرُءوُس أَْمَوالُِكْم اَل تَْظلُِموَن َواَل تَْفَعلُوا فَأَْذنُوا بَِحْرٍب ِمَن هللاَّ )278اآلية : سورة البقرة(تُْظلَُموَن o ye who believe! fear allah, and give up what remains of your demand for usury, if ye are indeed believers. if ye do it not, take notice of war from allah and his messenger: but if ye turn back, ye shall have your capital sums: deal not unjustly, and ye shall not be dealt with unjustly quran (2:278). in order to do that ]27[ pointed out that some sharia scholars have raised concerns regarding its legitimacy of establishing themselves using capital from conventional banks. in the same vain; ]27[ stated that dealing with these branches may lead to mixing permissible with impermissible money according to sharia. another group expresses that dealing with islamic branches or windows in certain cases is considered better than dealing with pure conventional banks ]9[ . ibn alqayem stated that when permissible and impermissible money are mixed, we must purify the impermissible money percentage and retaining the rest (permissible) ]9[ . the main methods to get rid of the impermissible money are: the general islamic relief worldwide; scientific and technical assistance to poor islamic countries; islamic educational, medical and social institutions; and homeless, orphans and poor muslims ]5[ . 3conventional banks offer islamic products: one of the simple methods that conventional banks follow to maximize profit is to attract sharia-compliant investors. they offer diverse traditional and islamic products. in this method, conventional banks offer islamic instruments such as musharaka, murabha and ijara ] 9[ . this form is used by foreign banks in muslim countries to satisfy the market needs ]26[ . these products are not separately managed, but are part of the conventional bank. this form needs to be more fully accepted by sharia scholars and has a lot of doubts about its credibility. sharia scholars have different points of view. the first group argued that muslims must avoid dealing with this form because of the absence of the compliance with the provisions and principles of islamic law. the second group permits dealing with this form only if necessity and in the absence of specialized islamic banks. in this case the profit must be purged and investigated to know the proportion of the sacred transactions ]8[ . v. aaoifi standards and the conversion process: the accounting and auditing organization for islamic financial institutions aaoifi is responsible for developing and issuing standards for international islamic finance industry. aaoifi appointed members from central banks, regulatory authorities, financial institutions, accounting & auditing firms, legal firms and so on. it is supported by over 200 institutional members from over 40 countries ]1[ . sharia standards issued by aaoifi considered as guidance on sharia permissibility and rules for specific islamic finance products and mechanisms. the collective personal reasoning (ijtihad) of the aaoifi is very important to all sides of islamic economic life ]28[ . he considers that the existence of a sharia supervisory board, management committed to sharia principles and the compliance with the standards of the accounting and auditing organization for islamic financial institutions (aaoifi) are the main conditions to conversion process. thereby; we shed the light toward aaoifi sharia standard number (6) which implies explanations of procedures, mechanisms and treatment which are required for the conventional bank to be converted into islamic bank. aaoifi did not consider the islamic windows or the conventional banks that offer islamic services as islamic banks because sharia supervision board did not exist to make sure of transactions validity. to make sure the conversion process succeeds and meets sharia requirements; aaoifi offers an overview about conversion process as follow: a. measures of conversion process: 1) setup necessary procedures and required tools of conversion: ]6[ argued that this step needs a lot of effort especially with a dual banking system. the conversion plan must be under supervision of islamic expert in sharia and islamic finance [21]. he argued that this plan implies; firstly doing settlements of the interest on loans by returning it back or donating to charity tubes; loans granted by the bank; deposits and savings accounts; secondly, developing a plan for training employees on the principles of jurisprudence and islamic banking. thirdly, modifying the bank accounting standards to be consistent with islamic accounting standards. 2) changing operating licence according to sharia: the articles of association should explicitly consist of the existence of a sharia board ] .28 [ however, ]23[ argued that some converted banks is a part of the conventional bank. almost 53% of the islamic banks have a financial and administrative separation while 74% have not the same. 3) restructure organizational structure to fit conversion process: according to this point ]23[ found that the restructuring process reflects the development of new department of islamic banking management and nominate sharia supervisory board. this suggests that 88% of the ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 islamic banks sample restructure their organization while 12% did not do any modification. 4) changing employing procedures to fit conversion process: to fit with islamic values ] 21[ pointed out that faith and morals are as important as banking experience. he indicated that this concept must be followed in the islamic bank employing selection 5) formation of a sharia supervisory board: previous studies ]28[ ; ]27[ ; ]6[ ; ]11[ argued it is necessary for any islamic bank of any islamic financial institution to have independent and fully free sharia supervisory board to give opinions on proposed contracts and transactions. in the same regard ]27[ ; ]11[ stated that sharia supervisory board is an initial component to any islamic bank. the bank should, therefore, take the conversion decision and provide permanent checking of contracts, transactions, and procedures. sharia supervisory board should also consist of experts trustworthy scholars in sharia and modern financial transactions, highly qualified to issue fatawa. almost every paper that has been written on sharia supervisory board includes a section relating to the articles of association which emphasize the importance of the existence of a sharia board, whose resolutions should be binding upon the islamic bank's management. 6) formation the sharia auditing department in the bank: supervision and consultation with this department is so important to ascertain whether the licensing of different activities, contracts as well as transactions are compatible with islamic principles ]11[ . 7) reformatting contracts to comply with sharia standards: an apparent principle behind islamic is to maintain the moral purity of all transactions ]27[ . 8) open local and international islamic banks accounts: it is an important step to prepare the islamic branch to open individual, institutional, local and international islamic banks accounts compatible with sharia law ]23 [ . 9) revamping accounts that are maintained with conventional banks: the bank could rely on a tawarruq instrument “contract whereby a customer requests a bank to acquire a specific commodity (e.g. metal or wool) on his behalf” to get rid of interest. hence, through this transaction, the customer can purchase a commodity) which will be repaid at later dates ]27[ . in order to prepare bank’s employees to deal with islamic banks practice, ]21[ reported that, in case of shareqa bank (uae), they offered two types of rehabilitation programs public and private program. public programs offered to all the bank employees regarding principles and rules of islamic banking and islamic finance forms. after restructuring and allocation of staff in their departments, every specialized group get a private program convenient to their activity to help them to practice their work according to sharia. moreover, the conversion committee is responsible for surveillance the training process to make sure that everything in the right path. the absence of the employee training resulting in slaw innovation in islamic products and affects the relationship with central bank ]26 [ . b. dealing with other banks: 1) opening investment accounts in the central bank. central banks in some countries that ban to practice operations of direct sale and dealings in real estates and movables, in consideration of the nature of islamic bank operations in the fields of trading and murabaha , allow such banks to have, real estates, and goods. in addition, central banks modified some of the concepts considering the different nature of such islamic investment accounts, based on participating in profits and losses, and subject to the rules of legal mudaraba contracts ]18[ . 2) revamping the transactions with conventional banks according to sharia. regarding to ]3[ he pointed out that islamic banks must cancel or modify the transaction with conventional banks and central bank to be compatible with sharia law avoiding dealing with interest. islamic banks have to provide intensify transactions with islamic fianncial institutions and increase the collaboration between the islamic institutions by opening dual invetsments accounts and banks transfers ]3[ . c. the effect and treatment of conversion process on bank’s receivable and investments: 1) liquidating all the previous traces of conventional transaction. in case of deposits, ]21[ argued that the converted bank as shareqa bank (uae) gave the bank's customers choice to withdraw their deposit or keep it as a musharaka, mudarba or any of islamic finance contract. in addition; the bank legally is forced to keep the previous contract if the customer refused the settlement. 2) increasing the bank capital by increasing the shareholders capital or any other permissible means such as issuing sukuk and estesnaa (manufacturing). 3) issuance of islamic certifications such as mushaka ,mudarba and ijara. one of the studies reported that 80 % of the islamic instruments in islamic banks in saudi arabia is mudarba and tawaroq due to its low risk ]23 [ . 4) destroying impermissible tangible assets. it is not allowed to benefit from these assets by direct or indirect method and must be donated to charity if the bank sold these commodities and just receive the price. 5) employing all lawful means to avoid paying interest. notwithstanding converted banks seeking to get rid of interest by law; e.g. shareqa bank (uae); consider that if the bank did not convince the customers to finish impermissible transactions, it is permissible for the bank to receive the interest from the customers and pay it for the interest deposits that legally the banks forced to pay and spent the rest of this interest in charity outlets ]21[ . 6) in case of liabilities the bank refuses to provide non permissible services even if it has to pay compensation. 7) accelerateing the redemptions of all impressible pledges attached to the assets of the bank. 8) any interest or impressible earnings should channel to charity or general utility. ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 9) paying zakah: the liability of zakah starts from the date of conversion if the conversion made by outsider while in case of shareholders they bind to pay the previous years even if it is the money impressible. vi. conclusion: the conversions process is based on the belief that there is a need to make the right change. . there is religious and financial motivation behind conventional banks conversion. the religious motivation must be supported by stable and good plan to guarantee a successful conversion. the conventional banks conversion into islamic banking is obligatory in islam. independent sharia supervisory board is a very important element in conversion to islamic bank. moreover, aaoifi sharia standard put explanatory procedures and show how to follow the conversion process. the conventional banks must adhere with all conditions to complete the conversion successfully and to be fully committed to sharia law. references [1] aaoifi, conversion of a conventional bank to an islamic bank, shariah standard 2010, published by aaoifi, kingdom of bahrain. 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[27] j. sole, “introducing islamic banks into conventional banks system”. international mandatory fund, july, 2007. ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 [28] n. yacuby, “ shariah requirements for conventional banks”. available at: http://www.islamic-banking.com/iarticle_7.aspx ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 waqf: a contributory tool for bridging infrastructural deficit in nigeria ibrahim mohammed lawal heritage bank plc, maiduguri, borno state abstractthis paper seeks to examine waqf as a tool for bridging infrastructural deficit in nigeria. infrastructure has always been the bone of contention in nigeria due to its inadequacies and couple with its role towards economic growth and development. though, successive administrations have done their part towards resolving the infrastructural gap but it still persists, coupled with an increasing population. however, plans and strategies such as creating rooms for public private partnership (ppp), sourcing for funds within and outside country etc have been rolled out. though, some of these steps have further widened the expenditure profile of the government via debt servicing. despite all this moves it is yet to fill the infrastructure deficit. thus, this calls for a waqf system, an aspect of islamic social finance. this paper revealed the various conceptual definition of waqf, its types, permissibility and how is to be managed. however, a government budget constraint function was introduced to analyze how waqf can contribute in bridging infrastructural deficit which was further supported by adopting a modified revenue function via assumption that it only considers the population statistics of nigerian citizen within the ages of 1564yrs, n20 will be contributed per week and 5% level of cash collection error rate will be considered. the study revealed that nigeria could earned a projected amount of about n1.4b and n5.8b weekly and monthly respectively which will amount to n76b yearly if for instance the cash waqf is adopted. this means that there will be some boast on the government revenue and if such fund is expended on certain components of developmental expenditure, it will go a long way to bridge the infrastructural deficit. the study recommends legislation of act setting up waqf, public awareness should be properly done etc. keywords-waqf; infrastructure; shariah; budget function; population i. introduction the role of infrastructure to any economies of the world in driving its growth and development cannot be relegated to the background. infrastructure is considered as the “spinal cord to economic growth and development”. this is further supported by the view of world bank that every 1% of government funds spent on infrastructure leads to an equivalent 1% increase in gross domestic product (gdp), which invariably means that there is a correlation between any meaningful inputs in infrastructure development which reflects on economic growth [5]. according to national bureau of statistics (nbs), over the last decade, nigeria’s infrastructure spending contributed about 1.9 percent (approximately $4 billion) per annum to nations gdp. more so, in compliance with the recommendation of the asian development bank as per the2 report (2007) that in order for a developing country to sustain growth and development, not less than 6 percent of gdp should be invested on infrastructure. nigeria has superseded the bench mark but taking into cognizance its population size compare to other african countries [19], its spending is still like a tip of an iceberg, hence the need to do more and that is why in 2016 budget, total expenditure had nearly doubled to ₦6.1 trillion while capital allocation rose to just ₦1.6 trillion, just over 25% of the total compared to 2008 budget[1]. it is against this background that nigeria economy is characterized as thus, traffic congestion, power black outs in major cities, bad quality of roads, access to capital and market, inadequate telecommunication services, shortage of drinking, irrigation and industrial water, even schools are not equipped with basic infrastructure that enhances human capital development [11].however, nigeria’s infrastructure stock in 2012 stood at 20-25% of gdp which is equivalent of less than $100bn [28], compared to 58% in india and 87% in south africa. the international benchmark is 70% – doubled our current ratio – and nigeria has targeted this figure for 2043. though, based on assessment, the investment requirement across the regions is as thus; north west -$481 billion, north east$316 billion, north central -$482 billion, south east -$419 billion and south-south -$585 billion.” [20]. consequently, a total investment target of $3.0 trillion over a 30 years is required, with 33 per cent (about $1trillion) going to deals in energy, 25 per cent (about $775billion) set aside for transport, while 14 per cent ($400billion) will go to agriculture, water and mining. others are 11 per cent (about $350billion) for housing and regional development, ict will take $325billion (about 11per cent also), a total of 5 per cent ($150billion) is set aside for social infrastructure and vital registration and security will take the remaining 2 per cent, representing $50 billion of the total amount at constant 2010 prices[13]. therefore, this implies that there is a huge gap in the nigeria’s infrastructure. the nation requires about $14 billion https://www.thebusinesspost.ng/economy/infrastructure-master-planll-raise-nigerias-stock-70-gdp-2043-minister ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 annually to bridge the huge gap in the nation’s public infrastructure out of which $10 billion should come from the federal level and currently the country’s spending on infrastructure is about $6billion which means it requires additional $8billion to meet up the $14billion projected amount [29]. nevertheless, plans like the national integrated infrastructure master plan for example was rolled out whereby $100 billion will be spent each year for the next 30 years to reach this target. in addition, the nigeria infrastructure fund (nif) was created to focus on domestic investments in selected infrastructure sectors with a 40% allocation of funds under management with special emphasis on agriculture, healthcare, real estate, motorways and power [30] and the establishment of an infrastructure bank, which is mainly to provide financial solutions to support key long-term infrastructure projects. furthermore, in its bid to integrate the private sector in bridging the infrastructure gap, the government realises its blue print on its “economic recovery & growth plan” with emphasis that it would be "leveraging on private sector capital". this may come in a variety of ways; direct investment, concessions, public-private partnerships, investment funds, and other arrangements. consequently, achieving all these plans & objectives is a function of government revenue but with dwindling global price of crude oil at the international market, the nation’s revenue is grossly affected, taking into play that bulk of the nation revenue is from the oil sector. therefore, the government is now diversifying the economy to the non-oil sector, and strengthening its tax system so as to boast revenue etc and opening up her financial landscape etc. by broadening the country’s financial landscape, this gradually paves way for the inclusion of islamic financing into the existing conventional financial system in order to mobilize funds within and outside the country’s corridors. however, islamic finance can be refer to as the provision of financial services in accordance with the shariah [19]. this form of finance has different components, amongst which is the islamic social finance. islamic social finance is made of waqf, zakat etc which are meant for the purpose of mobilizing resources to address the problems of financial exclusion, poverty, unemployment among the vulnerable group of people and provision of infrastructural facilities. therefore, this study will focus on waqf , an instruments of islamic social finance and also argue that waqf can be a contributory tool in bridging infrastructural deficit if adopted. in fulfilling this aim, the following objectives are developed. i. to examine the permissibility of waqf amongst muslims & non-muslims ii. to explore how waqf can contribute in bridging infrastructural deficit. iii. to examine how waqf can be managed if adopted ii. conceptual issues a. infrastructure infrastructure is a heterogeneous term, comprising of physical structures of several kinds employed by numerous industries as inputs to the production of goods and services. this description includes “economic infrastructure” (such as network utilities) and “social infrastructure” (such as hospitals and schools). the former involves digital communications, water, energy, and transport. they represent the vital ingredients for the success of a modern economy [25] [12]. investment in infrastructure consists of capitalintensive projects, which in most countries are largely publicly owned and regulated, and which also provides the backbone of the production and distribution system. they are often regarded as the wheel of economic activity because of the crucial role they play in providing the foundation upon which production and distribution stands (economic reflection vol b. no. 4 april 2008). b. waqf waqf is an arabic word derived from a root verb waqafa. its plural is awqaf which literally means “hold, confinement or prohibition” [16]. technically it means “holding certain property and preserving it for the confined benefit of certain philanthropy and prohibiting any use or disposition of it outside that specific objective” [13]. waqf is called boniyad or habs (pl.abhas) in iran, north and west africa while it’s been termed as foundations and endowments in europe and usa [9] [2] [15]. therefore, we can define waqf as the dedication of privately owned property (movable eg cash, shares, cattles, books waqf or immovable, eg lands, building) and/or its benefit and usufruct in perpetuity for the well-being of the society [14]. it can also be referred as an islamic endownment of property to be held in trust and used for a charitable or religious purpose [24].there exist four major components that are needed to make up a waqf. these are the founder or waqif, the beneficiaries or mawquf’alaih, the trustees or mutawalli, and the entity of waqf itself or mawquf [10] [32] [15] [2]. waqf is made up of different kinds. it can either be in form of private or public waqf or quasi waqf. subsequently, it can be decomposed as thus; religious waqf) -this form of waqf is aimed to assist and satisfy the religious needs of the ummah. it can be land for mosques buildings, mosque maintenance in terms of its operational expense. philanthropic waqf-this form of waqf is aimed at supporting the poor or needy, orphans in the society and it can be used in the maintenance of public utilities like water, schools, hospitals etc and posterity or family waqfin this form waqf the revenue earned must be given to the waqf founder and his or her descendents and only the surplus if any should be given to the poor [16]. moreso, waqf has certain distinct features such as:-perpetuity which implies that once a property is decided as waqf so shall it http://www.niimp.gov.ng/?page_id=1059 ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 be. this encompasses other features like permanent, irrevocable, inalienable, certainty etc and the condition specified by the waqf founder must be followed in as far as it does violate shariah. c. waqf and its permissibility although the holy quran does not directly define waqf or make any particular reference to it, however, it encourages muslim to do charity and donation. allah has promised multiple rewards for those who generously spend thier wealth in his path[27]. this is supported by the following verses; “they ask you what they should spend.say: whatever you spend of good must be for parents and kindred and orphans and al-masakin and the wayfarer and whatever you do of good deeds, truly allah knows it well (q2:215)”. similar verses can also be seen obtained in q2: 254, 270 and 280. in a similar view, there are hadiths which further supports waqf. abu hurairah reported allah’s messenger as saying: when a man dies, all his acts come to an end, but three: recurring charity, or knowledge (by which people benefit), or a pious offspring, who prays for him” (muslim, 1992: bab3, hadith 14). however, the concept of waqf is not entirely new to the nonmuslims as well because it has been practiced non-muslims during the ottoman period [2][34]. though, several verses of the bible have stressed the need for charity such as hebrew 13:16, proverbs 19:17, ii corinthians 9:7 etc. therefore, based on the submission given, we can explicitly deduce that waqf is permissible for muslims and non muslims. iii. waqf and bridging infrastructural deficit waqf is driven by spirituality, social justice, and personal satisfaction of the donors and its purposely meant to provide key essential services like health, education etc so as to improve the welfare of the people in the society at no cost. this was evidenced during the ottoman empire in which the waqf was incorporated in its fiscal system to cater for its public expenditures for decades. in addition, the prophet (pbuh) also used waqf to finance its weaponry in times of war via the fruits from ochards left by mukhayriq and well as financing its economy (siddiqi,1995). this reasons for the background of waqf, formed a cogent fact to justify the argument of bridging infrastructural deficit via waqf. however, existing literatures have also been captured along such lines. most especially the works of çizakça (1998), he stressed that economists looking at the waqf system would be perplexed by the fact that a myriad of essential services such as health, education, municipal, etc., have historically been provided at no cost whatsoever to the government. therefore, ceteris paribus, the waqf system can contribute significantly towards that ultimate goal of so many modern economies as it lead to a massive reduction in government expenditure, which leads to a smaller budget deficit. consequently, it will turn lowers the need for government borrowing [9]. in fact, waqf can assist modern govern ments to eradicate interest as well as promoting better distribution of income. çizakça (1998) further stressed that this can be achieved by instructing islamic banks to combine cash waqf contributed by investors with mudarabah firms or “joint-stock company shares” to generalize, the manner at which waqf can assist in briding infrastructural deficit is for waqf to support public expenditures or at least part of it [9]. çizakça (1998) also pointed out that despite the success of the ottoman empire in implementing waqf, there were some shortcoming as there were focused on capital distribution while disregarding capital accumulation which was further confirmed by the works of balla and johnson (2009), it was associated with cases of corruption, it was family waqf, therefore liitle was done to provide public goods [3]. furthermore, waqf in terms of cash can also be a veritable tool whereby citizens can donates voluntarily and such funds is invested in mudarabah deposit, sukuk (islamic bond), islamic mutual fund and islamic compliant stock etc. this can further assist to finance government intervention programmes rather than using taxpayer money, hence there will revenue surplus, which can be used to service debt. mohamed, shahida, abdul and zaini (2012) hold the same view, which they proposed cash waqf as an alternative to finance bantuan rakyat 1 malaysia (br1m). br1m is a social safety net that is currently implemented in malaysia. they advocated for a cash waqf fund which is to be invested in mudarabah deposit, sukuk (islamic bond), islamic mutual fund and shari’ah compliant stock, researchers simulated that the malaysian government can save more than rm13 billion in the period of 30 years. in other words, br1m can be financed by cash waqf instead of tax revenue or government borrowing thus enabling savings. these savings can be channeled in the provision of infrastructural facilities[26]. islahi (1992), stated that there is need to internationalize the voluntary institution of awqaf nowadays, by setting up a nongovernment world muslim foundation which should provide public goods on large scale and in much more significant fashion than has been the case up till now, to combat illiteracy, sickness and lack of technical know-how [13]. similarly, kahf (1998), explain the importance of waqf for socioeconomic development, which is consists of creating and developing a third sector distinct from the profit-motivated private sector and the authority-based public sector, and changing this third sector with the responsibility of performing a group of tasks whose nature make them better achieved. this third sector assigned in education, health and social and environmental welfare. furthermore, it can provide defense services and public utilities in many instances which will go a long way to discourage borrowings [17]. for instance, islamic waqf influenced the development of trusts in western europe-most notably the establishment of such venerable educational institutions such as the university of oxford and merton college, [33]. in eygpt, the first hospital to adopt medical records which later became the medical ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 school sector of medicine called al noorie hospital in damascus founded in 1145ad,was built on waqf. many eminent physicians graduated at the medical center, including ibn nafis, a scholar who discovered the theory of the respiratory system in the human lung so also the al-azhar university. other users of waqf revenues include health services which cover construction of hospitals and spending on physicians, apprentices, patients, and medicines. one of the examples of health waqf is the shishli children hospital in istanbul which was founded in 1898[18]. in addition, more than 8,000 educational institutions and more than 123,000 mosques in bangladesh are waqf institutions. also, university in karachi, pakistan was financed by a waqf. a large shopping complex in dhaka is a waqf, providing employment to a large number of people and even financing a publication house, a large auditorium, and a mosque (sadeq, 2002). iv. application of waqf towards bridging infrastructural deficit infrastructural development is considered as a component of the nation’s public expenditure. deducing from the 2017 budget of about n7.44tn revealed a budget deficit of n2.32tn which is to be financed from borrowings out of which n1.254tn and n067tn will be raised from the domestic market and external sources. debt service amounted to n1.66tn and n2.1tn on capital expenditure [6]. all this is largely dependent on the nation’s revenue and bulk of it is from the oil sector. though, the government is in a tight situation to fill this infrastructural deficit due to its little resources; thus, all hands must be on deck as government alone cannot fill this gap. however, section ii has shown that waqf has the potentials to bridged infrastructural deficit as pointed out by cizakca (1998), mohammed et al (2012), kahf (1998) and islahi (1992). this further necessitates the need for nigeria to explore this grey area taking into cognizance that it’s a country with large number of muslim populations. however, for the purpose of convenience, this section will limit its discussions to the waqf in form of cash. cash waqf refers “the devotion of an amount of money by a founder and the dedication of its usufruct in perpetuity to the prescript purposes"[22]. relating the cash waqf model to the nigeria context with the aim of bridging infrastructural deficit, it consists of three major phases namely: the phase of cash collection rate, the investment phase and the implementation phase. the first phase which is the cash collection rate is considered as the bedrock in which other phases are built upon. this has to do with how long it takes to mobilize these funds. these funds can be traced to the contribution from the general public which is usually voluntary in nature. this can be in physical cash or through other platform like e-waqf funds which is deducted from their bank account or via mobile by sending coded sms to a designated sever number ordering for deduction from his or her airtime. this is considered as the easiest means for the public to join waqf scheme. however, a key mitigating factor to the cash collection rate is population. however, available record have shown that nigeria has a population of about 140m (census,2006) out of which 49.3% are muslims, 48.8% are christians while 1.9% traditional beliefs [31].. however, the main contributor would be from the muslim faction of the population. the second phase which is the investment phase has to do with investing the said waqf funds. these can be via mudarabah deposit, sukuk (islamic bond), islamic mutual funds and shariah compliant stocks. it is very pertinent to note that such funds must be invested in businesses that are shariah compliant. proceeds from such investment are either plough back or used at the last phase called the implementation phase. at this stage, the funds can be used four key purposes such as education, health, housing, social and community services etc. which are considered key component of government expenditure as demonstrated in the ottoman’s fiscal system. by implication, the idle tax revenue will now be used to finance infrastructural facilities and as such it can assist in bridging the infrastructural deficit. the reason behind this analysis can be further demonstrated mathematically via the government budget constraint (mathias et al, 1999) as thus; let tt be the real revenue raised by the government in the period t, let gt be real government spending in the period t, (including all transfer payments) and let bt be the real outstanding stock of government debt at the end of period t,.[23] therefore if bt > 0 means that government is a net borrowers in the period t, while bt < 0 means that the government is a net lender in the period t. there is a real interest rate of rt, that the government must pay on its debt. assuming, that the government does not alter the money supply, the government budget constraint becomes as thus gt + rt-1b t-1 = tt + (btt – bt-1) (1) if eqn 1 is converted into a single, infinite horizon, budget constraint as against period by period budget constraint as in eqn (1) under the assumption that real interest rate is constant, so that rt=r all period t and government does not start with a stock of debt or with any net wealth, so bt-1=0. the above equation can be re-written as thus; gt + (1 +r)b t-1 = tt + bt (2) the left hand side gives the government expenditure in the period t, it must also service the debt by paying interest (1 +r)b t-1. on the right hand side give tax revenue in the period t, and it can also raise revenue by issuing new debt in the amount of bt. in other words, government collects revenue tt and incurs debt bt to spend on government expenditure gt and pay previous debt with accrued interest inclusive (1 +r)b t-1. if gt is increased due to the contribution of waqf fund, more tax ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 revenue will be available to pay debt. and also if tt is increased via waqf funds, then it will also increase gt. therefore in both cases, infrastructure gap can be bridged. in addition, to further buttress the argument on waqf potentials, a projected cash flow is conducted. a simple revenue function (p*q) is adopted and modified. (i.e price x quantity) as thus; t= wa*pop. where t: total cash generated, wa: waqf amount contributed per individual; pop: total population. therefore, relating the works of mohd, et al (2012) to the nigeria case with a total population of about 140,431,790m out of which 77,158,732 are within the age of 15-64years (census, 2006), the following assumptions was made: it will consider only population within the age bracket of 15-64 years (77,158,732). every citizen in respective of religion contributes a minimum of n20 per week.5% level of cash collection error rate (i.e. some remain uncollected, some did not pay in full and some paid above n20 etc) is considered. use of existing structure and facilities of government and waqfs are managed by prudent and efficient trustees. table 1. projected cash inflows age bracket total population (muslims & non muslims) cash waqf of n20 per week (ngn) assume if 5% error rate(ngn) 15-64 77,158,732 1,543,174,640 1,466,015,908 total cash realised per week 1,543,174,640 1,466,015,908 total cash realised per month 6,172,698,560 5,864,063,632 total cash per annum (52wks) 80,245,081,280 76,232,827,216 source: authors computation, (2017)-for research purpose table i, shows the total cash waqf realized if nigerians within the age bracket (15-64yrs) donate n20 per week. this is to generate about n1,466,015,908 and n5,864,063,632 weekly and monthly respectively while total of n76,232,827,216 will be generated on yearly basis. and, in worst case scenario if only muslims donates to the cash waqf, then it will be 38,116,413,608 which approximately 50% of 76,232,827,216 based on the available records on muslim population. it is pertinent to note that the government expenditure is made up of development and operating expenditure. the development expenditure consist of defense and security, economic services (i.e. agriculture and rural development, trade and industry, transport etc), general administration and social services (i.e. education, health, housing etc) where as the operating expenditure is made up of debt service, emoluments, asset acquisition, pension and gratuities, grants and transfer, subsidies etc. therefore, from the projected funds realized, if it can be judiciously expended on just three (3) sectors (health, water & housing) of the economy that constitute a component of the developmental expenditure, it will go a long way to filled certain infrastructural gap. this is presented as thus; table 2. projected expenditure(s) sn sector location estimated unit cost estimated total cost 1 health (phc) 387 (½ of 774 lga’s) 29,115,628 *** 11,267,748,175 2 housing (2bedroom) 36 states (300 units) 3,029,400* * 32,717,520,000 3 water (boreholes) 59,987 (1/2 of 119,973 polling units) 575,000* 34,492,525,000 total 78,477,793,175 source: *castle (2017 [8]). **building contractors secret (2017) [7]; ***badeshi (2017).note: *cost of boreholes ranges from n150kn1,000,000 depending on location(avg.taken); ***avg. was taken from the total contract awarded for the construction of phc across the country between 2014 and 2015 43]. for research purpose. from the table ii, it depicts that in its first year of adoption, funds to be realized can be able to build about 387 primary health care (phc) centers spread across the 774 lgas across the state with an estimated cost of n11.2b. in the housing sector, part of the funds can also be used to build about 300 housing units across the 36 states of the federation (2-bedroom apartments) at the cost of n32b so also same funds can be used in the provision of about 59,987 boreholes spread across the polling units in the country with a total cost of n34b. if this tempo can be sustain for a period of 10-20years on certain identified sectors, it can go a long way to bridge the infrastructural deficit that exist in the country. v. management of waqf system under this form of proposed waqf system, nigerians are considered as the waqif or the founder in the waqf model. as waqif, they can choose to waqf for what purposes the funds will be expended for. it can be for agricultural and rural development, trade and industry, transport, public utilities, education, health, housing, social and community services, etc in as far as it constitute government expenditure and its shariah compliant. waqif can contribute any forms of mawquf that is deemed beneficial and can indeed help finance the federal government expenditures. the mawquf is to be managed by both the state and ngo’s. under the state, it is to constitute the ministry of finance, internal revenue board, central bank of nigeria, ministry of budget and planning, ministry of works, housing, education, transport, health & water, debt management office and representatives from the various religions. the waqf system should be centrally coordinated with a well decentralized structure at the state and local levels but must be independence from government interference. though, in some countries like kenya, sudan etc there exist waqf act or ministry in favour of ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 waqf that manages the entire waqf system. other religious organizations like state islamic religious council (nigeria supreme council for islamic affairs, christian association of nigeria) are to be appointed to support the ministry or dept. however, as trustees or mutawalli, these stakeholders must cooperate to carry out key responsibilities like; creating awareness on waqf and collection waqf contributions, ensuring that the mawqufs are used only for the purposes assigned by the waqif, ensure the protection of the rights for both muslims and non-muslims, as beneficiaries or mawquf’alaih and to monitor the investment of mawquf so that the shari’ah law is conformed [2]. see a flow chart of the waqf management system. figure 1. figure i: flow chart of waqf management system founder or waqif beneficiaries (nigeria citizens) investment waqf purpose -mudarabah investment -health islamic mutual fund -agric & rural dev. shariah compliant stock etc -trade & industry -transport education trustee or mutawalli -internal revenue board (firs/sirs) -ministry of finance, central bank of nigeria (cbn) -ngo’s, -rep from various religions (nscia, can) -ministry of budget & planning, debt mgt office (dmo) -rep from ministry of works, education, housing, water, transport & health source: modified by author from works of azniza & mohamed (2015) -for research purpose vi. conclusion nigeria is considered amongst the popular african countries with a large number of muslim populations that is yet to adopt the waqf system. this is a system that been practiced since the time of the prophet (pbuh) and his followers. thus, it is permissible to muslims and non muslims. most countries like malaysia, kenya, morocco, sudan etc that are have adopted it as a tool for financing public expenditure in terms of provision of essential facilities and eradicating of poverty at no cost to the government have enjoyed the benefit. hence nigeria should not be an exception. taking into consideration nigeria’s infrastructural deficit in virtually all the critical sectors and coupled with the required fund of about usd8bn annually to fill the gap. it depicts a long journey ahead and this has further put the nigeria government in critical position because of the shrinking position of the country’s oil revenue due to the dwindling price of oil at the international market. therefore creates the need to have a second thought as regards adopting it a waqf system. juxtaposing, the role of waqf to our current infrastructural deficit, it will go a long way to assist in bridging the gap at no cost to the government, thus reducing government borrowing in the long run. therefore, it is not too late to incorporate it as a fiscal tool by the nigerian government as it is an all inclusive package which means “the founder eats their cake and to some extent still has it”. hence the need to welcome it by all nigerians as a fiscal tool that will aid the government in it governance process without religious biasness so that the desired result can be achieved. based on the foregoing, below are some of the recommendations:-since waqf is permissible in shariah and it has been practiced by non-muslims in the past, then there is need to intensify effort on public awareness in order to enlightened the nigerian populace about benefits of waqf via local media like tv, radio in local dialects, magazines, articles etc as this will go along way to address some of the misconceptions about waqf, there is need to have a legal framework such as waqf act or creation of a ministry of waqf as this will ensure transparency as its record will be subject to public scrutiny. establishment of waqf advisory board so as to moderate its financing activities in ensuring that the government expenditure to be financed should not be vague and non shariah compliance.there was case of corruption associated with previous implementation of waqf. in lieu of that there is need to improve the welfare of the staff involved and also train and retrain them on task ahead of them. taking into play that cash collection rate goes a long way to determine the performance of the waqf system, there is to deploy of it equipments, portals so as to fasten waqf cash collection rate so easy and convenience. there is need to adopt a mix of financing waqf model so as to take care of the peculiarities that may exist, training, retraining and organizing development program for officers involved in the entire administration of waqf, ensure that the waqf officers welfare are properly taken care off so as to avoid them tempering with the revenue generated and contracts for provision of infrastructural facilities to host communities should be awarded to their indigenes so that the community can know who to look up to incase whether the job is abandoned or done haphazardly. references [1] anselem k (2017).” investing in nigeria's infrastructure” viewed 23 august 2017. < https://www.stearsng.com/article/investing-in-nigeriasinfrastructure> [2] azniza, h a & mohamed, a h (2015), “the possible role of waqf in ensuring a sustainable malaysian federal government debt” procedia economics and finance. sciencedirect. 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(2013) “nigeria’s $8b infrastructure deficit” – daily independent | the citizen. viewed 23 august 2017.< http://thecitizenng.com/public-affairs/nigerias-8b-infrastructure-deficitdaily-independent/> [30] national planning commission (2015).” nigeria’s current infrastructure stock and investment level” viewed 05 september,2017 <www.niimp.gov.ng/?page_id=1109 [31] nigeria sovereign investment authority (2015)” nigeria infrastructure fund” viewed 05 september,2017.<http://nsia.com.ng/nigeriainfrastructure-fund/> [32] pew research center ,(2012), “ religious composition by country in percentages”. available [33] at:www.pewforum.org/2012/12/18table_religious_composition_by_cou ntry_in_percentage/retrievedjanuary05. retrieved on 05 january 2016 [34] pengenalan wakaf (2015), yayasan waqaf malaysia: viewed 20 april,2015, <https://www.ywm.gov.my/wakaf/pengenalan> [35] sadeq, a m. (2002). “waqf, perpetual charity and poverty alleviation”. in [36] masoud a 2015, “role of waqf in sustainable economic development and poverty alleviation: bangladesh perspective”. iistejournal of law, policy and globalization. (42). 118-130 [37] shaham, r( 1991), “christian and jewish "waqf" in palestine during the late ottoman period”. bulletin of the school of oriental and african studies, 460-472. http://www.buildingcontractorssecrets.tk/2017/06/what-would-it-cost-to-build-a-standard-2-bedroom-flat-in-nigeria.html?m=1 http://www.buildingcontractorssecrets.tk/2017/06/what-would-it-cost-to-build-a-standard-2-bedroom-flat-in-nigeria.html?m=1 http://www.castle.com.ng/magazine/article/construction/67 http://monzer.kahf.com/papers/english/waqf_a_quick_overview.pdf http://monzer.kahf.com/papers/english/waqf_a_quick_overview.pdf https://guardian.ng/features/focus/bridging-infrastructure-development-gaps-in-nigeria/ https://guardian.ng/features/focus/bridging-infrastructure-development-gaps-in-nigeria/ https://www.merriam-webster.com/dictionary/waqf http://nsia.com.ng/nigeria-infrastructure-fund/ http://nsia.com.ng/nigeria-infrastructure-fund/ https://www.ywm.gov.my/wakaf/pengenalan ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france microsoft word 1046-4684-2-ed _1_ _2_.docx http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 islamics principles versus green microfinance lucky nugroho1 1accounting department, mercubuana university. email: lluckynu@ulb.ac.be or lnugroho@bsm.co.id abstract – the purpose of this literature review is to find out the link islamic principles based on the qur’an, and hadith that in line with the green microfinance activities. the scope of this literature review is divided into four main sections: (1) is islamic perspective on economic activities has concern with the environmental issues?, (2) why microfinance has an important role to implementing green microfinance activities?, (3) what's the link between islamic principles and green microfinance activities, (4) who has responsibilities on the implementation of green microfinance activities?. based on islamic perspective, the people can run their business as long as they didn’t destroy environmental. the conservation of environmental very important to support the sustainability of human life, it's reflected in the qur’an and hadith as the supreme sources of islamic law. furthermore, islamic finance has a strong engagement with the microfinance activities, because the main clients of microfinance are low income people, and the one of microfinance objectives is related to poverty alleviation. furthermore, the majority clients of microfinance are poor people that also as the contributor of environmental destruction. linked to this condition, must be exist appropriate law enforcement from the government who has the legitimacy to force microfinance institution for implementing environmental conservation activities. keywords – islamic principle, environmental concern, microfinance, low income people, legitimacy i. background al quran as a way of life for humans to govern all aspects of human life. qur'an was revealed by allah through the prophet. furthermore, in order that the qur'an as a source of law and the rules can be applied in human life, must be provided with the hadith and ijtihad (choudhury, 2014). qur'an and hadith as super cardinal in human life, stated in the qs al baqarah verse 2 and in an nisa verse 59 meaning: “this is the book about which there is no doubt, a guidance for those conscious of allah“ meaning: “o you who have believed, obey allah and obey the messenger and those in authority among you. and if you disagree over anything, refer it to allah and the messenger, if you should believe in allah and the last day. that is the best [way] and best in result.” in addition quran and hadith is a unity that can not be separated. quran as the first and main source of the revelation by god to the prophet muhammad to be delivered to humans. obligation for muslims to study the qur'an also stated in the hadith: meaning: "from usman he said, the prophet saw said: (muslim) good among you are those who learn the qur'an and teach it to others.” (hr. bukhari). from the hadith is stated how magnificent a person's character when he was able to learn the qur'an well, then he teaches to others. thus he will get double reward from god and had the honor of man on earth. the nature of the revelation of the qur'an is to be a universal moral reference for humanity to solve social problems that arise in the middle of the community., hadith as the source of the teachings of both appear to explain (bayan) generality of the contents of an issue if the law can not be in al-qur'an (choudhury, 2014). moreover, the qur'an surah al-maidah verse 92 also explains about the obligation to believe and accept everything that is delivered by the prophet muhammad told his followers to be used as way of life ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 meaning: “there is not upon those who believe and do righteousness [any] blame concerning what they have eaten [in the past] if they [now] fear allah and believe and do righteous deeds, and then fear allah and believe, and then fear allah and do good; and allah loves the doers of good.” related to al maidah verses 92, can be illustrated that every command obedience to allah in the qur'an always accompanied by obedience to the command of his messenger. similarly, the warning (threat) because of disobedience to god, often equated with threats because of disobedience to the prophet muhammad. allah has stated the obligation for muslims to obey rasul saw and guided by his hadith. prophet muhammad was the one who was given the mandate by god to convey the shari'ah are revelation to mankind, and he did not deliver anything, especially in the field of religion but derived from revelation. therefore, every muslim is obliged to adhere to the hadith. prophet muhammad advised regarding the necessity to make the hadith as a way of life, in addition to the qur'an as its main guidance. prophet said: meaning: "from the anas bin malik prophet said: i left two treasures for you all, that you will not get lost while you sticking to both the form of the qur'an the book of allah and the sunnah of his messenger" (hr. malik). the hadith indicates that the prophet has left two guidance as a way of life that is the qur'an and sunnah as a handle and guidance in order not to misguided in carrying out of life in the world and also survived to reach the hereafter the third world and developing countries in general try to stimulate economic growth aim increasing the prosperity of their citizen contributing to the reduction of the poverty. in any case the improvement of the individual welfare during the process of economic development presents a lot of controversial issues in terms of environmental impact. in this respect grossman and krueger (1994) are questioning if the economic development of developing countries is putting in danger the environment or actually is only through the increase of income and wealth that is possible to solve ecological problems. the economic development increases the industrial activities and generates ecological problems such as the extinction of species, land degradation and global warming. these ecological problems have a negative impact on the individual's quality of life and on the development of a sustainable society (mc donald et.al., 1997, cook et.al., 1999). many environmental damages are caused by human activities driven only by an economic motivation without taking into consideration the importance of the environment for human life (jegasothy, 1999; abbas, 2012). nevertheless, the economic development and economic growth should continue, because these processes allow the achievement of a better condition for the people. in any case economic development should be useful not only for the current but also for the future generations (sustainable development). thus, we need to balance economic growth, ecological impact and social impact (as a triple bottom line) with those three elements that should be integrated into every development activity (pereau, et.al, 2012). furthermore, in developing countries, there are a series of constrains to the implementation of sustainable development processes, especially associated with environmental issues. these constraints are the following: (i) the approach to development is very pragmatic, focused only on economic development (profit oriented); (ii) the use of natural resources is driven by the need of products, which is actually the satisfaction of all the market needs. this condition leads to an uncontrollable exploitation of the natural resources; (iii) in the developmental process the areas of finance, trade, investment, and technology is not integrated with the environmental planning. in developing countries, the economic development may result in two diverging kinds of impact,. a positive impact represented by the increase of the national per capita income but also a negative impact resulting in the environmental damage. according choudhury (2009), sustainability in the islamic development methodology is defined as the process of establishing complementarities between economic, social and ethical issues of human development. related to the environmental destruction in the development, its also not allow in the islamic perspective. environmental preservation also stated in the qur’an ar rum verses 41 meaning:” corruption has appeared throughout the land and sea by [reason of] what the hands of people have earned so he may let them taste part of [the consequence of] what they have done that perhaps they will return [to righteousness].” in the ar rum verse 41 stated that all environmental damage is the result of human greed, which exploits the natural world all-out. therefore, since the beginning of god's warning of the human-induced. ii. theoritical background the majority of the people in developing countries has a low income or are poor. they need access to financial services to sustain their economic activity and also to fulfill their household needs. according to hudon (2011), microfinance institutions (mfis) play an important role in the economic development of developing countries, as it is happening in asia and latin america with the cases of bangladesh, indonesia and brazil. mfis have an important role in the reduction of poverty in developing countries (karlan and goldberg, 2011) serving the poor and at the same ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 time balancing financial and social performance (morduch, 1999; copestake et al, 2005, armendariz & labie, 2011). mfis in developing countries also relate to the preservation of the environment. in developing countries the small-scale activities conducted by the micro entrepreneurs entail environmental risks representing direct threats to population’ health and livelihoods. mfis clients are poor people who have low income. usually poor people, lack of education and knowledge, thus they are not concerned by environmental issues and sometimes they’re also directly contributing to the destruction of the environment. associated with this condition, recently, some donors and experts claim that mfis could play a role in fostering pro-environmental behaviors among their micro entrepreneur clients (allet, 2012). indonesia as the biggest muslim population countries as well as the part of developing countries also has the environmental degradation. apart from the success of development that contributed to the advancement of technology and the development of industry-in indonesia, in fact there has been a deterioration of natural resources and increased environmental pollution, especially in cities such emerging gresik, surabaya, jakarta, bandung lhoksumawe, medan, and so on (sitorus, 2004). some damage occurred, according amsyari.et.al (1996) are as follows:  the decline in the quality of surface water around industrial areas. the concentration of pollutants that are harmful to the health of the population such as mercury, cadmium, lead, pesticides, pcb, a sharp increase in the water content of the surface and the water biota;  scarcity of fresh water to be increased, particularly in the dry season, while the rainy season tends to occur floods that hit many areas that cause harm due to the condition of ecosystems that have been damaged;  maximum and minimum water temperature varies often, even the highest temperatures in some cities such as jakarta has reached 37 degrees celsius;  an increase in the concentration of air pollution such as co, no2r s02, and dust;  the natural resources of the indonesian nation dwindling, such as petroleum and coal are expected to be exhausted in 2020;  indonsia forest area is getting narrower due to uncontrolled encroachment intentional or by fire;  more soil nutrient conditions are not fertile, and agricultural land narrowing and polluted. the above conditions is certainly contrary to the principles of islam which the majority of the indonesian population are muslim. iii. research design the research method is based on a qualitative research, the framework of this research is defined by research questions as follows: a. is islamic perspective on economic activities has concern with the environmental issues?; b. why microfinance has an important role to implementing green microfinance activities?; c. what's the link between islamic principles and green microfinance activities?; d. who has responsibilities on the implementation of green microfinance activities?. iv. result and discussions a. is islamic perspective on economic activities has concern with the environmental issues? the ultimate goals of activities in islamic perspective is maslahah. maslahah is is all activities should bring benefits and refusing all activities that harm nature, or bring damage. nevertheless, according to nugroho (2014) the existing human in the world should give positive contribution to others not only for human live but for all the elements. this statement argued by the hadith as follows: meaning: “the best man is the most useful for others.” furthermore, the maslahah can be divided by the priority level and can be illustrated as follows: figure 1.1 explanation of figure 1.1 as follows: a) the essentials/necessities (al-daruriyyat) are those on which lives of people depend, and whose neglect leads to total disruption of chaos. dharuriyat (necessity) include religion, life, intellect, lineage, wealth is a unity that can not be separated. if there is one thing that is ignored, will cause imbalance in human’s life; b) the needs/exigencies (al-hajiyyat). hajiyyat (needs secondary) function completes dharuriyat aspects make it more solid. examples of hajiyyat is sunnah worship. sunnah worship was done after the implementation of compulsory worship; c) the complementary interests (al-tahsiniyyat), the function makes the human being in a noble manners and good manners. so as to add to the beauty of human life, ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 for example: make use of clothes neat and nice in worship. for further explanation of maslahah the part of al daruriyat should be based on the principles of maqhasid sharia. according bahsoan (2011), the principles of maqhasid sharia are: a) first, maintaining religion. humans require absolute religion. without religion, there is no point in life, even religion is the most important requirement of all basic needs. religion ranks first, because the whole teaching of law leads people to act in accordance with his will and good pleasure of god. because it is in the qur'an and hadith of a man driven to believe in allah, and that is the foundation of islamic economics in particular. as for economic relations with aspects of aqidah allows economic activity in islam became a worship. b) second, preserving life. nourishes the soul is intended to preserve the right to live in dignity and nourishes the soul in order to avoid acts of persecution in the form of murder, as well as actions that hurt includes eating foods that can damage the body or excessive in taking it. c) third, maintain mind. sharia sees the human mind as a gift of allah, which is very important. with the human mind can discern what is good and what is bad. with the human mind assigned to worship god. people lacks unencumbered tasks shari'a. because of that mind must be maintained and protected. for this reason the law forbids alcohol and all that can kill the creativity of the human mind and morale (drugs). thus, in islamic economics, alcohol or and the like is deemed not to have value. d) fourth, maintaining descendants. mashlahah world and hereafter are intended by god to discontinuity from one generation to another generation. therefore, islam regulates marriage and forbid adultery, assign anyone who may marry, the ordinance of marriage and terms, and the pillars that must be met. all of which is a form of preserving a clean and healthy descendants in a serene and peaceful atmosphere. thus, there will be more and stronger as well as the creation of union and unity in the community where they live. e) fifth, maintain the property. although essentially all of the property belongs to allah, but islam recognizes an individual's personal right. islam requires that regulations concerning such muamalat purchase, lease, borrow or lend, pledge and so on, and prohibits fraud and practicing usury. maintaining a well-understood property set muamalat system on the basis of fairness and willingness, trying to develop wealth and handed into the hands of people who are able to maintain good property is also understood to regulate muamalat system on the basis of fairness and willingness, trying to develop wealth and handed into the hands of people who are able to maintain good. f) sixth, qs. ar-rum verse 41 stated:”corruption has appeared throughout the land and the sea by [reason of] what the hands of people have earned so he may let them taste a part of [the consequence of] what they have done that perhaps they will return [to righteousness].” in this verse, allah revealed the emergence of the environmental damage caused by human activities, and people will accept the consequences. because of environmental damage would threaten human existence, especially our future descendants. based on the maqhasid sharia, the environtmental issues is very important point in the islamic perspective, because of all the activities include of financial acivities should be embedded with the islamic values that nota bene maqhasid sharia. b. why microfinance has an important role to implementing green microfinance activities? the originality of microfinance objective, it's to achieve the double bottom line. that is mean microfinance institutions are mindful not only about financial performance, but also by social indicators. econometric analysis is used to assess financial performance, and guidance is provided for extending the analysis of social performance indicators or mfis have a double aspect: financial and not-for-profit. it is, therefore, appropriate to assess their performance by means, not only of financial ratios, but also by means of social indicators. (frank, 2008; armendariz and labie, 2011; hudon, 2011; stuart, 2011; balkenhol and hudon, 2011; cinca et al, 2011). in other word the mfis was designed to serve unbanked poor and, it's seen by some as a magic wand against poverty that is supposed to solve it all (armendariz and labie, 2011), but microfinance neither a panacea nor a magic bullet, and it can’t be expected to work everywhere or for everyone (armendariz and morduch, 2010). global warming is caused climate change has a negative effect that is remarkable for human life on earth, natural disasters that could be due to the effects of climate change turns occur various countries in the world. greatest impact when it's covered by the natural system: extreme weather such as heavy rain, storms with stronger force, and heat waves. polar ice melt triggering sea level rise that threatens citizen community, ecosystem, and in the coastal city, also have broad impact of ocean acidification for marine species, including coral reefs. nevertheless the most dangerous, according to scientists fear is the impact on human life, such as health, home, and food that is caused by the increased of temperature (abbot and wilson, 2014). then the question comes up, is there a link between poverty and environmental concerns? the link between poverty and environment is often mentioned in sustainable development (reardon and vosti, 1995), its mean the development should be given the impact not only for recent generation but also for the next generation. link between poverty and environment its shown in recent year, there is an ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 effort from the development practices to the empowerment of mfis with starting to consider their environmental bottom line in addition to their financial and social objectives (allet and hudon, 2013). but why should microfinance should concern in environmental bottom line? allet (2013) mention the clients of mfis should be responsible for climate change because they have an impact on the environment. the clients of mfis have contributed in major environmental risk like chemical pollution, solid and liquid wastes, pollution emissions, inefficient production processes (energy-consuming, wasteproducing), and degradation of natural resources. regarding this risky, there are environmental issues in the community, such as health and sanitary issues, economic consequences, risk of conflicts, increased vulnerability and food security. associated in this condition the donors in mfis and the experts in this field, believed mfis has capacity to involve in environmental concern in their activities to be third bottom line or additional from the original mfis objective double bottom line, the triple bottom line element that consist of financial performance, social performance and environmental performance (copestake, 2007; green microfinance, 2007; van elteren, 2007; fmo, 2008; schuite and pater, 2008; rippey, 2009; agier and szafarz 2013). we believe green microfinance activities will be significant contribute to anticipate the impact of climate change for livelihood, because of the small scale activities in developing countries has the threat of environmental destruction (allet, 2013), and mfis as the institution directly contact with the grassroots community. addressing in this condition, the services of mfis could be as intermediaries, and have the opportunity for the dissemination of environmental awareness-raising information (hall et al, 2008; seep network, 2008). in line with this issue, kaushal and kala (2005) also mention that microfinance has a positive impact on the environment, because of there is a positive link between access to micro credit and forest regeneration in 27 indian villages. c. what's the link between islamic principles and green microfinance activities? qur'an and hadith are the two main pillars of islam. every detail of the teachings of islam should refer to the qur'an and hadith. qur'an is the principal source of islamic teachings as a guide for mankind (hudan-linnasi), as a guide human life towards a prosperous life in the world and safely in the hereafter. in addition hadith role to interpreting the qur'an in the practice or application of islamic teachings in a factual and ideal. we would be hard to imagine if without "intervention" hadith, the qur'an, especially those related to legal issues can be understood and actualized in practical muslims. as guidance of human life, of course, the teachings contained in the qur'an and hadith should be implemented in public life. islam as rahmatan lil 'alamin means that islam is a religion that brings grace and prosperity for all the whole universe, including animals, plants and the jinn, and of course human beings, it’s stated in qur’an al-anbya verses 107: meaning:” and we have not sent you, [o muhammad], except as a mercy to the worlds.” according the purposes of microfinance, there is strong similarity with islamic bank, the in line purposes of microfinance with islamic bank are social performance and poverty alleviation. although the practice of islamic finance is based on the belief that money is not a productive asset in and of itself. furthermore, aiming to implement islamic law sharia maqhasid, so the the activities of islamic banks emphasize factors ethical, moral, social, and religious to promote equality and justice for kindness the ummah. although this analysis of islamic banking focuses on the economic aspects, the system can be fully understood only in the context of islamic attitudes towards ethics, wealth distribution, social and economic justice, and the role of the state. principles encouraging risk sharing, indvidual rights and obligations, property rights and the sanctity of contracts is part of the universal values that underlie the islamic banking system (dhumale and sapcanin, 1998). the caused of environmental destruction is the low income people or poor people that nota bene they also as the clients of microfinance (allet, 2013). islamic persepctive related to the poor people, very concern in poverty alleviation. islam encourages equity and income distribution policies that favor the poor (pro-poor income distribution). there are three main instrument in islam related to the distribution of income is land ownership rules, the application of zakat, as well as advocating qardul hasan, donations, and endowments. islam arranged for everyone who revive the dead land, the land belongs to her. and for anyone who abandon their land, the right to take the country to then give to others who are ready to process it. with the application of zakat, then there will be no concentration of wealth in the community group. zakat also make sure that each person will be guaranteed minimum living so it has a chance to get out of poverty. furthermore, to ensure that the property is not only circulated among the rich alone, islam also strongly encourages the rich to give qard, donations, and endowments. the concern of islam to the poor people expressed on the qur’an at tawbah verse 60 as follow: meaning:” zakah expenditures are only for the poor and for the needy and for those employed to collect [zakah] and for bringing hearts together [for islam] and for freeing captives [or slaves] and for those in debt and for the cause of allah ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 and for the [stranded] traveler an obligation [imposed] by allah . and allah is knowing and wise.” based on surah at-tawbah verse 60, we must help the poor to become selfsufficient not only in terms of finance, but can survive with decent conditions. nevertheless, the microfinance services also has the same purpose that survive the poor people. the differences of microfinance and islamic microfinance on the operational mechanism. the islamic microfinance institution always put the social, ethics and morals issues in the all financial activities because those of variables are complementarity (choudhury, 2009). subject to the islamic microfinance very concern to the environmental destruction, that also stated in hadith "la dlarara wala diraar" (not to be malakukan deeds danger to yourself and others). prophet. said: "there should not be committing a danger to yourself and others. who makes harm others, then god will harm as well. who complicate others, god will make it as well " (sunan al-bayhaqi). nevertheless the qur’an also stated how the environmental very important issues in the islamic perspective , there are many verses in the qur'an related to the environment, among others: a) qs. al baqarah verse 11, as kholifah, human beings have the duty and responsibility to take care for, maintain and preserve the natural resources that have been provided by god for man. indeed, god has allowed man to use all of these resources as a source of life for humans and all living beings that exist on it. meaning:” and when it is said to them, "do not cause corruption on the earth," they say, "we are but reformers." b) qs. al a’raf verse 56, therefore, the use of it should not be arbitrary, and carelessly in exploiting it. utilization of natural resources both at sea, on land and in the forest should be proportionate and rational manner to the needs of broader community and future generations as well as maintaining the ecosystem. meaning: "and cause not corruption upon the earth after its reformation. and invoke him in fear and aspiration. indeed, the mercy of allah is near to the doers of good." c) qs. an-nahl verse 112, realizing this, the implementation of development, the use of natural resources in indonesia should be used rationally. excavation source of wealth to be undertaken with a vengeance with a strategy that does not damage the environment and governance system of human life. the need for the use of environmentallyfriendly technologies and to maintain its sustainability so that the that exist natural resources can be exploited sustainably. therefore, we should be able to take i'tibar or introspective of the meaning contained in this verse meaning: "and allah presents an example: a city which was safe and secure, its provision coming to it in abundance from every location, but it denied the favours of allah. so allah made it taste the envelopment of hunger and fear for what they had been doing." d) qs. al-baqarah verse 164, in essence, the universe and its contents, both concrete and abstract is a facility to achieve wellbeing of mankind. that's the nature, the world was created to always provide the best for human survival. humans derive from them to eat, drink, shelter, safety and livelihood. meaning:” indeed, in the creation of the heavens and earth, and the alternation of the night and the day, and the [great] ships which sail through the sea with that which benefits people, and what allah has sent down from the heavens of rain, giving life thereby to the earth after its lifelessness and dispersing therein every [kind of] moving creature, and [his] directing of the winds and the clouds controlled between the heaven and the earth are signs for a people who use reason.” so, based on the qur’an, the islamic law also support and very concern related to green microfinance activities that nota bene green microfinance is financial services to the poor in one region or country, which is one of the activities is to provide soft loans to individuals or groups of individuals who work directly to support the development of green and sustainable social development, create green jobs and environmental solutions progressive for the things that destroy and pollute the earth (rouf, 2012). furthermore, according allet (2012), the financial activities of the green on microfinance institutions include: loan screening in accordance with environmental criteria, offering micro credit to support clean technology, or training their clients about the practices of pro-environment. there is a close relationship between microfinance institutions (mfis) in protecting the environment, because clients of microfinance are also actors on environmental destruction, and they are not aware of it because of the low level of education. discourse latest green microfinance, and became the topic of a workshop-hosted by ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 the university meets microfinance organizations which held on 3-4 july 2014 at the frankfurt school of finance & management, making green microfinance activity is a part of the operations of microfinance institutions in the world. in this event also declared activity green finance is as balancing on operational microfinance institutions. with green microfinance activity put it on the agenda of the mfis, the workers and clients on microfinance institutions have an understanding, that survive life at this time with no harm to the environment, and doing a business activity today without compromising the next generation wellbeing. d. who has responsibilities on thee implementation of green microfinance activities? to enforce the implementation of the green microfinance, needed a regulation (law or act) from the government as a key player that conduct and govern these activities and supervise (make sure that the law is respected and how to apply the regulation) the implementation of it. as rule makers, government has function to promote financial inclusion, consumer protection, rule making, design business models, and as authority to give permit a new actor into the financial service sector (ehrbeck et.al, 2012). furthermore staschen and nelson (2012) mention the main participant in developing formal rules related mfis operation are: legislature (parliament), government department (relevant ministry and bureaucracy), and the regulator (the central bank or regulatory authority). nevertheless the implementation of green microfinance activities also need of legitimacy. legitimacy is the recognition of the right to govern (coicaud, 2004), therefore, to implement the green microfinance program, needed a strong motivation and desire of the authorities to govern (government, investors, donors, creditors, etc.) of implementation in green microfinance. a strong desire or motivation the government can be reflected through regulation or legislation related to green microfinance that have been issued by the authorities (central banks, financial authorities service, ministry of social welfare, etc.). moore (2000) also builds a legitimate framework for understanding the concerns of managers of non-profit and public sector organizations that encompasses their concerns with mission, operations, and the environment. he argues that the mission of organizations is to create “public value”, value that benefits customers directly, and benefits other stakeholders indirectly. he mentioned that effective managers deploy resources efficiently and effectively to ensure the delivery of public value, while managing their “authorizing” environment to ensure that they receive the legitimacy and support necessary to do their work. based on these definition, backstrand (2006) also mention legitimacy can be characterized as the normative belief held by actors that a particular rule, institution or order ought to be obeyed. nevertheless the regulation is legitimate if and only if (stillman, 1974): a) it is based on the beliefs of: (all or some) other nations, states, or persons; the people unanimous; a majority of the people; a majority of any portion of the people; the king, dictator, etc.; tradition, ancestors, prescription, etc.; god; other; noun or irrelevant. b) it has possession of a certain quality (or qualities); pursuit of a certain value (or set of values); none or irrelevant. nevertheless in islamic perspective regarding choudhury (2008), consider the wellbeing function of sustainable socioeconomic development in the context of islamic political economy. here the goal of economic growth is a derived relation of wellbeing criterion. economic growth is not a primal goal. it is intertwined with other goals, all together interactively leading to the criterion of wellbeing such as population change, ownership and distribution of wealth, employment and enterprise, ecological consciousness, sectoral linkages, price stabilization and resource mobilization, etc. are some of the other variables that we can interactively simulate in the wellbeing function by simulating knowledge-flows and their causal interrelationships with knowledge-induced forms. based on the according choudhury and silvia (2008) the responsibilities for the implementation is all stakeholders in charge and must be embedded with the consciousness for the sustainability. furthermore, all stakeholders i.e government, central bank, private sectors, non goverment organization, etc. should be has circular causation connection in term to achieved of wellbeing or maslahah on the framework of maqhasid sharia. v. conclusion islamic perspective has a strong relevance to the green micro-finance activities, especially in terms of philosophy and purpose. however, the principles of islam based on the qur'an, hadith and ijtihad are embedded with ethics and morals. the final goal in the principles of islam are subject to the implementation of the community based on maqhasid sharia. associated with environmental damage, in islam is not allowed because it would threaten human life. green microfinance activities are an effort to prevent environmental damage through microfinance services that their customers are mostly actors from environmental damage. furthermore, this concept must be implementation in real activity is not only a slogan but also need the support and the active participation of all stakeholders to gain legitimacy. the important points of islamic principles vs green microfinance a) islamic perspective its mean outlook based on point of view from sharia or islamic law (the qur'an, hadith and ijtihad). relevance of environmental issue, al qur’an and hadith put the preservation of environment as the part of ultimate goal or maqhasid sharia. the reason of environment as the important issue, because of the damage or destruction of environment could be threat the continuously of human life ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 b) the majority clients of microfinance are the small and micro entrepreneur or low income people. in addition they also have lack knowledge and consciousness related to environmental care. nevertheless they also the actor of the environmental destruction, because of that evidence, microfinance services must be embedded with the environmental care activities. c) the islamic principles have strong relationship with the green microfinance activities. the relationship be on the goals and philosophy of microfinance institution activities that have concern in triple bottom line concern that consist of financial performance, social performance and environment performance. in addition the islamic philosophy it’s subject to implementation of maslahah for the ummah very concern in the balancing of financial performance, social performance and environment performance. in addition there also existence of islamic microfinance institutions. furthermore, the term of islamic microfinance institutions is the microfinance institution plus (moral, ethics and halal). d) all the parties should be active participate to implementation of wellbeing in the world. to implement of it we need law and regulation for legitimate the all parties same frame work and same way to implement the environmental activities must be embedded with the economics activities especially for the activities of low 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(2007). environmental and social risk management and added value at mfis and mfi funds: the fmo approach, the hague: netherlands development finance company (fmo). ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 dynamic causal relationship between islamic banking and economic growth: malaysian evidence ahmad khaliqa, hassanudin mohd thas thakerb a kulliyyah of economics and management studies, international islamic university malaysia b faculty of business, accounting and economics, help university, malaysia abstract – islamic banking and finance have emerged as one component of a significant competitive and comprehensive market, where it is reliable with conventional financial development in term of economic contribution. as of today, islamic banking accounts for a minimum of 11 percent growth in malaysia economic development and indirectly contributes to the global agenda of developing sustainable growth. thus, this paper aims to empirically assess the dynamic contribution of islamic banking towards economic growth in malaysia based on selected variables, namely, real gross domestic product (gdp), total deposit, total financing, total assets and nonperforming loan. the quarterly time – series data from (2007: q1 – 2014: q1) are used to uncover short–run and long–run relationship between real gdp and islamic banking key financial indicators. using a battery of time series econometric techniques, we document that there is robust evidence suggesting favourable result where islamic banking does contribute towards economic growth in the long-run where the total deposit, total financing and total assets of islamic banking have a positive relationship where the non-performing loan is found to have a negative relationship. to test the causality relationship of variables in the short-run, the wald – test granger causality has been carried out and it shows that there is evidence of a bidirectional causality relationship between economic growth and total deposit of islamic banks. in addition, the bidirectional relationship also exists between non-performing loan and total deposit of islamic banks. however, the majority of the variables are found to be having unidirectional causality relationship among the variables. overall, our conclusion state that islamic banking and finance still act as one of the dominant key contributors to malaysian economic development and growth. the results obtained in this paper are much more robust to alternative econometric specifications. keywords: islamic banking, economic growth, long – run, short – run, malaysia jel classifications: c1, c5, 01, z10 i. introduction the steady growth of islamic banks has been a trademark of the muslim world financial landscape in the present age. according to governor of bank negara malaysia, dr zeti akhtar, malaysia has proven that islamic finance does not only contribute to financial stability, rather at the same time it promotes the number of economic sectors to participate in the financial system. this can be observed when islamic finance is extremely favourable to small and medium-sized businesses (smes). by the incorporation of smes and other micro-credit agencies, this has led to an increase in the diversification of the financial system, which later improves its flexibility and stability. moreover, possibilities to expand the international relations is realised. although with the slowed global economy and the siege of conventional banking in western countries, islamic finance continues to flourish with robust growth. gheeraert (2014) study reveals that islamic asset size and growth from 2000 to 2005 annual average by countries as below (figure 1); figure 1. islamic finance summary statistics source: world development indicators (world bank, 2009) from the graph above, it indicates that the average growth for the islamic asset lies around 19 to 26 percent for the listed countries above except ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 for thailand (which experience almost 119 percent growth due to extraordinary demand for islamic finance) for the period of 5 years. in comparison to the above, table 1 below shows the islamic finance shariah-compliant assets, the share of banks and number of firms according to countries in 2010. while likening both data, it simply designates steady growth of the islamic finance industry since 2005 and 2010 compared to the current market position. table 1. islamic finance by country (us$ billion) source: the banker (2010) according to rajabi & muhammad (2014), the global market for islamic financial services has tangibly grown by 15 to 20 percent ($1460 billion) in 2012. most of the asset comprises of commercial banks’, while the rest are from investment banks’. having considered this growth rate, it is forecasted by the end of 2014 that the market would elevate to $2 trillion in assets. the alliance among financial institutions, growing competition and constant innovation in providing financial services, all contribute to rising attentiveness in a detailed evaluation of islamic banks. in fact, the performance evaluation is essential for both managerial and regulatory purposes. while managers mainly concern on the outcome of previous management decisions, bank regulators are keen towards the well-being and soundness of banking structure to make sure the public confidence is preserved. in addition, bank performances are also monitored to identify problems, which if it is left unnoticed, could lead to severe financial issues in future. similarly, depositors and investors keen to track the bank's performance in realising greater investment experience and their turnover. generally, well-developed domestic financial sectors system such as the one that is 1 see goldstein and turner (1996) for these banking crises discussion available in developed countries can significantly contribute to raise savings and investment rate and henceforth reach the economic growth (becsi and wang, 1997). however, in defining specific variables which contributes to economic growth, this paper empirically assesses the dynamic contribution of islamic banks towards economic growth in malaysia based on selected variables namely real gross domestic product (gdp), total deposit, total financing, total assets and nonperforming loan and their significant relationship in short and long term time frame. by studying the contribution of islamic banks towards economic growth, this paper contributes to the ongoing discussion and existing literature on the performance of islamic banking and their contribution towards successive domestic and foreign economic growth. ii. literature review economic development is usually seen as a process of creating prosperity for a country through the mobilisation of human, physical, capital, financial, and natural resources to generate marketable good and services (american economic development council, 1984). financial intermediation plays and important role in an economic activity, failing which such as banking crisis, can be very costly for society. in some cases, banking crisis also may exact a high cost estimated to be greater than ten percent of gross domestic product (gdp)1. extant literature proves that islamic banking and finance institutions manage to escape without being severely hurt by the global financial crisis2. to study among the reasons, contribute to this, monzer kahf (2005) discover that developmental characteristics of islamic modes of financing can be categorised in few manners. among them, monzer kahf (2005) discovered that the essential characteristics are their direct and undetachable link to the real economy or physical transactions as islamic banking and finance practices promote the sharing mode and sale-based mode. kaleem (2000) in his study discover on general similar findings by other researchers3 that islamic banking system is more stable compared to the conventional banking system. this is mainly because of the fact that islamic banks operate in a free-interest environment (bacha, 2004) and operates on a non-debt based framework, rather asset-based structure with a risk-sharing mechanism are practised (maximilian j.b. hall & muljawan, 2000). the expert found that conventional banking 2 studies by (smolo and mirakhor, 2010) and ahmad (2010) 3 see (kia and darrat, 2003) and (samad, 2004) ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 had been notorious due to its operation in highly leveraged, greed and poor enforcement of inadequate regulatory exercises. the practices and undertakings of islamic banks reflect the atmosphere in which they are based. strong retail operations are mainly practices in iran and saudi arabia. on the other hand, for secular societies such in northern africa, islamic banks compete on the basis of the quality of the products rather than competing more on a religious base. in kuwait, financing focused more on the petroleum sector and real estate investment while in the united arab emirates, the emphasis given is more on trade and finance (zaher and hassan, 2001). these simply indicate that for islamic banking and finance industry to sustain continuous growth and compete in local as well as global markets, they have to design and innovate shariah compliant instruments that can cope with the continuous innovations in the present financial markets. with regard to islamic banking contributions to the economic growth, the extant literature indicates that there are only a few studies carried out in this area. among them, (abduh & chowdhury, 2012) and (abduh & omar, 2012) both verified on islamic banking relationship and contribution towards the economic growth of bangladesh and indonesia was found to have a positive significant relationship both in short run and long run with the bi-directional relationship. later, (manap, abduh, & omar, 2012) further investigate the causal relationship between islamic financial development and economic growth in the context of malaysia by employing the toda and yamamoto wald test. the results indicate that islamic financing granger causes economic growth but not vice versa which is consistent with schumpeter’s view of supply-leading hypothesis where it is believed that financial development promotes economic growth. in addition, al-oqool, et. al. (2014) in their study of financial islamic banking development and economic growth in jordan results that bi-directional long run granger exists between real gdp and total finance of jordanian islamic banks, which reflect the positive contribution of jordanian islamic banks to the economic development. however, their short run causality indicates no significant relationship between these two (financial islamic banking development and economic growth). surprisingly, different finding opted by furqani & mulyany (2009) where their study found that only in short run, the fixed investment granger cause islamic bank. in the long run, it possesses bidirectional relationship between the islamic bank and fixed investment which support the ‘demand following’ hypothesis of gdp and islamic bank where an increase in gdp causes islamic banking to develop and not vice versa. on the other hand, even though using almost similar time span data, this finding was inverse to (majid & kassim, 2010) whereby it was concluded that the relationship is supporting the supplyleading interpretation. uniquely, (johnson, 2013) study on the role of islamic banking in economic growth revealed that on average, countries with islamic banks possess much-advanced population growth rate, added muslim shares of the population, a bottomless financial system, and greater gdp per capita than countries without islamic banks. however, while using the exogenous instrument in 2sls regression, results show that islamic bank is not significantly correlated with economic growth. moreover, while examining the role of banking during the process of economic development evolves over time, demirguc et.al (2012) found the relationship between economic activity and bank development decreases with economic development, while the relationship between economic activity and securities market increases during growth. ensued from the present studies on islamic financial framework, this paper meant to narrow the literature gap in the discussion of determining the relationship and contribution of islamic banks towards economic growth, specifically in malaysia. furthermore, to achieve a more dynamic result compare to other studies, this paper employs a battery of time series econometric techniques to attain bottomless analysis. iii. methodology the empirical data and analyses in this paper cover an 8-year-period using quarterly time – series data (2007: q1-2014:q1) which should be adequate to test the short – run and long –run relationship between the independent and dependent variables. the data series required involves real gross domestic product (gdp), a total deposit of islamic bank, total financing of an islamic bank, total assets of an islamic bank and nonperforming loan of an islamic bank. the data are obtained from bank negara quarterly statistical bulletin, imf’s international financial statistics database (ifs) and complemented by data from www.econstats.com for chosen years. first of all, we assume that real gdp is a function of its macroeconomic variables as expressed by equation below; ),,,( nplibtaibtfibtdibfrgdp  next, to examine this relationship the generic model applied takes the form as follows; ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 tttttt lnnpliblntaiblntfiblntdiblnrgdp   43210 (1) where: lnrgdp = natural log of real gross domestic product lntdib = natural log of total deposit of islamic bank lntfib = natural log of total financing of islamic bank lntaib = natural log of total assets of islamic bank lnnplib = natural log of nonperforming loan of islamic bank 𝜀𝑡 = error terms based on the vector auto regression (var), the above – mentioned equation (1) has 5 variables and can be written as follows;                                                                         5 4 3 2 1 1 1 1 1 1 5 4 3 2 1 )( et et et et et lnnplib lntaib lntfib lntdib lnrgdp lr a a a a a lnnplib lntaib lntfib lntdib lnrgdp t t t t t t t t t t where r is known as 5 × 5 matrix polynomial parameter estimators, (l) is lag length operators, a is an intercept vector and et is gaussian error vector with mean zero and ω is a varian matrix. firstly, we utilise the most common method used in the unit root test namely; (i) augmented dickey-fuller (adf) and phillips – perron (pp) tests to determine the variables stationarity properties. in order to avoid spurious results, we have conducted the test for the stationarity. time series is considered as stationary if a series is mean – reverting, that is, the series repeatedly returns back to its mean and does not have a tendency to drift (asmy et al, 2010). therefore, if the mean and variance of the series are constant over time, while the value of the covariance between two periods depends only on the gap between the periods and not on the actual time at which the covariance is considered, then the series is stationary. but if one of the above conditions is not fulfilled, then the series is non-stationary (paramaiah and akway, 2008). second, we proceeded with cointegration tests suggested by johansen (1988) and johansen and juselius (1990). this test provides information in regards to the variables associated in the long run, which particularly measure the real gdp and other explanatory variables are tied together in the long run. thirdly, we further our analysis by using vecm where it is widely known as restricted vector autoregression (var) and used for non-stationary variables known to be cointegrated. generally speaking, vecm restricts the long – run behaviour of endogenous variables to converge to their cointegrating relationship whereas induce short – run adjustment dynamics take place. moreover, by using vecm, it allows us to differentiate the short – run and long – run association of the variables given specified time period. the variables might have dispersed in the short – run from one another which may cause disequilibrium in the system. therefore, the statistical significance in regards to the coefficient associated with ect (-1) will give us an error correction that drives the variable back to the long – run relationship (gujarati, 2009). the next would be granger causality test which aims to see how many directions the variables will have a relationship in the short run. the reason for checking the short – run relationship is to know whether the lags of one variable enter into the equation for another variable (gujarati, 2009). basically, there are two major steps involved in conducting granger causality tests namely; (i) data that are stationary needed and (ii) selection of lag length criteria. therefore, for this study, we used akaike information criterion (aic) to determine lag length structure. lastly, the study proceeded with the variance decomposition (vdc) and impulse response function (irf). these two analyses portray the behaviour of a surprise to each variable on its own future dynamics and future dynamics of other explanatory variables in the system. the vdc is used to capture the percentage of unpredicted deviation in real gdp accounted for by surprise in explanatory variables. on the other hand, irf is used to identify the causal dynamic interaction among variables. to produce irf graphical analysis, it is required to make sure the variables in the system are in order and that a moving average process represents the system. iv. empirical findings a. unit root test in determining the variables stationarity, we applied the adf and pp tests for unit root tests. the aim for running these tests is to check whether the null hypothesis has a unit root against the alternatives that it does not. both of these tests are conducted with the trend and intercept hassanudin et.al (2013). in addition, akaike information ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 criterion (aic) has been used to determine the optimal lags after testing for first and higher order serial correlation in the residuals. the investigation using the adf and pp shows that there are no variables having unit root at level. however, unit root is obtained when the first difference condition of all variables are conducted using the same adf and pp test by comparing the level using 1%, 5% and 10% alpha values (see table 2). table 2. unit root test variab les level first difference adf pp adf pp lnrg dp 1.457 188 1.454 704 4.95039 1* 5.03950 6* lnta 3.183 900 3.205 909 6.27095 9* 6.63029 5* lntf ib 2.366 603 2.004 564 3.48727 6*** 3.37115 5*** lntd ib 2.348 313 1.964 474 5.07676 0* 18.9732 4* lnnp l 2.092 265 1.216 636 1.05282 1* 5.24888 0* note: values based on mackinnon (1996) onesided p-values. the value in parenthesis refers to tstatistic. *, **, *** indicates significance at 10%, 5% and 1%. source: author’s own b. cointegration test a set of variables will be cointegrated if a linear combination of the variables is stationary even though the variables are not stationary individually. if there is evidence of cointegration, then there will be long–run equilibrium among the variables (hassanudin et.al 2013). in this study, by employing the johansen and juselius cointegration test, we compare the value of the likelihood trace statistic (lts) and max – eigen statistic (me) with the 5% critical value and it was found that there exists only one cointegration in the long run (see table 3). therefore, there is a long-run unique cointegrating vector governing the long run relationship among the variables. it means that there is a one cointegrating long–run association among real gdp, islamic bank total deposit, islamic bank total financing, total assets of an islamic bank and non – performing loan of an islamic bank. table 3. johansen-juselius cointegration tests hypothesi zed trace maxeigen critical values (5%) no. of ce(s) statisti c statisti c trace maxeigen r = 0 78.338 5** 37.357 7** 69.81 88 33.87 68 r ≤ 1 40.980 7 20.414 2 47.85 61 20.41 42 r ≤ 2 20.566 5 10.738 2 29.79 70 10.73 82 r ≤ 3 9.8282 8 8.0819 8 15.49 47 8.081 98 note: the test statistics are compared to the critical values from mackinnon – haug – michellis (1999) with trend assumption; linear deterministic trend. *, **, *** denotes significant at 10%, 5% and 1% significance levels. lag interval: 1 to 1 (based on optimal lag test) source: author’s own c. estimation of long – run equation using the vector error correction model (vecm) in order to come out with the long–run equation, we have used the vector error correction model (vecm). this estimation method will provide information regarding the velocity of adjustment on the instability relationship from short–term to long term equilibrium. variables that are not stationary at the level will be analysed by testing the unit root at the first difference level. this application of first difference data can eliminate the long-term information in the study. for this reason, vecm will be used in order to anticipate a loss of long-term information as long as the data are cointegrated. table 4 shows the long–run equation derived from the vecm modelling depicts the long-term relationship among the variables with the number in parentheses being the t-ratios. table 4. vector error correction model (vecm) explanatory dependent variable variables coefficient tstatistics lntdib -0.5228 2.5059** lntfib -0.1217 1.3337** ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 lntaib -1.2606 2.5390** lnnplib 0.4720 6.0069** c -22.1657 𝑅2= 0.9517 f – statistic = 18.3256 (0.0000) jarque bera =3.4833 (0.1752) diagnostic test dw= 1.5384 lm = 3.2350 (0.1984) arch = 0.3574 (0.0054) note: (t_table for alpha 5% = 1.67. dw represent durbin-watson test, lm refers to the lagrange multiplier statistic for serial correlation form and arch represents the test for autoregressive conditional heteroscedasticity. *, **, *** denotes significant at 10%, 5% and 1% significance levels source: author’s own thus, the final long-run vecm equation derived is as follows: lnrgdp t-1 = 44.627 – 0.5228lntdib t-1 – 0.1217 lntfib t-1 – 1.2606lntaib t-1 + 0.4720lnnplib t-1 or lnrgdp t-1 = 44.627 + 0.5228lntdib t-1 + 0.1217 lntfib t-1 + 1.2606lntaib t-1 – 0.4720lnnplib t-1 t-stat [2.5059] ** [1.3337] ** [-2.5390] ** [6.0069]** the equation above indicates the respective signs of all variables in the long-run. the negative sign in total deposit and total financing shows that any increase in total deposit and total financing in islamic banking will cause an increase in economic growth and it is statistically significant (p=0.001). this is very true and robust for malaysia economic growth where financial sectors include both conventional and islamic banking contribution towards economic growth is expected to grow significantly at 8.6 percent in 2010 to between 10 and 12 percent by 2020. the result shows that the role of financial sectors is very important in achieving good economic growth. in malaysia, the deposit of islamic banking as of 2012 was rm386.2 billion with the market share of 25.6 percent. on the other hand, total financing of this industry was at rm315.0 billion with the market share of 25.8 percent. in addition, the islamic banking financing is expected to account for 40 percent of total financing in malaysia by 2020 (bimb report, 2012). the findings further stipulated that as islamic banking grows, it will stimulate the economic growth of malaysia as this industry continuously received a good support from malaysian government which may significantly contribute to the higher economic growth especially in the real sector. for example, since 2006, the malaysian government has implemented various strategic positioning and international integration global systems where it can let malaysia become a strategic hub for islamic finance which may further enhance malaysia economic growth and development. this is consistent with furqani and mulyany (2009) where they have found that there is strong evidence of a bidirectional relationship between islamic banking total deposit and total financing towards economic growth in malaysia. this study was carried out using time – series such as cointegration and granger causality test analysis between 1997: q1 and 2005. in addition, our result is also consistent with abduh and chowdury (2012) where they have utilised quarterly time series data from 2004 till 2011 and employed various econometric techniques. the results show there is strong justification where islamic bank financing and deposit have a positive relationship with bangladesh economic growth in both long and short run. as for total assets of islamic banking in malaysia, it shows that there positive and significant relationship (p=0.000) towards economic growth. to be simple, if the islamic banking total asset increases, it will stimulate malaysia economic growth. as reported by bimb reports, 2012, it is very clear that islamic banking total asset represents 23.8 percent of the total proportion of banking systems in malaysia which is equivalent to rm494.6 billion. the annual growth rate of islamic bank total asset in malaysia was about 18.6 percent between 2008 and 2012. in contrast, conventional banking assets growth was about 9.3 percent during the same time period. in addition, the islamic banking assets in malaysia are more than usd132 billion as at end november 2013 without taking into account the development financial institution (dfis) and the worldwide with dfis statistics, malaysian islamic banking total assets represent 13 percent share of global islamic banking. this further shows that this industry popularly gaining acceptance from the public especially from the non-muslim customer (mifc, 2013). as the total asset size increases, it indicates that this industry is highly stable in term market capitalisation where it can build an inclusive financial system and replace the shadow economy and indirectly contributes to the economic growth. this finding supports yusof and bahlous (2013) findings where they have utilised the panel ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 cointegration analysis, they found that islamic bank total assets contribute to economic growth both in the long run and the short run for both gcc countries and selected east asia countries including malaysia. in addition, they have also postulated that in the short run islamic banking contributes more to economic growth in malaysia and indonesia compared to the gcc countries. the same was result found by abduh and omar (2012) for indonesian market by adopting ardl approach. as for islamic bank non-performing loan (npl), an inverse relationship between npl and economic growth (p=0.001) is recorded. generally, npl is one of the most important factors which cause reluctance for the banks to provide credit assistance to the borrower. the higher the npl, it requires the bank to raise a provision for loan loss, and subsequently causes bank revenue to decrease because of cutting down the fund for new lending. as for islamic bank, many empirical literature has proven that npl for islamic bank is much lower in compared with the conventional bank as islamic bank practices are based on profit and loss sharing basis. lower the level of npl, lower would be the default risk in islamic bank which can indirectly contribute to the higher economic growth. this negative relationship is also similar to past studies in regards malaysian islamic bank relationship with economic growth by ryu et.al (2012), rahim and zakaria (2013) where they suggest that islamic banking system in malaysia are much more stable and sound in term of lower npl level (low default risk) compared with conventional banking (high default risk due to higher npl where it has contributed positively towards economic growth. the diagnostic test has been conducted to test the robustness of the error correction model and the result shows there was no evidence to prove normality failure, serial correlation and autoregressive conditional heteroscedasticity (arch) effect in the disturbance. therefore, we conclude that the model is pertinent for this study. d. granger causality test after estimating the long-run vecm model, then we proceed to the short-run granger causality test. with cointegration, the dynamic causal interactions among the variables should be phrased in a vector error correction form. this allows us to assess both long-run and short-run causality, respectively, on the 2  -test of the lagged first differenced terms for each right-hand-side variable and the t-test of the error correction term. the results of the test are presented in table 4 and the causal channels are summarised in table 5. table 5. granger causality results based on vecm independent variables dep ende nt 2  -statistics of lagged 1st differenced term [p-value] ec tt-1 coef ficie nt vari able δl nr gd p δl nt dib δl nt fib δl nt aib δln npl ib (trati o) δlr gdp - 0.24 75 [0.6 188] * 1.58 35 [0.2 082 ] 2.94 79* [0.0 860 ] 6.94 10** [0.0 084] 0.93 48* * (4.34 03) δln tdi b 2.98 82* [0.0 839] - 11.2 954 ** [0.0 008 ] 2.51 86 [0.1 125 ] 12.4 118* ** [0.1 125] 0.31 99* * (1.8 694 ) δln tfi b 0.10 63 [0.7 443] 0.84 90 [0.3 568] - 0.12 65 [0.7 221 ] 1.63 02 [0.2 017] 0.24 06 (0.7 781 ) δln tai b 0.79 81 [0.3 717] 0.33 62 [0.5 620] 2.47 02 [0.1 160 ] -0.76 61 [0.3 814] 0.91 91 (1.5 642 ) δln npl ib 1.00 92 [0.3 151] 4.54 94 [0.0 329] ** 3.60 38 [0.0 576 ]* 0.41 74 [0.5 182 ] -0.67 44 (1.8 462 ) note: *, ** and *** denotes significant at 10%, 5% and 1% significance level, respectively. the figure in the parenthesis (…) denote as t-statistic and the figure in the square brackets […] represent as pvalue. source: author’s own ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 figure 1. causal channel from granger causality tests source: author’s own as shown in table 5 and figure 1, it is very clear that in the short – run there is bidirectional causality between lnrgdp and lntdib. on the other hand, the bidirectional relationship also exists between lnnplib and lntdib. therefore, we can reject the null hypothesis and it is significant at 5 percent. in addition, the majority of the variables have unidirectional causality in the short – run where lnrgdp granger cause lnnplib, lnrgdp granger cause lntaib, lnnplib granger cause lntfib and lntdib granger cause lntfib. all these variables are statistically significant at 10 percent and 5 percent. e. variance decomposition and impulse response function the result of vecm indicates the exogeneity or endogeneity of a variable in the system and the direction of granger-causality within the sample period. however, it does not provide with the dynamic properties of the system. the analysis of the dynamic interactions among the variables in the post-sample period is conducted through variance decompositions (vdc) and impulse response functions (irf). therefore, we proceed to check this via vdc and irf. the variance decomposition (vdc) will show the variation of percentage of forecast error of variable that explained by another variable in the short-run dynamic interaction. vdc and irf were conducted based on var specification and we have chosen lag length 2 where it was full enough to measure error terms that are serially uncorrelated. the flow of variables direction is consistent with abduh and chowdury (2012) and murumba (2012). based on table 6, the result shows the vdc at 12 – month and 24 – month time horizon. the result also indicates the existence of an interaction between the dependent variable with the explanatory variables. as we can notice from the table 6, the variation of output forecast error variance in real gdp contributed by its own variations where it is accounted for 21.13% for the 12 – month. the innovation in explanatory variables such as tdib, tfib, ta and npl were accounted for 5.25%, 66.52%, 0.74% and 6.34%. however, after 24 months, rgdp reduces to 18.76% where it was due to its own variation. followed by innovation in tdib, ta where the fraction has increased slowly, namely, 7.16% and 1.37%. in addition, the variation in tfib was huge where the fraction of tfib has inclined to 60.84% after 24 –month time horizon. on the other hand, another major innovation was occurring in npl where the fraction was predominantly increased to 11.86%. table 6. result of variance decomposition analysis varia nce deco mposi tion of pe rio d innovations in ln rg dp ln tdi b ln tfi b ln tai b ln np lib lnr gdp 1 2 2 4 21. 135 37 18. 763 52 5.2 507 96 7.1 635 23 66. 525 15 60. 845 13 0.7 445 30 1.3 719 19 6.3 441 54 11. 855 91 lnt dib 1 2 2 4 2.8 626 76 3.1 605 93 34. 371 18 31. 847 81 26. 035 64 22. 715 69 4.0 418 17 4.6 213 63 32. 688 69 37. 654 54 lnt fib 1 2 2 4 1.3 749 90 1.9 286 10 8.7 480 31 12. 004 42 71. 970 50 60. 677 57 2.1 814 52 2.9 130 74 15. 725 03 22. 476 33 lnt aib 1 2 2 4 0.6 590 22 1.3 013 34 31. 756 81 29. 432 45 38. 317 20 32. 468 04 11. 812 00 10. 042 96 17. 454 97 26. 755 21 lnn plib 1 2 2 4 11. 974 20 10. 535 01 20. 254 23 21. 397 22 16. 192 45 16. 622 39 11. 959 05 10. 870 33 39. 620 07 40. 575 06 source: author’s own ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 as shown in figure 2, we have identified several interesting relationships in the short -run and long run. as seen from figure 2, the results of irf is consistent with vdcs where rgdp response positively for a shock in tdib and tfib. between 13 months, tdib increased gradually and become slow in the long-run (10 months). in addition, this result confirms the movement of tdib is consistent with the granger causality test. in the case of tfib, it was positively slow during 1 – 3 months but increased gradually in the long-run. consistent with long run equation, rgdp where respond positively stable towards shock in ta in the short-run and long-run. the same result was found for npl where it is consistent with long – run equation where innovation in rgdp responds negatively during short-run and positively in the longrun. figure 2. result of impulse response function (irf) source: author’s own iv. conclusion and policy recommendations this purpose of this study is to add value to the literature on the contribution of islamic banking towards economic growth in malaysia by looking at various diffusions of islamic key performance indicators. using cointegration methodology, the findings indicate that islamic bank does contribute to the malaysian economic growth in the long – run and short-run. this finding is supported by previous evidence where islamic banking did contribute to the economic growth (yusof and bahlous, 2013; and abduh and chowdury, 2012). hence, it is very clear that islamic banking and finance (ibf) are experiencing marvellous growth around the world and also in malaysia. as identified by ernst and young (e&y), world islamic banking competitiveness report (2012-2013) stated that malaysia has emerged one of the six significantly important markets for ibf together with saudi arabia, qatar, bahrain, indonesia, turkey and the united arab emirates. moreover, as reported by the economist magazine, over a fifth of malaysia’s banking system was already shariah – compliant and the ability to capture a larger slice of the global sukuk or islamic bond market in 2014. there are many factors contribute to such a remarkable achievement such as population where in malaysia, over 60% of the population are muslims, the role of government in promoting ibf, collaboration among banks, standard guidelines in regards rules and regulations pertaining to shariah and many other factors. in addition, as of november 2013, mifc reported that the islamic banking assets in malaysia were already reached usd132 billion and it is also representing 13 percent of the global banking assets. moreover, the role of malaysian government has also stimulated further development of ibf and prime minister yab dato’ sri mohd najib bin tun abdul razak highlighted the benefits of the country’s islamic finance sector to the global financial community by touting malaysia as the world’s islamic finance marketplace and malaysia has also show intention to introduced maqasid al shariah index which will take place very soon. therefore, it is very clear that the islamic banking has been the lynchpin and key factor for malaysia’s successful transformation, especially in the banking industry. these are all credible and praiseworthy efforts but the government must be wary that many issues which presently exist that obstruct the development of ibf in malaysia need to be quickly addressed and dealt with so that there would be a greater contribution by islamic banking towards malaysian economic growth. such issue would include the global regulatory reforms in terms of capital and liquidity, product innovation, macroprudential measures, war for talents and global market condition. however, there are a few limitations in this study where the numbers of variables are questionable. this is because there would more key performance indicators for islamic that may have a significant impact that can be used in this study to obtain comprehensive results. in addition, the numbers of years covered in this study were less due to the limited data provided by bank negara statistical reports. worth to mention, future researchers nevertheless still required in this broad area of ibf in malaysia whereby other relevant variables and .0 4 .0 2 .0 0 .0 2 .0 4 .0 6 2 4 6 8 10 response of lnrgdp to lnrgdp .0 4 .0 2 .0 0 .0 2 .0 4 .0 6 2 4 6 8 10 response of lnrgdp to lntdib .0 4 .0 2 .0 0 .0 2 .0 4 .0 6 2 4 6 8 10 response of lnrgdp to lntfib .0 4 .0 2 .0 0 .0 2 .0 4 .0 6 2 4 6 8 10 response of lnrgdp to lnta .0 4 .0 2 .0 0 .0 2 .0 4 .0 6 2 4 6 8 10 response of lnrgdp to lnnpl .0 2 .0 1 .0 0 .0 1 .0 2 .0 3 .0 4 2 4 6 8 10 response of lntdib to lnrgdp .0 2 .0 1 .0 0 .0 1 .0 2 .0 3 .0 4 2 4 6 8 10 response of lntdib to lntdib .0 2 .0 1 .0 0 .0 1 .0 2 .0 3 .0 4 2 4 6 8 10 response of lntdib to lntfib .0 2 .0 1 .0 0 .0 1 .0 2 .0 3 .0 4 2 4 6 8 10 response of lnt dib to lnt a .0 2 .0 1 .0 0 .0 1 .0 2 .0 3 .0 4 2 4 6 8 10 response of lntdib to lnnpl .0 8 .0 4 .0 0 .0 4 .0 8 2 4 6 8 10 response of lntfib to lnrgdp .0 8 .0 4 .0 0 .0 4 .0 8 2 4 6 8 10 response of lntfib to lntdib .0 8 .0 4 .0 0 .0 4 .0 8 2 4 6 8 10 response of lntfib to lntfib .0 8 .0 4 .0 0 .0 4 .0 8 2 4 6 8 10 response of lnt f ib to lnt a .0 8 .0 4 .0 0 .0 4 .0 8 2 4 6 8 10 response of lntfib to lnnpl 5,00 0 0 5,00 0 10 ,0 00 15 ,0 00 2 4 6 8 10 response of lnta to lnrgdp 5,00 0 0 5,00 0 10 ,0 00 15 ,0 00 2 4 6 8 10 response of lnt a to lnt dib 5,00 0 0 5,00 0 10 ,0 00 15 ,0 00 2 4 6 8 10 response of lnt a to lnt f ib 5,00 0 0 5,00 0 10 ,0 00 15 ,0 00 2 4 6 8 10 response of lnt a t o lnt a 5,00 0 0 5,00 0 10 ,0 00 15 ,0 00 2 4 6 8 10 response of lnt a to lnnpl .0 4 .0 0 .0 4 2 4 6 8 10 response of lnnpl to lnrgdp .0 4 .0 0 .0 4 2 4 6 8 10 response of lnnpl to lntdib .0 4 .0 0 .0 4 2 4 6 8 10 response of lnnpl to lntfib .0 4 .0 0 .0 4 2 4 6 8 10 response of lnnpl to lnt a .0 4 .0 0 .0 4 2 4 6 8 10 response of lnnpl to lnnpl response to cholesky one s.d. innovations ± 2 s.e. ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 more sophisticated statistical measures are applied. apart from that, future research must concentrate on a comparable study among other countries to obtain a significant picture on how does islamic bank would contribute to the economic growth. moreover, future research should concentrate on pre and post crisis analysis in regards islamic banking and economic growth. references abduh, m., & chowdhury, n. t. (2012). does islamic banking matter for economic growth in bangladesh? journal of islamic economics, banking and finance, 8 (3), 104-113. abduh, m., & omar, m. a. (2012). islamic banking and economic growth: the indonesian experience. international journal of islamic and middle eastern finance and management, 5(1), 35-47. al-oqool, m. a., okab, r., & bashayreh, m. (2014). financial islamic banking development and economic growth: a case study of jordan. international journal of economics and finance; vol. 6, no. 3, 72-79. bacha, o. i. (2004). dual banking systems and interest rate risk for islamic banks. mpra paper 12763, university library of munich, germany, revised mar 2004. demirguc, k., feyen, a., & levine, e. r. (2012). the evolving importance of banks and securities markets. national bureau of economic research working paper no. 18004. furqani, h., & mulyany, r. (2009). islamic banking and economic growth: empirical evidence from malaysia. journal of economics cooperation and development, 59-74. gheeraert, l. (2014). does islamic finance spur banking sector development? journal of economic behavior & organization, 1-17. hassan, m. k., & bashir, a.-h. m. (2003). determinants of islamic banking profitability. 10th erf annual conference, morocco, 16-18. hassan, m. k., sanchez, b., & yu, j.-s. (2011). financial development and economic growth in the organization of islamic conference countries. journal of king abdulaziz university: islamic economics, vol. 24 no. 1, 145-172. hassanudin.m.t.t, tan.s.e, & vaidik.s. (2013). export led growth hypothesis: econometric evidence from malaysia. journal of international business and economy. vo.14 (2)., 95-112. hermes, n., & lensink, r. (2003). foreign direct investment, financial development and economic growth. the journal of development studies, 142-163. iqbal, z. (1997). islamic financial systems, finance and development. 42-45. johnson, k. (2013). the role of islamic banking in economic growth. cmc senior theses. paper 642. majid, s. a., & kassim, s. (2010). islamic finance and economic growth: the malaysian experience. paper presented at kuala lumpur islamic finance forum, kuala lumpur, 2-5 august 2010. manap, t. a., abduh, m., & omar, m. a. (2012). islamic banking-growth nexus: evidence from toda-yamamoto and bootstrap granger causality test. journal of islamic finance, vol. 1 no. 1, 59-66. maximilian j.b. hall, h. a., & muljawan, d. (2000). a capital adequacy framework for islamic banks: the need to reconcile depositors’ risk aversion with managers’ risk taking. proceedings of the fifth harvard university forum on islamic finance: islamic finance: dynamics and development, 21-42. rajabi, e., & muhammad, j. (2014). the stock markets, banks and growth nexus: asian islamic countries. economic notes vol. 43, no. 2-2014: review of banking, finance and monetary economics, 137-165. volker, n. (2006). islamic economic system – a threat to development? mpra paper no. 6449. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 using islamic finance for infrastructure projects in non-muslim countries 1 university of turin, italy, paolo.biancone@unito.it 2 university of turin, italy, mohammad.shakatreh@unito.it abstract— using islamic project finance is the solution to fill the gap between infrastructure demand and available finance. this study aims to investigate if it is appropriate to use islamic finance to fund the infrastructure project, as one specific sector that is facing major challenges in long-term financing, and it intends to select the most appropriate instrument that is inconsistent with non-muslim countries’ law and culture. the methodology and approach that will be used is a qualitative method which is used to study the islamic financial tools, compare them with other financial instruments, and discuss the potential implementation of islamic project finance structure to fund the infrastructure project in italian environment. the study concentrates on exploring the italian laws that are resembled to shariah principle in order to make it more acceptable for the italian culture. the study concludes that using islamic finance can be used to finance infrastructure projects by using existing laws and regulations. this study is also expected to benefit the italian government and investors in making their financial decision, and it will be a new experience for europe countries. keywords: islamic project finance, shariah principle, islamic financial instrument, infrastructure project. i. introduction after the financial crisis, the traditional sources of investment financing are all facing challenges,[1] the global crisis have shed the light on the islamic finance system. after the appearance of islamic finance, the capital market has provided more alternatives for investors, companies and governments that need finance. funding resources are drying out and has become more expensive; thus forcing governments, banks, and corporations alike to seek alternatives outside the interest-based system. one alternative that has received wide attention is islamic finance and its crown jewel—sukuk.[2] sukuk created a framework for participation of a large number of people in financing project in public and private sectors, including those of infrastructure such as roads, bridges, ports, airports, etc. on the basis of various modes.[3] in europe, islamic finance offers a unique proposition through alternative ethical driven products and services. these are capable of further enhancing trade and financial linkages between the eu and various oic countries, where islamic finance has a deep presence [4]. islamic finance is growing at 10 to 15 present per year; it is one of the fastest growing areas of the global financial service industry [5], and the spread of islamic finance into western market demonstrates that it is now being viewed by investors, financial institutions and regulators as a viable alternative to conventional products. this paper aims to investigate if it is appropriate to use islamic finance to fund the infrastructure projects in nonmuslim countries, and select the most appropriate instrument that is inconsistent with law and culture for those countries. moreover, it attempts to overcome the lack of acceptance of islamic finance in non-muslim countries, and the challenges that could face the islamic project finance in non-muslim countries, and convince the decision makers about the benefit of these financial tools by comparing it with conventional bond. in the absence of the italian islamic finance law, the study concentrates on exploring the italian laws that are resembled to shariah principle in order to make islamic finance more acceptable for italian culture; in other words, we try to find islamic project finance structures which are both shariah compliant and compatible with the conventional products. the methodology and approach that will be used is qualitative and theoretical method. the paper will use the theoretical method to understand the islamic finance, infrastructure project and finance tools available for funding this project. making a comparison between bond and sukuk. the paper will examine the implementation of sukuk to fund infrastructure project, by using ijarah and musharkah contract in italian environment, and that will be a real example of using islamic finance in non-muslim countries. the paper proceeds as follows. section ii provides the islamic finance. section iii talks about infrastructure project characteristics and the financing method. section iv provides the information about islamic project finance .section v illustrates the sukuk. section vi explains the difference between the bond and sukuk. section vii demonstrates the main challenge and limitation that can be faced in the implementation. section viii includes a real implementation of sukuk in finance infrastructure project in italy. section ix concludes this paper. paolo pietro biancone 1 and mohammad ziad shakhatreh 2 mailto:paolo.biancone@unito.it mailto:mohammad.shakatreh@unito.it ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ii. islamic finance islam is a way of life, and islamic finance is a part of the overall islamic religion, therefore muslim people need to make their finance consistent with religion. islamic finance system is based on islamic religious law (shariah). the basic islamic finance principle is that money has no intrinsic value and is just a means of exchange, an individual or an institution should not be able to generate income from money; financing under islamic principles is typically based on the exchange of, in general, non-liquid assets with the principle’s aim to create real assets and inventories. we can summaries the main islamic finance shariah principle as the following: the first principle is prohibition of (riba) interest. riba as it is used in the arabic language which means the excess or increase; the interest means any added amount paid by the borrower to the lender more than the principle amount as cost of borrowing; islam has replaced the interest with profit and loss-sharing principle, means that any returns must be earned from real commercial trading, and there is no guarantee of the principle or return, risk and profit must be shared equally between the parties of a transaction. the second principle is the prohibition of gharar "uncertainty or speculation‖. the trading under uncertainty in financial transactions must be eliminated. however, risk-taking is allowed when all terms and conditions are clearly stipulated and known to all parties. the third principle is the use of asset-backing. each financial transaction must relate to a tangible and/or identifiable underlying asset, ensuring that islamic banks remain connected to the real economy. [5] the fourth principle is prohibition of haram investment; any transactions that involve alcohol, pork, prohibited drugs, and pornography. the fifth principle is prohibition of maysir in arabic means gambling which is hazard game of chance and it is considered as an extreme form of gharar. it refers to all transactions that have the element of gambling i.e. based merely on chance. the logic behind the prohibition of maysir is that the unjustified gains and increase of wealth through games of pure chance is a transfer of wealth from one to another and this kind of transfer is done on the expense of the society. [6] iii. financing infrastructure project advanced economies face the challenge of maintaining extensive transport, power, water, and telecommunication networks, upgrading and modernizing them as growth flags. in the developing world, countries dedicate a large proportion of their national income just to meet basic human development needs (access to water and sanitation, electricity, and allweather roads, for instance) and still cannot cater to large swaths of their populations. the challenge in these countries is becoming even more daunting as rapid growth on fuels demand for infrastructure to support economic and social development. infrastructure is a corner stone of a stable and productive society. the right approach to delivering and maintaining transport, housing, energy, water, and communication infrastructure is essential to create a strong and competitive economy and provide social services. while infrastructure presents unique challenges, it also offers opportunities for both the public and private sectors. [7] the mckinsey global institute estimates $57 trillion in infrastructure investment will be required between now and 2030—simply to keep up with projected global gdp growth, the task of funding the world’s infrastructure needs is more difficult because of the constraints on public-sector budgets and commercial debt in the wake of the financial crisis, higher and more volatile resource costs, and the additional costs of making infrastructure resilient to climate change and less harmful to the environment[7]. building infrastructure is a capitalintensive process, with large initial cost and low operating cost. it requires long-term finance as gestation period, for such projects is much longer than for a manufacturing plant. infrastructure projects are characterized by non-recourse or limited recourse financing, that is, lender can only be repaid from revenue generated by the project.[8] since large amounts are typically invested for long periods of time, it is not surprising that the underlying risks are also quite high.[9] in addition to project finance, other financing structure are available for infrastructure and other project. these include (i) government funding, through grant, loans, and guarantee; (ii) government investment (iii) third party project participant financing; such as from equipment suppliers, off take purchasers, and construction financing from contractors (iv) non-project finance structure from multi–and bilateral agencies and from banks and other lenders, in reliance on the assets of creditworthy project sponsor or creditworthy host government,(v) capital market financing, in reliance on the assets of a creditworthy project sponsor or creditworthy host government (domestic bond offering, eurobond offering, private placements), and (vi) securitization. [10] while additional government funding for new infrastructure may come from privatization of existing infrastructure assets, this is unlikely to be enough for many infrastructure projects such as military infrastructure or public schools, pure public procurement may be the only feasible option and may absorb large shares of public funding capacity. the key sources of increasing infrastructure demand such as the large infrastructure gap in developing economies or the shift to renewable energy sources in developed economies will therefore require additional sources of financing from the private sector.[11] many governments turn to the private sector to design, build, finance, and/ or operate new and existing infrastructure facilities in order to improve the delivery of services and the management of facilities hitherto provided by the public sector.[12] the private sector in publicprivate partnership (ppp) can be either islamic bank or islamic finance instruments in project finance, because the primary feature of a ppp is that it is a contract or an arrangement between a government entity and a private entity. ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 european investment bank has been estimated that the eu’s infrastructure investment needs to meet the europe 2020 objectives could reach as much as eur2tln in the sectors of transport, energy and information technology. in order to maintain the region’s competitive position globally and to meet the future demand for infrastructure, european states are actively looking for alternative funding sources. increasingly, the focus is shifting toward public private partnerships (ppps) and institutional investor driven fundraising. in this regard, islamic finance presents yet another avenue for raising funds for infrastructure projects in europe. sukuk could be used to supplement the europe 2020 project bond initiative which is intended to enable the issuance of long-term bonds by project companies. [4] iv. islamic project finance project finance is used to fund infrastructure project, project finance defined by the international project finance association (ipfa) as the financing of long-term infrastructure, industrial projects and public services based upon a non-recourse or limited recourse financial structure where project debt and equity used to finance the project are paid back from the cash flow generated by the project. 1 project financing has evolved through the centuries into primarily a vehicle for assembling a consortium of investors, lenders and other participants to undertake infrastructure projects that would be too large for individual investors to underwrite [13] project finance is a debt financing of specific assets securitized by expected cash flows and the asset itself. [14] project financing is a structured financing that needs a special purpose vehicle (spv) in the form of a company to run the project and sponsors to contribute equity and debt. an spv can consist of sponsors, equity investors, off-take purchasers, bondholders, lenders, government, constructors, suppliers and operator. all the stakeholders are managed through contracts and arrangements [15]. in the project finance mode, interlocking contracts covering almost every aspect of operations especially those related to capital structure circumscribe managerial autonomy. furthermore, cash flows are isolated, and restricted to a single-purpose capital asset with the life of the project finance firm (usually a special-purpose vehicle) limited to the life of the asset [16]. the islamic project finance is expected to be one of the best alternatives in infrastructure financing. in order to make it complied with shariah principle, we can use diverse islamic finance tools in project finance, and islamic finance is suitable to finance the infrastructure investment, because infrastructure is an asset and it does not contain any activities that are prohibited in the shariah [15]. some of islamic financial instruments can be used in infrastructure project like musharkah, mudarabah, ijarah, istisna, and sukuk.  mudarabah: a contract between the capital provider and a skilled entrepreneur, whereby the capital provider would contribute capital to an enterprise or 1 http://www.investopedia.com activity that is to be managed by the entrepreneur as the mudarib (or work provider). profits generated by that enterprise or activity are shared in accordance with the terms of the mudarabah agreement, while losses are to be borne solely by the capital provider unless they are due to the mudarib ’s misconduct, negligence or breach of contracted terms [17].  musharakah: also known as partnership or joint venture, is the cooperation between two or more parties at which each party shares equity with a covenant that profit and losses will be shared together (joint venture).  ijarah: also known as leasing, is hiring or renting an asset to gain benefit of its usufruct.  istisna: an agreement to sell to a customer a nonexistent asset that is to be manufactured or built according to the buyer’s specifications and delivered on a specified future date at a predetermined selling price [15].  sukuk are securities that comply with shariah rules and regulation, the investment is based on shariah principles which prohibits the charging of interest, which mean the profit in sukuk is not interest, but it is generated from the performance of the underlined assets [5]. the governments should have laws and codes that regulate the islamic financial process in order to use these instruments, but most of non-muslim countries don’t have codes that regulate the islamic finance at all. in order to overcome this challenge, we attempt to find the laws that are resembled to shariah principle, and we should utilize the conventional finance tools with some modification to create project finance complied with shariah. growing capital needs in the infrastructure sector globally present strong opportunities for sukuk to enhance its role as an important source of financing to the development requirements of the world economy. [18] because infrastructure does not contain any activities that are prohibited in the shariah. several studies talk about the sukuk benefits comparing with other financial tools, (usmani) said that sukuk are among the best ways of financing large enterprises that are beyond the ability of a single party to finance. and sukuk provide an ideal means for investors seeking to deploy streams of capital and who require, at the same time, the ability to liquidate their positions with ease whenever the need should arise [19]. sukuks are the most widespread between islamic financial instrument, because sukuk not confined only on muslim countries but also non-muslim countries. the sukuk has become an important vehicle for international fundraising and investment activities that generate significant cross-border flows.[5] this is shown clearly by the increasing in the number of international issued sukuk, in 2013 the international sukuk issuance closed at around usd26, and in 2014 is likely to be similar to 2013 though the encouraging change is entry of nonislamic countries plus addition of several new jurisdictions, and http://www.investopedia.com/ ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 the global sukuk market also continued its positive upward, in 2013 the global sukuk issuance reached to usd138 billion and the close of 2014 will again be in excess of 130 billion[5]. v. definition of sukuk sukuk is a plural of sakk, sukuk is an islamic financial certificate that complies with shariah principle and laws. investment sukuk as defined by aaiofi are the certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity, however, this is true after the receipt of the value of the sukuk, the closing of the subscription and employment of funds received for the purpose for which the sukuk were issued. (aaiofi 2008). sukuk frequently referred to as ―islamic bonds‖, are certificates with each sakk representing a proportional undivided ownership right in tangible assets, or a pool of predominantly tangible assets, or a business venture (such as a mudarabah), these assets may be in a specific project or investment activity in accordance with shariah rules and principles. [17] this definition includes two important points; the first is that sukuk holders must have rely ownership of the asset of the specific project. the second is that the project and the sukuk issuance procedure must be consistent with shriah principle. to be shariah-complaint, sukuk must be possible to be owned and sold legally, in accordance with the rules of the shariah. aaoifi shariah standards concerning sukuk advises islamic financial institutions and shariah supervisory boards to adhere to the following matters when issuing sukuk:  sukuk holder must have a complete ownership in real asset. the manager issuing sukuk must certify the transfer of ownership of such assets in its (sukuk) books, and must not keep them as his own assets.  sukuk, to be tradable, must not represent receivables or debts, except in the case of a trading or financial entity selling all its assets, or a portfolio with a standing financial obligation, in which some debts, incidental to physical assets or usufruct, were included unintentionally, in accordance with the guidelines mentioned in aaoifi shariah standard (21) on financial papers.  prohibition for the manager of sukuk, whether the manager acts as the mudarib (investment manager), or sharik (partner), or wakil (agent) for investment, to undertake to offer loan to sukuk holder when there is a shortfall in expected earnings, it is permissible, however, to establish a reserve account for the purpose of covering such shortfalls to the extent possible, provided the same is mentioned in the prospectus. it is not objectionable to distribute expected earnings, on account, in accordance with article (8/8) of the aaoifi shariah standard (13) on mudarabah, or to obtaining project financing on account of the sukuk holders.  it is not permissible for the sukuk manager (mudarib, sharik, or wakil) to undertake {now} to re-purchase of the assets from sukuk holders or from one who holds them, for its nominal value, when the sukuk are extinguished, at the end of its maturity. it is, however, permissible to undertake the purchase on the basis of the net value of assets, its market value, fair value or a price to be agreed, at the time of their actual purchase.  the permissibility to undertake to purchase the asset of ijarah sukuk for the remaining rental value of the remaining assets; since it actually represents its net value.  shariah supervisory boards should not limit their role to the issuance of fatwa on the permissibility of the structure of sukuk, but it must follow up all the procedures and transactions to be sure if it is complied with shariah. there are two common classifications for sukuk structure, sukuk can be classified as either an asset-based sukuk or asset-backed sukuk. under asset-based sukuk, they do not undertake true sale in the structure. sukuk holders have beneficial ownership in the asset, and the sukuk holders have resource to originator. the asset stays on the balance sheet of originator, and the source of payment comes from originator cash flows; but under the assetbacked sukuk, the sukuk holders have the full ownership of the underlying asset, this sukuk structure is therefore more in accord with shariah principles, the sukuk holders have resource to assets. the asset is separated from the originator's book, and the source of payment comes from the revenue generated by underlying asset. sukuk can be in many types depending on the contract; this contract must be complied with shariah principles. fourteen different structures have been acknowledged and these fourteen structures can be divided in three basic categories: equitybased, lease-based, and sale-based. for the equity-based sukuk, this is the sukuk al-musharakah. the lease-based sukuk, it is the sukuk al-ijarah, and for the sale-based sukuk it is the sukuk al-murabahah. [20] vi. sukuk &bond bonds is a debt instrument issued for a period of more than one year with the purpose of raising capital by borrowing, bonds is a promise to repay the principal along with interest (coupons) on a specified date (maturity). when an investor buys a bond, he/she becomes a creditor of the issuer. the buyer does not gain any kind of ownership rights to the issuer. 2 from this definition of bonds, we can discern the general difference between sukuk and bonds as followed: first, the relationship between the bond holder and the issuer is lender borrower relationship, while the relationship between sukuk holder and issuer is buyer-seller relationship; it represents a real commercial operation, it is suitable for italy because sukuk is not considered as debt instrument, and it will 2 http://www.investorwords.com http://www.investorwords.com/ ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 not increase the indebtedness. sukuk is an investment instrument, in which the sukuk units represent a partial ownership of the underlying assets with direct claim to those assets and profits in distribution or liquidation. [2] sukuks are considered as off balance sheet finance because under shariah principle, the originator should transfers the ownership of assets from its balance sheet. and the originator do not report any related debt or interest expenses on their consolidated financial statements. second, they are different in return. in case of bonds return, it is predetermined amount of interest (coupons) regardless of whether the bonds issuer achieved gain or lose. in contrast, the return of sukuk released from operating of underline asset or specific project, it reflects the profit loss relationship. the bonds guarantee the return of the principle at maturity; the bond holders have the priority to recover their money in case of liquidation and bankruptcy; but in case of sukuk, there is no guarantee for the principle, if the sukuk issuer wants to redeem the sukuk at maturity date they must repurchase it on the basis of the net value of assets, its market value, fair value or a price to be agreed, at the time of their actual purchase; therefore, the sukuk holder can make profit or lose according to purchase price. third, while determining the price of a bond depending on expectations about the movements of interest rates, the sukuk is related to the expected return of the project [21]. in fact, there is no big difference between bond and sukuk in pricing because some sukuk, such as ijarah sukuk, is related to linking distributions to the libor or sibor, similar to conventional bonds. most ijarah sukuk pay a predetermined rate of return to investors. variable rate sukuk linked to an agreed upon pricing benchmark, usually the libor, may also issue under a master lease agreement. [22] fourth, the sukuk can be acceptable to both muslim and non-muslim investor, but bond is not acceptable for muslim investor because it is interest based (riba). sukuk will be useful for both muslim and non-muslim countries, it attracts capital investment from muslim investors, and it is suitable for investors who are looking for diversify in their investment. european banks are currently being encouraged to provide islamic investment solutions, not only for their overseas arab/muslim clients, but also for domestic populations showing increased demand for shariah-compliant products. [5] fifth, in bond the originator does not have restriction in the use of funds, but in some types of sukuk, the originator loses the control over the company transactions; in other words, the issuing company (spv) must be compliant with shariah principle in every transaction. in my opinion, this restriction can be advantage especially if we know that the shariah principle is not against other religions; in fact it is ethical and fairness principle, it helps to ensure that a project is run efficiently, and to reassure the sukuk holder that their investment is safe and as profitable as expected, and we can call it shariah governance. the fundamental role of shariah governance is to ensure that the operations of the islamic finance activities comply with the shariah and the rights of the involved parties are not violated.[23] the corporate governance involves a set of relationships between a company’s management, it’s board, its shareholders and other stakeholders, corporate governance also provides the structure through which the objective of the company are set, and the mean of attaining those objective and monitoring performance are determined, the legal and regulatory requirements that affect corporate governance practices in a jurisdiction should be consistent with the rule of law, transparent and enforceable.[24] vii. main challenges and limitation many researches point out that sukuk can be subjected to different types of risk such as market risk, shariah compliant risk, credit and counterparty risk, operational risks, liquidity risk, legal risks, taxation risks interest rate risk, and foreign exchange risk.[25][26][27] sukuk share most of these types of risk with conventional bond. this paper does not go into detail on this risk and we just try to discern the main challenges that could face islamic project finance implementation in nonmuslim countries. sukuk would require appropriate enabling laws to protect the interest of investor and issuers, appropriate accounting standard, study of targeted market, monitoring of standardized contracts, appropriate flow of financial data to investors and provision of standard quality service to customers.[3] in addition to the normal challenge that face the conventional infrastructure project, the main challenge in structuring the sukuk is to obtain approval from shariah committee on sukuk structure in non-muslim countries, because the project can be implemented based on fatwa from shariah board, "fatwa" is a religious opinion concerning islamic law issued by an islamic scholar, this fatwa is valid only for specific case and it must be approved before issuance. the lack of shariah board and skilled human capital in these countries, which may cause difficulties in developing a framework for governing, supervising, and regulating islamic finance process, and treats with shariah board from other countries will increase the cost of project and may cause misunderstanding for the structure and actual situation. each contract, agreements and transaction in the company should be approved by shariah board, this will increase the time and cost to accomplish these transactions. this problem can be eliminated by developing business plan and guideline for expected transaction in the company, especially since the nature of these companies’ actions are repeated and specified. islamic contract documentation should complies with shariah rules and principles with regard to formation, termination and elements possibly affecting contract performance such as fraud, misrepresentation, duress or any other rights and obligations.[26] another issue is the restrictions on joint venture company transaction. the spv and the joint venture company are restricted in their actions; they will do specific transactions, and should not permit them to engage in any other transactions, like acquire any other assets, or create any other debts. since the italian securitization law does not include the sukuk, the italian company cannot issue sukuk, that leads the originator to establish the spv under other country’s law like ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 english law; in this case, the spv will be subjected to other county’s tax in addition to italian tax because the musharakah company will subject to several tax like ownership transfer cost and tax on rental payment and income tax. the sukuk holder can potentially face multiple tax duties, in addition to incur additional transactional and legal costs. to overcome this problem, the originator should develop tax planning to avoid these tax impositions, each transaction should be carefully reviewed by tax advisors, and should benefit from taxation system in other europe country like uk. because uk has introduced a series of tax and legislative changes specifically designed to remove obstacles to the development of islamic finance. the first significant change came in the finance act 2003 which introduced relief to prevent multiple payment of stamp duty land tax on islamic mortgages. the finance acts 2005 and 2006 contained further measures aimed at putting other islamic products on the same tax footing as their conventional counterparts. most recently, the finance act 2007 clarified the tax framework further, in the case of sukuk. [28] therefore, the government should try to add new articles to the special tax treatment section of the law. under shariah principle, the sukuk holder is the real owner of the project and he is responsible for maintenance and insurance cost for the assets of the project, and the challenge is the prohibition of conventional insurance in islam, and the lack of shariah compliant insurance system (takaful) in nonmuslim countries. the originator should find shariah compliant insurance company because leaving the infrastructure project without insurance is consider a big risk. viii. potential implementation a. about the project a case study using sukuk for finance the second subway line in turin, that would connect the northern area of the city with the south (mirafiori and santa rita) going throw porta nuova and porta susa stations in the city center, the length of this line is about 14.8 kilometer , estimated cost was between 1.1 and 1.4 billion of euro. the project of subway line can be easily structured as entities are legally separated from the turin municipality and the operator (gtt). this paper will adopt sukuk structure depending on musharakah and ijarah contracts because the musharakah contract is relatively similar to joint venture in italian law; joint venture can set a conditions in the contract to insure that all transaction will be shariah compliant, for example the joint venture transaction should be interest free. after the completion of the construction phase, the joint venture company can rent the project for operating company gtt by using ijarah contract (lease) under italian law. the structure will be diminishing musharakah because under the italian law, the lease contract has a maximum term of 30 years. 3 the spv would sell part of its share in musharakah company to the originator mt, based on pre agreed time, and the price would be at market value or a price to be agreed, at the time of their 3 the pursuant to section 1573 of the italian civil code actual purchase, the spv ownership in the musharakah company decreases over the validity of the sukuk, musharakah means a relationship established under a contract by the mutual consent of the parties for sharing of profits and losses in the joint business. all providers of capital are entitled to participate in management, but not necessarily required to do so. the profit is distributed among the partners in pre-agreed ratios, while the loss is borne by every partner strictly in proportion to respective capital contributions.[29] sukuk al musharakah are documents of equal value issued with the aim of using the mobilized funds for establishing a new project or developing an existing one or financing a business activity on the basis of one of partnership contracts. the certificate holders become the owners of the project or the assets of the activity as per their respective shares. these musharakah certificates can be treated as negotiable instruments and can be bought and sold in the secondary market. [29] sukuk – al ijarah are sukuk that represent ownership of equal shares in a rented real estate or the usufruct of the real estate. these sukuk give their owners the right to own the real estate, receive the rent and dispose of their sukuk in a manner that does not affect the right of the lessee, i.e. they are tradable. the holders of such sukuk bear all costs of maintenance of and damage to the real estate. (aaoifi) b. main parties involved in the sukuk process:  the originator: is the partner how wishing to rise funds, to do a specific project, in our case it is turin municipality tm  the issuer of the sukuk: it’s a special purpose vehicle spv, it will be established under other countries’ law that allow to issue sukuk and usually are done under english law.  sukuk: which represent an undivided ownership of share of spv in the musharakah underlying asset or transaction. they also represent a right against issuer spv to payment of the periodic distribution amount and the dissolution amount.  the manager: is the party managing the whole sukuk process, every partner can either get involved in the management of the business or the partners may employ a particular individual to manage the business.  the guarantee:spv will be as trustee  the sukuk holder: the investor in the project, are regarded as the owner of the spv respective shares of the assets of the musharakah.  shariah advisor: the shariah advisor board in the selected market, some market like luxemburg market have shariah board.  consultant: european research center for islamic finance. ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 c. process before issuance:  prepare feasibility study, the tm must ask a trusted company to prepare a professional feasibility study to demonstrate the profitability of the project, and to attract the investment from other countries, because the professional financial analysis will be considered as a guarantee for investor.  take into consideration the legal, procedural, organizational issues, prepare business plan, set long term objective and also budgeting for proper long-term maintenance of assets. legal documentation relating to a musharakah financing shall clearly stipulate all costs and expenses agreed and borne by each party  the sukuk structure and all transaction must be approved by shariah advisor board by issuing fatwa, and that’s must be done before the issuing process. d. sukuk structure 1) establish spv, in the absence of italian sukuk law. the paper supposes that we can establish the spv as a company under english or luxemburg law; sukuk transactions are often governed by english law. because under italian law, the only assets that can be securitized are pecuniary credits, this is a substantial difference from the very broad provisions of the common law systems. in the uk and the usa, in fact, securitization can involve not only future credits, unlimited in time or in any other way, but also future financial lows are not necessarily deriving from credits (e.g., highway tolls, revenues of railways, airlines, ferries, football team ticket sales, entertainment revenues, and so on) or the sale of assets other than loan portfolios, such as real estate (in sale and leaseback operations), these systems also permit securitization of the future profits of a division of a corporation or even from one or more business deals, as long as they are identified as a whole (the so-called securitized block).[30] 2) the investors subscribe for sukuk and pay the proceeds to issuer spv. 3) issuer spv declares a trust over the proceeds and any asset acquires using the proceeds and thereby acts as trustee on behalf of the investors. 4) spv will enter a partnership agreement (musharakah) with the originator (turin municipality) in order to implement the subway line project, by establishing the subway joint venture company under italian law, corporate joint ventures are either incorporated as private limited company spa or srl format. 5) issuing of sukuk, the amount will be determined depending on estimated cost of the project. 6) spv paid the proceeds of the sukuk issue in cash as its capital contribution to the joint company, and the turin municipality will be contributed in kind, by transferring the ownership of the project’s land to joint company, and also it can contribute by any form of participation that it wants with consent of other parts; its share shall be determined on the basis of evaluation according to the market price prevalent at the date of the contract, and we suggest that the estimated price of the land must be evaluated on the basis of the mining right assessment. 7) trustee and originator will get into a management agreement to provide administrative services for the musharakah. this agreement will set out the services to be provided by the administrator to the musharakah company, the agent gets a fixed agency fee under italian law. the management of the company is entrusted to the board of directors and the management can be also entrusted to a sole director but this is very unusual in a joint venture situation, the civil code also requires that a board of statutory auditors ("sindaci") be elected by the shareholders to supervise the management of the company by the directors. [31] 8) select another part to begin the implementation phase of the subway project, (just to save time, we will divide the subway line into several steps or sections, and select more than one company to execute the line). 9) a deal with the operator (gtt) should be done to rent the complete section of the line, by using leasing contract; leasing contract is possible under shariah and italian law. 10) under islamic law, the musharakah company is responsible for all ordinary maintenance for the subway line, (typical repair, replacement and maintenance other than major maintenance). in addition, the musharakah company will be responsible for insurance of the assets, and shariah compliant insurance must be used. 11) the profit from musharakah venture (rental payments) will be distributed among the partners according to the preagreed profit sharing ratio. however, any loss must be shared among the partners according to their respective capital contribution. 12) the losses of the musharakah must be shared by the partners in proportion to their capital contributions to the musharakah. 13) use the municipality’s share of profits to redeem the sukuk issuance in pre-agreed schedule, but the municipality will not purchase the sukuk itself, but it will purchase spv share in joint venture company. 14) the spv pays the purchase price of the units through to the sukuk holders and the sukuk will be redeemed ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 ix. conclusion the study seeks to fill the gap between infrastructure demand and available financial recourses by using islamic project finance. this paper has considered that most countries do not have laws that can be applied to islamic finance or islamic securitization, and concludes that islamic finance could be used to finance infrastructure projects by using existing laws and regulations that do not conflict with shariah principle; the islamic finance is not against the non-muslim cultures but the fact is quite the contrary, its ethical and fairness principle and it is consistent with infrastructure requirements and characteristics. sukuk is an appropriate choice as compared with the conventional bond for the muslim and non-muslim investors. many challenges still lie ahead in during the islamic finance implantation in non-muslim countries. our findings suggested that in order to fund the world’s infrastructure needs, we should develop a unified legal framework, islamic accounting principle, pricing mechanism, regulations and tax policies, which can play an important role in the development of islamic finance and competitive global sukuk market as an complementary finance resource, that work together with conventional financial system. references [1] della croce, r., & yermo, j. 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( 2012) joint ventures and shareholders agreements in italy, centre for international legal tudies salzburg,austria ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 the challenges of bad debt monitoring practices in islamic micro banking amercu buana university, jakarta, indonesia bstudent of european microfinane program, universite libre de bruxelles, belgium abstract—the study aims to assess and compare the monitoring procedures in two bank syariah mandiri (bsm) branches located in cengkareng and duri kosambi of west jakarta city. the research implemented qualitative data analysis tools that consisted in to develop focus group discussion (fdg) to obtain reliable and depth data related to monitoring practices among loan officers. meanwhile, interviews were designed to the branch managers of each institution to determine their role in the npf management. the study results divide into two parts: on the one hand, it highlights the standard monitoring procedures for the non-performing financing (npf) in islamic micro banking and the main differences between conventional and islamic in npf management. on the other hand, the second result exposes three main key findings: first one, it confirms the importance of count on proper risk management for islamic micro banking and harnessing of the sharia principles to maintain the quality of the portfolio. second, the study reveals a correlation that exists among screening, monitoring, and enforcement, thus how a proper testing and supervision practices may affect in the following steps of the loan cycle. finally the third one, it shows the impact of real leadership from the head manager in the performance of the institution. keywords—islamic micro banking, monitoring, non performing financing, portfolio quality jel classification: g02, g14, g21 i. introduction in the last thirty years, islamic bank has been developing, and it started in egypt 1970 as an initiative in the rural area. since that time islamic bank it has been spread around the world especially for those countries with dominant muslim population (iqbal & molyneux, 2016). furthermore, challenges of development and growth of islamic banking differs according to the country thus each country has its own such as historical, social and economic condition. according to sukmadilaga & nugroho, (2017) and anugroho et al., (2017), the argumentation of islamic bank established in several countries as follows:  in the middle eastern countries, the increase of petrodollars commercial activities in 1970-1980 was the most significant driver for islamic finance development. for middle eastern countries such as saudi arabia, kuwait, and bahrain islamic banks represent around 48.9%, 44.6% and 27.7% of the market share;  in european countries due to the increasing phenomena of islamic banking, many middle east investors move their funds from conventional banking to islamic banking in their country. therefore, european governments especially the united kingdom started to develop policies that boost and enable conventional banks to establish either sharia financial services in parallel with conventional financial services or only pure islamic banking institutions. financial institutions that offer both conventional and islamic financial services are named islamic windows. furthermore, fully sharia-compliant institutions were established at that time;  in malaysia, the islamic banking development was driven by the government policies that allow the rapidly growing and the desire to become a hub for international islamic funds. therefore, the government develops policies related to the tax breaks and license facilities that look attractive to investors in the islamic finance industry in malaysia. the major establishment of islamic banking was the bank islam malaysia berhad (bimb) in 1984;  in indonesia, the islamic banking has been developed relatively late mainly because of the pancasila (five pillars) as the fundamental way of life in indonesia that recognizes the free will of people to hold a religion. the recognize religion in indonesia are christian, budha, hindu, catholic, konghucu, and islam thus the economic activities were developed separately from religion. however, the majority of the population of indonesia is muslim around 85% (venardos, 2012 and bureau statistic of indonesia). lucky nugrohoa, wayra villaroelb., and wiwik utamia ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 so, the religious context and the muslim scholar development were the main catalysts that encouraged the growth of islamic banking activities. the muamalat bank is the first islamic bank in indonesia, it was established in 1992. the principle of islamic finance based on equality, social justice, no discrimination and the protection of the weak people (venardos, 2012; arafah & nugroho, 2016). such concepts align with the microfinance ideals which pursue secure access to financial instruments for people with low income exposed to the "triple whammy" (mersland & strøm, 2012; collins et al. ,2009). however, inside islamic banking there is microfinance product (nugroho, 2014). according to armendáriz & morduch (2010) and sheth et al. (2011) microfinance has to contemplate both finance and social approaches to keep financial sustainability and expand the outreach of its operations. concerning to financial aspect, sustainability is correlated to manage the risks such as credit risk, operational risk, reputation risk, liquidity risk. therefore, since the major part of the asset of mfis is compound by the outstanding loan, mfis have to focus on the quality of its portfolio and must develop effective screening, monitoring and enforcement practices (chakrabarty & bass, 2015; shuteng et al., 2015). microfinance industry has particular characteristics which differ from the conventional banking sector such as high volume, high risk and high administrative cost (mersland & strøm, 2012). islamic banking is developing around worldwide especially for muslims countries as a new pathway to offer microfinance services that align with sharia principles. furthermore, within the islamic bank industry of indonesia, bank syariah mandiri (bsm) has the major in term of their assets, branches (extensive network) and market share on islamic banking. bsm has microfinance products designed to fulfill the microentrepreneurs and low-income sector which follow the bsm vision and mission (annual report of bsm, 2015). the rapid growth of islamic banking might imply a worsening of the quality of microfinance services that means a relaxing on the screening or monitoring process (assefa et al., 2013). hence an increase of non-performing loan (npl) that since now is going to be called as non-performing financing (npf) which is the terminology used in bank syariah mandiri for the npf. thus, increasing of npf become critical for islamic microfinance services providers to work consistently on the improvement of screening, monitoring, and enforce collection (figure 1) figure 1. npf/l of islamic bank vs npf/l of conventional bank 1,42 4,01 3,02 2,52 2,22 2,62 4,95 4,84 3,20 3,31 2,56 2,17 1,87 1,77 2,16 2,39 2008 2009 2010 2011 2012 2013 2014 2015 graphic 7 npf of islamic bank vs npf of conventional bank npf gross islamic bank npf gross conventio nal bank 103,65 95,49 89,67 88,94 100,00 100,32 86,66 88,03 74,58 72,88 75,21 78,77 83,58 89,70 89,42 92,11 2008 2009 2010 2011 2012 2013 2014 2015 graphic 6 fdr/ldr of islamic bank vs fdr/ldr conventional bank fdr/ldr islamic bank fdr/ldr conventional bank source: bnugroho et al., (2017) the nature of microfinance services has a focus on clients who are exposed to the “triple whammy” means low, irregular and unpredictable income (collins et al., 2009). moreover, most of those clients do not count with fixed assets which in conventional financial institutions are used as collateral. so, for mfis work with this segment of customers implies high risk. therefore to anticipate the high of npf, monitoring practices have a significant role in the quality of the portfolio, as a part of the risk management actions. monitoring embeds in the credit cycle and to anticipate the default by detecting early sign of bad debt (churchill & coster, 2001). ii. methodology regarding hulme (2000) that stresses the advantages of qualitative research to get depth information that quantitative methods cannot achieve. therefore, the study was conducted in the qualitative method that located in two bsm branches were developed focus group discussion (fgd) among the micro banking team (loan officers, micro-manager, administrative, risk analyst). to collect information related to the monitoring mechanism for the clients in arrears, and the main differences between conventional and islamic practices. furthermore, it was also conducted interviews with the branch managers to collect information about the role that they play in the npf (same as npl) performance. also, bsm provided data such as annual report, micro strategies, and organizational structure of micro banking, that supported the research. the research mechanism is going to implementing as in figure 2. flowchart below: figure 2. research mechanism flowchart start identification problems: 1. how the mechanism of monitoring in the islamic microfinance for the nonperforming financing (npf)? 2. what the role of branch manager to ensure the quality of non-performing financing? 3. what the differences between conventional and islamic microfinance treatment to their bad clients? literature review primary data that supported by secondary data data collection and sampling method discussion conclusion finish ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 source: own the data was collected from two branches that historically have different performance regarding npf thus through a comparison analysis also it was possible to find both good and bad practices. the final insights were used to develop recommended strategies that might enhance the current operations in both branches. the structure of the questionnaires strives to fulfill the research questions set as objectives: description of the monitoring mechanism in islamic banking, find the main difference between conventional and islamic banking, and the role of the branch manager in the npf management. furthermore, the hypothesis of scardovi, (2015) was evaluated. this theory sustains that features such as a segment of the client, the training degree of the staff, and macroeconomic characteristics have an impact on the npf's behavior. therefore, as an ex-ante hypothesis, the study considers that npf performance relies on both internal and external factors (scardovi, 2015). a. forum group discussion (fgd) the questionnaire 1 (one) was used as a guide to conduct the fgd between the micro banking team (loan officers, micro banking area manager, administrative, risk analyst) and the researcher. the questionnaire considered two parts; the first one pursued to understand the internal performance inside the micro banking area, and the second one was oriented to describe the monitoring mechanism. the questionnaire as follows: questionaire 1: the guidance questions for fdg with the loan officer for exploring information related to micro banking internal practices and the procedures for clients with arrears as follows: 1. what is the composition of the client portfolio (%employees and %entrepreneurs)? 2. a. how often do you receive training or workshops to improve the quality of the services delivery? (formal) b. how often do you organize sharing session within the staff to improve the quality of the services delivery? (informal cafe morning, etc. ) 3. how do you screen the client before the loan disbursement? therefore, what features do you analyze in the character, capacity, collateral, capital, and conditions? 4. why do you think that 5c’s assessment is essential for loan approval? 5. do you think that the 5c’s elements have to be embedded in the credit evaluation process? 6. do you have a formal manual procedure to manage the non-performing financing (npf)? 7. what are the procedures for the clients with arrears as follows?. collectibility 1 collectibility 2 collectibilityy 3 collectibility 4 collectibility 5 describe the handling of arrears account? financing at risk (far) (30 days-90 days) financing at risk (far) (120 days-180 days) financing at risk (far) (180 days-270 days) financing at risk (far) (>270 days) 8. in your experience what are the major causes of default among the clients (internal and external)? 9. what do you think that are the main differences between conventional and islamic banking during the collection practices? b. interviews the questionnaire 2 (two) was used as a guide to interviewing the branch managers and the researcher to determine the role of the branch manager has in the npf management and the staff performance. moreover, the interviews were used to reveal the micro strategies and also to describe the segment of clients that each bsm micro banking branch focuses, the questionnaires that relate are below: questionaire 2: questionaire for the branch manager 1. what are the strategies that you apply to enhance the performance in the micro banking area? 2. how often do you organize training activities for the staff of micro banking area? what are the topics? 3. what is the limit for npf? what is the warning value? 4. what are the characteristic of target clients for the micro banking area? 5. how strong is the communication between the branch and headquarter? c. secondary data information bsm facilitated the access to documents that were helpful to support the results from the qualitative methods. the annual report was used to describe bsm as all islamic bank and its commitment to pursue sustainable development in indonesia. the micro business strategies were used to explain the segment orientation of the micro banking area, describe the standard procedures for credit processing, risk management, and their training strategies for the staff. d. forum group discussion (fgd) observation the principal aim of observation is to understand the screening, monitoring and enforcement activities inside the branches through empirical observation. therefore, during the internship two weeks were exclusively dedicated to understanding the operational mechanism in cengkareng and duri kosambi branches units (west jakarta, indonesia). iii. literature review islam is a holistic religion. therefore, all the affairs of the world and the hereafter have been described in islam (doktoralina & bahari, 2017). as in al-an'am 38, it means: “and there is no creature on [or within] the earth or bird that flies with its wings except [that they are] communities like you. we have not neglected in the register a thing. then unto ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 their lord, they will be gathered.” the commercial activity is the nature of human beings because with a human endeavor to fulfill various needs. any business run by people will inevitably lead to two consequences in the future, namely profit and loss. thus the risk itself is a nature that is always inherent in human life. therefore islam does not recognize the existence of risk-free business transactions. the logical consequence is the person entitled to profit is the person who must bear the loss (if it happens). a trader is allowed to take advantage of the goods he sells because he has assumed all the risks associated with his merchandise (damage of property before a sale, loss of merchandise, unsold and so on). based on these rules then islam prohibits any transactions in which there is an imbalance between risk and profit . in other words, islam prohibits any profit-making deal without any willingness to bear a loss. that is why islam forbids any additional (interest) in debt transactions that can occur in the conventional financial system. the lender has no risk whatsoever for the funds it lends because islam requires each borrower to pay off his debt. therefore, any additional debt repayments are considered usury. the principle of risk management in islamic perspective is “al ghorm bil ghurmy al kharaj bid dhamany” (soekapdjo et al., 2018) that means “any gains are risks, and these risks must be managed responsibly." islamic banks in lending/financing will inevitably face the risk of financing problems. nevertheless, according to soekapdjo et al. (2018), the low level of risk management in an institution will fail the establishment. moreover, it can even lead to a loss of confidence from investors. the internal and external environments of the banking sector have grown rapidly, resulting in increasingly complex business risks. therefore, to keep pace with the rapid development of bank business, it is necessary to implement adequate risk management. sufficient risk management policy can support the bank's business growth optimally while maintaining the principle of prudentiality. the primary structure of risk management includes identification, quantification, and monitoring of the risks. therefore, the analysis of critical indicators and risk trends is necessary to prevent and control the risk among financial institutions (van greuning & iqbal, 2008). indeed, there are several risk drivers such as include credit risk, operational risks, market risk, liquidity risk and systematic risk (churchill and coster, 2001; rahman et al., 2014). however, for islamic bank face additional risk such as non-compliance risk. nevertheless, regarding hull (2012) credit/financing risk is the highest risk that is facing by the conventional bank and islamic bank. islamic law also teaches the "la darara wa la dirara" rule in which we are not allowed to engage ourselves in harm that will harm or destroy ourselves without any attempt to minimize the harm. even in al-baqarah verse 195, its mean: “and spend in the way of allah and do not throw [yourselves] with your [own] hands into destruction [by refraining]. and do good; indeed, allah loves the doers of good.” this rule encourages islamic banks to be more careful in managing their business activities so that any inherent risks to the bank's business can be minimized and managed properly. before approving the financing proposal, the sharia bank must know the profile of the prospective customer, especially related to the inherent risk to the customer. by knowing the risk of each customer, the sharia bank can develop risk mitigation measures to minimize the potential loss from the existing risk. the bank should take prudentially provide loan for the client. this has happened to the banking industry in indonesia 1997-1998. the banking crisis that occurred during that period was triggered by the behavior of many banks in indonesia which easily lend to unworthy debtors without taking into account the level of risk and risk mitigation measures that can be done to minimize potential losses that may occur. the booming loan disbursement resulted in high bank bad debts in 1997-1998, causing public confidence in banking institutions to decline dramatically, especially the bank that majority portfolio loan in the corporate segment. islamic bank objectives is not only to achieve financial performance but also to achieve social performance that objective create social well-being (maslahah/beneficiaries for ummah/community) therefore, islamic bank has focused on microfinance services (akhtar, 1998; dhumale and shapcanin, 1999; al harran, 1999; ahmed, 2002; el-gamal, 2006; wajdi dusuki, 2008; arafah & nugroho, 2016; aysan et.al., 2016). furthermore, according to prastowo (2015), islamic principle in the financial institution such as islamic bank should concern in sustainability that means the business activity should be a concern not only for presents condition but also taking considerations for next generation. in islamic point of view, all the business activity included islamic bank the objectives are not only a triple bottom line (profit, people, and planet) but extended into prophet, profit, people and planet which mean the bussiness activities should comply with the sharia principle (chotib & utami, 2014; nugroho et al., 2018). on the other hand, financing to the micro-entrepreneur sector is constrained by several things. microentrepreneurs do not have a standard financial report format, even if there are often unaudited. so the financial information provided is less reliable (unreliable). the condition is theoretically known as information opacity. in addition to information opacity, other factors that make microentrepreneurs less desirable by banking is; the micro business is new, there is no guarantee/adequate collateral, little technological mastery and the founder and manager of microentrepreneurs do not have sufficient managerial experience managing the business (track record) (schurmann and johnston, 2009; ibtissem and bouri, 2013). the existence of information opacity, causing banks are reluctant to channel funds to microentrepreneurs. if willing, the bank will ask for higher yields as the potential increase in the number of nonperforming loans as a result of mistakes to choose the debtor (adverse selection). to minimize this risk, the bank should use an effective selection tool to distinguish which debtors will default or fail after the bank approves its financing request. information opacity of microentrepreneurs is not only a problem for banks at the time of selection but also occurs ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 during the period of financing running (kiweu, 2011). the value of financing given to micro entrepreneurs are small, but the number is very much. this condition is called granularity and causes enormous monitoring costs for banks. in the end, this can reduce the efficiency of the bank's operations. therefore, banks serving the sme sector are required to have effective and efficient supervision. nevertheless, sharia banks (including bsm) remain committed to developing the real sector. this can be demonstrated by the portion of financing for microentrepreneurs that are consistent at the level of 60% of the financing portfolio provided. it is no secret that the sme sector is an area with a very high yield, higher than the corporate sector. al ghumu bil ghurmi, high-risk, high return, that is sunnatullah. if you want to get a high yield, then be prepared to bear a high risk as well. therefore, the islamic bank risk management system needs to be ready to minimize adverse selection risk and to reduce the necessary monitoring costs. iv. results and discussion. a. bsm micro banking scenario as it was described above the analysis was conducted in two bsm sharia branches. historically, cengkareng branch during 2014 had faced an unstable financial situation where the npf surpassed the safe range with an npf higher than 10 %. therefore, cengkareng had to freeze the credit unit, which entailed that the credit officers had to stop looking for clients and focused only on the collection of installments of defaulting customers. currently, cengkareng branch has recovered from the bad situation and still walking toward continuous improvement, until now it has a 0,9 % of npf which still in the green zone. moreover, duri kosambi has a different landscape because historically it had managed to keep an acceptable npf of 0%, and currently still maintains control of the npf because duri kosambi has active screening strategies that prevent adverse selection. b. finding in the fgd with the loan officers the analysis of responses of the fgd in both cengkareng and duri kosambi branches highlights the findings described below: 1) client’s profile in cengkareng, previously during the bad situation, the portfolio was mainly compound by entrepreneurs than employees, approximately 60%, and 40 % respectively. however, currently this figure had changed, so at this time the portfolio is 60% clients with a fixed source of income such employment, the double source of income, or lease business, while the rest 40% are clients with their own business. in duri kosambi the figure is opposite; the current portfolio is mainly composed of entrepreneurs approximately 70%, employees 20% and the remaining 10% are hybrid clients, means customers with more than one source of income such as employment and own business. 2) training for the staff for the staff training, both branches have the same understanding of the difference between formal and informal training. in cengkareng the informal training considers a group in social media (whatsapp) that connects all the micro team to share information regarding clients, solve together some difficulties, etc. furthermore, the team has meetings during the breaks exchange information between each other, also the “day of knowledge” (minimum once per month) to solve problems related to the services, share some knowledge, or answer any internal problem. in duri kosambi the figure is similar. also, they have a group in the social media, but at the end of the day, all the micro team has a meeting to review the agenda’s compliance, the difficulties faced along the day and find together the solution. for the formal training, both institutions receive workshops from the learning area of bsm headquarters, minimum twice per year. the loan officers have to be prepared to develop many functions such as sales, screening, monitoring, and collection. 3) credit analysis procedures to some extent, both institutions have the same scheme of credit analysis thus both assess the 5c’s (character, capacity, collateral, capital, and condition). a) character: the main features that loan officers have to consider during the character assessment are: data from the credit bureau, credit history of the client, personal documents, how is the relationship with his relatives, neighbors and suppliers, testimony from the local leader, corporal expression during the interview that the client’s honesty. b) capacity: at this step the micro officers collect information from the credit bureau (collectability category, current loans, etc.) and to proofs of the source and the amount of income (inflows), clients expenses (outflows), the value of the customer’s ownership (house, vehicle, inventory), payment system with his supplier.deletion: delete the author and affiliation lines for the second affiliation. c) collateral: at this level, the credit agency has to collect information about the assets that the clients present as collateral such us certificates of ownership, land location, the market value of the property, check the taxation of the building.deletion: delete the author and affiliation lines for the second affiliation. d) capital: the micro officer has to build the balance sheet using the information provided by the client and evaluates the value of the customer’s equity. e) condition: this stage entails an assessment of economic and market features that might insert risk of default in the applicant. both institutions (cengkareng and duri kosambi) are consistent with the fact that is important to assess the 5c’s. however, both consider that for micro banking clients the ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 character, capacity, and collateral are the most critical features in credit analysis. 4) npf management both institutions are governed by the central bank regulation that classifies the client compliance in five categories. however, the actions for each category depending on the different level of client's overdue. therefore, the pressure strategies will tend to increase in parallel with the time of default. the enforcement tools described in the fgd consider calls, messages, and visits to clients, shock therapies that consist into visiting the clients with all the micro team to put pressure on him, use the religion as an enforcement collection mechanism, use the relatives, family and local leader, warning letters, among others. table 1. the client's compliance they are categorized and treated as following 5) sources of default regarding the internal source of default, the perception of both institutions is different. in cengkareng the internal factors are related to the internal operations of the branch while in duri kosambi the internal source is related to internal problems in the client's household such family problems, loan sharing, liquidity problems. though, regarding the external source of default, both institutions agreed that the main issue is related market and economy. table 2. the major causes of default among the clients (internal factor evaluation and external factor evaluation) cengkareng internal the performance of the business external market risk duri kosambi internal -family problems (marriage, children, relatives) -the client asks the loan for another person (fake loans, broker) -share the loan mainly between family members (broker activity) liquidity problems (accounts receivables) external -market risk -changes in the macro economy conditions 6) differences between conventional and islamic banking both institutions stress that enforcement procedures are the main difference between conventional and islamic banking. according to their comments, islamic banks use the religious values as an enforcement mechanism thus they appeal to the client’s conscious. also, the intensity of enforcement practices among islamic banks increases progressively while in the conventional sector the enforcement procedures tend to be more severe since the beginning. table 3. the main differences between conventional and islamic banking during the collection practices cengkareng islamic conventional not allowed to be rude in the beginning use the sharia principles as an enforcement alternative appeal to the conscious of the client they are rude since the beginning they do not use the religion as an enforcement alternative duri kosambi islamic conventional the client receives the complete amount, but he has to pay the up-front fee before to receive the loans they use the religion as an enforcement strategy they are more polite and diplomatic. they use rigid enforcement techniques only in extreme cases appeal to the muslim leader the client receives the loan amount minus the upfront fee they do not use the religion as an enforcement strategy  they apply rigid collection strategies since the beginning 7) screening, monitoring, and enforcement in cengkareng vs. duri kosambi from the observation of the daily activities and the comments from fgd, it was possible to recognize that there are specific differences between both branches in the screening, monitoring and enforcement activities a) selection: in duri kosambi the micro officers stress a lot on the selection process to diminish adverse selection ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 (karlan & zinman, 2009). therefore, they invest much effort to make sure that the client is financially capable of affording the loan. in cengkareng currently, there is a lack of administrative personnel. thus, the micro officers have to be capable of developing sales screening, monitoring, enforcement, and administrative activities. b) additionally, the micro staff in cengkareng is quite newer. thus, they have less time experience comparing to duri kosambi. therefore, the two extreme difficulties mentioned above have an impact on the screening quality of cengkareng which is still toward continuous improvement of its agency's activities. c) monitoring: at this level, both described more or less the same monitoring procedures. therefore, both branches use calls, message and regular visits as a defensive mechanism to anticipate the default of the client. such mechanisms of warning are named early warning system, however on the other hand after the loan disbursement, the micro officers start to follow the evolution of the client to identify some signals of default, also to keep strong relationships with the clients. through the observation method, it was possible to acknowledge that each bsm's client is visited at least once per month. d) enforcement: on this stage, both institutions take advantage of the religion as an enforcement tool that seems to have good results, as their portfolio is mostly compound by muslim clients. according to the opinion of the micro officers, this element makes a big difference between conventional and islamic banking (iqbal et al., 2006). moreover, the institutions describe the enforcement procedures which are soft at the beginning, but these tend to become harder as long late time is increasing. c. findings in the interviews 1) micro-banking strategies bsm settle yearly the micro-strategies that act as the guide to drive the activities of each branch. however, the branch manager has the freedom to organize its staff and activities as long as it fulfills with the broad parameters of bsm headquarters. in this sense, the strategies within branches may vary by the branch manager creativity and the context of each branch. in cengkareng for instance, the branch manager drives the institution according to what he calls “triangle of leadership” which consists in to develop strategies that boost leadership among all the stakeholders. to this end, the cengkareng manager strives to enhance continuously the agents which are the leader, follower and the environment. in duri kosambi the branch manager has a different strategy that encourages the team working and mutual solidarity among the staff, which means that he puts the effort in to harmonize the work among all the staff. 2) the role in the training of the staff all the branches count on a formal manual of practices that has to be shared with the newer staff and periodically reminded of the old team. nonetheless, each branch manager has his method to spread the manual among the staff likewise the area micro banking manager who is in charge to make sure that the staff of each branch in west jakarta knows the formal procedures described in the manual. in cengkareng, the branch manager created the "knowledge day" that regularly take place at least once per months and consists of a meeting among the staff to receive some training regarding topics that may be useful to improve the service accompanied by spiritual messages. the objective is to foster bsm values in the branch, positive thinking, and proactivity among staff. moreover, the branch manager is to any consult from the staff. in cengkareng, the branch manager is conscious of the lack of personality in the micro banking thus the branch manager strives to boost independence, proactivity, and creativity among the staff to make them able to deal with such lack. therefore, each micro agent in cengkareng is capable of developing functions like sales, screening, monitoring, and enforcement. in duri kosambi, the branch manager boosts continuous surveillance of the internal performance inside the branch where the more expertise micro officers shared their knowledge with the newer integrant to prepare him to deal with the most demanding clients or solve any difficulty. besides, as the internal policy, the micro team has daily a meeting to follow its performance and solve together problems. moreover, the area micro banking manager is the agent in charge of supervising the performance of both branches thus he also delivers training to keep the staff updated about practices that enhance the quality of service likewise the financial sustainability of the area micro. 3) npf limits according to policies of headquarters, the performance of the nfp is classified into three zones that shown in figure 3 below: figure 3. npf classification a) green zone: when the npf is between 0 to 1%, b) yellow zone: that goes from 1 to 3%, c) red zone: when the npf is higher than 3%. on this stage, both institutions take advantage of the religion as an enforcement tool that seems to have good results, as their portfolio is mostly compound by muslim clients. according to the opinion of the micro officers, this element makes a big difference between conventional and islamic banking (iqbal et al., 2006). moreover, the institutions ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 describe the enforcement procedures which are soft at the beginning, but these tend to b. furthermore, if the npf is above 5% the unit of credit has to be a freeze, means that the micro officers must stop the sales of credit and shift only to collection activities until reach an acceptable npf. in this sense, the branch managers have to follow the formal procedures and instructions of headquarters. ecome harder as long late time is increasing. 4) segmentation although branch managers have the freedom to manage their agency activities, also they have to drive their strategies toward the fulfillment of the business strategies of headquarters. there is not an explicit instruction for the type of client (employees, entrepreneurs, hybrid). thus the branch has the freedom to settle his portfolio composition as long as they consider the client's needs. d. discussion between findings and literature review according to the interviews, it seems that duri kosambi has better risk management strategies comparing to cengkareng. duri kosambi emphasizes on the screening activities to avoid the client exceeds the collectivity 2b which means no more than two months, according to the comments from duri kosambi manager the branch has not faced until now clients that surpass 60 days of overdue. in contrary cengkareng during 2014 had to come out from financial instability. until now cengkareng manager is capable of surfacing the crisis and currently keeps an acceptable npf despite the staff limitation. moreover, in cengkareng the staff is newer than duri kosambi thus the staff still has to develop natural skills than come over time. 1) risk acceptance according to the interviews, it seems that duri kosambi has better risk management strategies comparing to cengkareng. duri kosambi emphasizes on the screening activities to avoid the client exceeds the collectivity 2b which means no more than two months, according to the comments from duri kosambi manager the branch has not faced until now clients that surpass 60 days of overdue. in contrary cengkareng during 2014 had to come out from financial instability. until now cengkareng manager is capable of surfacing the crisis and currently keeps an acceptable npf despite the staff limitation. moreover, in cengkareng the staff is newer than duri kosambi thus the staff still has to develop natural skills than come over time. 2) credit analysis regarding credit analysis, both institutions assess the 5 c’s (character, capacity, collateral, capital, and condition) of each application. however, both consider the character, capacity and collateral assessment as core features in the microfinance field. the figure between cengkareng and duri kosambi is opposite. however, both have the same appreciation of the clients which are classified into three categories: • entrepreneurs • employees • hybrid (those who are both at the same time) note: in figure 4 of cengkareng branch the percentage of employees includes the percentage of hybrid clients. cengkareng currently, in cengkareng the portfolio composition has a major percentage of employees which are 60%, and 40 % are entrepreneurs (figure 4). according to the branch manager, the reason is that the clients with fix source of income tend to be less risky than real entrepreneurs. therefore, they seek customers who have a second source of income means that even if they have a regular job in parallel, they develop their own business and need some capital to invest. such us client fulfill the capacity requirements. however, any client is a good candidate as long as he is capable of proving his financial ability to repay. figure 4. micro financing portfolio of cengkareng branch the clients with a second source of income are included in the 60%. the history of cengkareng highlights that the behavior of the npf is positively correlated with the entrepreneur’s percentage. therefore, the meanwhile higher percentage of the pure entrepreneur in the portfolio, the npf in cengkareng tends to be higher. duri kosambi according to the theory of mersland and strom, (2010) which supports that in emerging economies, micro and enterprises might be an attractive market opportunity for microfinance services providers. duri kosambi embraces this theory thus the figure is different, they support mostly the entrepreneurs. the entrepreneur sector commonly has an income which is sensitive to external features thus tend to be fluctuating. therefore, during the screening process in duri kosambi, the micro officers are more exhaustive. moreover, the micro officers take advantage of their innate work experience that equips them to assess efficiently the entrepreneurs’ ability to pay. in duri kosambi branch the significant percentage of the portfolio is compounded by clients who are entrepreneurs (figure 5). according to the comments of the micro officers, the entrepreneurs' customers in duri kosambi are dedicated mostly to rent, groceries, and repairs services. figure 5. micro financing portfolio of kosambi branch ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 3) training strategies even though the topics for the training in both institutions pursue the continuous enhancement of the quality of services, both managers’ strategies are supported by different bases. it consists in to boost leadership, independence, skills to cope with problems and creativity. on the other hand, the dimension of climate environment pursues to create enabling an environment that encourages efficiency, solidarity, and satisfaction of the staff. in duri kosambi the central pillar is supported by work team and mutual solidarity among the staff. the branch manager is entirely convinced that under a good work team the micro officers may quickly solve any problem inside the institution. therefore, in duri kosambi there is a daily meeting at the end of the day to review the daily compliance, exchange experience, and work together to solve problems. for the newer staff despite the formal training, the new team is supported by the former officers who have more skills gained in the field. 4) collection to some extent, both institutions have enforcement techniques. however, in cengkareng the most effective mechanisms are the promise of a new loan and encourage social pressure from relatives, family or local leader (gine & karlan, 2008). meanwhile, in duri kosambi the most effective mechanisms are first the religion and second what is named "shock therapy" which involves all the team visiting the client. the shock therapy is usually used when the clients overdue is higher. v. conclusion islamic bank acts as financial intermediaries providing access to financial services such as savings, loans, insurance, remittances. therefore, islamic bank has to be active for screening, monitoring, and enforcement activities. the experience of bsm proves the inherent relation among screening, monitoring and enforcement and the importance of developing innovative monitoring mechanisms that allow anticipating bad debt. also, it requires awareness from customers that debt obligations in the perspective of islamic law are mandatory so that in the case of arrears, then it is caused by business failure is not due to bad faith from customers. in the last years, technology has been developing rapidly to facilitate operations in every kind of field. in field microfinance sector the information technology (it) is an innovative tool that can save optimize operations and cost among mfis. currently, it has been acknowledged that tools such as management information system mis decrease significantly the burden of mfis operations. bsm micro banking has basic mis that allows them to manage the information of clients and monitor the indicators each certain period references 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(2008). banking for the poor: the role of islamic banking in microfinance initiatives. humanomics, 24(1), 49-66. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 islamic crowd-funding as the next financial innovation in islamic finance: potential and anticipated regulation in indonesia abstract— crowd-funding is an innovative concept. the online nature and the usually small size of investments of crowd-funding makes it different from private placement or other similar activities. crowd-funding is still infant industry but growing fast, including islamic crowd-funding. islamic crowd-funding is the platform designed to comply with the sharia. considering as the most populous muslim in the world, the third largest democracy, and the biggest muslim nation in the world, with favorable demographics and transition to a middle-income country, indonesia will mean eventually become the biggest market for islamic finance. hence, the coming era of islamic crowd-funding in indonesia is also underway. however, there is still lack of awareness and understanding about islamic crowd-funding including its prospects and challenges. there is also no specific regulation on islamic crowd-funding yet. in near future, regulation must also be put in place for crowd-funding. regulator needs to create frameworks that provide sufficient structure and protections while allowing enough space for an orderly and robust market to grow. it is incumbent on indonesia to ensure the groundwork in its place. otoritas jasa keuangan (ojk) has shown resolve and determination to ensure the requisite infrastructure and regulations needed. sharia and crowd-funding have similar goal and philosophical foundation. our paper suggests that crowd-funding and islamic finance are inherently compatible and mutually reinforcing. islamic crowdfunding may also help islamic finance to play more important roles with more significant market share in the indonesian economy. our paper also describes possible anticipated regulations for crowd-funding in indonesia. keywordsislamic finance; crowd-funding; financial innovation; indonesia i. introduction in the last few years, crowd-funding has been a global rising star phenomenon. at home, principles of crowd-funding are similar to indonesian collective values called "gotongroyong" – or working together towards a common goal. for indonesians, the values and tradition of ‗‘gotong royong” is a legacy from their ancestors, a source of pride and an epitome of long standing traditions. the spirit of collective and mutual sharing and togetherness have been passed on from generations and should be kept alive. crowd-funding is an umbrella term describing the collective effort of individuals or organizations who network and pool their money to support a wide variety of activities, to fund the project, a business or personal loan, including startupcompany funding, and other needs through an online webbased platform. the online nature and the usually small size of investments of crowd-funding makes this industry different from private placement or other similar activities. benefits from crowd funding can be reaped and reverberate when there is greater public understanding of what it stands for. indonesia has the prerequisites to support crowd funding as the next successful financial innovation in islamic finance. building on industries (islamic finance, internet and ecommerce industry) at the background and with robust national economic growth, the overall growth potential is exponential. crowd-funding and islamic finance are inherently compatible and mutually reinforcing. considering that indonesia is the most populous muslim in the world: this will significantly support indonesia‘s aspiration to become the center of islamic finance in the world – when the right policies are developed and implemented. the indonesian financial services authority or known as otoritas jasa keuangan (ojk), therefore, as regulator, needs to create a framework which provides adequate structure and protection while allowing sufficient space for an orderly and robust market to grow. it is incumbent on indonesia to ensure the groundwork is in its place. ojk should make use of the remaining time to anticipate the coming era of islamic crowdfunding. ii. towards defining of islamic crowd-funding a. the nature of crowd-funding and parties involved in less than a decade, crowd-funding has spread across the developed world, and is now attracting considerable interest in the developing world as well. crowd-funding, or crowd-financing or crowd-capital, is a type of crowd-sourcing. as explained by estellés-arolas & gonzález-ladrón-de-guevara (2012), crowd sourcing can be defined as: “…a type of participative online activity in which an individual, institution, non-profit organization, or company proposes to a group of individuals of varying knowledge, heterogeneity, and number, via a flexible open call, the iggi h. achsien, mba and dien l. purnamasari, me ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 voluntary undertaking of a task which always entails mutual benefit. the crowd participates in bringing work, money, knowledge and/or experience.” therefore, crowd-funding is the application of this concept to the collection of funds through small to medium-size contributions from a crowd in order to finance a particular project or venture, offering small businesses and entrepreneurs a chance at success. other definition, according to massolution (2012), ―crowdfunding is the practice of developing an online group-based investment campaign to generate financing for a specific project.‖ this practice leverages dedicated internet fundraising websites to spur community support and financing for an assortment of ventures, through numerous small dollar investors. kirbi and worner (2014) in iosco working paper ―crowdfunding: an infant industry growing fast” defines crowd-funding as “an umbrella term describing the use of small amounts of money, obtained from a large number of individuals or organisations, to fund a project, a business or personal loan, and other needs through an online web-based platform.” even though it is a small amount, crowd-funding should not be confused with micro-financing (for example, such as the grameen bank style of micro-lending). micro financing is predominately a bank based exercise, whereby the bank is the sole provider of the loan, is the originator of the loan and bears the risk of the loan. as such, it does not draw on the principles of many investors funding small parts of a required capital need. there are two main categories of crowd-funding, according to world bank (2013) and iosco (2014): (1) donation crowd-funding or community crowd-funding, (2) crowd-fund investing (cfi) or financial return (fr) crowd-funding. the main difference between these forms of crowd-funding based on its financial return where community crowd-funding primary objective is to gain a non-financial reward, thus, do not provide any return in the form of a yield or return on investment. this donation or community are usually used for campaigns that appeal to funders‘ personal beliefs and passions. further, according to world bank (2013), five business models currently are practiced within these two broad categories, and crowd-funding platforms typically are organized around one of the five models: (1) donation-based, (2) reward-based, (3) equity-based, (4) lending-based (peer to peer lending) and (5) royalty-based. the first two business models are under ―donation‖ or ―community‖ category, while the last three business models are within ―cfi‖ or ―fr‖ category. however, iosco (2014) and massolution (2012) only define four models which do not include royalty-based model. in donation-based crowd-funding, funders donate to causes that they want to support, with no expected compensation while in reward-based crowd-funding, the funders‘ primary objective for funding is to gain a non-financial reward. in equity-based crowd-funding, funders receive compensation in the form of fundraiser‘s equity-based or revenue, or profitshare arrangements. whereas in lending-based or peer to peer lending crowd-funding, funders receive fixed periodic income and expect repayment of the original principal investment. ordanini, miceli, pizzetti, and parasuraman, (2011) described that crowd-funding shares some characteristics with traditional resource-pooling and social-networking phenomena, but has a novel and defining characteristic: it involves consumers who act as investors, providing monetary support to others‘ proposals and expecting some payoffs, either monetary or non-monetary. thus, instead of traditional investors, the general public funds crowd-funding campaigns. crowd fund investing (cfi) is the newest asset class
 in private capital markets. it fills a void left between microfinance and professional/institutional investors, in that it is capable of providing larger amounts of capital to start-ups and small businesses. it extends some of the social mechanics of microfinance to help fund high-growth start-ups, frequently in the technology sector, or to provide expansion capital to existing businesses. successful service businesses that organize crowd-funding and act as intermediaries are increasing worldwide, as banks have augmented interest rates or pulled back from lending to consumers and small businesses. interestingly, lending supplied by a crowd has lower interest rates than those offered at large retail banks or by credit cards. for lenders, the platforms are viewed as investment opportunities, yielding them more than bank deposit accounts. to sum up, crowd-funding is very much a collaborative endeavor linking investor, entrepreneur and platform as agents. it creates a social economy with a focus on building ideas. therefore, there are three primary parties in the crowdfunding model: (1) creator, (2) lender/investor, and (3) platforms. the first participant in the market is the ―creator‖ (entrepreneurs, artists, business owners and others who initiate projects). these individuals have an idea and are looking for financial and non-financial support to commercialize it. the second parties is the ―investors/lenders‖ – funders, pre-buyers, donors and contributors – representing the next participant. these individuals believe in the strategic value proposition being offered and lend their support to get the venture off the ground. the last is ―platforms‖ which are the online community that links investors with entrepreneurs. one may think of platforms as the matchmaker in the crowd-funding world. b. benefits and risks of crowd-funding crowd-funding has
 the potential to play several important roles in the developing world‘s entrepreneurial and venture finance ecosystem. crowd-funding is perceived to contribute to economic growth through the creation of new and increasing flows of credit to smes and other users in the real economy. crowd-funding may offer many benefits including: (a) crowds often spur diversity of thoughts and ideas, (b) crowds materialize ―collaboration‖ and ―co-creation‖ , (c) crowds ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 have strong ties to innovation and breakthroughs, (d) crowds provide cheaper access to capital, (e) it help fill the gap left by the banks, (f) it offers convenience, and (e) geographical boundaries are removed. on the other side, there are also a number of risks which are currently surrounds business model. as awareness of crowd-funding increases, questions pertaining viability and future of the business model will be under the spotlight. these risks include: (a) platform risk, (b) risk of default, (c) risk of fraud, (d) information asymmetry and quality, (e) risk of investor experience, (f) liquidity risk, (g) tax treatment in global e-commerce environment, and (h) risk of cyber attack. the template is used to format your paper and style the text. all margins, column widths, line spaces, and text fonts are prescribed; please do not alter them. you may note peculiarities. for example, the head margin in this template measures proportionately more than is customary. this measurement and others are deliberate, using specifications that anticipate your paper as one part of the entire proceedings, and not as an independent document. please do not revise any of the current designations. c. definition of islamic crowd-funding islamic finance is perceived as value oriented, where it should meet maqosid (purposes or goals) of sharia. maqoshid is to accomplish maslahah (benefit). these are the preservation of (1) religion, (2) life, (3) lineage, (4) intellect, and (5) property. islamic finance is constructed through concept such as ―equity‖, ―justice‖, ―human dignity‖, ―freedom of enterprise‖, and ―moderation‖, with the ultimate objectives of utilizing economic and financial resources to satisfy the material and social needs of all members of the community. islamic finance and crowd-funding are inherently compatible and mutually reinforcing. islamic finance, ideally, is a way of financing based on sharia principles that are ethical and adheres to socially responsible standards, which should ensure fair distribution of benefits and obligations between all the parties in any financial transaction. on the other side, crowd-funding also embodies these characteristics and provides ground for novel developments in the field. islamic finance and crowd-funding both conceptualize costumers as investors and can potentially provide investment opportunities with higher returns. in addition, they both place a strong emphasis on transparency, mutual involvement, and trust. sharia and crowd-funding have similar goal and philosophical foundation, which are aimed to build communities, encourage risk sharing, democratize wealth, and channel capital to real economic activity. consequently, we can define islamic crowd-funding as the platform designed to comply with sharia principles. islamic crowd-funding is further described as the use of small amounts of money, obtained from a large number of individuals or organizations, to fund a project, a business or personal loan, and other needs through an online web-based platform in accordance with sharia principles. there seems to be some basic features distinguishing islamic crowd-funding from conventional one, which relate to: (1) investing only in halal projects, (2) the absence of interest rate, prohibition of gambling and speculation (riba, maysir, and gharar), (3) existence of sharia supervisory boards. in indonesia, sharia compliance can be in form of existence of a sharia supervisory board or a sharia opinion as formal certification process. islamic financial institutions will have sharia board, while sukuk issuance will only require sharia opinion. for islamic crowd-funding, there is a formal certification process to ensure sharia compliance of platforms. further, similar to islamic banks, sharia supervisory boards may also present as a part of its governance. islamic banks employ scholars of islamic law in a consultancy and advisory capacity to examine the sharia-compliance of their contracts and transactions. according to el-gamal (2006), this sharia certification is actually the most obvious distinguishing feature of islamic finance. it is envisioned, however, that when islamic financial products become standardized, the role of these boards is reduced substantially. d. islamic crowd-funding as the next financial innovation islamic crowd-funding can potentially become the next financial innovation in islamic finance industry. islamic crowdfunding will manifest itself into five business models: (1) zakat-based, (2) infaq-shadaqah-waqf-based, (3) qard-alhasan-based, (4) syirkah-based (mudharabah and musyarakah) and (5) lending-based (murabaha, ijarah, istishna, etc) as islamic financial services industry, especially the banking sector, has successfully designed interest-free alternatives to debt-based financing for small and medium enterprises (smes) (typically based on islamic trade instruments), islamic equity financing for this smesremains elusive. islamic crowd-funding offers a transparent, cooperative, and cost effective way for sharia-compliant equity financing. as for lending based model, crowd funding essentially transforms what was previously ―off-line‖ into ―online‖ financing. equity-based crowd funding brings some advantages from islamic finance perspective, which include: (a) it is based on profit and loss sharing, as characterized in original form of islamic finance, (b) it provides access to capital to wide range of entrepreneurs, (c) it opens avenues for new asset classes for small and medium-sized investors, (d) it minimizes risk through the split of limited capital across multiple start-ups, (e) it promotes innovation, preserves local talents, generates job creation, and also (g) supports growth of ventures and possible future initial public offerings (ipos) in many sectors. in many ways, crowd-funding resembles the economic relationships in pre-modern islamic countries as trust becomes a precondition for longstanding business relationships. merchants would often send their agents to sell their goods in distantly located markets, occasionally for little to no profits. agents would venture out into markets and sell the products, returning with the profits earned, to be given to the merchants. to sustain and maintain this relationship trust was crucial. ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 anyone who broke the trust would be excluded from the community. similarly, crowd-funding relies on trust. nevertheless crowd-funding, where it is still mostly unregulated, is risky as the donors/investors may not have full information of the originators. but the internet has created online communities that brings together people from around the world. overseeing each member of a platform is a challenge and may not be possible, but platform operators are well aware that any desired impact will not be attained if the originator fails to bring 
 the pitched idea to fruition. it is upon the platform to ensure that the originator is honest and hardworking. the originator in search for fund is also aware that in order to receive funding, the idea has to be original and well thought out. crowd-funding brings about the social aspects of finance as it draws individuals together 
 to essentially evaluate the importance of an 
 idea and its impact to society. donors, by donating, are not buying a product they need or to enhance their lives, they are donating because they believe in its value. this is value maximization and not profit maximization. this is where the masses know what they want and are not swayed by the insinuations of advertising and excessive investments. this is a value driven, bottom up model. and we are only seeing the beginnings of its potential. based on alonso (2013), there are over 450 crowd-funding platforms in the world, some of which are sharia compliant based. shekra.com and yomken.com, both based in cairo, egypt, were considered as first compliant online funding services in the world. shekra is an example of equity-based crowd-funding, and yomken, of micro finance product-based crowd-funding, which could be considered a type of rewardbased crowdfunding. there was also a recently launched peer to peer (p2p) lending site based on sharia compliant principles, first introduced in the middle east region, liwwa.com. it was an amman, jordan based site, liwwa gives a way to allow people in the region to invest in small businesses belonging to their friends and peers. unlike other microfunding sites, however, liwwa is not limited -nor brandedas a service catering to lowincome populations exclusively. other sharia-friendly crowd funding sites in western world are halalfunder.com and ummahhub.com. the first mentioned is united kingdom (uk)-based site, while the second is the platform for muslim projects and based in canada. the islamic crowd-funding platforms are typically independent. however, we may well see the next generation of islamic financial institutions introducing elements of crowdfund investing to their own customers. some islamic financial institutions already had similar crowd-fund investment modalities, but without online or p2p platform. as a final note, islamic crowd-funding is not exclusive in offering benefits and immune to risks as those of conventional crowd-funding. iii. background of the industry in indonesia a. islamic finance define abbreviations and acronyms the first time they are used in the text, even after they have been defined in the abstract. do not use abbreviations in the title or heads unless they are unavoidable. as the forth most populous country, the third largest democracy, and the biggest muslim nation in the world, with favorable demographics and transition to a middleincome country, indonesia will eventually become the biggest market for islamic finance. in the near future, indonesia is expected to be a leading model of development for islamic finance in the world. indonesia is looking to islamic finance as it is expected to play more significant role in the economy. islamic finance increasingly stimulates economic growth to a higher level, reduces poverty, and enhances the stability of the financial system. indonesia is also considered as a leading model of democracy for the islamic world. indonesia represents, because of its size and importance, a massive and even more relevant proof that democracy can work as well in muslim societies as in others. indonesia‘s islamic finance sector is characterized by growing economy. economic growth in indonesia has averaged about 6% for the last five years. the growth of islamic finance industry has been outpacing growth of conventional financing for over the last 10 years. with the unbanked accounting for more than half of the population, the potential for growth is still immense. the sector is expected to continue its growth at a double-digit level for the next five years. however, due to a late start in establishing islamic finance, which just began in indonesia in early ‗90s, the industry remains in a nascent stage. the national share of islamic finance sector is still around 5% or less. the share has only less than 2% of global islamic finance asset. with such high expectation and potentials it is unfortunate that islamic finance industry makes up less than 5 percent of the total asset of the industry. something is not quite right. the new administration sparks hopes for further development of islamic finance industry. president jokowi is known as a reform-minded leader, while jusuf kalla had demonstrated an experience to provide great opportunities to promote islamic finance industry under his administration. as vice president from 2004-2009, kalla succeeded in driving the enactment of sovereign sukuk law number 19 of 2008. for broader economic reform at that time, kalla was also among prominent figures in converting the use of firewood and kerosene into gas. the financial service authorities (fsa) or otoritas jasa keuangan (ojk) is now preparing a new blueprint to expand islamic finance in the country. the new blueprint may include additional benefits to current fee and tax incentives to revive the domestic sukuk market. the document will also address issues in islamic finance including lack of economies of scale, consolidation of opportunities, and the role of foreign ownership. therefore, a combination of hope that new ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 leadership and administration brings, together with ojk‘s new blueprint, it is envisioned that the sector will be empowered with much-needed catalyst. the development of islamic finance industry in indonesia until 2014 indicates that the new administration has no significant effect yet for the industry to transform. this analysis captures progresses of the industry up to 2014 and the outlook of the industry. sharia banking continues to be the largest contributor to the sector. strong growth in the past five years has been propelled by the sharia banking law introduced in july 2008. besides banking, the islamic finance sector in indonesia is building insurance (takaful) and capital market (sukuk and managed funds), that continue to catch-up and develop. b. internet those who might wonder about the future of the internet need to look no further than indonesia. like many countries, indonesia has swiftly entered into the universe of global digital communications. the internet sector in indonesia is now in a rapid growth phase. according to ambardi k., et.al (2013), in mapping digital media: indonesia, reported that ownership of household personal computers (pcs) trebled between 2005 and 2010, which was recorded to be the highest increase in electronic device ownership (compared to tv-set and radioset). mobile or cellular phone penetration has increased even more than 100 percent, to 115 mobile phone subscriptions per 100 inhabitants. table i. pc ownership, internet and mobile penetration rate (2009-2012) 2009 2010 2011 2012 pc 10.2 10.8 12.0 15.0 internet 1 19 22 32 mobile phone 69 88 102 115 source: open society foundation, 2014 the country report further explained that the number of internet users reached 55 million in 2012, accounting for some 32 percent of the total population, which was still lower than the south-east asian region (for example, malaysia‘s internet penetration rate was close to 66 percent in 2012, while in singapore was 74 percent in the same year). this figure is lower than the actual subscription rate, which indicates that there are more connected devices than actual users. it is very likely that internet users have their own choice of devices to access the internet now that the communications industry has opened up this possibility. internet-capable mobile phones are more frequently used by indonesian users. as is so often the case today among newly-connected countries, the primary means of communicating online in indonesia is mobile devices—many indonesians carry two of them—making the country‘s citizens highly wired and fully engaged. the active mobile broadband subscription rate per 100 inhabitants stood at 32 in 2012, according to data from the international telecommunications union (itu). in 2011, eric schmidt, ceo of google, commented about indonesia tech boom, ―you have 180 million cell phones, but did you know that you have only about 18 percent internet penetration? you‘re going to have an internet explosion.‖ indonesia is quickly becoming the ―social media capital of the world.‖ furthermore, the nation‘s capital, jakarta, is said to be the most active twitter city in the world while indonesia is the fifth largest twitter nation with around 29 million users. indonesia now also has the fourth largest number of facebook users with total users at around 49 million (or 20 percent of population). indonesia is also the fourth largest blackberry users with around 7 million users. indonesia also has kaskus as the largest community forum with over 4 million users. consensus forecasts that the number of internet users will grow from 55 million in 2012 to 125 million in 2015. in sum, the growth rate in indonesia will exceed 30% per annum for the next three years. both demand side and supply side drive the accelerating and sustaining growth. on the demand side, the fundamental element is the robust economic growth which is consistent at around 6% per year with personal spending levels which are currently rising by over 10% per year. therefore, the middle class in indonesia is growing rapidly, bringing with it strong demand for technology devices and online services. on the supply side, intense competition between the mobile companies is pushing prices down and also raising consumer awareness through mass market advertising campaigns. the government is also planning to increase internet penetration to the country‘s easternmost islands. according to the report from citizen lab (2014), the ministry of communication and information technology, recognizing the importance of high-speed internet to economic and social development, launched the indonesia connected program to boost connectivity in border and remote areas. the fiber-optic palapa ring network is being implemented throughout indonesia to accommodate this growth. not only is the user base growing rapidly, the profile of the typical internet user is changing too. within the user base, a big shift in the age of users is currently underway. traditionally the internet base in indonesia has been dominated by the under25s, leading to music, entertainment and social media being the most popular uses. starting in 2011 the 25-50 age groups begin to play catch-up, and has grown so quickly over the past two years that the user base is now relatively evenly spread across all age groups. this has led to the rapid expansion of more lucrative online services such as e-commerce, travel services and online banking. the vast majority will access the internet via their smartphone or tablet. c. e-commerce based on accenture internet business framework, the internet elements capture four categories: access, publish, interact, and transact categories. publish, interact and transact are the phases in e-commerce that encompass a value chain of players from buyers to sellers. online business or as it is more known as electronic commerce (e-commerce) is one of many results which are ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 produced from the massive growth of internet usage. ecommerce is a type of transaction of goods or services that are conducted with the media of internet. the growing of internet usage itself directly influences people to use e-commerce websites as their media to perform transactions, to sell or buy anything they want. there are also several reasons of the increasing popularity of e-commerce, they are: easiness/simplicity, unlimited verities, easy comparing, and competitive price/negotiable price. it is open to any one, whether individual, groups, or organizations. the transaction of goods and services must be ordered through internet, but the payment and delivery may be facilitated by internet (online) or not (offline). according to luthfihadi m. & dhewanto, w. (2013), ecommerce can be categorized into 4 (four) types as shown in table (2) below: table ii. e-commerce types type definition business to consumer (b2c) enterprises provide the commodities or services in internet directly and offer sufficient information and convenient interface to attract consumers to buy online in order to eliminate channel intermediaries. consumer to consumer (c2c) website's operator is not responsible for the logistics. they only help in gathering information and establishing credit-rating systems. the ebay is a good example of c2c platform. consumer to business (c2b) consumers come as groups categorized by topics and needs. facilitated by group negotiations bodies and demand aggregators, they can play a leading role for the products. business to business (b2b) by using edi (electronic data interchange), commerce among businesses can be conducted over the internet to integrate supply chain and logistics to reduce costs and promote efficiency in internet environment. e-commerce is developing in indonesia, albeit slowly. credit card use is increasing sharply, secure payment networks are being built, and stronger regulations are being 
 put in place. in 2011, the indonesian government enacted non-bank money transfer regulations, which stipulates that any online transaction should go through 
 a licensed bank or company. bank central asia (bca) has launched an innovative online payments platform
 by leveraging its atm network. this
 has popularized the notion of klik-bca –customers can use a disposable otp (one time password) to buy goods or pay bills online with one easy click. at the same time, innovative indonesian companies are finding clever ways to do ecommerce. current reported e-commerce transaction values are growing fast but absolute values are still low. according to survey by veritrans and daily social (2012), the size of indonesian e-commerce market in 2011 was estimated at usd 0.9 billion, which stood at only 0.7% of total retail sales (usd 134 billion). e-commerce penetration was assumed at 8% while e-commerce buyers was estimated at 4.4 million users. furthermore, majority of online shoppers spend up to rp. 500,000 (us$ 55) per transaction and average annual e-commerce spending per user is around usd 256. on payment method, the survey found that bank transfer is the most widely used method of payment for e-commerce. online payment solutions are fragmented and therefore still not widely used. e-wallet solutions also account for very small portion. more from the survey, fashion goods are the most popular things bought, followed by online travel bookings. half of online shoppers uses facebook or kaskus to buy goods. this implies that facebook and twitter are heavily used and present great opportunities to reach potential e-commerce customers. many indonesian entrepreneurs and businesses are connecting online through online advertising and social commerce to reap profit from these activities the market size of indonesian e-commerce in 2015 is expected to increase exponentially to usd 10 billion in 2015 considering the support of robust economic growth, stronger purchasing power, and higher credit card usage. in addition, better infrastructure, better products and services, and better payment system at the same time will push explosive growth of e-commerce in indonesia. law no. 11 of 2008 on electronic information and transactions (eit) was adopted on 21 april 2008. it is the first cyber law in indonesia and constitutes the main instrument regulating online content and transaction. iv. potential, challenges, and cases a. potential everything is in indonesia. many institutions made ―bullish‖ forecasts on indonesia. mckinsey and citi investment predicted that in 2030 indonesia will be 7 th largest economy in the world, while standard chartered forecasted more aggressively that indonesia will be 5 th largest. robust economic growth, with so called demographic advantage‖, for the next 15 years ahead, will place indonesia to a very powerful economic force in the world. this will push further the prospect for all related industries supporting sharia crowd-funding business. islamic finance will continue to grow with bigger and more significant market share, at the same time with higher penetration rate of internet and bigger size of e-commerce industry. we also should not leave behind the fact that indonesia is the most populous muslim in the world. indonesia is even bigger than total 5 counties in north africa and also slightly bigger than total 16 countries of middle east. this will support, if policy is rightly taken and developed, indonesia to become the center of islamic finance in the world. ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 b. challanges there are at least three major issues that need to be addressed: (1) trust, (2) quality of projects presentation, and (3) improper project campaign. first and foremost is trust. a lot of indonesians still have yet to trust the internet for e-commerce or to facilitate financial transactions. even for those who are comfortable with online transaction, trusting a total stranger with executing a project is another problem compounding the issue. the presentation of projects in indonesia‘s crowd-funding platforms is also another hurdle faced by the industry. we believe that many project owners have not tried their best to present how interesting their projects are. a lot of projects are still presented with minimal effort. project owners often just post a description and a cover image for their projects. lastly, campaigning on projects have not always been conducted properly by many project owners. many project owners seem to think that tweeting once or twice about their project will set things rolling. a crowd-funding platform, to get funded, of course need to gather the crowd first. other challenges that also seem to be solved include: (1) payment method, and (2) regulation support to develop ecosystem. we believe that more education to the market about crowdfunding will solve above mentioned challenges and issues. the crowd-funding industry can catch up with the whole startup industry in indonesia soon. it has been a proven working alternative to fund projects in some developed countries. many believe, when crowd-funding has gained its foothold, it can provide indonesia with a more vibrant startup. c. cases in indonesia there are some crowd-funding portals in indonesia that mostly donation-based. wujudkan.com, patungan.net, and also kitabisa.co.id. until this paper is written, islamic crowdfunding has not been launched. there have been a number of phenomenal cases in indonesia. these cases have attracted the interest of regulators in anticipating future development and regulation of crowd funding in indonesia. at the same time, the size of crowdfunding is relatively still very small in indonesia. 1) crowd-funding for movie-making : there was some major headlines at indonesia‘s crowd-funding scene. at the top of the list is the successful funding for ―atambua 39º celcius‖, a movie directed by renowned indonesian writer and director mira lesmana. posted in indonesian crowd-funding site wujudkan.com, the project collected more than the rp 300 million (approximately $31,071) that it needed. another movie that was successfully funded by the public in 2012 was ―demi ucok‖. the movie, which screened in indonesian cinemas in january 2013, gathered about rp 250 million also after seven months of self-organized crowd-funding. 2) yusuf mansur case: yusuf mansur, the well-known islamic religious public figure, with its famous campaign of ―power of giving‖, recently pulled on a string of attention after making an investment worth of rp 500 billion (around us$49,77 million). however, the investment scheme is yet to be approved. yusuf mansur did not collect the crowd-money through the web platform – worth noting. on his official website, yusuf promised that the investment will manifest in various business outlets like hotels at soekarno-hatta airport. investors will have 8 percent profit and cashback in a 10-year period. his investments include hotel and apartment, kazahkstan's oilrig, private tv station, 4.7 hectares of land, paddy fields in sukabumi, and also 2 banks. v. anticipated regulation and policy recommendation a. current regulation implication the regulatory implications arise under indonesian law in relation to the development of an online platform for peer to peer (p2p) crowd-funding in indonesia. the relevant and prevailing laws on islamic crowd-funding in indonesia are as follows: 1) the indonesian civil code, kitab undang undang hukum perdata law 2) no. 7 of 1992 on banking, as amended by law no. 10 of 1998 3) law no. 23 of 1999 on bank of indonesia, as amended by law no. 3 of 2004 and government regulation in lieu of law no. 2 of 2008, as ratified into law by law no. 6 of 2009 4) law no. 21 of 2008 on sharia banking 5) law no. 8 of 1995 on the capital markets 6) law no. 8 of 2010 on the prevention and eradication of money laundering 7) law no. 23 of 2006 on population administration as amended by law no. 24 of 2013 8) law no. 25 of 2007 on investment 9) law no. 40 of 2007 on limited liability company 10) law no. 11 of 2008 on electronic information and transactions 11) law no. 25 of 2009 on public services 12) law no. 7 of 2011 on currency 13) law no. 21 of 2011 on financial services authority 14) law no. 7 of 2012 on cooperatives 15) law no. 9 of 2013 on prevention of financing of terrorism criminal action 16) law no.20 of 2008 on micro, small, and medium enterprises 17) law. no. 3 of 2006 on religious court the related regulations on islamic crowd-funding in indonesia are as follows: 1) government regulation no. 82 of 2012 on electronic system and transaction providers ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 2) bapepam-lk regulation no. ix.a.13 kep 181/bl/2009, on general guidance on issuance of sharia instruments 3) bank indonesia regulation no. 7/6/pbi/2005 on transparency in bank product information and use of customer personal data 4) bank of indonesia regulation no. 14/21/pbi/2012 on reporting of foreign exchange activities 5) bank of indonesia regulation no. 14/27/pbi/2012 on implementation of anti-money laundering and countering financial of terrorism for commercial banks 6) bank of indonesia regulation no. 9/19/pbi/2007 on fund mobilization and financing agreements for banks conducting business based on sharia principles 7) bank of indonesia circular no. 15/7/dint 2013 on the reporting of foreign exchange activities for offshore loan plans, changes in offshore loan plans, and financial information; 8) bank of indonesia circular no. 15/6/dint 2013 on the reporting of foreign exchange activities for the realization and position of offshore loans; 9) presidential regulation no. 39 of 2014 on business sectors that are closed or partially open to foreign investment 10) ministry of finance decree no. 279/kmk.01/1991 on implementing regulations for offshore loans and bank guarantee issuance for offshore loans by foreign exchange banks 11) ministry of finance decree no. 84/pmk.012/2006 on finance companies 12) presidential regulation no. 9 of 2009 on consumer finance institutions; 13) minister of cooperatives regulation no. 19/per/m.kukm/xi/2008 on implementing regulations for savings and loan businesses; and 14) transaction reports and analysis centre regulation no. per09/1.02.2/ppatk/09/12 on suspicious and cash transaction report procedure; and 15) ojk regulation no.31 of 2014 on agreements in sharia financing 16) ojk regulation no.37 of 2014 on collective investment contracts b. scope of legal analysis based on above mentioned relevant laws and regulations, the analysis therefore classifies 2 major subjects i.e (1) lending business in indonesia, and (2) platform business in indonesia. islamic crowd funding is created to allow small and medium enterprises and individuals to access funding which may not be available otherwise through other channels. regulatory framework therefore have to ensure that a minimum extent of due diligence is performed to protect both lenders/investors and borrowers while allowing the platform to remain flexible and easily accessible. the purpose of the analysis is therefore to provide overview of how existing regulatory framework may apply under schemes proposed. table iii. subjects of legal analysis type definition (1) lending & investment business in indonesia a. licensing requirements for a lending & investment business b. loans, lending, and investment business under indonesian capital market laws and regulation c. reporting obligations (offshore and kwc) d. restriction on rupiah conversion, and associated reporting obligations e. agreement (aqad) and shariah compliance f. dispute settlement (2) platform business in indonesia a. electronic transaction provider for public services b. electronic loan/investment agreements: implications under eit law c. know your customer (kwc) exercise d. data protection e. foreign ownership f. language law compliance g. currency law compliance source: digi, 2014 c. policy recommendations according to kirbi and worner (2014), in general there are five regulatory regimes for peer-to-peer lending: 1) exempt or unregulated through lack of definition : some countries have not regulated this sector due to a lack of definition regarding the service provided to the investors and consider the market too small for regulation (tunisia and the uk). 2) regulated as an intermediary: this classification usually requires the registration of the platform as an intermediary. the obligations and requirements for intermediaries vary according to the jurisdiction. 3) regulated as banking: due to their credit intermediation function, platforms are therefore regulated as banks. as such, the platforms must obtain a banking licence; fulfil disclosure requirements and other such regulations. in jurisdictions that require bank-like regulation, the industry is comparatively small (e.g. germany and france). 4) the us model: the us regulatory regime, in summary, is structured as follows. at the federal level, each platform is required to be registered with the sec. one level below the federal requirements is state regulation. some states outright ban the practice of peer-to-peer lending and equity crowdfunding (e.g. texas). 5) prohibited: some jurisdictions ban the practice of peerto-peer lending. ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 there is other form of regulation anyway. another possible form of regulation that could be implemented is the regulation of peer-topeer lending as a collective investment contracts (cic) or kontrak investasi kolektif (kik) in indonesia. kik is managed under fund manager. though this regulation does not seem to exist, some peer-to-peer lending business models do seem to act as a cis. this can potentially qualify as a collective investment scheme for the purpose of regulation. other possible form in indonesia is to put p2p crowdfunding as part of sharia banking service. it is already wellregulated. however, financial services authority or otoritas jasa keuangan (ojk) needs to make use of remaining time available to perform more comprehensive analysis, as crowdfunding is still at its infancy and its sharia-based scheme is still awaiting to be launched. vi. conclusion the definition of islamic crowd-funding is outlined in this paper as the platform designed to comply with the sharia principles. islamic crowd-funding will describe the use of small amounts of money, obtained from a large number of individuals or organizations, to fund a project, a business or personal loan, and other needs through an online web-based platform in accordance with sharia principles. islamic crowd-funding, are still in the beginning of its development. there are not more than 10 platforms of islamic crowd-funding in the world. even more, indonesia still awaits for the first launch of this islamic crowd-funding. there is growing anticipation in indonesia as the conventional crowd-funding have experienced exceptional growth since 2010. although crowd-funding in muslim markets is relatively still new, but the rate at which new platforms are being launched suggests that a fundamental shift is underway. indonesia also has witnessed examples and cases which can be considered as initial crowd-funding and with similarities to islamic crowd-funding. policymakers and regulators should focus on the growth of this segment which has the potential to develop into a credible investment option for sophisticated and retail investors alike. there are a number of benefits as well as risk associated with crowd-funding. benefits need to be balanced with the risks posed by these innovative industries. there are still some questions on the future of the industry, both in terms of how the benefits of this type of market-based finance can be best directed to the real economy, and how the risks of this infant industry can be controlled. although regulatory regimes vary across jurisdictions, broadly speaking they can be classified into four regimes for regulating crowd-funding: exempt market/unregulated due to lack of definition; regulated as an intermediary; regulated as a bank; and the us model, with a possibility of a fifth regime: regulating as a collective investment scheme. other possible form in indonesia is to place p2p crowd-funding as part of sharia banking service. it is already well-regulated. financial services authority (otoritas jasa keuangan), as regulator, can continue to maintain research focus on this topic. this would aid regulator in monitoring the development of the industry. much of the impact factor assessment is qualitative in nature and further research towards developing indicators for those areas lacking hard data; as such the development of quantitative indicators, can also help with this assessment, as crowd-funding is still infant and sharia crowd-funding remains un-launched. references [1] a. agrawal, c. catalini, and a. goldfarb, ―some simple economics of crowdfunding‖, in j. lerner and s. stern (eds), innovation policy and the economy, chicago: university of chicago press, 2013, pp. 63-97. [2] ambardi, k., et.al., mapping digital media: indonesia, country report, open society foundations, january 2014. [3] at kearney, lifting the barries to e-commerce in asean, 2015. [4] a. ordanini, l. miceli, m. pizzetti, and a. parasuraman, ―crowdfunding: transforming customers into investors through innovative service platforms‖, in journal of service management 22, no. 4, 2011, p.p 443–470. [5] b. king, bank 3.0, singapore: marshall cavendish business, 2013. [6] citizen lab, islands of control, islands of resistance: monitoring the 2013 indonesian igf, report number 29, 2014. [7] e. estellés-arolas, and f. gonzález-ladrón-de-guevara, ―towards an integrated crowdsourcing definition,‖ in j. inf. sci. 38, no. 2, 2012, pp. 189–200. [8] e. kirby, and s. worner, crowd-funding: an infant industry growing fast. staff working paper of iosco research department, 2014. [9] ernst & young. ―growing beyond: dna of successful transformation‖, in world islamic banking competitiveness report, 2013. [10] h. godjali, t.k. wong, r. marino, a. sleigh, and l. davarzani, ready for indonesia‘s digital future? accenture, 2012. [11] h. rehman, crowd-funding and the muslim world, available at: www.crowdsourcing.org, 2012. [12] i. h. achsien, and d. l. purnamasari, ―different markets different stories: indonesia‖, in h. dar, et.al. (eds), global islamic finance report 2015, islamic banker association, london: edbiz consulting ltd 2015, pp. 101-104. [13] i. m. alonso, ―crowdfunding in islamic finance and microfinance: a case study of egypt‖, in h a el-karanshawy, et.al. (eds.), access to finance and human development – essays on zakah, awqaf and microfinance, doha, qatar: bloomsbury qatar foundation, pp. 86-94. [14] j.w best, and a.a. rehman, crowdfund investing in muslim markets: an action plan for governments, crowdfund capital advisor & fajr capital advisor, 2013 [15] massolution, ―crowd-funding industry report: market trends, composition and crowd-funding platforms‖, available at: http://www.crowdfunding.nl/wp-content/uploads/2012/05/92834651massolution-abridged-crowd-funding-industry-report1.pdf, 2012. [16] massolution, ―the crowd-funding industry report‖, available at: http://www.crowdsourcing.org/editorial/2013cf-the-crowdfundingindustryreport/25107?utm_source=website&utm_medium=text&utm_content=l p+bottom&utm_campaign=2013cf+launch, 2013. http://www.crowdsourcing.org/ http://www.crowdfunding.nl/wp-content/uploads/2012/05/92834651-massolution-abridged-crowd-funding-industry-report1.pdf http://www.crowdfunding.nl/wp-content/uploads/2012/05/92834651-massolution-abridged-crowd-funding-industry-report1.pdf http://www.crowdsourcing.org/editorial/2013cf-the-crowdfunding-industry-report/25107?utm_source=website&utm_medium=text&utm_content=lp+bottom&utm_campaign=2013cf+launch http://www.crowdsourcing.org/editorial/2013cf-the-crowdfunding-industry-report/25107?utm_source=website&utm_medium=text&utm_content=lp+bottom&utm_campaign=2013cf+launch http://www.crowdsourcing.org/editorial/2013cf-the-crowdfunding-industry-report/25107?utm_source=website&utm_medium=text&utm_content=lp+bottom&utm_campaign=2013cf+launch http://www.crowdsourcing.org/editorial/2013cf-the-crowdfunding-industry-report/25107?utm_source=website&utm_medium=text&utm_content=lp+bottom&utm_campaign=2013cf+launch ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 [17] m. luthfihadi, and w. dhewanto, ―technology acceptance of ecommerce in indonesia‖, in international journal of engineering innovation and management 3, 2013, pp. 9-18. [18] open society foundation, mapping digital media: indonesia, country report, 2013. [19] r. oberman, et.al, the archipelago economy: unleashing indonesia‘s potential, mckinsey global institute, september 2012. [20] s. gulati, crowdfunding: a kick starter for startup, special report td economics, 2014. [21] s. marzban, and m. asutay, standing out with the crowd, the banker, 2012. [22] sp ecommerce, indonesia‘s ecommerce landscape 2014: insights into one of asia pacific‘s fastest growing markets, 2014. [23] t. prive, what is crowd-funding and how does it benefit the economy, forbes, 2012. [24] unctad, unlocking the potential of e-commerce for developing countries, information economy report, switzerland: un publication, 2015. [25] veritrans and dailysocial, e-commerce in indonesia, available at: http://api.dailysocial.net/en/wp-content/uploads/2012/08/ecommerce-inindonesia.pdf, 2012. [26] world bank, crowdfunding‘s potential for the developing world. infodev, washington dc: finance and private sector development department, 2103. http://api.dailysocial.net/en/wp-content/uploads/2012/08/ecommerce-in-indonesia.pdf http://api.dailysocial.net/en/wp-content/uploads/2012/08/ecommerce-in-indonesia.pdf ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) can gdp growth linked instrument be used for islamic monetary policy? 1 school of business, university of creative technology, chittagong. email: aktherpu@gmail.com 2 taylors’ business school, taylors’ university, malaysia. email: bmhakimru@gmail.com 3 department of management, university of turin, italy. email: maha.radwan@unito.it abstract— we investigate islamic monetary policy and propose an alternative monetary policy instrument, namely gross domestic products (gdp) growth linked instrument. the study adopts the ordinary least square (ols) method to a dataset of 99 countries for the year 2012 and time-series data for malaysia throughout 1983-2013. moreover, six months (january – june 2014) daily data on islamic and conventional interbank rates are used for the correlational study. the results show that adjusted gdp growth rate can be set as a benchmark for money market instruments and also can be used as the reference rate for the capital market to set the cost of capital. moreover, we find that real interest rate is not representative across 99 countries since policy rates are often determined by either the money market which is usually disintegrated with the real sector of an economy or the central bank. interestingly, islamic and conventional money market rates are found significantly correlated in the presence of the dual banking system. moreover, inflation and employment rate in the organization of islamic cooperation (oic) countries are higher than in non-oic countries. therefore, the interest rate can be replaced with a more representative policy rate like the gdp growth rate linked instrument which could provide a benchmark rate for pricing products in islamic commercial banks and an avenue for investment in the islamic financial market. keywordsgdp growth rate, real economy, real interest rate, real exchange rate, inflation, islamic monetary policy, gross savings i. introduction monetary policy in a conventional economic system, is a mechanism to handle the demand and supply of money through manipulating the interest rate, while this interest rate (riba) is prohibited in islamic economic system. so, an alternative method or instrument to interest rate is necessary in order to control the supply and demand of money in the economic system. this instrument is essential since the change of this can set stable local currency, stable inflation, lower unemployment, and sustainable growth. there are two types of monetary policy i.e. expansionary and contractionary. expansionary monetary policy is applied to enhance the supply of money in the economy whereas contractionary monetary policy is applied to reduce the availability of money in the economy. moreover, the expansionary policy is traditionally used to combat unemployment in the economy by lowering interest rates assuming that easy credit entices businesses into expanding. on the other hand, contractionary policy is applied to slow inflation in order to avoid the resulting distortions and deterioration of asset values. in conventional definition, monetary policy refers to the management of expectations (wallace & sargent, 1976), expectation of the central bank and general public. in a detail way, the relationship between the interest rate and the supply of money is hinged by monetary policy. therefore, monetary policy applies a number of tools to control either one or both in order to influence the economic growth, inflation, exchange rate, saving and unemployment rate. monetary policy mechanism based on interest rate has mostly failed to reflect the real growth of an economy in the last century as well at the beginning of this century; the great depression of 1930s and 2007-2008 global financial crisis are the results of this catastrophic failure. since the great depression the classical school was overtaken by the keynesian thought, and later friedman (1968) has introduced monetarist approach. global financial markets faced several financial crises over the last 100 years, which were directly or indirectly due to the failure of interest rate mechanism in the economy. economists and academicians are motivated to develop a comprehensive framework for modern islamic monetary economy by the reemergence of islamic economics and finance particularly in the middle of the last century. since riba 1 , (interest rate) is banned in islam, a possible alternative is essential. mowdudi’s writings on sood 2 (interest) incited economists and academicians to rethink about riba free economy and thereupon many scholars such as khurshid ahmed, m.n. siddiqi, m. uzair, umer chapra, muhammad anwar, al-jahri, mohsin khan, abbas mirakhor, mohsin 1 the glorious qur’an (30:39; 4:161; 3:130 and 2:275-9) 2 mawdudi, a. a. (1961). sood means the interest. md akther uddin1, md hakim ali2, and maha radwan3 http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 mailto:aktherpu@gmail.com mailto:bmhakimru@gmail.com mailto:maha.radwan@unito.it ejif – european journal of islamic finance no13, august (2019) khan and others provided some theoretical framework and islamic instruments to solve this problem. scholars on the one hand propose profit loss sharing instrument to conduct monetary policy, on the other hand, few scholars argue that the system is inherently instable and not relevant in real economic sense. to this regard, islamic economic system would be stable if there is no interest rate and no speculative demand for money (chapra, 1985; 1996). whereas, speculative demand is likely to exist due to the unstable nature of return on equity-based instrument and therefore demand for money is also going to be unstable (khan, 1996). the following figure 3 summarizes the recent economic condition of dominant muslim countries which was also not very different in the last century. in nut shell, we can say that while inflation and the interest rate in developed economy remained too low for too long before finally hit zero lower bound, monetary authorities, lost their conventional weapon to control economic business cycle, and we have seen unprecedented and unconventional monetary policy like qe on the both side of atlantic, the muslim world however has been suffering from higher inflation and unemployment. fig 1: inflation and unemployment in oic fig 2: oic philips curve (authors’ estimation) 3 these graphs were based on top 14 from selected top 15 economies of oic (excluding iraq and khazakstan) algeria, bangladesh, egypt, indonesia, iran, iraq, kazakhstan, kuwait, malaysia, nigeria, pakistan, qatar, saudi arabia, turkey, and united arab emirates) source: world economic outlook october, 2017 fig 3: disintegration of real sector from financial sector in oic on the backdrop of above situation, we make an attempt to give an overview of islamic monetary policy framework, and rationally argue on why interest rate cannot be an ideal instrument of monetary policy and benchmark for money and capital market, and propose a viable alternative benchmark rate, which could be set up realistically, a true represent of real economic growth by target employment, stable inflation, stable exchange rate, maximum savings and investment opportunities depending on the real sector. accordingly, we develop a linear econometric model to see whether key monetary policy variables can explain interest rate or gdp growth rate better. we have followed two steps in our study. firstly, we have looked at the cross-country level and then at the country level. we have applied ordinary least square (ols) method as this gives consistent and efficient results when the estimations are best linear unbiased estimate (blue). all our estimated equations fulfill the blue criteria and pass the diagnostic tests. the results tend to show that all the key monetary economics variables, at both cross-country and country level, can explain real gdp growth rate better than real interest rate. money market is usually disintegrated with the real sector of an economy or it is controlled by the central bank. the study finds that islamic and conventional money market rates are highly correlated. on top of that, it finds that inflation and employment rates are higher in oic countries than non-oic countries. therefore, it is proposed that the interest rate should be replaced with more representative policy rate like the gdp linked instrument that can provide a benchmark rate to set the price for islamic banking products and services and also an avenue for investment in the islamic money and capital market. the structure of the paper follows. section 1 presents introduction, section 2 elaborates the theoretical foundation of islamic monetary economics. later on section 3 provides the theoretical model specification, data and the econometric methodology. the empirical results and discussions stand in section 4, and the last section finishes with the concluding remarks and policy implications. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ejif – european journal of islamic finance no13, august (2019) ii. literature review the present monetary system has come to this stage after passing through several stages of evolution, but the monetary system during the prophet’s time was a bimetallic standard based on gold and silver (dinar and dirham) circulating simultaneously. the ratio between these two coins was 1:10 which seemed stable throughout the period of first four caliphs. afterwards, such stability could not persist continually because of the different supply and demand condition which made to destabilize the relative prices of those. the ratio varied at different times particularly at the time of umayyad period and abbassid period, it was 1:12 and 1:15 respectively. over the time of decline, the exchange rate between dina and dirham fluctuated widely in different parts of the then muslim world (chapra, 1996). the evolution of money is given in the following figure; fig 4: evolution of the money over the period of time (based on chapra, 1996) islamic finance has emerged as a viable alternative of conventional finance (zaher and hassan, 2001); particularly during crisis period, islamic banks performed comparatively better that its counterpart-conventional banks (kayed & hassan, 2011; beck et al., 2013; & hussain et al., 2015). it has been proved by the recent financial crisis, that interest rate determined in the money market without considering the real economy is unable to solve the unemployment, high inflation, low income, saving and investment, and slow and unstable growth of real economy (kayed & hassan, 2011). thus, conventional monetary policy is deemed unsuitable to control the economic system both in developed and developing countries, which led policy makers to think about unconventional policy measures 4 . however, to get a sustainable and growing economic growth, we need to search a suitable alternative approach to run and manage monetary policy. though the interest rate is not acceptable in islamic economic system, a number of conventional monetary instruments are still available: changes in reserve 44 the ongoing debate on rethinking macroeconomic policy shows the importance of this issue. requirements, overall and selective controls on credit flows, changes in the monetary base through management of currency issue, and moral suasion. anwar (1987), khan and mirakhor (1989), and khan (1996) attempted to develop interest-free economic model with the help of conventional islm framework. a 25% of demand deposits with the banks for advancing interest-free loan to government were proposed by chapra. to comply with the islamic monetary policy, he further emphasized the need fulfillment, optimum growth, full employment, equitable distribution and economic stability and proposed to include such monetary instruments as statutory reserve requirements, credit ceilings (in particular, goal-oriented allocation of credit), equitybased instruments, changes in profit-and-loss sharing ratio and moral suasion (chapra, 1985; chapra, 1996). equity-based profit and loss sharing products would be effective in interest free economy (khan and mirakhor, 1989). moreover, the profit-sharing ratio, public share of demand deposit, refinance ratio, allocation of credit and qard hasan ratio are also recommended as distinctive. throughout the all shariah compliant monetary policy instruments, mudarabah mode deposit mobilization was focused more in the literature of khan and mirakhor (1994). there is a great semblance between their thinking and what is available in conventional economics. of course, the instruments like mudarabah and musharakah certificates are expected to have shari`ah legitimacy. moreover, they regard macroeconomic stability, characterized by price stability and viable balance of payments position as the chief goals for monetary policy. as for monetary policy, they conclude: monetary policy of an islamic state takes place in a framework in which all conventional tools normally available in a modern economy are at the disposal of the monetary authorities with the exception of the discount rate and other policy tools that involve interest rate. all other tools, namely open market operations (where equity shares rather than bonds are traded) and credit policies, can be as effective in an islamic system as they are in interest based conventional system. additionally, the authorities in an islamic system can utilize reserve requirements and profit-sharing ratios to achieve changes in the stocks of money and credit (khan and mirakhor, 1994). later, choudhry and mirakhor (1997) proposed the use of equity-based government securities with rates of returns based on budgetary surplus for the purpose of monetary management. the area has lost its motivation since mid-nineties, and since then no significant contributions have been made on theoretical developments in monetary economics from islamic perspectives. khan (2004) argued against elimination of interest by a legal decree and favored free market forces to bring the interest rates down to zero. he further stressed on providing incentives for the use of equity over debt financing, and proposed following policy measures: i) reducing reserve requirements to increase supply of loanable funds; ii) enforcing unlimited liability; iii) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 ejif – european journal of islamic finance no13, august (2019) gradual decline in interest to make investments in debt based instruments less lucrative and shift loanable funds towards equity based instruments; iv) allowing dividend as a tax deductible expense; and v) providing fiscal incentives to non-leveraged firms and disincentives to leveraged firms. furthermore, zangeneh and salam (1993) proposed that the central bank could charge the borrowing bank a weighted average rate of return in different sectors of the economy. however, this will create problems with reference to choose of sectors to calculate the weighted average rate of return. a particular bank may not have any investment in certain sector or sectors. furthermore, this suggestion is not considered as a solution of all the problems pertaining to pricing of products in islamic finance. hanif and shaikh (2010) referred to usmani’s (2003) proposal of issuance of gdp growth linked instruments to finance public debt. secondary market can be made for it by directing banks to meet their statutory requirements by way of trading in these instruments. this will deepen money market and the rate at which this instrument will be traded can be taken as the benchmark for pricing and structuring other products. since the source of funds and use of funds both use the same benchmark as in the current system, adopting an alternative benchmark on the source of funds side can be used in pricing commercial banking products on the use of funds side. hanif and shaikh (2010) recommended the use of a nominal gdp growth rate (ngdpgr) as a benchmark rate. they argued that the appeal in the use of ngdpgr is that not only can it be used as a base rate for the banking sector but also for central banks as their monetary policy tools that encompass both the conventional and islamic financial systems. in their analysis using data from various countries, they showed that there are no statistical differences between ngdpgr and various benchmark rates (for example, discount rate, treasury bill rate, deposit rate etc.) used in those countries under their study. therefore, this instrument can be used for indexing financing for public exchequer and could also be a major investment alternative for money market players as well as an alternate to open market operations (omo). the number of empirical studies on monetary policy from islamic economics perspectives are still very few but recent attention from international monetary fund (imf) has motivated few insightful publications (cevik and charap, 2011; kammer et al., 2015; khatat, 2016). earlier empirical works confirm the stability of money demand function in interest-free economy (darrat, 1988) but the results are still not convincing and need further research in this area. on the one hand, some empirical findings suggest that monetary policy works through islamic banking channel (sukmana and kassim, 2010; basu et al., 2015), on the other hand, it is argued by other researchers that monetary transmission channel does not pass through islamic banks (zaheer et al., 2012). the mix results are not surprising as in most muslim countries islamic banks operate under dual banking system and financial developments are heterogeneous. in addition, most of these countries suffer from higher inflation, little or no monetary freedom due to fixed exchange rate regime, shallow financial markets and strict capital control, among other reasons. the relevant literature shows that the aims of islamic monetary policy and conventional monetary policy are quite similar even though in the islamic economic system justice and equitable social welfare get priority and no existence of ‘riba’ i.e., interest rate makes the islamic system unique (ahmad and hassan, 2007; biancone & radwan, 2018; biancone & radwan, 2019). there are many tools available in the conventional monetary policy which can easily be replicated in islamic monetary policy with the exception of the discount rate and other policy tools that involve interest rate. inflation, exchange rate, unemployment, gross savings and investment are variables frequently mentioned in the literature as the best indicators of effective monetary policy outcome both in conventional and islamic. therefore, an attempt has been made to develop two models to compare and see whether real interest rate or gdp growth rate can better reflect and predict the monetary policy outcome. since our aim is to study a muslim country for a long time period, it is not easy to choose a country from 56 oic member countries. however, malaysia has shown tremendous potential as an emerging economy among muslim countries. moreover, malaysia is an emerging economy in the south-east asia with a per capita gdp of more than 10,000 usd and has a vision to become a developed economy by 2020, and considered as a bright example among muslim community for upholding the true value of islamic teachings, only country from 56 oic countries to be included in the islamicity index developed by askari and rehman (askari and rehman, 2013). malaysia has succeeded in developing the most robust islamic money market in the world, with a range of sharia`h compliant instruments for liquidity management for banks and financial institutions and other corporations. to this end, ali et al, (2018) find that sukuk as a shariah compliant instrument is able to reduce excess liquidity problem in malaysia. in malaysia, the islamic inter-bank money market (iimm) was introduced on january 3, 1994 as a short-term intermediary to provide a ready source of short-term investment outlets based on shari`ah principles. through the iimm, the islamic banks and banks participating in the islamic banking scheme (ibs) match the funding requirements effectively and efficiently. some of the islamic monetary instruments used in malaysia for money market operations are as follows (bacha, 2008): http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 ejif – european journal of islamic finance no13, august (2019) fig 5: overall structure of the iimm in malaysia (bacha, 2008) however, on the theoretical ground there are potential shortcomings while using gdp growth linked instrument as a policy tool. shaikh and hanif (2009) argue that in recession, real gdp may be negative, but nominal gdp growth rate will be positive. they wonder if it will not give an undue upward bias to the cost of capital when the production to which it is linked with is not increasing in recession. they further argue that stagflation and cost push inflation can be better tackled with better supply chain management, reducing intermediaries, and promoting market competition. scarcity of capital created by interest can better be managed through a high wealth tax and inheritance tax (piketty, 2014) i.e., zakah (2.5% on wealth, 5% and 10% on productions) in an islamic economy. this will boost up production, improve competition and remove obstacles giving rise to cost push inflation, and increase revenues for the government by increasing the tax base. inflation is most likely to be low in recession and hence gdp growth rate would not be that high. even if it is high, private sector financiers like banks would give financing based on cash flows discounted on that gdp growth rate. therefore, cost would have to be paid by the finances that have higher cash flows discounted on gdp growth rate. we could further argue that by including inflation in the public and corporate finance with the benchmark rate, and gdp growth rate, which takes into account inflation; as a result, the government do not need to resort to printing paper money, quantitative easing, to meet the fiscal deficit. if necessary changes are made to avoid budget deficits paper money may not need to be printed often and seignior age, profit made by a government by issuing currency, will not be presented as a compelling problem. to the best of our knowledge no study has so far looked at the issue from this perspective by taking cross-country and country level data over the period. therefore, we have attempted to investigate whether monetary policy goals are more achievable by following the gdp growth rate or real interest rate. iii. data and methodology we follow two steps in our study. firstly, we look at the cross-country level and then at the country level. the ols estimator is consistent when the independent variables are exogenous and multicollinearity is not an issue. moreover, when the errors are homoscedastic and serially uncorrelated it provides unbiased estimators. in other words, we apply ordinary least square (ols) method as it gives consistent result when the estimations are best linear unbiased estimator (blue). all of our estimated equations fulfill the blue criteria. in this study we use data collected from world bank, imf and bank negara malaysia database. to determine the impact of the independent variables on real interest rate and gdp growth rate we apply standardized ordinary least square (ols) regressions by using cross sectional data of 99 countries for the year 2012 and time series data from 1983 – 2013 for our country of concern malaysia. to detect model misspecification, multicollinearity, irrelevant variables and explaining power of the independent variables we run additional regressions as robustness check. in appendix table 1 and table 2, we present descriptive statistics and correlation matrix, the following standard diagnostics tests are conducted: jarquebera test for normality, heteroskedasticity test: breuschpagan-godfrey and breusch-godfrey serial correlation lm test. we estimated the following two equations: rir = β0 + β1 y + β2 z + ε (1) gdp = β0 + β1 y + β2 z + ε (2) where, rir is real interest rate (%), gdp is nominal gdp growth rate (%), y and z are control and focus variables respectively, β0 is intercept, β1 – β2 indicate coefficient of the independent variables, and ε is error term. we have incorporated the independent variables from literature. it is well established that maintaining stable inflation, strong currency, sustainable growth, higher savings, and investment are fundamental objectives of monetary policy. we assume that gdp growth rate and the real interest rate models would provide equal estimation. we expect oic dummy and two other interactive dummies to be statistically significant. appendix 1exhibits definition of the variables. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 ejif – european journal of islamic finance no13, august (2019) iv. empirical results and discussions table 1:ols estimation output for cross-country data variables real interest rate gdp growth rate intercept -64.711* (26.834) -12.596 (23.814) inflation 0.275 (0.217) 0.419* (0.134) log real exchange rate 14.681* (5.759) 2.426 (5.154) log gross savings -0.138 (0.797) 1.072 (0.580) unemployment rate 0.155 (0.082) -0.153* (0.076) oic dummy 3.071 (2.026) 3.561* (1.722) oic*une -0.096 (0.159) 0.105 (0.125) oic*inf -0.535 (0.295) -0.498* (0.193) r2 0.117 0.338 adjusted r2 0.047 0.285 f-value 1.668 6.405 probability 0.127 0.000 notes: standard errors are in the parentheses. *denotes statistical significance at the 5% table 1 shows the baseline estimation of equation 1 and 2. in the first model the r2 is 0.117 and adjusted r2 is 0.047 which indicates all independent variables together could explain only 11.7% of independent variable, which is not statistically significant as p-value is 0.127. however, in equation 1, real exchange rate has positive relationship with real interest rate at 5% significance level. surprisingly, we didn't find any significant relationships with other key independent variables. most importantly, the model is not good fit to explain the focus variables which represent key objectives of conventional monetary policy. however, we expect better results in time-series data for a single country, malaysia, where dual banking system has been prevalent. in the second regression, all the independent variables are regressed on gdp growth rate. in this regression four statistically significant variables are identified. inflation, unemployment, oic dummy and oic x inf interactive dummy show statistically significant relationship with gdp growth rate at 5% significance level. in this model, r2 (r square) is .338 (0.338) and adjusted r2 (r square) is 0.285 which means all independent variables together could explain 33.8% of change in gdp growth rate, which is statistically significant as p-value is 0.000. in robustness test, both regressions were run through jargue bera normality test, breusch-pagan-godfrey heteroskedasticity test and breusch-godfrey serial correlation lm test. as we are dealing with cross-sectional data, we apply newy-west method to solve heteroskedasticity problem. v. discussions of results: the first column of the table 1shows one percent increase in exchange rate would lead to 14.68% increase in real interest rate. as discussed earlier the overall model is not good fit the explanation of the co-efficient may be misleading. however, we have a large number of cross section observation (99). the results of this equation clearly indicate that commonly accepted monetary policy variables cannot explain the changes in real interest rate which is considered as the key conventional monetary instrument. we have been experiencing the unprecedented monetary policy measures since the global financial crisis of 2007-08. we find a clear evidence that interest rate as a monetary policy instrument has lost its significance. this is mainly due to dis-integration of real economy from financial economy and ex-ante nature of the interest rate. on the other hand, the second model indicates that inflation and unemployment rate have significant positive and negative affect on nominal gdp growth rate respectively. to further elaborate one standard deviation shock to inflation would lead to increase in 0.419% increase in nominal gdp growth rate. higher inflationary pressure is detrimental to economic growth as real growth tends to slow down. on the contrary, low and moderate inflation can stimulate growth in the long run as it push down the interest rate which promote investment and reduce unemployment. it is clear from the second estimation that oic countries have higher growth prospect but not without the expense of higher inflation. nominal gdp growth rate and inflation for sample countries are shown below. fig 6: gdp vs inflation of sample countries in 2012 http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 ejif – european journal of islamic finance no13, august (2019) a. inflation in oic member countries in the second model, oic x inf interactive dummy has statistically significant affect on nominal gdp growth rate. one way to explain the coefficient is 1% increase in inflation rate would lower oic nominal gdp growth by -0.498% compare to non-oic countries. it clearly shows oic countries are more prone to inflation than the non-oic countries. many oic countries like turkey, pakistan, egypt, indonesia, nigeria, and bangladesh have been suffering from higher inflation and weaker currency in the recent past. on this backdrop, inflation targeting has become more popular among many oic central bankers. moreover, almost all oic countries are developing and the economy of gcc countries are largely dependent on oil windfall, decrease in oil price would lead to skyrocketing inflation. however, central bankers are facing challenges due to relationship breakdown between inflation and unemployment rate. the figure 4 shows the inflation rate in non-oic and oic countries. fig 7: inflation rate in non-oic and oic member countries in 2012 b. unemployment the second model of cross-sectional estimation shows increase in unemployment rate would reduce the economic growth significantly. for instance, the co-efficient indicates 1% increase in unemployment rate would decrease the gdp growth rate by 0.153%. unemployment is one of the most common problems in many oic countries, more specifically, youth unemployment which was one of the key factors of arab spring. however, we didn't find any significant difference in level of unemployment between non-oic and oic countries. the figure 5 exhibits the unemployment rate scenario of the two groups. fig 8: unemployment rate in non-oic and oic member countries in 2012 c. oic economic growth oic dummy in the second estimation shows oic countries have 3.56% higher nominal gdp growth rate than the nonoic countries which is statistically significant. the convergence hypothesis could potentially explain the situation, developing countries tend to have higher gdp growth rate compare to developed countries. the figure 6 illustrates the gdp growth rate of non-oic and oic countries. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 ejif – european journal of islamic finance no13, august (2019) figure 9: gdp growth rate in non-oic vs oic member countries in 2012 in this part of the study we have analyzed the relationship of real interest rate and nominal gdp growth rate with inflation, unemployment by taking into account other key monetary policy variety. we have observed key monetary variables have no significant affect on real interest rate even though vice-versa may happen. we argue that interest rate is usually determined in the money market and consequently it has no strong influence on the real economy. this has become evident in the recent past as the central bankers start using unconventional monetary policy instruments to control unemployment and inflation and stimulate growth. the figure 7 shows that nominal gdp growth rate and real interest rate. figure 10: real interest rate vs gdp growth rate of sample countries in 2012 interest as monetary tool in conventional way is negatively related to gdp (r=-0.076) and positively related to inflation but in our study, it shows it is negatively correlated (r=0.150), this may be due to relatively low and stable inflation rate for a long time in malaysia. normally, the central bank will adjust the interest rate accordingly based on their economic objective that is whether it is for inflation targeting or growth targeting. fig 11: real interest rate vs gdp growth rate in malaysia (1983-2013) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 ejif – european journal of islamic finance no13, august (2019) on the other hand, gdp growth rate is positively correlated with gni growth rate and fdi net inflow. in other words, higher gni and fdi growth will lead to increase in gdp growth rate which is supported by the literature. moreover, inflation is positively correlated with gdp growth rate which indicates low and moderate inflation can stimulate growth of an economy. in this stage of our study we focus at the specific country level. as malaysia has recently developed its islamic interbank market, it would be interesting to see whether this market operate independently from conventional market. table 2 correlation matrix of islamic vs conventional interbank rate islamic interbank rate conventional interbank rate islamic interbank rate 1.0 0.90*** conventional interbank rate 0.90*** 1.0 notes: ***. correlation is significant at the 0.001 level (2tailed). to investigate the difference between current islamic and conventional money market we have taken six months’ data (figure 7) from bank negara malaysia database. we have observed that there is no statistically significant difference between these two rates and they are highly correlated with each other (table 2). fig 12: islamic interbank rate vs. conventional interbank rate (january – june 2014) table 3: ols estimation output for malaysia from 19832013 variables real interest rate gdp growth rate intercept -26.811 (53.678) -12.187 (15.601) gni -0.934** (0.320) 1.124*** (0.093) net fdi -1.799 (0. 873) 0.717** (0.254) log gross savings 2.431 (7.678) 0.701 (2.232) log real exchange rate 5.907 (6.186) 1.745 (1.798) inflation -0.338 (0.059) -0.040 (0.170) gni*fdi*loggs 0.081** (0.029) -0.021** (0.008) r2 0.353 0.961 adjusted r2 0.185 0.952 f-value 2.097 96.078 probability 0.093 0.000 notes: standard errors are in the parentheses. *, **, and *** denotes statistical significance at the 10%, 5% and 1% levels respectively. in the first model (table 3), the result of ols estimation indicates that real interest rate is not reflected in overall growth of the economy, not statistically significantly correlated with net inflow of foreign direct investment, gross savings, real exchange rate and inflation and only little impact when three key variables combined. however, real interest rate is negatively correlated with gross national income; in other words, increase in gni by one point would lead to decrease in real interest rate by 0.934% assuming ceteris paribus. it can be explained in another way, increase in real interest rate would discourage production and investment activities which will lead to decrease in gross national income. nevertheless, the estimated model shows the real interest rate is very weakly (r2 =0.357; p-value =0.0.093) explained by key macro-economic variables. on the other hand, in the second model (table 3) result of the analysis shows that gross national income and net foreign direct investment are significantly correlated with gdp growth rate (r=0.97; p=0.001 and r=0.58; p=0.001). from the ols estimation (2) we can explain that increase in gni by one unit would contribute in 1.124 % of gdp growth rate. this of course is quite significant which need further investigation or variable itself is highly exogenous. at the same time, increase in fdi by one unit would lead to increase in gdp growth rate by 0.717%. in other words, if http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 ejif – european journal of islamic finance no13, august (2019) we can predict gross national income and net inflow of foreign direct investment we can predict the gdp growth rate more accurately. in addition to that, when we added more independent variables to see the impact of these variables on gdp growth rate, we observe that explaining power of the model increases. in other words, inclusion of gross savings, real exchange rate and inflation help better explaining the change in gdp growth rate (adjusted r2 =0.952; p=0.001). however, when we try to see the impact of three variables jointly namely gross national income, net inflow of foreign direct investment and gross savings, we find that the model even explain better but there is a sign change for inflation and decrease in coefficient from 0.077 to -0.040 which indicates weakness in this model. from the above discussion, we can conclude that in the estimation 2 (table 3) reflects the overall aim of islamic monetary policy and explain gdp growth rate much more accurately and consistently. vi. implications and conclusions a comparative literature review of islamic and conventional monetary policy has revealed that there are many monetary policy instruments which can be adopted in islamic monetary policy with or without major modifications such as: legal reserve ratio, credit rationing, selective credit control, issue of directive, and moral suasion. at the same time, islamic economists and researchers have come up with instruments which are unique and shari`ah compliant such as: profit sharing ratio, refinance ratio, public share of demand deposits, value-oriented allocation of credit, and qard hasan ratio (biancone & radwan, 2018). in islamic economic system, the main objectives of monetary policy are to 1) promote a sustained and balanced economic growth and mobilize resources for economic development; 2) maintain stability in the value of money so as to avoid excessive periodic fluctuations; and 3) maintain stability in the external value of money to promote an equitable distribution of income and wealth. we have found gdp growth holistically represents the real economy and connects real sector and financial sector of an economy. therefore, we can argue that it is reasonable to use gdp growth rate as the benchmark for making and refining instruments for money market. it is unlike a bond indexed for inflation which is not recommendable as inflation does not always imply growth in production especially in stagflation. moreover, inflation is more subjective and relative a measure to index an instrument with. if indexation for inflation allowed in financial intermediation at broad based level, then it is not practicable in the financial system. as interest rate is prohibited in islamic economic system, and all loans linked with inflation, then more the loans taken, more will be the credit money generation (assuming fractional reserve system) and more will be the inflation. for those who had nothing to do with all this who were neither the borrowers nor the lenders, would suffer with this inflation, and this cannot be controlled since there is no interest rate mechanism. so, we also need to think of how to control inflation which is in essence a tax, as argued by many economists rather than encouraging indexation for inflation and thereby fueling expected inflation. for the last two decades, an increasing number of islamic monetary management tools and policies have been developed by financial institutions and markets in malaysia and other muslim countries around the world but still libor is the ultimate benchmark in the money and capital market. consequently, we found that islamic and conventional money markets rate highly correlated. dual banking system could be one of the main reasons of this phenomenon. moreover, this conjecture is likely to be true for other oic countries where islamic banks co-exist with the conventional banks. also, we found that real interest rate is mostly not representative across 99 countries as most of the time policy rates are either determined in the money market, which is usually disintegrated with the real sector of an economy, or it is fixed by the central bank. as many economists argue after such a long time of great moderation, a reduction in the volatility of business cycle fluctuations starting in the mid-1980s believed to have been caused by institutional and structural changes in developed nations in the later part of the twentieth century. the recent global financial crisis has proven to us that interest, which is the definitive instrument of monetary policy regulation has not only failed to control the economic system but also has created inequality, social injustice and rampant corruption and manipulation by global financial institutions supported by the government officials (chapra, 2011; mirakhor, 2014;). for example, during the recession, the usa and many european countries have intentionally violated the socalled market principles and intervened overwhelmingly to protect many giant financial institutions. given that, the interest rate needs to be replaced with more representative policy rate like the gdp growth rate linked instrument, which could provide a benchmark rate for pricing products in islamic commercial banking and provide an avenue for investment in the islamic money market and capital market such as gdp growth linked sukuk (bacha and mirakhor, 2013). the gdp growth linked benchmark can also be used to benchmark not only domestic debt but also foreign debt. central bank in an interest free economic framework will continue to have statutory reserve ratio to contain money supply and control credit creation. furthermore, introducing gdp linked instruments would provide a base instrument for omo and create a secondary market for the instrument. using refinance ratio, qard hasan ratio issue of directive, and moral suasion the central bank will be able to manage liquidity in the banking sector. in conclusion, we acknowledge that due to the limited and http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 ejif – european journal of islamic finance no13, august (2019) focused scope of the study we could not take into account other macro-economic variables that may affect real interest rate and gdp growth rate. it is also important to remember that there are arguments against using gdp growth rate as benchmark rate. moreover, further research is required in this emerging area, especially by taking large panel dataset and advanced econometric techniques in order to determine the relationship and consistency across countries and regions. vii. references 1. ahmad, a.u.f., & hassan, m.k. 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(2015). monetary operations and islamic banking in the gcc: challenges and options (no. 15/234). international monetary fund. 8. beck, t., demirgüç-kunt, a., & merrouche, o. (2013). islamic vs. conventional banking: business model, efficiency and stability. journal of banking & finance, 37(2), 433-447. 9. biancone, p. p., & radwan, m. (2018). social finance and unconventional financing alternatives: an overview. european journal of islamic finance, (10). 10. biancone, p. p., & radwan, m. (2018). shariacompliant financing for public utility infrastructure. utilities policy, 52, 88-94. 11. biancone, p. p., & radwan, m. (2019). social finance and financing social enterprises: an islamic finance prospective. european journal of islamic finance. 12. biancone, p., & secinaro, s. (2016). the equity crowdfunding italy: a model sharia compliant. european journal of islamic finance, 5, 1-10. 13. cevik, s., & charap, j. ( 2011). the behavior of conventional and islamic bank deposit returns in malaysia and turkey. imf working papers, 1-23. 14. chapra, m.u. (1996). monetary management in an islamic economy‖, islamic economic studies, 4(1), december, 1–35. 15. chapra, m.u. (1985), towards a just monetary system, the islamic foundation, uk. 16. chapra, m.u. (2011). the global financial crisis: can islamic finance help?. in islamic economics and finance, 135-142. palgrave macmillan uk. 17. choudhry, n.n., & mirakhor, a. (1997). indirect instruments of monetary control in an islamic financial system. islamic economic studies, 4(2), 27-66. 18. darrat, a.f. (1988). the islamic interest-free banking system: some empirical evidence. applied economics, 20, 417−425. 19. friedman, m. (1968). the role of monetary policy, american economic review lviii, 117. 20. hanif m.n., shaikh s. (2010). central banking and monetary management in islamic finance environment. j. ind. stud. res., 8(2). 21. hussain, m.m., shahmoradi, a., & turk, r. (2015). an overview of islamic finance, 15-120. international monetary fund. 22. kammer, m.a., norat, m.m., pinon, m.m., prasad, a., towe, m.c.m., & zeidane, m.z. (2015). islamic finance: opportunities, challenges, and policy options, 15. international monetary fund. 23. kayed, r.n., & hassan, m.k. (2011). the global financial crisis and islamic finance. thunderbird international business review, 53(5), 551-564. 24. khan, m. a. (2004). elimination of interest: a proposed strategy. renaissance. 14, 1. 25. khan, m.s., & mirakhor, a. (1994). monetary management in an islamic economy. islamic economics, 6(1), 3-22. 26. khan, m.s., & mirakhor, a. (1989). the financial system and monetary policy in an islamic economy. journal of king abdulaziz university: islamic economics, 1(1), 39-57. 27. khan, m.s., & mirakhor, a. (1994). monetary management in an islamic economy. islamic economics, 6 (1), 3-22. 28. khan, m.f. (1996). a simple model of income determination, growth and economic development http://www.ojs.unito.it/index.php/ejif issn 2421-2172 11 ejif – european journal of islamic finance no13, august (2019) in the perspective of an interest-free economy, in m.a. mannan (ed.), financing development in islam (jeddah: irti, idb), 79-108. 29. khatat, m.h., 2016. monetary policy in the presence of islamic banking. imf working papers 16 (7)2, 141. 30. piketty, t. (2014). capital in the twenty-first century. harvard university press. 31. shaikh, s.a., & hanif, n. (2009). role and functions of central bank in islamic finance. j. ind. stud. res., also available at ssrn: http://ssrn. com/abstract, 1709368. 32. sukmana, r., & kassim, s.h. (2010). roles of the islamic banks in the monetary transmission process in malaysia. international journal of islamic and middle eastern finance and management, 3(1), 7-19. 33. usmani, m.t. (2003). “islam aur jadid maeeshat-otijaraht”. karachi: maktaba ma’ariful quran. 34. wallace, n. and sargent, t.j. (1976). rational expectations and the theory of monetary policy, journal of monetary economics, 2: 169-183. 35. zaheer, s., ongena, s., & van wijnbergen, s., 2012. the transmission of monetary policy through conventional and islamic banks. european banking center discussion paper, (2011-018), 2011-078. 36. zaher, t. s., & kabir hassan, m. (2001). a comparative literature survey of islamic finance and banking. financial markets, institutions & instruments, 10(4), 155-199. 37. zangeneh, h., & salam, a. (1993). central banking in an interest-free banking system. islamic economics, 5(1), 25-35. appendix 1 variables defined real interest rate (%) real interest rate refers to the lending interest rate for inflation which is measured by the gdp deflator. gdp growth (annual %) gdp growth rate is the annual percentage growth rate of gross domestic product in local currency market price. aggregate acre constant 2005 usd. real effective exchange rate index (2010 = 100) this variable means the nominal effective exchange rate (a measure of the value of a currency against a weighted average of several foreign currencies) which is devided by a price of deflator. gni growth (annual %) gni is calculated as such; the sum of value added by all resident producers plus any product taxes (less subsidies) not included in the valuation of output plus net receipts of primary income (compensation of employees and property income) from abroad. foreign direct investment, net inflows (% of gdp) foreign direct investment (fdi) refers to the net inflows of investment in order to acquire a lasting management interest in an a firm which operates in any state other than that of investor. this is the sum of equity capital, reinvestment of earnings, other long-term capital, and short-term capital as shown in the balance of payments. this series shows net inflows (new investment inflows less disinvestment) in the reporting economy from foreign investors, and is divided by gdp. gross savings (% of gdp) gross savings are constructed as gross national income deduct total consumption and add net transfers. inflation, consumer prices (annual %) the variable inflation refers to consumer price index which means the annual percentage change in the cost to the average consumer for acquiring a basket of goods as well as services that could be fixed or varied at a specific time intervals such as quarterly, yearly. unemployment, total (% of total labor force) (modeled ilo estimate) unemployment is the share of the labor force which is without job but available and seeking for job. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 12 ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france i. introduction ii. literature review iii. data and methodology iv. empirical results and discussions v. discussions of results: a. inflation in oic member countries b. unemployment c. oic economic growth vi. implications and conclusions vii. references paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 integrated reporting, cultural environment and religion: the case of two islamic banks abstract— over the last few decades a growing awareness of the role of firms in society has emerged and, consequently, a call for a different approach towards accounting and accountability. among various proposals, integrated reporting (ir) represents the more recent and ambitious one to date, even if some critical matters have to be dealt with by companies involved in its implementation. amongst them, some authors have already highlighted that it is necessary to introduce a cultural change in order to develop a new approach with reference to the measurement, communication and disclosure. in this sense, in recent years critical and interdisciplinary research has significantly challenged the predominantly technical and apolitical view of business and accounting. this has led to growing consensus that the most valuable insights are gained from studying practices in the organizational and broader social settings in which they operate, i.e. their cultural context. on the basis of the above, islam does represent a strongly important field of study for the cultural context into which ir could develop. in effect, in islamic thought, it is believed that adam, the progenitor of the human race and islamic prophet-was appointed trusteeship (khalifa) or guardian of the planet earth; in addition, a concept unique to man is amana or trust. in this sense, allah offers amana to the heavens, to the earth, to the mountains to the rest of creation who all refused; only mankind was foolish enough to accept it. a trust entails one who entrusts and a trustee. qur’an is embodied with the principles of moderation, balance and conservation, which are the core of sustainable development and provide a framework for discernment, without which there would arguably be no limits to waste, extravagance or greed both individual as well as corporate. further exploration does suggest that the accountant, and hence accounting, is actually given a very key role. the person that is described as accountant or muhtasib in islam is the one responsible for making sure that business is not harming the individual and the community. tawheed (unity) stimulates the desiderata of an explicit public commitment to reasonable and comprehensible accounting – full and relevant disclosure – in the public interest, as such an explicit commitment becomes a charge in relation to which those formally regulating accounting can be held accountable. at the same time, islam encourages humankind to experience lazkiyah (self-correction) through active participation in life, since only behaving ethically in the materialistic life (duniya) muslims prove their worth to allah. the paper is mostly theoretical, yet it offers fruitful practical insights since only a truthful assessment of the cultural pattern, as such as islam, can lead to a conscious approach towards sustainability. this paper offers insights for future research on the broad field of social and environmental issues, as well as integrated reporting, since it suggests to take always in account – when addressing issues and potentialities of non financial reporting – the cultural pattern. i. introduction this paper, after having addressed the main issues and challenges of integrated reporting (ir), poses the question of the mutual intersection between ir and the cultural context, with particular reference to religion. the paper is structured as follows: section 2. develops the main literature, section 3. discusses the findings of two case studies and section 4. concludes. ii. literature review integrated reporting over the last few decades a growing awareness of the role of firms in society has emerged and, consequently, a call for a different approach towards accounting and accountability. among various proposals, integrated reporting (ir) represent the more recent and ambitious one [35], even if some critical matters have to be dealt with by companies involved in its implementation [35]. for instance, flower (2014) presents a comprehensive analysis of the iirc project and arrives at the pessimistic conclusion that it will fall substantively short of its original objectives [20]. his critique is based on a comprehensive content analysis of key iirc documents. the analysis identifies a shift away from its founding sustainability infused objectives to a weak, diluted, business-as-usual reporting framework embedded within an explicit capitalist ideology. in doing so, he demonstrates that integrated reporting in 2014 is a far cry from the integrated reports envisaged in 2009. at the same time, adams (2015) contests flower (2014) argument [2], that is the iirc’s proposals will have little impact on reporting practice, since they on the contrary have been having an impact. over a hundred businesses in fact have paid to be involved in the pilot programme and according to her many others are adopting elements of integrated reporting and internationally regulation is increasingly requiring disclosure of, for example, strategy, risks and business model information in annual reports and operating and financial reviews. lorenzo gelmini ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 in this sense, according to adams (2015): “i believe that to a large extent, their impact on reporting practice depends on those critical of the status quo both engaging with practice and ensuring their voices are raised and heard” [2]. that said, rationales and motives of ir have been studied, as such the institutional context and stakeholder theory. for instance, using the words of dragu (2014) “the vision of integrated reporting has developed on the grounds of novel theorizations” [17]; in fact this paper highlights the most relevant theories for integrated reporting, mainly mentioning three theoretical circles that surround integrated reporting initiatives: stakeholder theory versus shareholder theory, new institutionalism and legitimacy theory and innovation diffusion theory. moreover, dragu (2014) reminds that “the diffusion and adoption theory for organizational practices [..] originated from the institutional theory, as the latter states the influence of certain factors in the practices adopted by corporations” [17]. in effect, “integrated reporting represents the reconciliation of two main theories, namely: shareholder theory and stakeholder theory. the theory of shareholder primacy states that the main objective of companies should be to maximize shareholder’s value. from the perspective of this theory, the role of integrated reporting would be to approach environmental, social and governance issues that are considered to influence the value of the company” [17]. taking into account the points above, potential and multiple relationships between ir and its cultural context have now to be addressed as indicated below. ir and religion some authors have already highlighted that it is necessary to introduce a cultural change in order to develop a new approach with reference to the measurement and communication. in this sense, in recent years critical and interdisciplinary research has significantly challenged the predominantly technical and a-political view of business and accounting. this has led to growing consensus that the most valuable insights are gained from studying practices in the organizational and broader social settings in which they operate, i.e. their cultural context. some authors have already included in their agenda the role of religion for sustainability reasons: consider for instance abeydeera (2016), according to which “previous studies examining influences on corporate sustainability reporting have tended to focus on the influence of global initiatives such as the global reporting initiative (gri) and the united nations global compact (ungc)” [1]. despite these global initiatives encompassing well-meaning and beneficial components, according to abeydeera (2016) they can be argued to be primarily “self-serving, and selfabsorbing and very rarely systems-changing” [1]. in this line, for that author “dealing with fundamental systems issues requires transformational thinking and action [..]. it would appear that approaches that are based on moral values to foster sustainability offer greater possibility in this regard” [1]. on the basis of the above, islam does represent a strongly important field of study for the cultural context into which ir could develop. in effect, in islamic thought, it is believed that adam, the progenitor of the human race and islamic prophet-was appointed trusteeship (khalifa) or guardian of the planet earth; in addition, a concept unique to man is amana or trust [34]. allah offers amana to the heavens, to the earth, to the mountains to the rest of creation who all refused; only mankind was foolish enough to accept it. a trust entails one who entrusts and a trustee. qur’an is embodied with the principles of moderation, balance and conservation, which are the core of sustainable development and provide a framework for discernment, without which there would arguably be no limits to waste, extravagance or greed both individual as well as corporate [34]. further exploration does suggest that the accountant, and hence accounting, is actually given a very key role. the person that is described as accountant or muhtasib in islam is the one responsible for making sure that business is not harming the community [27]. tawheed (unity) stimulates the desiderata of an explicit public commitment to reasonable and comprehensible accounting – full and relevant disclosure – in the public interest, as such an explicit commitment becomes a charge in relation to which those formally regulating accounting can be held accountable. in these terms, social responsibility in islam is multifaceted and this can be clearly seen from the prophet’s hadith (no. 7138, 1229): ‘abdullah ibn ‘umar reported: the messenger of allah, peace and blessings be upon him, said, “every one of you is a shepherd and is responsible for his flock. the leader of the people is a guardian and is responsible for his subjects: amana is the guardian of his family and is responsible for his subjects, a woman is the guardian of her husband’s home and of his children and is responsible for them, and the slave of a man is a guardian of his master’s property and is responsible for it. surely, every one of you is a shepherd and responsible for his flock”. with specific reference to sustainable development, hassan (2016) suggests that the islamic approach is more agreeable to environmental protection and the issues associated with environmental and sustainable development have moral, ethical and social responsibilities, so that “the businesses should have on intense commitment to islamic ethics in justice and welfare of human beings” [26]. ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 iii. findings and discussion methodology the paper comments on the integrated report, as of 2015 (the latest available to date), of al rajhi bank, saudi arabia, and shahjalal islami bank (limited), bangladesh. the methodology is qualitative, since it is grounded on a case study approach, and it encompasses a visual analysis of some figures included in the integrated reports, in this sense, visual methodologies for accounting and accountability have been already largely studied by davison (2017) and other authors, who have classified some of them as “visual rhetoric” – that is, visuals are an art of persuasion and have a performative function using antithesis and repetition [16] – and who acknowledge the utility of visuals in “recognising the socio-political context of images generated for the purposes of impression management and [..] influence stakeholder perceptions of value and self-worth” [16]. a brief description of the two banks according to its website, al rajhi bank “was founded in 1957, and is one of the largest banks in saudi arabia, with over 9,600 employees and $88 billion in assets. the bank is headquartered in riyadh, and has over 600 branches, primarily in saudi arabia, but also in kuwait, and jordan, with a subsidiary in malaysia. the bank was started by four brothers, sulaiman, saleh, abdullah, and mohamed, of the al rajhi family, one of the wealthiest families in saudi arabia. the bank initially began as a group of banking and commercial operations which, in 1978, joined together under the umbrella of the al rajhi trading and exchange company. the company changed to a joint stock company in 1987, and after two years was rebranded as the al rajhi banking and investment corporation. in 2006, the bank rebranded itself as al rajhi bank. it is traded on the saudi arabian stock exchange (tadawul), and around 75% of their shares are publicly owned. al rajhi family members are the bank's largest shareholders. in 2006, after nearly 50 years of operation solely within saudi arabia, the bank launched in malaysia, signifying its first foray into international banking. following the saudi business model which adheres closely to the deeply rooted islamic banking principles, the shariacompliant banking group is planning to be instrumental in bridging the gap between modern financial demands and intrinsic islamic values, for the numerous industry standards and development in malaysia. further regional expansion has seen the 2010 opening of a national office, men's branch and separate women's' branch in kuwait. it is traded on the saudi arabian stock exchange (tadawul), and around 45% of their shares are publicly owned. al rajhi bank offers a variety of banking services such as deposits, loans, investment advice, securities trading, remittances, credit cards, and consumer financing. all services are offered according to islamic requirements. the bank has won numerous awards for its middle east operations. in september 2016, al rajhi became the first bank in saudi arabia to partner with the ministry of housing, participating in the government's plans to increase home ownership by offering mortgages funded in part by the state. traditionally, the bank had focused on consumer banking, but had begun diversifying its revenues with plans to adjust focus towards mid-corporate and small and medium-sized enterprise (sme) business as the saudi government implemented its broader social reform agenda and the national transformation programme (ntp). as of 2016, 70 percent of al rajhi's assets and 55 to 60 percent of its revenue were generated from consumer banking and the bank has an 18 percent share of the mortgage market in the kingdom”. according to its website, shahjalal islami bank limited “commenced its commercial operation in accordance with principle of islamic shariah on the 10th may 2001 under the bank companies act, 1991. during these years the company has diversified its service coverage by opening new branches at different strategically important locations across the country offering various service products both investment & deposit. islamic banking, in essence, is not only interest-free banking business, it carries deal wise business product thereby generating real income and thus boosting gdp of the economy. shahjalal islami bank provides financial aid through rural branch establishing agro-based industry and to produce agrarian crops under the rural investment programme. the bank also plays an important role to improve lifestyle creating new field of income and generating employment opportunities through investment in industrial sectors. as a part of social liabilities, shahjalal islami bank provides free treatment of insolvent and needy people, distributes eatable materials in povertystricken region, endows financial aid to the poor but meritorious students and contributes in various public welfare works. in order to perform such activities the bank found 'shahjalal islami bank foundation'. a deal has been signed up with western union for reaching migrated labour's money to their relatives with swiftly and in short time.” https://en.wikipedia.org/wiki/saudi_arabia https://en.wikipedia.org/wiki/riyadh https://en.wikipedia.org/wiki/kuwait https://en.wikipedia.org/wiki/jordan https://en.wikipedia.org/wiki/malaysia https://en.wikipedia.org/wiki/tadawul https://en.wikipedia.org/wiki/al_rajhi_bank_malaysia https://en.wikipedia.org/wiki/islamic_banking https://en.wikipedia.org/wiki/sharia https://en.wikipedia.org/wiki/islam https://en.wikipedia.org/wiki/tadawul ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 the reasons declared for issuing an integrated report (2015) according to the integrated report of al rajhi bank, as of 2015, “this publication – ‘al rajhi bank in 2015’ – is an integrated report. it complements our annual report 2015 while communicating coherently the relationships of the many aspects of our business, such as strategy, governance, performance and prospects in the context of creating value over time. the underlying concepts that provide the structure of this integrated report are discussed in the section on business model commencing on page 17. it is a new approach that aims to engage our readers more effectively. by integrating both financial reporting and sustainability reporting, we bring into focus the broader concept of value creation and capital formation – a recurrent theme that runs throughout this report. in preparing this report we have drawn on concepts, principles and guidance given in the global reporting initiative (gri) sustainability reporting guidelines g4 (www.globalreporting.org), the international integrated reporting framework (www.theiirc.org) and the smart integrated reporting methodology. we have used digital technology to serve the information needs of our diverse stakeholders. the print version is thus complemented by an interactive online report and a summary report for smartphones. report boundary the overall boundary of this report comprises al rajhi bank (‘bank’) and its subsidiaries (together referred to as the ‘group’, detailed in note 1 on page 99). key financial aspects are discussed in the context of the group (consolidated), while unless otherwise stated the nonfinancial aspects are discussed in the context of the bank and its operations in the kingdom of saudi arabia (ksa). the bank’s operations in the ksa dominate group performance. our reporting focuses on aspects that are material or important. it is an assessment based on the extent to which they may substantively affect the bank’s ability to create value over the short, medium and long term. compliance this report covers the 12-month period from 1 january to 31 december 2015, and is consistent with our usual annual reporting cycle for financial and sustainability reporting. the information contained herein is in compliance with all applicable laws, regulations and standards as well as guidelines for voluntary disclosures. additional details are given in the compliance report (page 77), financial statements and the notes thereon (pages 94 to 161) and in the independent auditors’ report (page 92). we are aware of the social and environmental impacts of our actions. the bank adopts a precautionary approach across the group with regard to sustainability before embarking on new ventures and initiatives. we are fully compliant with all local regulatory compliance requirements having in place best in class systems and risk management processes”. according to the integrated report of shahjalal islami bank as of 2015, which is more concise than the preceding report, “the primary purpose of this integrated report is to explain to providers of financial capital how an organization creates value over time. however, an integrated report benefits all stakeholders interested in an organization’s ability to create value over time, including employees, customers, suppliers, business partners, local communities, legislators, regulators and policymakers. an integrated report aims to provide insight about the resources and relationships used and affected by an organization collectively referred to as ‘the capitals’. it seeks to explain how the organization interacts with the external environment and the capitals to create value over the short, medium and long term. the capitals are categorized in the international framework as financial, manufactured, intellectual, human, social & relationship and natural capital”. that said, it is noteworthy that when it presents its integrated report, both banks do not mention explicitly any element which could bring the readers attention towards religious issues. for instance, their publications aim to (1) communicate and to (2) integrate the relationships of the many aspects of the business within society: and these desiderata are not different from companies located in non islamic countries. at the same time, the fact that information is compliant with “all applicable laws, regulations and standards as well as guidelines for voluntary disclosures” and the awareness of the social and environmental impacts of the bank’s actions are routinely described in the majority of integrated reports. a closer analysis of some parts (sentences, words and images) of the integrated reports, nevertheless, could depict a different scenery. sentences and words i have chosen from the integrated reports, as of 2015, some words which are commonly used and referred to in the islamic context (shari’a or shari’ah; islamic; islam) and i have extracted the sentences they are included in [28]. the results are as follows. shari’a it is mentioned the following 38 times in the integrated report of al rajhi bank: “the new bank strictly followed islamic shari’a rules” (1). “to be most successful bank admired for its innovative service, people, technology and shari’a compliant products, both locally and internationally” (1). “i, together with the board, express our gratitude to their eminence the chairman and the members of the bank’s shari’a board for their advice, patience and explanations on all issues http://www.globalreporting.org/ ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 presented to them as well as for their monitoring the bank’s shari’a compliance” (2). “they are carried out in accordance with the bank’s articles of association and bylaws, the banking control law and the council of ministers’ resolution noted above, and in strict compliance with islamic shari’a legislations” (1). “given shari’a constraints, treasury has limited investment options available” (1). “the bank is addressing this issue through diversifying its investments into other shari’a compliant products through dedicated research” (1). “retail banking provides individuals with a full range of shari’a compliant financial products and services such as current accounts, personal finance, car finance, home finance and credit cards across the kingdom” (1). “they fulfil the working capital, capital expenditure, trade finance and cash management needs of entities operating in the ksa through shari’a compliant products and services” (1). “product development is carried out in coordination with the shari’a group of the bank. treasury is expanding its investment avenues to products such as sukuk and mutual funds” (1). “each of our products is fully shari’a compliant, carefully studied and approved, by our shari’a committee – a group of the kingdom’s most prominent and esteemed islamic scholars” (2). “the group, being shari’a compliant, is not exposed to market risks from speculative operations such as hedging, options, forward contracts and derivatives” (1). “compliance with shari’a principles: an independent shari’a board with a membership of a number of shari’a scholars, has been in existence ever since the bank was founded. the shari’a board's regulations are approved by the general assembly and all business activities of the bank are in accordance with islamic banking principles. during the year under review, the shari’a board held 40 meetings and issued 60 decisions and 230 guidelines. the shari’a board is served by two departments: the shari’a board secretariat studies and prepares banking products, agreements and contracts for the various units within the bank. it also submits shari’a research and studies to the shari’a board. more than 230 such studies were prepared during 2015. the shari’a supervisory department ensures bank-wide compliance with the decisions and instructions of the shari’a board. this is implemented through shari’a auditing through automated systems as well as field visits in accordance with professional custom. the department also prepares the annual plan and operational quarterly plans, and identifies goals, tools and methods of auditing” (12). “it is a foreign branch operating in hashimi kingdom of jordan, providing all financial, banking, and investments services and importing and trading in precious metals and stones in accordance with islamic shari’a rules and under the applicable banking law” (1). “shari’a authority: as a commitment from the bank for its activities to be in compliance with islamic shari’a legislations, since its inception, the bank has established a shari’a authority to ascertain that the bank’s activities are subject to its approval and control. the shari’a authority had reviewed several of the bank’s activities and issued the required decisions thereon” (4). “the bank offers non-interest based products including mutajara, instalment sales, murabaha and istisnaa to its customers in compliance with shari’a rules” (1). “in accordance with the shari’a authority’s resolutions, special commission income received by the bank is excluded from the determination of income and is recorded as other liabilities in the consolidated statement of financial position and is paid as charities” (1). “the bank provides its customers with banking products based on interest avoidance concept and in accordance with shari’a regulations” (1). “the bank has structured a number of financial products which are in accordance with shari’a law in order to meet the customers demand” (1). “the bank is committed to shari’a guidelines which does not permit it to enter into contracts or speculative instruments such as hedging, options, forward contracts and derivatives shari’a principle governing guarantees” (2). “shari’a: islamic jurisprudence” (1). “it is an asset-backed bond which is structured in accordance with shari’a” (1). it is mentioned the following 76 times in the integrated report of shahjalal islami bank: “strict observance of shari’ah” (1). “we believe and are committed to provide banking service that is purely based on shari’ah” (1). “adhering to the shari’ah and implementing its principles” (1). “however, it has a shari’ah supervisory committee to look after the shari’ah matters and gives suggestions to the management on shari’ah issues” (3). “our investment is based on islamic values as defined by the principles of shari’ah (islamic law). the islamic shari’ah attempts to maximize social welfare. consequently islamic investment involves the screening out of those companies whose primary business does not conform with the shari’ah principles” (3). “the shahjalal islami bank limited (hereinafter called ‘the bank’-‘sjibl’) was established as a public limited company (banking company) as on the 1st day of april 2001 under the ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 companies act 1994 as interest free islamic shari’ah based commercial bank” (1). “[..] shari’ah supervisory committee [..]” (23). “the bank has also a shari’ah council consisting of prominent fuquah, economists and bankers to advise and guide the bank operating strictly on shari’ah principles” (2). “under the guidance of the board of directors, executive committee, audit committee and shari’ah council, the management team has been able to ensure best corporate governance practices and risk management process in the bank” (1). “[,,] shari’ah based commercial bank [..]” (7). “strengthen risk-based internal audit (including shari’ah audit) to add value to the risk management process in the bank” (1). “shahjalal islami bank has implemented real time 24/7 core banking solution called bank ultimus, an integrated shari’ah banking solution” (1). “(they) advise and guide on the implementation of islamic shari’ah in business activities” (1). “the committee enjoys a special status in the structure of the bank and playing a vital role to make the bank as shari’ah compliant” (1). “[..] shari’ah compliance” (2). “the company has been operated as the shari’ah compliant bank in the country” (1). “shari’ah council of the bank has been contributing their best towards invention” (1). “the bank is complying shari’ah principles time to time and to introduce new products which is based on shari’ah principles” (2). “non-compliance with shari’ah law and principles” (1). “shari’ah non-compliance risk: risk arises from the failure of compliance with the shari’ah rules and principles” (2). “the committee gave necessary instructions and guidelines to the management from time to time to operate the banking transactions according to the principles of islamic shari’ah” (1). “members of the committee delivered valuable speech and suggestions at the shari’ah workshops and seminars arranged by the management of the bank for the bank officials”. (1) “shari’ah audit reports of the branches are submitted to the committee by shari’ah inspection” (2). “shari’ah awareness has been developed during the year compared to previous ones due to motivation and other measures taken” (1). “distribution of profit among the various mudarabah depositors have been made as far as possible in accordance with the principle of islamic shari’ah; the management of the bank should remain more careful to operate all its banking transactions as per shari’ah principles” (2). “shari’ah audit should be conducted in all branches more frequently to verify/rectify banking transactions to comply with shari’ah and to ensure effective compliance of shari’ah principles” (3). “the bank offers all kinds of commercial banking services to its customers through its branches following the provisions of the bank companies act 1991, bangladesh bank’s directives of other regulatory authorities and the principles of the islamic shari’ah” (1). “although the operations of the bank are in compliance with the rules of islamic shari’ah, the financial statements have been prepared in accordance with the first schedule” (1). “shari’ah non-compliance income” (1). “moreover, incomes which are irregular (doubtful) as per shari’ah are also not included in the distributable income of the bank. bank charges compensation on unclassified overdue investments. such compensation is not permissible as regular income of the bank as per shari’ah. interest received from the balances held with foreign banks abroad and from foreign currency clearing account with the bangladesh bank and also other interest based banks are also not credited to regular income since it is not permissible as per shari’ah” (3). “the mobilized fund from islamic bond is investment by bangladesh bank and a portion of realized profit distributes among the bond holders as per mudaraba principle of islamic shari’ah on the basis of the tenor of the bond” (1). “shari’ah council meeting expenses” (1). “the company follows shari’ah based rules, so the income from non shari’ah based banking & financial institutions has not been recognized as income” (2). islamic it is mentioned the following 29 times in the integrated report of al rajhi bank: “glossary of key islamic finance terms” (1). “the new bank strictly followed islamic shari’a rules” (1). “al rajhi bank is the largest islamic bank in the world by total assets” (1). “as an islamic bank, our investments are non-speculative” (1). “we are in strict compliance with islamic shari’a legislations” (1). ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 “deeply rooted in islamic banking principles, the shari’acompliant al rajhi bank has seven subsidiary companies” (1). “the group continues to be instrumental in bridging the gap between modern financial demands and intrinsic islamic values” (1). “tracing its roots to its founding in 1957, al rajhi bank is the largest islamic bank in the world with total assets of sar 316 billion (usd 84 billion)” (1). “as one of the oldest islamic banks in the world, our products have been adopted as models by other banks locally, regionally and internationally” (1). “each of our products is fully shari’a compliant, carefully studied and approved, by our shari’a committee – a group of the kingdom’s most prominent and esteemed islamic scholars” (1). “the shari’a board's regulations are approved by the general assembly and all business activities of the bank are in accordance with islamic banking principles” (1). “guided by our islamic culture, we continue to drive the growth of our business while supporting social, economic and environmental development in the communities in which we operate” (1). “our culture is heavily guided by the principles of islamic banking” (1). “all our financial products and services are influenced by islamic teachings” (1). “as the world’s largest islamic bank, we provide customers and partners with the strength and stability of a world-class banking organization” (1). “in addition, we operate six branches in jordan including four in amman, and one branch in kuwait to offer our customers a full suite of islamic banking products and services” (1). “it is a licensed islamic bank under the islamic financial services act 2013, incorporated and domiciled in malaysia” (2). “it is a foreign branch operating in hashimi kingdom of jordan, providing all financial, banking, and investments services and importing and trading in precious metals and stones in accordance with islamic shari’a rules and under the applicable banking law” (1). “as a commitment from the bank for its activities to be in compliance with islamic shari’a legislations, since its inception, the bank has established a shari’a authority to ascertain that the bank’s activities are subject to its approval and control” (1). “when assets are transferred under a finance lease, including assets under islamic lease arrangements (e.g. ijara muntahia bittamleek or ijara with ownership promise) (if applicable) the present value of the lease payments is recognised as a receivable” (1). “islamic jurisprudence” (1). “it is one of three fundamental prohibitions in islamic finance (the other two being riba and maysir)” (1). “many islamic investment funds operate on the basis of joint mudaraba” (1). “however, the modern murabaha has become a popular financing technique among islamic banks” (1). “this equity financing arrangement is widely regarded as the purest form of islamic financing” (1). “permanent musharaka: an islamic bank participates in the equity of a project and receives a share of the profit on a pro rata basis” (1). “islamic bond” (1). “an obligatory contribution which every wealthy muslim is required to pay to the islamic state” (1). it is mentioned the following 45 times in the integrated report of shahjalal islami bank: “our commitment is to contribute in building and expanding islamic banking industry” (1). “central shari’ah board for islamic banks of bangladesh islamic banks consultative forum (ibcf)” (2). “bankers, lawyers and economists to advise and guide on the implementation of islamic shari’ah in business activities to encourage them in following islamic principles in their business entities and to make them real partners of the bank, the bank takes various initiatives” (2) “our investment is based on islamic values as defined by the principles of shari’ah (islamic law). the islamic shari’ah attempts to maximize social welfare. consequently islamic investment involves the screening out of those companies whose primary business does not conform with the shari’ah principles” (4). “a bank whether islamic or conventional is to take calculated risks for its business” (1). “unique risks for islamic banks” (1). “the risk arising from assets managed on behalf of investment account holders which is effectively transferred to the islamic financial institution’s own capital” (1). “interest free islamic shari’ah based commercial bank” (1). “principles of the islamic shari’ah” (1). ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 “the shari’ah supervisory committee gave necessary instructions and guidelines to the management from time to time to operate the banking transactions according to the principles of islamic shari’ah” (1). “distribution of profit among the various mudarabah depositors have been made as far as possible in accordance with the principle of islamic shari’ah islamic banking and its benefits” (2). “may allah (swt), the lord of the universe, grant us the strength and courage to establish islamic society on the soil of bangladesh through islamic banking” (2). “islamic banking is a form of banking that is harmonious with the goodness of humanity” (1). “interest free islamic shari’ah based commercial bank” (1). “the bank offers all kinds of commercial banking services to its customers through its branches following the provisions of the bank companies act 1991, bangladesh bank’s directives of other regulatory authorities and the principles of the islamic shari’ah” (1). “the operations of the bank are in compliance with the rules of islamic shari’ah” (1). “guidelines for islamic banking” (1). “islamic financial institutions” (1). “profit on investment in bangladesh government islamic investment bond (islamic bond) is recognized on accrual basis” (2). “islamic investment bond: investment in bangladesh government islamic investment bond is reported at cost price” (2). “guideline for islamic banking issued by bangladesh bank vide brpd circular no.15 dated november 2009” (2 times). “the city bank islamic banking branch” (1). “icb islamic bank limited” (1). “government bond (islamic investment bond)” (1). “bangladesh bank has introduced mudaraba bond named “bangladesh government islamic investment bond (islamic bond)” in september 2004 on behalf of the government to facilitate islamic banks and financial institutions, investment in this funds is to be considered as a component of statutory liquidity ratio. the mobilized fund from islamic bond is investment by bangladesh bank and a portion of realized profit distributes among the bond holders as per mudaraba principle of islamic shari’ah” (5). “aibl islamic mutual fund” (2 times). “ifil islamic mutual fund” (1). “placement to islamic investment bond” (1). “islamic refinance fund bangladesh bank” (1). “profit has been acounted for 2015 from islamic investment bond at an expected provisional profit rate of 1.13% on average investment” (1). islam it is mentioned the following 4 times in the integrated report of al rajhi bank: “riba in all its forms is prohibited in islam” (1). “conventional insurance is prohibited in islam because its dealings contain several haram elements, such as gharar and riba” (1). “according to islam, zakat – the third pillar of islam – purifies wealth and souls” (2). it is never mentioned in the integrated report of shahjalal islami bank, apart from (1) being intertwined in some sentences and (2) some conventional expressions, the words mentioned above contain nevertheless some elements which offer an interesting perspective upon the ir in islam, as it is and as it could be fostered in future research. for instance, the two banks admit that their approach towards ir is driven by their “islamic culture”, as well as their products are influenced by “islamic teachings” and they are “shari’a compliant”; moreover a shari’ah awareness is stimulated and developed “with motivation” by the banks towards their counterparts. furthermore, the integrated report of al rajhi bank mentions the item “modesty”, “humility” and “humble” 2, 3 and 3 times respectively; likewise, the integrated report of shahjalal islami bank contains some excerpts from the qur’an and it systematically asks for allah to help the bank, for instance, to “maximize the value for all stakeholders in coming days”. these words, even if they do not exclusively pertain to the islamic culture, as well as the invocation to allah, are commonly in use in islam and they are almost always excluded in an integrated report prepared without consideration of the islamic religion. images the integrated report of al rajhi bank contains n. 6 images at the end of 6 parts of the report, which are presented below. where: message from the chairman. title: care for society. subtitle: contributing to a better tomorrow. figure: below. for societyntributing towards a better tomorrow ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 where: business model. title: a passion to serve. subtitle: anticipating and addressing customer needs, to deliver results that go beyond expectations. figure: below. where: management discussion and analysis. title: integrity and transparency. subtitle: being open and honest while maintaining the highest standards of corporate and personal ethics. figure: below. where: stewardship. title: meritocracy. subtitle: defining, differentiating and reinforcing excellence in people. figure: below. where: identity. title: modest and humility. subtitle: being humble in thought, word and deed. figure: below. where: financial report. title: solution oriented. subtitle: helping our customers achieve their objectives through effective and efficient solutions. figure: below. the images as above are depicted with islamic signs and notation, as they are rooted in the islamic culture, and they are placed clearly at the end of each section as a closing remark. moreover, apart from some conventional hints of integrated reports and ir as well, they explicitly convey specific hints of islamic religion and cultural environment, as “being open and honest” and “being humble in thought, word and deed”. similarly, the integrated report of shahjalal islami bank contains n. 7 images at the end of 7 parts of the report, which are presented below. where: preface. title: messages from the holy qur’an. allah will destroy riba (usury) and will give increase for sadaqaat (deeds of charity, alms, etc.) and allah likes not the disbelievers, sinners. figure: below. for societyntributing towards a better tomow where: preface. title: door to ethical progression. figure: below. for societyntributing toward s a better tomow ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 where: board of directors. title: the truthful merchant (is rewarded by being ranked) on the day of resurrection with prophets, veracious souls, martyrs. figure: below. for where: management and executives. title: o you who believe! be afraid of allah and give up what remains (due to you) from riba (usury) from now onward, if you are (really) believers. figure: below. where: five years financials. title: may allah be pleased with him. the prophet said: nobody has ever eaten a better than that which one was earned by working with one’s own hands. the prophet of allah, david, upon him prayer and peace, used to eat from the earnings of his manual work. figure: below. where: report of the director. title: allah will destroy riba (usury) and will give increase for sadaqaat (deeds of charity, alms, etc.) and allah likes not the disbelievers, sinners. figure: below. where: reports. title: islamic banking is a form of banking that is harmonious with the goodness of humanity. figure: below. different from the integrated report by rajhi bank, shahjalal bank depicts figures taken from a pastoral and reassuring natural landscape, which could be easily appreciated by a non-islamic reader as well. that said, however, the quotations refer always to the qur’an and they discuss mainly the matter of “riba” (usury), the benefits of honest work and the ethical progress; in other words, the conversation retrieves some crucial points of islam, which do not explicitly come to the surface from the analysis of the figures. since the two integrated reports make a large use of the repetition of concepts and images, an issue of narrative and visual rhetoric is present. ** a comprehensive assessment of the main evidence extracted from the integrated reports of al rajhi bank and shahjalal islami bank limited, as of 2015, is now necessary, since the importance of the results obtained – in terms of words, sentences and images connected to the islamic religion – is debatable. the presence and the influence of the islamic thought is formally debatable (the number of words and sentences which are strongly related to the islamic culture is in effect probably limited, as well as the contribution of the images) so i could adopt the words of abeydeera (2016) in the case of sustainability reporting and buddha, since “buddhism would seem to have the potential to inform sustainability – yet, there appear barriers to its application and representation in the corporate world. it would seem that global institutions which ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 11 are dominant in relation to reporting limit the potential for local institutions that have the potential to transform business-asusual” [1] and again “global standardization in the form of powerful global institutions poses a challenge to incorporating and representing locally prevalent institutions in corporate sustainability reporting” [1]. in other words, institutional theory drives companies to prepare standardized reports and, in doing so, the truly positive and inspiring impact of ir is reduced as long as, according to brown (2009), “standardized and commodified information in itself cannot be a strong instrument for empowering or mobilizing social action” [10]. at the same time, the results of this research (even if it is in its infancy) induce to adopt a more subtle approach, which make prevail substance over form: the paucity of citations of islamic culture, in fact, is mitigated by the strong relevance of some of them. for instance: islamic culture and teachings do inspire the integrated report of the banks, according to the bank itself, and this is explicitly declared in the report; modesty and humility are mentioned and depicted in images; some passages of the qur’an are clearly mentioned in pivotal parts of the reports. hence, a contribution of the islamic culture to the preparation of the integrated reports is noticeable and it is disclosed in the reports as well. iv. conclusion this paper offers insights for future research on the broad field of social and environmental issues, as well as integrated reporting, since it suggests to consider explicitly and to tackle – when addressing issues and potentialities of non financial reporting – the cultural and religious pattern, as such islam. at the same time this paper is preliminary and exploratory (it studies only two reports using a case study approach) and it is addressed only towards the financial industry: fruitful avenues of research could foster larger samples with different religious environments. furthermore, as already highlighted by kamla (2013) with reference to social reporting and islamic banks, even if these institutions are “keen to link their activities to shari’ah principles” [27] not all their claims are supported by significant disclosure reflecting their actual practices, so another stream of research could be the measurement of the rhetoric instilled in their reports. references [1] s. abeydeera, h. tregidga,, k. kearins, "sustainability reporting – more global than local?"; meditari accountancy research, vol. 24, no. 4; 2016; pp 478-504. [2] c. adams, “the international integrated reporting council: a call to action”; critical perspectives on accounting, vol. 27, no. 7; 2015; pp 23-28. [3] r. afshari, "an essay on islamic cultural relativism in the discourse of human rights”; human rights quarterly; vol. 16, no. 2; 1994; pp 235-276. [4] a. al-bukhari, s. al-bukhari. (2nd edn.) al-riyadh: dar al-salam li alnashr wa al-tawzi; 1999. [5] a. ali, the holy qur'an: text, translation, and commentary; amana publications; 1983; usa. [6] y. al-qaradawi, the lawful and the prohibited in islam; islamic book trust; 1985; malaysia. [7] y. al-qaradawi, safeguarding the environment in islamic sharia. alkhaleej; 2000. [8] r. beekun, islamic business ethics; international institute of islamic thought, virginia;1997; usa. [9] r.. beekun,, j.a. badawi, “balancing ethical responsibility among multiple organizational stakeholders: the islamic perspective”; journal of business ethics, vol. 60, no. 2; 2005; pp. 131–145. [10] h.s. brown, m. de jong, d.l. levy, “building institutions based on information disclosure: lessons from gri’s sustainability reporting”; journal of cleaner production, vol. 17, no. 6; 2009; pp 571-580. [11] j. callicott, “religion and ecology: can the climate change?”; daedalus; vol. 130, no. 4; mit press; 2001; pp 77-97. [12] m. chapra, islam and the economic challenge; the islamic foundation; 1992; leicester. [13] m. choudry, m. hoque, “corporate governance in islamic perspective”; corporate governance; vol. 6, no. 2; 2006; pp 116-128. [14] m. cone, “corporate citizenship: the role of commercial organizations in an islamic society”; journal of corporate citizenship; vol. 9; 2003; pp 49-66. [15] m. cook, commanding right and forbidding wrong in islam; cambridge university press; 2001; united kingdom. [16] j. davison, s. warren, “visual methodologies for accounting and accountability” in “the routledge companion to qualitative accounting research methods”; routledge; 2017; new york. [17] i. dragu, a. tiron-tudor, “research agenda on integrated reporting: new emergent theory and practice”; procedia of economics and finance; no. 15; 2014; pp 221-227. [18] o. dsouli, k. nadeem, n. kakabadse, “spiritual capital: the coevolution of an ethical framework based on abrahamic religious values in the islamic tradition”; journal of management development; vol. 31, no. 10; 2012; pp 1058-1076. [19] a.w. dusuki, “what does islam say about csr?”; review of islamic economics; vol. 12, no. 1; 2008; pp 5-28. [20] j. flower, “the international integrated reporting council: a story of failure”; critical perspectives on accounting, vol. 27, no. 7; 2014; pp 99-109. [21] l. gelmini, “does the cultural environment matter? the case of integrated reporting and islam”; proceedings of 7th global business research conference, 28-29 april 2017, biam foundation, 63 eskaton, dhaka, bangladesh. [22] r. gray, d. owens, c. adams, accounting and accountability: changes in corporate social and environmental reporting; prentice hall; 1996; london. [23] s.a. hamed, “egypt” in r.c. foltz (ed), environmentalism in the muslim world, nova science publishers, new york; 2005; pp 45-61. [24] r. haniffa, m. hudaib, “exploring the ethical identity of islamic banks via communication in annual reports”; journal of business ethics, vol. 76; 2007; pp 97-116. [25] l. hardy, h. ballis, “does one size fit all? the sacred and secular divide revisited with insights from niebuhr’s typology of social action”; accounting, auditing and accountability journal; vol. 18, no. 2; 2005; pp 238-254. [26] a. hassan, “islamic ethical responsibilities for business and sustainable development”; humanomics; vo. 32, no. 1; 2016; pp 80-94. http://www.journals.elsevier.com/critical-perspectives-on-accounting/ ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 12 [27] r. kamla, s. gallhofe and j. haslam, ‘islam, nature and accounting: islamic principles and the notion of accounting for the environment;’ accounting forum, vol. 30; 2006; pp 245-265. [28] r. kamla, h.g. rammal, “social reporting by islamic banks: does social justice matter?; accounting, auditing and accountability journal; vol. 26, no. 6; 2013; pp 911-945. [29] m. lewis, “islam and accounting”; accounting forum; vol. 25, no. 2; 2001; pp 103-127. [30] s.n. naqvi, ethics and economics: an islamic synthesis; the islamic foundation; 1981; leicester. [31] s.h. nasr, “islam and the environmental crisis” in stephen c. rockefeller and john c. elder (eds,) spirit and nature: why the environment is a religious issue; beacon press, boston; 1992; pp 85107. [32] g. rice, “islamic ethics and the implications for business”; journal of business ethics; vol. 18; 1999; pp 345-358. [33] r. rizk, “social and environmental disclosures: a comparative study of uk, indian and egyptian corporations”; phd thesis; 2006; durham university. [34] r. rizk, “islamic environmental ethics”; journal of islamic accounting and business research; vol. 5, no. 2; 2014; pp 194-204. [35] l. songini, a. pistoni, “accounting and control for sustainability”; 2015; emerald. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 shariah compliant model of currency management – expanding landscape of islamic finance from micro to macro level s. m. i. h. naqvi 1, b. shafique 2, and a. a. khan 3 1 associate professor/senior manager, center of islamic finance (cif)/hr section, comsats university islamabad, lahore campus. 2 joint director, islamic banking division, state bank of pakistan. 3 research assistant, cif, comsats university islamabad, lahore campus. abstract— the current interest based economic system is predominantly governed by capitalistic approach. repetitive crises in prevalent financial system indicated its structural flaws demanding a viable financial system. serendipiciously islamic finance (if) appeared as a viable alternate to capitalistic system. though if is one of the fastest growing sectors however currently it is focused on microeconomic contracts between islamic financial institutions (ifis) and their clients. to capitalise on the inherent strengths of if it is needed to encompass the overall economic system in compliance with shariah principles. taking this into account, this qualitative and conceptual study – methodologically and substantively analysed the prevalent currency management in general and with particular focus on pakistan for contriving its shariah compliant mechanism. in light of quran, sunnah and opinions of shariah experts we applied induction and deduction while analyzing how the prevalent currency management (cm) mechanism is deviant from shariah principles. expecting good accrual of if, it figured out the possible shariah compliant version of cm. subsequently our study compared the perceived shariah compliant version of latest cm with the actual islamic currency management model that was adopted by islamic caliphs in ancient times of islamic reigns. it thus contributes how to expand the horizon of islamic finance from microeconomic functions to the essential macroeconomic function of currency management in an islamic state. keywords: currency management and islamic finance i – introduction currency management (cm) is one of the most significant macroeconomic functions in every country [24], [26], [56]. in ancient times barter system was used to function as currency. later coinage remained in practice that was finally replaced with promissory notes. recently plastic and electronic/digital money started supplementing paper currency [19]. [69], [25], [26] and [27] had related economic performance with generation and flow of currency for its effective management and regardless of its physical shape. in the prevalent and dominant capitalistic system generation of currency count on riba (usury) based instruments which islamic finance (if) does not allow following islamic sources including al – quran as per [4], [5], [6], [7] and [8]; sahih al-bukhari as per [61], [62], [63], [64] and [65], and sahih muslim as per [66]. literature confirms that if is gaining increasing popularity across the globe especially beyond the muslim countries for its potential and strength that enable social enterprises generate both social and economic values for all stakeholders in the society [85], [86], [89]. world views if as a key to attract investments ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 from islamic investors into european, western, and other non-muslim countries despite various challenges to it [87], [88]. these facts invite pondering on questions such as: (i) how to generate money without riba in an economy that intends to switch to if completely? (ii) can if and conventional cm be integrated? if not, what alternate if provides for cm? (iii) will successful emergence of if and its accrual in certain economies since half a century urge a paradigm shift in cm? exploring a riba free knowledge solutions of cm is thus imperative. capitalist cm is pro – usury and complex [31], [32], [43], [48]. to the best findings of our investigation, relevant literature on one hand does not comprehensively consolidate factors of cm as indicated by references [19], [28], [29], [30], [34] and [35]. on the other hand most literature of if hovers around microeconomic issues [23], [36]. how if will support in macroeconomic functions? this question yet needs to be answered [57]. in this background, our research focused on investigating the perspective of if for macroeconomic issue of cm. the scope of our study was however restricted to find shariah compliant solution for cm only. it was thus a qualitative, foundational and theoretical study that consolidated various factors of conventional cm in first section of the study. second section analysed and discussed the available opinions of islamic scholars on the mentioned factors of cm in light of quran and sunnah following induction and deduction methods as applicable. this is then followed by the section contributing the shariah compliant version of the prevalent model of cm that may emerge as result of expanding if in near future. the last section of our contribution finally compares the shariah compliant version of prevalent cm model with the model of cm that has been derived on the basis of factors adopted by islamic caliphs in ancient times in islamic regimes of good governance as reported in history of islam. ii conventional currency management currency itself does not have any element which is against shariah. however, factors affecting the decision of issuance, maintenance and supply of currency need to be aligned with principles of shariah in line with guidance in al – quran ranging [9] to [16], hadith vide [61] to [65], and islamic jurisprudence as in [68] and [60]. therefore this section explores the underlying factors for money supply in an economy in detail under conventional system so that shariah opinion on each factor can be discussed in the following section [55], [77]. economists link money supply with the overall monetary possessions that are available in a specific economy at a specific time [43], [53], [25], [79]. based on economic conditions money in an economy can be classified into categories such as m0, m1, m2, and m3 that are summarized in annexure a adopted and interpreted from [26], [27], [55], [59], and [69]. in order to engineer an islamic solution for cm, m0 has been selected for this research as it is the most liquid form of money including currency notes and coins. it also covers demand deposits along with easily liquefy-able assets [73], [75], [77]. another rationale for selection of m0 for our study is its relevance for developing economies like pakistan. in order to understand the basis of m0 its following basic equation was taken from wright and quadrini as in reference [78]: m0 = currency in circulation + required reserves (crr & slr) + excess reserves eq – 1a where crr = cash reserve requirement, and slr = statutory liquidity requirement eq – 1a can be expanded to further explain each component of the equation, where currency in circulation, = advances by banks and others and crr, slr and excess reserves = cash in vaults + operational deposits with central banks ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 by incorporating the above mentioned explanation of factors of eq 1a, m0 can be expressed as follows; m0 = [advances by banks + others] + [cash in vaults + operational deposits with central bank] eq – 1b the literature on m0 alternately explains cm in the following shape [26], [27], [28], [29], [30], [31] and [32]: m0 = net domestic assets (nda) + net foreign assets (nfa) eq – 2 where nda = ncg + cng + oin ncg = net claims on government cng = credit to non-government sector oin = other items net (other liabilities – other assets) nfa = foreign assetsforeign liabilities (this implies lending/borrowing from foreign financial institutions) table 2 in annexure b explains each term in eq – 2. theoretically cm follows the principles endorsed by economics which states that the money supply (ms) in a country should be equal to the real gnp and inflation [56]. the latter is termed as money demand (md) [26]. cm in its nitty-gritty requires various sub functions like reprinting of soiled and defected notes, replacing the obsolete notes with new notes etc. [26], [78]. all such sub functions have to abide by the mentioned principle. this means that these sub functions do not demand generation of money exceeding real gnp. hence, according to this basic principle ms = md eq – 3 (78) where md = money demand = real gnp and inflation as eq – 4 (78), and ms = money supply based on eq – 1b and/or eq – 2 having explained conventional cm in mathematical equations, this is important to mention that in real practices of cm these equations and their foundational theory are not followed completely as variations in general practices are observed [30]. these variations give rise to many issues like inflation, depreciation of currency’s value etc. [31], [48], [43], [53], [85]. however details of such issues are being declared out of the scope of our study as the primary objective is the shariah analysis of perceived equation eq – 2. iii – shariah opinions on cm as per eq – 2 to the best of our efforts, this study entertains all available opinions of shariah scholars and/or islamic institutions on the factors constituting eq – 2. however, it is worth highlighting that so far in the exiting relevant literature that there was no opinion/analysis available for the overall equation of m0. therefore certain interpretations on the factors constituting m0 had to be drawn directly from al – quran and hadith/sunnah and also from prevalent practices of if in light of opinions (fatwas) of islamic scholars. following section discusses islamic perspective on each component of eq – 2. a net claims on government (ncg) most governments need to spend more than their earnings. for this purpose they use various options; one significant practice is issuance of monetary tools/instruments including prize/premium bonds, saving certificates, treasury bills etc. these overall constitute net claims on government (ncg) in books of the central bank [26], [27]. in pakistan treasury bills, prize bonds and national saving certificates are their relevant examples. these instruments are predominantly designed on riba ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 seeking loans and may also involve maysir, and/or gharar [57], [20], [45] and [47]. primary source of shariah guidelines that is, alquran vide references [4] to [8] strongly condemns and proscribes riba. further authentic sources of hadith and islamic jurisprudence mainly including sahih al-bukhari as in [61] to [65]; sahih muslim as per [66]; sunan abi dawud as in [71]; sunan ibn majah as per [72]; muwatta malik 1293 as in [49], jami’at-tirmidhi as in [37]; sadooq as in [68] and al-quran as per [81] all unanimously state riba, maysir/qimar, and gharar as haram (strictly prohibited). our study found diversified opinions of shariah scholars on national saving certificates. as per [18], [21] and [80] the profit earned on national saving certificates in pakistan is haram (proscribed) as it is expectedly generated through pro – riba loans. contrarily [22], [23] and [70] rendered these saving schemes halal (allowed) expecting that government utilizes these to generate money through investments in developmental and/or welfare projects such dams construction, power plant installations, health care schemes, educational projects etc. our study interprets that national saving certificates may be immune from maysir, gharar and riba however, these still stand questionable. reliance on such certificates for cm cannot be thus treated as pure islamic. similarly with respect to t-bills/bonds [1] stated that as per the ruling of fiqah council of jeddah no. 62/11/6 all sorts of t-bills and/or bonds under an agreement to return the principle amount with an excess or conditional usage were haram rendering them pro – riba, pro – maysir and pro gharar. [83] also rendered prize bonds haram. however, [84] declared prize bonds halal stating that they do not lead to loss as gharar, qimar and maysir. it can be concluded that all these opinions are though diversified but yet agree that all sort of t-bills/bonds do have element of riba and maysir and hence thus stand non-shariah compliant. a pragmatic islamic alternate to these can be instruments like sukuk designed on various if models for the governments to raise funds. moreover, funds collected through shariah compliant saving certificates/t-bills/bonds can be restricted only for development projects. in other words for shariah compliant projects specific instruments can be issued which impose a binding on government expenses and further trigger aspired economic activity and growth instead of creating pro – riba debt. for avoiding such confusion, [82] had also proposed a riba free loan among masterservant as an alternate solution to islamize ncgs. having analysed saving certificates, bonds, and other similar instruments from shariah perspective our study does not substantiate the existing practices under ncgs as islamic and thus highlights the need to engineer and adopt their islamic alternates. b – claims on non-government sector (cngs) this includes (i) credit to private sector (ii) credit to public sector entities and (iii) credit to non-banking financial institutions (nbfis). the first two components; credit to private sector and credit to public sector entities; refer to loans extended by banks of varying nature and tenure, to private sector and to public sector entities. similar to cng, instruments/products used to extend credit are predominantly pro – riba loans. [76] stated all these haram as these seek riba that cannot lead to welfare, development and poverty alleviation. he further stressed on adopting an alternate system truly based on shariah principles. our study finds the opinion of [76] in line with the teachings of islam. we thus recommend conversion of conventional banking to islamic banking because by virtue of its fundamentals, islamic banking aims at broad based development. this study thus does not substantiate money generation practices in pakistan under existing credit to private sector and credit to public sector entities as islamic and halal. credit to non-banking (nbfis) refers to products and services of companies including insurance and leasing companies, mutual funds, modaraba companies etc. insurance, leasing, instalment plan credit sale of items etc. are common products of nbfis. it is important to review the shariah opinions on cps. [22] and [39] shared that leasing itself is not haram and payments in instalments may also be right for reusable assets. however, an instalment plan that is founded on riba is haram. contrary to this liberal view, [3] narrated that instalments plan in leasing is not immune from riba. our study found [3]’s opinion conservative without concrete justification. on the other hand [2] opinionated, delayed payments in instalments with the inclusion of additional amounts as charges for delayed payment, halal. [2] founded such opinion imitating the hanafi scholars as in badaa’i’ alsanaa’i’: 5/187, the maaliki scholars reported in bidaayat almujtahid, 2/108, the shaafa’i scholars through alwajeez by al-ghazaali: 1/85 and the hanbali scholars through fatawa ibn taymiyah: 29/499. it must be noticed that the four schools of thoughts in islam though allow increase in price in credit sale but did not elaborate details. however, the conservative [3] on the other hand equated price increase of assets with riba again without solid explanation. ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 our study also investigated the view of jaferi school of thought about increasing price in deferred payment plan in instalment under leasing or credit sale. [70], [58] and [68] explained that jaferi school in islam primarily prefers on spot exchange for consumable commodities but simultaneously allows their credit sale or leasing as mutually agreed among seller and buyer. case of a deferred payment plan may become incumbent for any valid reason and in such cases price of consumable commodities/assets may be increased/reset with the mutual consents/bargain of both parties especially in long period of contract. although jaferia school encourages buyers to accept least possible price/increase, but under such scenario and expects seller not to exploit the need of buyer through deferred payment plan. jaferia school thus allows credit sale or leasing for any reusable asset such as horse, car, laptop, house etc. it is not necessary to undertake a lease agreement for selling reusable asset only as most nbfis practice these days. however if such contract is mutually desired by both parties, the seller of the reusable accessory or luxury item may increase price and offer a deferred payment plan in instalments. seller must not increase deferred price following compound interest approach as that can turn price increase in riba [7]. jaferi school advises the buyer to primarily avoid such contracts. however in case it is necessary to enter into such deal for acquiring an expensive accessory or luxury item then buyer better accepts the least possible increase in price offered under deferred payment plan. buyer and seller are thus encouraged to negotiate amicably intending win – win for each other and avoiding undue exploitation [68]. one possible solution of setting it based on actual changes has been proposed by [52]. so primarily for consumables and needs cash transaction must be preferred while for assets comprising accessories or luxuries under dire conditions deferred payment plans may be opted ensuring minimum increase in price. our study perceives that all fiqas in islam allow credit sale, leasing and price increase in instalment settings, but anecdotal argument suggests that the conventional nbfis in pakistan do not let their clients negotiate price increase/bargain while designing and offering lease products. such practice does not guarantee win – win deal among lessor and lessee. further they employ compound interest approach for setting future price of an asset that al – quran forbids [7]. such practices in conventional leasing by nbfis and financing by investment banks in pakistan are not adequately shielded from riba, maysir and gharar. based on such findings this study does not substantiate existing cps as purely shariah compliant factor for cm. c other items net (oin) as mentioned above oin implies to other liabilities less other assets. other liabilities are composed of paid up capital and reserve accounts, interbank items etc., while other assets include fixed assets, balancing items and advance tax etc. it is difficult to segregate transactions being halal or haram. however, given the big size of conventional banking industry it is inferred that most transactions inherently incorporate the element of riba and thus are not shariah compliant. current practices under oins are indeed mix of both halal and haram and are thus recommended to be immunized and purified from being pro – riba un-islamic objectives such as capitalistic gains without primarily intending the benefits of masses in line with shariah principles. d – shariah views on net foreign assets (nfa) at present net foreign assets are mostly composed of lending and borrowing of international/multinational institutions or of foreign countries inclusive of non-muslim countries. in prevalent practices all international contracts for conventional loans promise riba and thus not shariah compliant. another element in case of foreign lending borrowing is dealing with non-muslim countries or with banks operating in non-muslim jurisdictions. shariah allows dealing with non-muslims for loans such that riba from non – muslims can be received but must never be paid to them [68], [70]. [36] added that there is no prohibition in carrying out transactions in bank of non – muslims in their country provided it is for legitimate business. they cite imam abu hanifa’s ruling that any dealing between a muslim and a non-muslim in darul harb (in land of non – muslims) which involves addition or reduction of the capital amount is not regarded as riba. analysing opinions of [68] and [36], our study inferred that the practices of muslim government and individuals of placing money in foreign banks up to a legitimate threshold as defined in state’s law, are halal. on the other hand borrowing from foreign banks with a commitment to pay riba is haram. hence, it can be inferred that nfa practices in pakistan are thus partially halal. iv – conclusion having analysed the opinions of shariah scholars on various factors of cm constituting eq – 2, we found that only practices under nfas are conditionally/partially halal while all other factors ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 of ndas are not shariah compliant. hence it is concluded that overall the existing currency management (cm) adopted as per eq – 2 worldwide and especially in pakistan as per m0 is not shariah compliant. such inference reinforces the need to engineer a knowledge solution for cm that is in line with quran and sunnah. in this backdrop, we engineer shariah compliant alternate of equation 2 for each factor of cm and equations 5 and 6 next. v – discussion and contribution as a solution to avoid usury, [42] and [28] suggested that in order to cover the deficits the government must explore the possibilities of financing options for developmental projects. in this context [39] and [40] suggested that instruments founded on profit and loss sharing and ijarah could be adopted for replacing debt based instruments. these suggested replacing bonds with sukuks for covering deficits as these would be effective in attracting foreign direct investment. our study identifies that musharakah, ijarah and modaraba can be helpful in engineering alternate islamic instruments for islamizing ncgs and csbs. the existing national saving certificates in pakistan are recommended to be re-engineered under modaraba contracts or shariah compliant loan among master servant as suggested by [82]. the prize bonds are recommended to be replaced with sukuks that may be designed using any appropriate islamic modes. an encouragement is that these if instruments are being tested in the emerging islamic banking and reported reliable. a shariah compliant solution for cm is thus predicted to be pragmatic and indeed mandatory as per islamic directives. the aforementioned literature and critical review helped in identifying halal alternates for ncgs and also for cngs islamic. our study acknowledges the need for furthering research and development in these for necessary optimization whose details are not in our scope. based on the analysis we derive the following equation eq – 5; a shariah compliant alternate of prevailing cm eq. m0h = net domestic assets (ndah) + net foreign assets (nfah eq – 5 where ndah = ncgh + cngh + oinh ncgh = net claims on government under sukuk, and other shariah compliant instruments cngh = claims on banks under advances by ibs under musharakah, mudarabah, murabaha and other islamic financial products oinh = other items net in ibs the eq – 5 is indeed result of analyses of shariah opinions, deductive reasoning and observing the ongoing trends in financial industries. we expect that this derived eq – 5 will be a means to reach to islamic economic system where inflation can occur because of natural and/or real market dynamics without any monopoly, speculations and/or manipulations [38]. this implies that change in prices will be linked with real economic activities instead of speculation, hypothecation and usury. we expect that our engineered and forecasted eq – 5 will help islamic states adopt a modern and shariah compliant cm. in conventional economic system, drivers of inflation are interest, taxes, speculative earnings and market imperfections whereas in eq – 5 such elements will not be allowed. the eq – 5 is indeed result of analyses of shariah opinions, deductive reasoning and observing the ongoing trends in financial industries. however it is the limitation of this subject that eq-5 is yet not applied and empirically tested anywhere in the islamic countries in full swing. it is thus significant to compare this eq – 5 with the ancient islamic model of cm that enabled muslims to run riba free fiscal states for over 15 centuries. [51] reported that the first islamic coin was issued during the reign of the fourth islamic caliph and imam ali bin abu talib (as) in years of 39 or 40 hijri. [44] re-affirmed this opinion that ali was the first muslim caliph who introduced the islamic coinage. however, due to immediate assassination of ali assassination immediately after issuance of the islamic coin, it was not continued by the predecessors due to political schism. earlier to the issuance of this islamic coin and even after it the roman and persian coins were allowed within the islamic state. [41] reported that four decades later terms with rome disconcerted and then imam muhammad baqir (as) advised the caliph abdul malik bin marwan to issue/restore the islamic coin following the standards laid by the fourth islamic caliph ali. islamic coins were thus minted first by imam ali bin abu talib (as) in 40 hijri and later restored by abdul malik bin marwan between 75 to 80 hijri. [41] further reported that then the coins of gold and silver were minted following specified weight, shape and outlay. from [33], [17], [54] and ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 [74] this study interpreted that prophet muhammad pbuh and the four caliphs after him considered the following factors significant for distributing or allocating the currency from baitulmal to provinces and/or state affairs. learning from these mentioned sources of islamic studies we learnt that imam ali bin abu talib (as), the forth islamic caliph considered the following factors for the production and distribution of coins: 1. net productivity in islamic state (gnp) (in terms of gold and silver available with baitulmal/treasury as result of taxes and other resources). 2. population of the country (p) 3. cost of best services in a country (cobs) 4. cost of defence, maintenance of law & order and provision of justice in a country (ndj) 5. necessary aid for poor in a country (nap) deriving from the above mentioned ancient islamic model of coinage and its factors our study derived equation eq – 6 as under: m0 = gnp + p + cobs + ndj + nap eq – 6 comparing eq – 5 with eq – 6, we acknowledge that eq – 5 yet does not comprise of all islamic parameters especially of population care and aid for the poor. the primary orientation of an islamic government towards broad based development by ensuring support and services across all income groups enabled ancient islamic rulers to ensure running a welfare state. this can be substantiated by evidences like 1) award of stipend to muslim mothers feeding their infants during the reign of second caliph hazrat umar bin khatab (ra) [54], 2) lifelong stipend to a companion (sahabi) of prophet muhammad pbuh who got blind due to aging during the reign of the fourth caliph hazrat ali bin abu talib (as) [46] and overall a service oriented non-commercial islamic treasury (baitulmal) developing the poor and nation as required. one reason behind such successful welfare was indeed pro – population and pro – poor strategy in cm. today even non-muslim advocates of if acknowledge its’ orientation towards value creation in multi dimensions covering social, economic, moral and ethical values creation through shariah compliant business contracts and instruments and render it not only adoptable rather need of the age for attracting business and investment from islamic investors in non-muslim world encompassing sme to mega enterprises [85], [86], [25], [35], [87], [28], [89]. extending scope of knowledge processing and optimization for if from islamization of bank-to-customer contracts and instruments to macroeconomic functions such as cm thus reinforces the stance of our study. next we thus figured out the possible merger of eq – 5 and eq – 6 considering the requirement of modern era and the indicators that today’s government may adopt for each factor of eq – 6. 1. for gnp under eq – 6, we cite [50] who contributed an islamic formula of gnp for this era. existing conventional formulas of gnp entertain riba as an important ingredient and thus not recommended. 2. for p under eq – 6, we entertain the indicators set by united nations (un) as its millennium development goals. further other sustainability factors that are global or specific to certain economy can also be used for calculating p for cm. for this study we recommend population size and required per capita income to be included for measuring p for eq-6. 3. for cobs, our study again refers to the global parameters set by un for cost of essential modern services such as: a. health, b. education, c. technology & transport, d. social security, e. infrastructure development, and f. islamic banking and takaful services. this element will merge entire eq – 5 in it. our study means to recommend islamic banking and takaful services as an essential factor under cobs in any islamic state. 4. for ndj of eq – 6, annual costs of country’s defence and provision of justice and law and order within it are well calculated these days. 5. and last for nap of eq – 6, the average philanthropy and charity within the country during recent year can be an effective indicator. ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 our study indicates few possible indicators under each category however this study can be used as baseline for future research to specify variables/indicators for each factor. better forms of eq – 6 with more pragmatic indicators can be helpful in developing adequate framework for modelling shariah compliant currency management in an economy. further research can be undertaken on modern and latest operations of treasury. in our observation bait-ul-mal in current era comprises of various institutions such as ministry of finance, central bank and federal board of revenue/income departments. we learnt that ministry of finance is dedicated to planning and allocation of budget related affairs, central banks regulates financial institutions while federal board of revenue maintains and overlooks necessary taxation related affairs. this arrangement and distribution of bait-ul-maal/treasury related affairs seems rational, logical and shariah compliant. in islamic currency management as taxation is identified to be a key factor, the study proposes that the modern taxation should be according to the guidelines provided by quran and sunnah. [50] contributed that islam imposes well defined and structured taxation that is meant for 1) purifying the savings and profits of productive members of society promising reward in both the existing and eternal lives, 2) ensure poverty alleviation in society, and 3) enabling islamic government to run fiscal and developmental affairs of the state. our study substantiated that existing agile and complex taxation should be brought in line with shariah standards. we deduced that money generation through increasing taxes may be islamic provided such taxation conforms to islamic objectives. a next version of this conceptual paper/study may be devised to investigate how these institutions can integrate and collaborate for adopting and exercising eq – 6? vi – way forward our study incorporated all available and accessible views on m0 and further invested efforts to ensure best conformance of its inferences and recommendations in line with quran and sunnah. however, it still remained limited to theoretical analysis of m0 while other forms currencies like m1, m2 etc. yet may call for explicit analysis. it has though tried to further the knowledge in the relevant domain, but yet its recommendations especially eq – 5 and eq – 6 are not adopted anywhere in the world as a composite system. eq – 5 is the probability while eq – 6 was the history. how effectively their merged form can enable islamic state needing m0 effective remains unanswered but yet an opportunity for further empirical research as possible by interested researchers. references [1] i. s. agic, “treasury bills,” in eshaykh, retrieved october 10, 2015, from http://eshaykh.com/halal_haram/treasury-bills/ as per december 10, 2010. 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[80] q. zaman, “saving certificate,” in muftisays, 2012, retrieved october 10, 2015, from http://www.muftisays.com/qa/question/2478/savingcertificate.html. [81] al-quran 5:90, chapter 5 sura-e-maida, verse 90. [82] i. h. naqvi, “islamic banking in pakistan: fiqa-ejaferia offers optimization,” african journal of business management, vol. 6(5), page 2071 – 2085, 8 february, 2012. [83] n. desai, nishith desai associate for legal and tax counselling worldwide, 2018 retrieved from http://www.nishithdesai.com/information/researchand-articles/research-articles. [84] m. t. qadri, “interest-free banking and islamic economy,” 1994, lahore, minhaj ul quran. retrieved from https://www.minhajbooks.com. [85] p. p. biancone & m. radwan, “social finance and financing social enterprises: an islamic finance prospective”, european journal of islamic finance, 2019. [86] p. p. biancone & m. radwan, “social finance and unconventional financing alternatives: an overview”. european journal of islamic finance, (10), 2018. [87] p. p. biancone & m. radwan, “european companies: evaluation for sharia compliance opportunities and challenges”, european journal of islamic finance, (5), 2016. [88] p. p. biancone & m. radwan, sharia compliant, “possibility for italian smes”, european journal of islamic finance, (1), 2015. [89] p. p. biancone & s. secinaro, “the equity crowd funding italy: a model sharia compliant”, european journal of islamic finance, 5, 1-10, 2016. http://www.muftisays.com/qa/question/2478/saving-certificate.html http://www.muftisays.com/qa/question/2478/saving-certificate.html http://www.nishithdesai.com/information/research-and-articles/research-articles http://www.nishithdesai.com/information/research-and-articles/research-articles https://www.minhajbooks.com/ ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 12 annexure a types of money – table 1 sources: extracted from multiple sources as in [26], [27], [55], [59], and [69] types of money m0 mb m1 m2 m3 mzm notes and coins (currency) in circulation i.e. other than central banks and vaults of depository institutions y y y y y y notes and coins (currency) in bank vaults y central bank credit (minimum reserves and excess reserves) y traveler’s checks of non-bank issuers y y y y demand deposits y y y y other checkable deposits (ocds), which consist primarily of negotiable order of withdrawal (now) accounts at depository institutions and credit union share draft accounts y y y y saving deposits y y y time deposits and money market deposits accounts for individuals y y large times deposits, institutional money market funds, short-term repurchace and other larger liquid assets y all money market funds y m0 is narrow money mb is monetary base mzm is money zero maturity ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 13 annexure b components of currency management and their islamic alternatives – table 2 source: [78] factor common instruments/ methodologies/ activities involved shariah alternatives ncg 1. treasury bills 2. bonds & other security instruments 1 & 2. sukuks (asset or project based financing with profit/loss sharing) cng 1. loans 2. bank accounts 3. export finance / refinance 4. agricultural loans 1. qarz-e-hasna 2. islamic banking 3. islamic export refinance 4. agricultural loans based on islamic principles claims on npfis and private sector 1. leasing 2. insurance 3. investment 1. ijarah 2. takaful, murabaha 3. mudarabah, murabaha, musharaka oin 1. nonfinancial assets 2. claims on foreign currency swaps 3. short-term claims because of purchase of services from the central banks 4. intermediate accounts 5. currency swaps 6. short-term loans all should be based on islamic principles of mudarabah, murabaha, musharaka and shariah compliant loans etc. net foreign assets foreign investments (lending & borrowing) 1. receiving interest allowed 2. payment of interest prohibited. real gnp overall real income halal gnp inflation time value, speculation and market imperfections only because of natural changes such as: a. rise in cost or b. rise in quality. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france waqf financing expenditure and its impact on government debt azniza hartini bt azrai azaimi ambrose1, mohamed aslam2, hanira hanafi3 1 kulliyyah of economics and management sciences, international islamic university malaysia, azniza_azrai@iium.edu.my 2 faculty of economics and administration, university of malaya, maslam@um.edu.my 3 faculty of economics and administration, university of malaya, hanira_hanafi@um.edu.my abstract – the malaysian debt has been under scrutiny since the 1malaysia development berhad (1mdb) scandal; placing pressure on the research for sustainable debt. the purpose of this article is to forecast the impact of waqf (islamic pious foundation) financing expenditure on federal government debt in malaysia. it is to ascertain whether waqf can be an alternative solution to government debt reduction. to perform this, the neoclassical dynamic stochastic general equilibrium (dsge) model is adopted. the theoretical framework is developed by considering the history, tradition, culture, and political influence of waqf primarily in muslim majority countries. it was also inspired by the european third sector framework. the result shows that federal government debt can be reduced when waqf finances federal government expenditure. this has several implications. for one, this study revives the cohesive government-waqf role in providing pure and mixed public goods without depending solely on government expenditure. it highlights the fact that these shared role has an impact of reducing government debt. the result also inadvertently provides evidence of a significant third sector role on public finance dynamics. as a matter of fact, this study is one of very few quantitative attempts in illustrating how waqf interacts with the economy and its impact on government debt. keywords – waqf, islamic economics, public finance i. introduction in conventional economic theory, there are multiple strategies to attain government debt sustainability. the new keynesian economics proposes that economic growth rate should supersede interest rate of debt (marattin et al., 2011; mabugu et al., 2013) [1, 2] while the new classical economics calls for an increase in tax rates or expenditure cuts (qin et al., 2006; sakuragawa and hosono, 2011; hansen and i̇mrohoroğlu; 2016) [3, 4, 5]. internalizing both of the schools’ recommendation, the balanced budget and multi period strategy came about. the former involves simultaneous manipulation of variables in the government budget constraint (cogan et al., 2012) [6] while the latter in different fiscal periods (reith, 2014) [7]. copious studies had verified these strategies by developing a macroeconomic model and generated a forecast of debt to gross domestic product (gdp) ratio. their modelled economy consists of a representative from households, a representative from firms, and the conduct of monetary and fiscal policy by the government. these studies however, never considered the inclusion of the third sector in their economy leaving a wide literature gap on the possible third sector impact on economic variables. the third sector or voluntary sector includes “all such individual and social activities, which are not by intent or design, undertaken to attain any economic or material benefit for the doer or doers, but generate wide ranging economic repercussions” (faridi, 1983, p.35) [8]. on the other hand, literature in islamic economics has long considered this. waqf, which is considered as a component of the third sector (faridi, 1983; kahf, 2014; arshad and haneef, 2016) [8, 9, 10], had acquired a pivotal role in the economic landscape of past muslim economies. the literature named waqf as one of several sources of revenue in past muslim governments; used to finance pure public goods, mixed public goods, as well as other social goods and services (faridi, 1983; siddiqi, 1995; gil, 1998; babacan, 2011; biancone and radwan, 2019) [8, 11, 12, 13, 14]. these items essentially make up the components of modern public expenditure. in addition, sultan salahuddin al aiyyubi of the ayyubid dynasty introduced waqf as a supplementary fiscal policy in the nile valley with its application lasting through the ottoman rule (frenkel, 1999) [15]. in fact, ambrose et al. (2018a) [16] had concluded that waqf financing modern expenditure is also doable with its model thought out by ambrose et al. (2018b) [17]. çizakça (1998) [18] had long envisioned that debt can be ultimately http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 ejif – european journal of islamic finance no13, august (2019) reduced should waqf be assigned to finance certain components of government expenditure. a simulation was specifically done for malaysia by marzuki et al. (2012) [18] which found that waqf can help government save more thus enabling the savings to finance debt. however, all these studies had only focused on the historic economic application of waqf or theoretically argued its uses and impact on modern economies. few studies had actually employed macroeconomic models using real data to show waqf’s evident impact on modern economy. hence, the purpose of this article is to examine the impact of waqf financing government public expenditure on debt using dynamic stochastic general equilibrium (dsge) model. the malaysian federal government is the country of choice for this study. this article is organised as follows. the second section discusses the construction of a waqf framework in light of modern economy. based on the framework, a theoretical model is built in the third section. the theoretical model then gave rise to the model equilibrium in section 4. the fifth and sixth sections present the calculation for parameter values and steady state values. simulation is then done in the eighth section and a conclusion is presented in the final section. ii. constructing the framework of waqf in modern economy waqf or its plural awqaf means retaining and preserving certain asset strictly for specific philanthropy purposes (kahf, 2014) [9]. just like sadaqah (donation), waqf endowments are mainly driven by the altruistic behaviour of humans. in islamic history, it had played a pivotal role in supplying pure and mixed public goods in a decentralized fashion. pure public goods are “goods that are non-excludable (not easily denied to unauthorized consumers) as well as non-rival (capable of being enjoyed by many consumers at once)” (kuran, 2001, p.841) [20] while mixed public goods possess the characteristics of both private and public goods. however, mixed public goods are also categorized as public goods in the islamic context (akhthar, 1995) [21]. at its height, awqaf were endowed by the state and society for the purposes of defence, water supply, education, training, healthcare, animal care, transportation, and others (peri, 1992; çizakça,1998; gil, 1998; kahf, 2014) [22, 18, 12, 9]. waqf for these purposes are often termed as public waqf. one of the earliest waqf was initiated by prophet muhammad peace be upon him (pbuh) in which the prophet had converted a property left by mukhayriq into waqf for defence (gil, 1998; kahf, 2014) [12, 9]. as the territories of islam expanded, caliph umar al-khattab converted many conquered villages and egyptian lands into waqf for military benefit and the muslim public (gil, 1998) [12]. later on, caliph al-ma’mun from the abbasid caliphate, provided healthcare through similar means and ensured continuous streams of income through a waqf investment fund (kahf, 2014) [9]. the fund had invested in business, residential buildings, and agricultural lands (kahf, 2014) [9]. later on, sultan salāh al-dīn of the ayyubid dynasty formally introduced waqf as a public policy that augmented his fiscal reforms which lasted through the ottoman era (frenkel, 1999) [15]. these are a few examples of how waqf had interacted with state rulers or governments. on the other hand, past upper class societies were also motivated to endow waqf (bonine, 1987; kuran, 2001) [23, 20]; indicating an interaction of waqf with past communities. one of the ways undertaken by them to sustain waqf was by using profits from their own businesses for waqf support. bonine (1987) [23] discussed at length the evolution of yazaad bazaar in iran which began through awqaf endowed by viziers and local patrons. it serves as proof that waqf had been the epicentre for economic expansion. scores of businesses were developed and then converted into waqf back then; operated to fund religious schools, mosques, water cisterns, and other purposes. it further shows that waqf had also interacted with the market. similarly, the waqf investment fund set up by caliph al-ma’mun mentioned earlier may also serve as another example. hence, it can be seen that waqf had integrated with the community, market, and state in the past. this is reminiscent of the modern third sector championed by europe. pestoff (1992) [24] had developed a specific framework of third sector to which evers and laville (2004) [25] as well as defourny and pestoff (2008) [26] claimed the best representation for europe by far. the framework, the third sector in the welfare triangle, is depicted in fig. 1. the outer shape namely the welfare triangle indicates two things (evers and laville, 2004) [25]. first, each vertex denotes the sources of welfare contribution namely state, market, and community. second, to show that the third sector is not juxtaposed with public sector (state) and private sector (community and market) but is in fact an intermediary sector. this is only rational because the third sector complements and interrelates with the other two sectors (defourny and pestoff, 2008) [26]. meanwhile, the inner circle comprises of third sector organisations (tsos). these tsos are “simultaneously influenced by state policies and legislation, the values and practices of private business, the culture of civil society and by needs and contributions that come from informal family and community life” (evers and laville, 2004, p.15) [25]. the limits of these influences are defined using three types of dotted lines outlining the behaviours of state, market and community while simultaneously forming overlapping areas. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ejif – european journal of islamic finance no13, august (2019) figure 1. the third sector in the welfare triangle source: pestoff (1992, p.25) [24] assuming that waqf can be termed as a type of tso, the overlapping area between the state and the third sector indicates the role that waqf has on implementing public policy which are public, non-profit, and formal in nature. this is similar to past muslim rulers that had converted conquered lands, villagers, and treasury revenues into waqf. modern government waqf organizations such as the department of awqaf, zakat and hajj in malaysia, kuwait awqaf public foundation in kuwait (kapf), and majlis ugama islam singapura or the islamic religious council of singapore fit in here too. meanwhile, the overlapping area between the market and the third sector involves third sector enterprises like cooperatives which are private, for profit, and formal in nature. this is where businesses that support waqf in the historic yazaad bazaar fit in. johor corporation in malaysia is an excellent modern example whereby part of the company’s shares are endowed as waqf (waqaf an-nur corporation berhad, 2015) [27]. the final overlapping area points to self-help or mutual-aid groups that often exist in community which are informal, private, and non-profit in nature. this area marks the action of past wealthy individuals whom had supplied goods through waqf for societies’ benefit. the vehbi koç foundation based in turkey is a good contemporary example (çizakça,1998) [18]. however, the framework can be further modified to discuss the case of waqf exclusively as a specific type of third sector instrument (tsi). the first consideration is the fact that it is imprecise for waqf to be a “pure” tsi depicted as the centre triangle in the circle of fig. 1. this is because waqf shares responsibilities with the government in providing for pure and mixed public goods as was alluded earlier in this section. perhaps only ṣadaqah may be qualified as a “pure” tsi. this makes the centre triangle of fig. 1 extraneous in a waqf framework. the second consideration is that the community, market, and state were not mere sources of waqf contribution. the well to do (community) supply pure and mixed public goods and guaranteed continuity of these supplies using their investments and business profits (market). this initiative by the well to do reduced the need for the state to provide such goods in the past. another role of the state is to include waqf as a public policy. hence, the community, market, and state actually agents of an economy that was born out of waqf; just like the economy in yazaad bazaar. assertion that waqf can contribute to economic development made by biancone and radwan (2018) [27] indeed has its basis. taking these considerations into account, fig. 2 was developed. as can be seen, the three inner triangles depict the state, community, and market which expectedly form an outer triangle. this outer triangle represents the economy thus elucidating the role of state, community, and market as economic agents which are similarly defined in most modern macroeconomic models. waqf is placed in a circle that touches the sides of this outer triangle and juxtaposes with the three agents’ triangles. these actually delineates the intermediary role of waqf and links the three agents together. thus in essence, the waqf circle located in the middle of the outer triangle is to emphasise waqf’s role as the crux of this economy. meanwhile, areas of the inner triangles that do not intersect with the waqf circle are the typical role of agents that do not concern waqf. figure 2. the public waqf framework however, this economic framework became dormant after the collapse of the ottoman empire. waqf was deemed unable to integrate into an economy that was rapidly industrialising (kuran, 2001) [20]. as a result, the views of waqf became restricted and were deemed only suitable for religious purposes. its former role as the supplier of pure and mixed publics goods together with the state were transferred completely to the latter. regardless, waqf possesses evolutionary characteristics that make it a practical instrument for any era (setia, 2014) [29]. kuran (2001) [20] claims that two scenarios have to occur in order for waqf to integrate in modern economies. one, all awqaf should be coordinated and two, formed into a waqf municipal of corporate status. the former is self-explanatory while the latter entails the creation of corporate waqf defined by mohsin (2014) [30] as “the confinement of an amount of liquid money, shares, profit, dividends by founder(s) such as individuals, companies, corporations, organizations or institutions, and the dedication of its usufruct in perpetuity to the welfare of society” (p.16). kuran (2001) [20] also believes that corporate waqf should acquire a legal entity and thus overseen by a board of http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 ejif – european journal of islamic finance no13, august (2019) managers. if these two scenarios occur, then by extension, the public waqf framework represented in fig. 2 will be applicable again in modern economy. the first scenario is already taking root in most islamic countries. the federal constitution of malaysia appoints the state islamic religious councils (sircs) as the sole trustees of waqf which require all awqaf be registered with the respective sircs. singapore is however much advance than malaysia in terms of trustee flexibility and transparency. majlis ugama islam singapura (2016) [31] contains records of all registered waqf deeds in the country which can be accessed by the public. trustees of these waqf are by no means confined to majlis ugama islam singapura or the islamic religious council of singapore. in india, where large muslim population resides, efforts to identify and compile a list of available awqaf are taking place through the waqf records computerization project (wrcp) under the tutelage of the ministry of minority affairs india [32]. data obtained are compiled in an online database named the waqf management system of india (wamsi). when all of these awqaf are registered, coordination of waqf for the same purpose will be less of a hassle. the kapf for instance, was tasked by the organization of islamic cooperation (oic) to coordinate waqf actions among muslim countries (kapf, n.d.; kuwait news agency, 1999) [33, 34]. there are also countries that coordinate newly founded awqaf. this is primarily done by a waqf authority that took the initiative to initiate waqf funds and categorize them into various purposes. in this regard, waqf often in the form of cash are pooled from various donors and placed in these funds; a concept called crowdfunding. for instance, kapf founded five waqf funds for the purpose of holy quran and its sciences, mosques, scientific and social development, health development, as well as guidance and crisis relief (busharah, 2012) [35]. also based in kuwait, the international islamic charitable organization (iico) offers cash waqf schemes for the purpose of financing certain public goods globally (mohsin, 2013) [36]. these schemes financed water wells, education, mosques, healthcare, training centres, farms and productive projects, orphans, seasonal projects, social projects, as well as aid relief (mohsin, 2013) [36]. in regards to the second scenario, waqf institutions are increasingly corporatized such as waqaf an-nur corporation in malaysia and do provide certain public goods like cheap healthcare. corporatisation of waqf has also been progressing in various facets which are management, law, transparency, and revenue making. countries that require waqf registration such as singapore and malaysia ensures that awqaf are protected and able to defend itself in court. unfortunately, to the knowledge of this researcher, corporatisation of waqf is not done within any municipality. the idea of applying waqf in municipalities alone is an alien concept. this is mostly because modern economies are dependent on government expenditures to provide said goods. aside from the occurrence of these two scenarios, this researcher believes that sustainable waqf is equally important to guarantee perpetual benefits. that is, waqf needs to find ways to generate revenue like that of investment fund set up by caliph al-ma’mun and profits from businesses in the case of the yazaad bazaar. the best example of revenue generating waqf in modern economy is kapf. its investment strategy requires the fulfilment of these criteria; economic, shariah (islamic law), diversifying geographic, diversifying investment instruments, diversifying investment sectors, and regulation (busharah, 2012) [35]. the economic criteria necessitates the conduct of feasibility studies for every investment activity while the shariah criteria takes into account the minimizing risk factor to safeguard the waqf capital. diversifying geographic, investment instruments, and sectors entails investments in separate locations, a portfolio of investment, and various sectors such as real estate, services and such. the oic fiqh academy in its resolution no.140 (15/6) also recommends diversification of assets. the full conditions for investment of waqf funds as detailed in the resolution are (mohsin, 2014) [30]: 1. the whole conduct of investment must be shariah compliant. 2. in order to minimise risk, diversification as an investment strategy should be considered. risk can also be managed by obtaining surety ships and guarantees, confirming contracts, and performing feasibility studies. 3. avoid high risk investments. however, it is permissible to invest cash waqf through permissible contracts such as murabahah (cost plus), muḍarabah (profit sharing, loss bearing), istisna (order to manufacture), and others. 4. chosen investment must be suitable to the corpus of waqf and duly protects the waqf and beneficiary rights. thus, muḍarabah mode is allowed due to its compatibility with cash waqf despite being considered as a high risk investment. 5. waqf investment activities should be transparent. iii. the theoretical model although a form of waqf municipality is almost non-existent, fig. 2 can still be applied as a framework to forecast the impact of waqf financing expenditure on debt at the federal government level. after all, fig. 2 forms an economy which coincides with the neoclassical dsge model that also contains three economic agents (mabugu et al., 2013; reith, 2014; hansen and i̇mrohoroğlu; 2016) [2, 7, 5]. the theoretical model resembles that of torres (2013) [37] with the addition of waqf and government. for simplicity, the economy in this model is assumed to be a closed economy. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 ejif – european journal of islamic finance no13, august (2019) dsge model is based on the general equilibrium theory formally introduced by léon walras in 1874 and culminated in its mathematical proof by gerard debreu and herbert scarf in 1963 (starr, 2011) [38]. the theory claims the existence of a set of prices across all markets that produce an overall economic equilibrium when demand equals supply in these markets (debreu, 1983; cardenete et al., 2012) [39, 40]. furthermore, dsge model is built on microeconomic foundations; a suitable method since it is assumed that altruistic household behaviour is the main drive for waqf endowments. a. households the economy consists of many households where each make economic decisions. since dsge model can only analyse one economic decision, the concept of a representative household agent is employed where all agents have similar preferences. two household functions to be defined are the utility function and budget constraint. household seeks to maximize total consumption, ctτ, and leisure, ot, in order to attain utility or happiness. total consumption is the amount of goods and services consumed by the representative agent while leisure is the remaining time left after labour services (lt). due to the altruistic behaviour of the representative agent, cash waqf contribution essentially becomes part of his consumption. cash has been chosen instead of other forms of waqf because cash can be endowed by households from almost all levels of income class. hence, ctτ can be broken down into main components namely generic consumption (ct) and cash waqf contribution (vt): ctτ=ct+vt (1.0) total available discretionary time is normalized to 1 so leisure is the total available discretionary time minus labour services or working time. this means that equation containing ot and 𝐿𝐿𝑡𝑡 can be written as follows: ot+lt=1 ot=1-lt (1.1) budget constraints the utility of the household agent. the agent is the owner of productive factors namely capital, kt and labour, lt. by renting these productive factors to firms, the representative agent receives rtwhich is the return for kt; and wage, wt, which is the return for the agent’s lt. vt also counts as a productive factor but as per waqf deed, return from vt is not gained by the household agent but is used for chosen federal government public expenditure. it is worth mentioning here that the federal government is assumed to name its public expenditure precisely as opposed to broad terms that is used in the national accounts. after paying for tax, tt, earnings from the household agent is spent on ct and vt while the remaining is put into savings, st. it is further assumed that due to a competitive sector, st is directly transform into investment, it, and federal government bonds, bt, without any cost thus: st=bt+it (1.2) the agent receives a return of rtr from purchasing past bonds, bt, and it follows a process of capital accumulation overtime following a simple inventory accumulation equation: it=kt+1-(1-δ)kt (1.3) although equation 1.3 is theoretically correct, capital is actually decided yesterday making capital a predetermined variable. this transforms equation 1.3 into equation 1.4: it=kt-(1-δ)kt-1 (1.4) substituting equation 1.4 into equation 1.2, equation 1.5 is obtained: st=bt+kt-(1-δ)kt-1 (1.5) therefore, the intertemporal maximization problem of the representative agent is given as: max et ∑ βtu[ct,ot,vt]∞t=0 (1.6) such that ct+vt+st=wtlt+rtkt-1 +bt-1(1+rtr)-tt (1.7) equation 1.6 is the utility function of the representative household with 𝛽𝛽 ∈ (0,1) being the intertemporal discount factor which specifies how much the agent values his/her future utility as oppose to his/her current utility. meanwhile, equation 1.7 is the household’s budget constraint. to facilitate simple calculation, the utility function can be expressed in a log linear form. further substituting equation 1.1 into equation 1.6 as well as equation 1.5 into equation 1.7: max et ∑ βt[μ log ct+ γlog(1-lt)+ƞ log vt]∞t=0 (1.8) such that ct+vt+kt-(1-δ)kt-1 +bt=wtlt+rtkt-1 +bt-1(1+rtr)-tt(1.9) μ, γ, and 𝜈𝜈 are the preference parameter for ct, 1-lt, and vt respectively where μ+γ+ƞ ≈1. specifically, μ represents the proportion of consumer spending to total income, γ represents the proportion of leisure to total income, and ƞ represents the proportion of cash waqf endowment to total income. in economic terms, μ can also be defined as the marginal propensity to consume, γ as the marginal propensity to leisure, and ƞ as the marginal propensity to endow cash waqf. basically, these preference parameters indicate the agent’s http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 ejif – european journal of islamic finance no13, august (2019) preferences toward consumption – leisure – cash waqf endowment decisions. by nature, household will want to maximize ct, vt, lt, kt, and bt. this household problem can be solved using a dynamic lagrangian calculation before deriving first order conditions (focs): μ log ct+ γlog(1-lt)+ƞ log vt ℒ = � 𝛽𝛽𝑡𝑡 ∞ 𝑡𝑡=0 λt[ct+vt+kt-(1-δ)kt-1+bt-wtlt-rtkt-1 bt-1 (1+rtr)+tt] λt is the lagrange multiplier of period t. as the capital for a given period appears in time t-1 and in time t, the restriction faced by households at time t is: …βtλt[ct+vt+kt -(1-δ)kt-1 + bt –wtlt-rtkt-1 bt-1(1+rtr)+ tt] –βt+1λt+1[ct+1+vt+1+kt+1 -(1-δ)kt + bt+1 –wt+1 lt+1-rt+1kt -bt(1+rt+1 r )+tt+1 ] (2.0) the first order conditions (focs) of the household problem are: ∂l ∂c = βt � μ ct -λt� =0 λt= μ ct (2.1) 𝜕𝜕ℒ 𝜕𝜕𝜕𝜕 = 𝛽𝛽𝑡𝑡 � 𝛾𝛾 1−𝜕𝜕𝑡𝑡 (−1) + 𝜆𝜆𝑡𝑡 𝑊𝑊𝑡𝑡 � = 0 𝜆𝜆𝑡𝑡 𝑊𝑊𝑡𝑡 = 𝛾𝛾 1−𝜕𝜕𝑡𝑡 (2.2) 𝜕𝜕ℒ 𝜕𝜕𝜕𝜕 = 𝛽𝛽𝑡𝑡 � ƞ 𝜕𝜕𝑡𝑡 − 𝜆𝜆𝑡𝑡 � = 0 𝜆𝜆𝑡𝑡 = ƞ 𝜕𝜕𝑡𝑡 (2.3) ∂l ∂k = -βtλt+βt+1 λt+1 [rt+1+1-δ]=0 βtλt=βt+1 λt+1[rt+1+1-δ] β λt λt+1 =rt+1+1-δ (2.4) ∂l ∂b = -βtλt+βt+1 λt+1 [1+rt+1 r ]=0 𝛽𝛽𝑡𝑡 𝜆𝜆𝑡𝑡 = 𝛽𝛽𝑡𝑡+1𝜆𝜆𝑡𝑡+1[1 + 𝑅𝑅𝑡𝑡+1𝑟𝑟 ] 𝛽𝛽 𝜆𝜆𝑡𝑡 𝜆𝜆𝑡𝑡+1 = 1 + 𝑅𝑅𝑡𝑡+1𝑟𝑟 (2.5) by equating equations 2.1 and 2.3, equation 2.6 is obtained: vt= ƞ μ ct (2.6) equation 2.6 determines the agent’s decision between endowing cash waqf or consuming. basically, the right hand side of equation 2.6 is the opportunity cost of endowing an additional unit of cash waqf. substituting equations 2.1 into equation 2.2, equation 2.7 is obtained: wt= γct μ(1-lt) (2.7) equation 2.7 equates the marginal rate of substitution between consumption and leisure �γ μ � to the opportunity cost of an additional unit of leisure (wt). another way to view wt is to substitute equation 2.3 into equation 2.2 instead: wt= γvt ƞ(1-lt) (2.8) equation 2.8 equates the marginal rate of substitution between endowing cash waqf and leisure to the opportunity cost of an additional unit of leisure. from equation 2.1: 𝜆𝜆𝑡𝑡+1 = 𝜇𝜇 𝐶𝐶𝑡𝑡+1 (2.9) substituting equation 2.9 and equation 2.1 into equation 2.4 and equation 2.5: 𝐶𝐶𝑡𝑡+1 𝐶𝐶𝑡𝑡 = 𝛽𝛽(𝑅𝑅𝑡𝑡+1 + 1 − 𝛿𝛿 ) (3.0) 𝐶𝐶𝑡𝑡+1 𝐶𝐶𝑡𝑡 = 𝛽𝛽(1 + 𝑅𝑅𝑡𝑡+1𝑟𝑟 ) (3.1) equation 3.0 defines the condition of the agent’s decision about investment. basically, the agent compares the utility of consumption with that of investment. on the other hand, equation 3.1 indicates that the agent compares the utility of consumption with that of purchasing bonds. b. firms the concept of representative agent is also employed here. the representative firm obtain production factors, 𝐿𝐿𝑡𝑡 , 𝐾𝐾𝑡𝑡 , and 𝑉𝑉𝑡𝑡 from households to be converted into final goods (𝑌𝑌𝑡𝑡 ). firms then pay labor 𝑊𝑊𝑡𝑡 𝐿𝐿𝑡𝑡 and 𝑅𝑅𝑡𝑡 𝐾𝐾𝑡𝑡−1 to households and channelling return 𝑉𝑉𝑡𝑡 𝐷𝐷𝑡𝑡 to the federal government. specifically for malaysia, 𝑉𝑉𝑡𝑡 𝐷𝐷𝑡𝑡 is channeled to yayasan waqaf malaysia, a federal government trust body enacted by the department of awqaf, zakat and hajj. the federal government is obliged to use 𝑉𝑉𝑡𝑡 𝐷𝐷𝑡𝑡 to finance for identified public expenditures only. since the sole owners of production http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 ejif – european journal of islamic finance no13, august (2019) factors are the households, firms do not make investment decision nor decide on the amount of hired inputs from period to period. this is to simplify the theoretical model following torres (2013) [37]. it causes the maximization problem of the firm to become a static equation: π= yt-wtlt-rtkt-1 -vtdt (3.2) yt follows a cobb-douglas production function and has constant returns to scale: yt=atf(kt-1 ,lt,vt)=atkt-1 α lt ρvt 1-α-ρ at is the technology or total factor productivity. following galí, vallés and lópez-salido (2007) [41], at is normalized to unity so yt becomes: yt=kt-1 α lt ρvt 1-α-ρ (3.3) α is the output elasticity of kt-1 and ρ is the output elasticity of lt. thus, the firm’s maximization problem becomes: π=kt-1 α lt ρvt 1-α-ρ -wtlt-rtkt-1-vtdt (3.4) the firm will want to maximize labour, capital, and cash waqf contribution. to solve the firm’s problem, focs are derived: 𝜕𝜕𝜕𝜕 𝜕𝜕𝜕𝜕 : 𝜌𝜌𝐾𝐾𝑡𝑡−1 𝛼𝛼 𝐿𝐿𝑡𝑡 𝜌𝜌−1𝑉𝑉𝑡𝑡 1−𝛼𝛼−𝜌𝜌 − 𝑊𝑊𝑡𝑡 = 0 wt=ρkt-1 α lt ρ-1vt 1-α-ρ (3.5) ∂π ∂k =αkt-1 α-1 lt ρvt 1-α-ρ -rt=0 rt= αkt-1 α-1 lt ρvt 1-α-ρ (3.6) ∂π ∂vt =(1-α-ρ)kt-1 α lt ρvt -α-ρ-dt=0 dt= (1-α-ρ)kt-1 α lt ρvt -α-ρ (3.7) substituting equations 3.3 into equation 3.5, 3.6, and 3.7, the below equations are respectively obtained: wt= ρyt lt (3.8) 𝑅𝑅𝑡𝑡 = 𝛼𝛼𝑌𝑌𝑡𝑡 𝐾𝐾𝑡𝑡−1 (3.9) 𝐷𝐷𝑡𝑡 = (1−𝛼𝛼−𝜌𝜌)𝑌𝑌𝑡𝑡 𝜕𝜕𝑡𝑡 (4.0) equations 3.8 to 4.0 show that the rate of productive factors (wage, capital return, and cash waqf return) are a constant proportion of the total output over factor quantity ratio. c. federal government the federal government budget constraint is given as: bt=bt-1(1+rtr)+gt-tt-vtdt (4.1) the government borrows bt when tt and value of return from cash waqf, vtdt are insufficient to finance for total federal government expenditures, gt (i.e. sum of federal government operating and development expenditure), federal government debt bt-1, and interest on that debt (rtr). it must be stressed that the federal government’s responsibility as a waqf manager is to spend the return of cash waqf only on permissible public expenditures as stated in the waqf deeds. let ŝt=tt-gt and dividing equation 4.1 by yt: bt=bt-1(1+rtr)-ŝt-vtdt (4.2) whereby, bt= bt yt (4.3) vt= vt yt (4.4) ŝt= ŝt yt (4.5) the fiscal policy rule that determines the primary balance-togdp ratio, ŝt is specified as: ŝt=θ0ŝ̅+θ1 ŝt-1+θ2dt+e1 (4.6) whereby, θ0=1-θ1-θ2 and e1 is the error term. this manner of specification is almost similar to sakuragawa and hosono (2011) [4] and torres (2013) [37]. equation 4.6 simply states that the current primary balance-to-gdp ratio is determined by its steady state value (ŝ̅), its past value, and the current rate of return from cash waqf, dt. the insertion of dt in equation 4.6 actually captures the excess income from cash waqf. d. market clearing the feasibility constraint in the economy can be stated as: yt=ct+vt+it+gt (4.7) whereby, gt=gtyt (4.8) gt is simply gt over yt or the total federal government expenditure over gdp. it follows an ar(1) process: http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 ejif – european journal of islamic finance no13, august (2019) gt=(1-φ)g�+φgt-1+e2 (4.9) whereby, g� is the steady state value of g and e2 is the error term. this form of specification follows torres (2013) [37]. fig. 3 shows the relationship between primary balance and debt. when primary deficit occurs (g-t), the value of debt increases. when primary surplus occurs (t-g), the value of debt decreases. thus the incorporation of d in the primary balance (equation 4.6) causes primary deficit to reduce which will eventually lead to primary surplus and reduced debt. figure 3. the relationship between primary balance and debt iv. model equilibrium the model equilibrium is derived from the theoretical model. it involves calculating sequences of endogenous variables which are ct, lt, vt, kt, wt, rt, it, rtr, dt, gt, yt bt, vt, ŝt, and gt such that the balance path conditions are satisfied. since there are 15 endogenous variables, thus 15 equations are needed to calculate the equilibrium of this modelled economy. these sets of equations are: it=kt-(1-δ)kt-1 (1.4) vt= ƞ μ ct (2.6) wt= γct μ(1-lt) (2.7) ct+1 ct =β(rt+1+1-δ ) (3.0) ct+1 ct =β(1+rt+1 r ) (3.1) yt=kt-1 α lt ρvt 1-α-ρ (3.3) wt= ρyt lt (3.8) rt= αyt kt-1 (3.9) dt= (1-α-ρ)yt vt (4.0) bt=bt-1(1+rtr)-ŝt-vtdt (4.2) vt= vt yt (4.4) ŝt=θ0ŝ̅+θ1ŝt-1+θ2 dt+e1 (4.6) yt=ct+vt+it+gt (4.7) gt=gtyt (4.8) gt=(1-φ)g�+φgt-1 +e2 (4.9) v. determining parameter values parameter values are acquired through extrapolation, ordinary least squares (ols) estimation, and values supplied by the literature. these methods are approved by torres (2013) [37]. the value of ƞ is rather difficult to obtain because almost no recent studies has been done to determine its value for malaysia. hence this study uses the household consumption expenditure for year 2016, the latest report published by department of statistics malaysia (dosm) (2017) [42]. unfortunately, there is no value recorded in the report for ƞ. however, assuming that public awareness on waqf is heightened, the component of miscellaneous goods and services may as well be replaced with cash waqf endowment. making that item as a proxy for ƞ, ƞ can thus be assigned its value of 0.077. meanwhile, recreation services and culture is a proxy for 𝛾𝛾 which holds the value of 0.05. as a result, μ=1-0.077-0.05=0.873. meanwhile, iwata, khan, and murao (2003) [43] estimated α as 0.19 and ρ as 0.58 for malaysia using non parametric technique. the value of δ=0.07 is appropriate for malaysia as claimed by nagaraj (2005) [44]. β=0.97 is deemed appropriate and taken from torres (2013) [37]. using eviews, θ0, θ1, θ2, and φ are estimated via ols method as shown below. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 ejif – european journal of islamic finance no13, august (2019) table i. ols estimation of ŝ note that symbols cannot be specified as a variable in ols estimation using eviews, certain alphabets are illegal, and results generated by eviews always show variables as capital letters. hence in table 1, s is actually ŝ while d return is simply d. data of malaysian federal government expenditure (g), federal government revenue (t), and gdp (y) from the first quarter of 1999 to the second quarter of 2018 were obtained from bank negara malaysia (2000 – 2018) [45] or the central bank of malaysia. meanwhile, the proxy of d is quarterly returns of public ittikal (pi) fund from the same period. pi is a shariah compliant unit trust fund offered by public mutual berhad. it consists of shariah compliant equities and related securities from among others, tenaga nasional berhad, telekom malaysia berhad, sime darby berhad, ihh healthcare berhad, and axiata group berhad (public mutual berhad, 2016) [46]. thus, it matches with the argument of the place of public waqf in modern economy (fig. 2) in that collected cash waqf are connected with firms through investments. based on table 1, equation 4.6 can be specified as: ŝt=-0.045361-0.029819ŝt-1-0.011057dt (5.0) from equation 5.0, the parameter values can be determined as: θ2=-0.011057, θ1=-0.029819 θ0=1-(-0.029819)-(-0.011057)=1.040876 table ii. ols estimation of g based on table 2, equation 4.9 can be specified as: gt=0.253924+0.012044gt-1 (5.1) hence, from equation 5.1, the parameter value can be determined as: φ=0.012044 table 3 lists the parameter values. table iii. the parameter values parameter definition values 𝜇𝜇 preference parameter of consumption 0.873 𝛾𝛾 preference parameter of leisure 0.05 ƞ preference parameter of waqf contribution 0.077 𝜌𝜌 output elasticity of labour 0.58 𝛼𝛼 output elasticity of capital 0.19 𝛿𝛿 depreciation rate of capital 0.07 𝛽𝛽 intertemporal discount factor 0.97 http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 ejif – european journal of islamic finance no13, august (2019) 𝜃𝜃0 parameter of fiscal policy rule 1.040876 𝜃𝜃1 parameter of fiscal policy rule -0.029819 𝜃𝜃2 parameter of fiscal policy rule -0.011057 φ parameter of expenditure per gdp 0.012044 source: iwata, khan and murao (2003), dosm (2017), nagaraj (2005), torres (2013), public mutual berhad (19992018), [43, 42, 44, 37, 47] and authors’ calculation. vi. steady state analysis the steady state values refer to the values of endogenous variables that remain constant throughout time. steady state occurs when the modelled economy has stationarised and is in equilibrium condition. this particular study decides to find the steady state values by using the method adopted in torres (2013) [37] which are solving simultaneously most of the equations in the model equilibrium while subjecting the remaining equations to ols estimation. the former requires eliminating the equations’ time subscript and solving simultaneously most of the equations in the model equilibrium. thus the equations are converted into: i=̅δk� (5.2) v�= ƞ μ c� (5.3) w� = γc � μ(1-l�) (5.4) 1=β(r�+1-δ) (5.5) 1=β(1+rr ����) (5.6) y�=k� α l�ρ v�1-α-ρ (5.7) w� = ρy � l� (5.8) r�= αy � k� (5.9) d�= (1-α-ρ)y� v� (6.0) b� = ŝ̅+v�d � rr��� (6.1) v�= v � y� (6.2) y�=c� +v�+i+̅g� (6.3) g�=g�y� (6.4) note that the “ – ” sign on the variables denote steady state variables. substituting δ=0.07 into equation 5.2 and β=0.97 into equation 5.5 as well as equation 5.6, below are respectively obtained: i=̅0.07k � (6.5) r�=0.1009 rr���=0.03093 inserting the values of α=0.19 and r�=0.1009 into equation 5.9: k�= y � 0.5311 (6.6) replacing equation 6.6 into equation 6.5: i=̅0.07 � y � 0.5311 � i=̅0.1318y� (6.7) substituting ƞ=0.077 and μ=0.873 into equation 5.3: v�=0.08820c� (6.8) from equation 5.1, the steady state value of g� can be derived: (1-φ)g�=0.253924 (1-0.012044)g�=0.253924 g�=0.2571 hence equation 6.4 becomes: g�=0.2571y� (6.9) inserting equations 6.7, 6.8, and 6.9 into equation 6.3: y�=c� +0.08820c� +0.1318y�+0.2571y� c� =0.5616y� (7.0) inserting the values of γ=0.05 and μ=0.873 into equation 5.4: w� = 0.05c � 0.873(1-l�) (7.1) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 ejif – european journal of islamic finance no13, august (2019) substituting equation 7.0 into equation 7.1 and rearranging: w� (1-l�)=0.03216y� (7.2) substituting ρ=0.58 into equation 5.8, equation 7.3 is obtained: w� = 0.58y � l� (7.3) substituting equation 7.3 in equation 7.2, l�=0.9475 is obtained. substituting α=0.19 and ρ=0.58 into equation 5.7: y�=k� 0.19 l�0.58v� 0.23 (7.4) assigning l�=0.9475, equation 6.6, equation 6.8, and equation 7.0 into equation 7.4, y�=0.4125 is obtained. assigning y�=0.4125 and l�=0.9475 into equation 7.3, w� =0.2525 is obtained. inserting y�=0.4125 into equation 7.0, c� =0.2317 is obtained. inserting c� =0.2317 into equation 6.8, v�=0.02044 is obtained. substituting v�=0.02044 and y�=0.4125 in equation 6.0, d�=4.6416 is obtained. substituting v�=0.02044 and y�=0.4125 in equation 6.2, v�=0.04955 is obtained. substituting v�=0.04955, d�=4.6416 and rr���=0.03093 in equation 6.1: b� = ŝ̅+0.04955(4.6416) 0.03093 (7.5) value of ŝ̅ can be derived from table 1: 1.040876ŝ̅=-0.045361 ŝ̅=-0.04358 hence, using ŝ̅=-0.04358, b� =6.02688 is generated. assigning y�=0.4125 to equation 6.6, k�=0.7767 is generated. assigning k�=0.7767 into equation 6.5, i=̅0.05437 is generated. finally, assigning y�=0.4125 to equation 6.9, g�=0.1061 is generated. table 4 lists the steady state values of the modelled economy. table iv. steady state values steady state values l� 0.9475 y� 0.4125 w� 0.2525 r� 0.1009 c� 0.2317 v� 0.02044 i ̅ 0.1385 k� 0.7767 v� 0.04955 rr��� 0.03093 d� 4.6416 ŝ̅ −0.04358 b� 6.02688 g� 0.1071 g� 0.2571 vii. simulation result the first step in simulation is to induce shock to the model equilibrium. shock is perturbation introduced to the system in order to observe the deviations of the variables in comparison to their steady state values and the trend of variables before the variables return to the steady state (torres, 2013) [37]. for the purpose of this study, shock in ŝ is introduced to indicate an increase in waqf return by specifying 1% shock to e1. as a consequence of this shock, impulse response function (irf) of variables that are affected by the shock will be generated. the generated irf of b will determine the impact of waqf financing public expenditure on debt. 1% is a sufficient amount of shock to produce irfs. the software used for simulation are dynare and matlab. fig. 4 depicts the irfs of b, ŝ and rr upon 1 percent increase on the standard deviation of equation 4.6. the y-axis of the graphs represents each variables’ unit of deviation from its steady state value while x-axis represent the period of time. hence at its basic, the irf show the trend of variables upon shock before the variables return to the steady state (torres, 2013) [37]. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 11 ejif – european journal of islamic finance no13, august (2019) figure 4. the irfs of b, ŝ and rr upon 1% increase in e1 as can be seen in fig. 4, increase in 1% of e1 translates into an increase of 1% in ŝ. this indicates a reduction in primary deficit which resonates with the claim made by çizakça (1998) [18] and marzuki et al. (2012) [19]. 𝑅𝑅𝑟𝑟 also increases upon impact but at a lesser rate namely 0.2%. on the other hand, an increase of 1% in ŝ has an opposite impact on b. the rate of increase in b is lowest which is 0.025% before heading back to its steady state. this goes to show that the incorporation of d in the fiscal policy rule (equation 4.6) impacts ŝ the most followed by rr and lastly b. several deductions can be derived. firstly, the increase in ŝ after impact extends the finding of ambrose et al. (2018a) [16] that is waqf financing expenditure is not only doable but also practical. secondly, the increase in rr after impact suggests that government will induce households to save more within an economic framework that recognises altruism (cash waqf contribution). this can be explained by referring to the equations in the theoretical model. as indicated in equation 1.2, savings will further increase investment. in turn, capital may increase (equation 1.3), firms will be more productive (equation 3.3), profits will increase and more return can be generated to finance expenditure (equation 3.2 and equation 4.6). thirdly, b has the least impact because employing d to reduce debt might not be enough aside from government borrowing and collecting t. albeit having the least impact, this result still answers the main purpose of the study namely b is reduced when waqf finances expenditure. there are two possible ways that debt is reduced. first, as waqf is now financing public goods, idle tax can be channelled to finance government debt. second, the government would not need to borrow a large sum in the future as internal financing from waqf has been acquired. thus intuitively in the long term, it is highly likely that government are able to reduce tax rates significantly. therefore, it can be stated that waqf financing public expenditure has an impact of decreasing federal government debt. this result also concurs with the findings of çizakça (1998) [18] and marzuki et al. (2012) [19]. note that other variables namely c, l, v, k, w, r, i, rr, d, g, y, v, and g are not affected by the change in ŝ hence no irfs are generated. intuitively, it indicates two things. one, v is not affected because the amount of v is not modelled as an ar(1) process. to model v as an ar(1) process is impossible because most state islamic religious councils in malaysia were unwilling to release the values of waqf fund in quarterly frequencies, some did not provide them despite persistent enquiries, while others cannot disclose the values. it is standard practice to use data in quarterly frequencies when simulating dgse model. second, the 1% increase did not affect the other aforementioned variables because of a simple fact whereby waqf return is not distortionary in nature. viii. summary and conclusions this paper had shown that waqf financing public expenditure has an impact of reducing government debt by considering the altruistic behaviour of households. such result was also obtained by considering the intermediary role of waqf. it showed that waqf can aid in government debt reduction and provided evidence of a significant third sector role on public finance dynamics. thus, this paper provides a fresh contribution on the field of modern public finance. further research can be done by considering an open economy and/or model the cash waqf data according to an ar process. considering that cash waqf alone (aside from borrowing and tax collection) has smaller impact on government debt, further research can also be done by modelling other government policy and/or financial instrument together with cash waqf. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 12 ejif – european journal of islamic finance no13, august (2019) references [1] marattin, l., marzo, m. and zagaglia, p. 2011, "a welfare perspective on the fiscal-monetary policy mix: the role of alternative fiscal instruments", journal of policy modeling vol.33 no.6, pp. 920-952. 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[45] bank negara malaysia (2000 – 2018), “monthly statistical bulletin”, available at: http://www.bnm.gov.my/index.php?ch=en_publication&lang=e n [46] public mutual berhad, 2016, quarterly fund review, kuala lumpur: public mutual berhad. [47] public mutual berhad, 1999-2018, "rate of return of public ittikal fund", unpublished raw data. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 14 http://www.bnm.gov.my/index.php?ch=en_publication&lang=en http://www.bnm.gov.my/index.php?ch=en_publication&lang=en ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france i. introduction ii. constructing the framework of waqf in modern economy iii. the theoretical model a. households b. firms c. federal government d. market clearing iv. model equilibrium v. determining parameter values vi. steady state analysis vii. simulation result viii. summary and conclusions references http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 development and perspectives of ethical finance in iran massimo papa and francesco petrucciano centro interdisciplinare per gli studi sul mondo islamico “francesco castro” (cismi), university of rome tor vergata , massimo.papa@uniroma2.it centro interdisciplinare per gli studi sul mondo islamico “francesco castro” (cismi), university of rome tor vergata , francesco.petrucciano@alumni.uniroma2.eu abstract— iran has a rich and old tradition of ethical finance and economics. well before the islamic revolution, institutes and initiatives were active in encouraging an inclusive vision of economy. although re-elaborated under a different light, these concepts survived in the current constitution, which defines economy using a “social” approach (art.43). under this light, the legality of capitalism and that of the use of private investment are one of the pillars of economy itself (art.44) only if subordinated to religiously inspired ethical principles of justice and equity and in a way that makes of them a mere complement to state or to the corporative actors. religious guidance is therefore immanent even in the very own definition of economy as a mean, and not as an end, to get social purposes like, inter alia, welfare, elimination of poverty and abolition of deprivation of means of self-sustainment. state-driven economics was nevertheless a prominent concept in original iranian constitutional thought. starting from the nineties, financial and economic reforms have been leading the system from a corporatist vision that characterised the first fifteen years of existence of the islamic republic to a more actual social market, putting in discussion and somewhat reinventing the relationship between the public and the private. keywords: iran, islam, bonyad, ethics, finance, law. i. introduction we can not make a net distinction between the market, that makes up the life of the companies and constitutes the environment where the business lives, and the general characteristics of the human society hosting and, somewhat, governing that market. instruments like corporate social responsibility or health, safety and environment are social tools, extremely important ones to understand the nature of this coexistence given they represent the way the business dialogues, communicates and introduces itself to the public. in the history of modern iran, we can clearly distinguish two different phases of development of the relationship between business and ethics: that of before the revolution, and modern revolutionary iran. in turn, each of these periods may be divided into different phases, with often very different characteristics the one to the others: the first period of the pahlavi kingdom (first industrialisation) and the period following the economic crisis of the ‘50es by one side; the first decade after the revolution and the current era, by the other. a reference has been done to the first period of pahlavi ruling, an historical moment dating prior to the first samples of ethical finance and of other tools like corporate social responsibility in western world. that would qualify the experiences of “attention to social issues” belonging to the first half of the 20th century’s iran as a separate matter. however, we shall not forget that responsibility and ethics in business and finance, as a concept, has lived a continuous process of transformation, and that every specific contest may witness a different experience. ethics is defined as a systematic approach to moral judgements based on reason, analysis, synthesis, and reflection. in the west, tools like csr were born as a philanthropic tool in an environment where capitalism, free market and a scarce presence of the state in public life and workers protection. iran represented (and still represents) a mailto:massimo.papa@uniroma2.it mailto:francesco.petrucciano@alumni.uniroma2.eu ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 deeply different context, characterised mainly by islam, under the light of the ja’fari doctrine. ja’fari islam is, by a social point of view, an extremely important presence given it makes of business ethics a religious matter, making of ethics an immanent concept in the whole system. we should not forget that islam overcomes the concept of “faith” as we commonly understand in the western world, and that it constitutes the very shape of the law itself [1]. law, under this light, is not in fact a human product but the manifestation of the will of god. it is, therefore, eternal and not liable to err. islam is, at the end, the entire system and islamic legal systems are completely correspondant to it. the islamic faith is itself a social matter where big attention is given to fairness in contracts, balance between the counterparts, and where a specific attention is given to the wellness of the community over the wellness of the individual. finance is, of course, the most significant and meaningful part of business by the point of view of fairness in contracts and lawfulness of transaction, given its very nature of trading services with no provision of material goods. ii. the industrialisation: the beginning of the 20th century during the time of reza shah pahlavi, iran witnessed a deep transformation of its society and of its economy. the iran left him by the qajars, the house that ruled the country prior to the pahlavis and up to 1925, was a rural society mostly unequally distributed in a vast land with few big cities, no linguistic cohesion and even less industrial development [2]. in that moment, the idea of a modern state itself was lacking in iranian identity. sophisticated financial activities were absent in iranian market and almost all of them belonged to the most traditional trade activities, already perfectly regulated by the religious authorities through their interpretation on, and personal effort (ijtihad, هاداجت ) in understanding the law in every single case. therefore, traditional trading activities (by which almost the entire economy was made up by) was considered conform to religious lawfulness (halal, حالل), which made of them “ethical” by definition. that conformity left no possibility to have a further need for a room to be enhanced. the first parliament (majlis, مجلس) of the country, created after a constitutional revolution seeking a european-styled development plan for iran, had to fulfil the most challenging event for a country en route to a deep transformation: that of the promulgation of a civil and of a commercial code. that happened in 1928, bringing with it the need to regulate and accept into iranian system some financial institutes and tools coming mainly from the west world, therefore proposing to then iranian legislator the challenge to consider them licit or not. iran took an extremely sophisticated choice while deciding to adopt the code system while completely adapting it to the islamic ja’fari orientation, therefore proposing a “new” model of codification. that model, differently from other countries of the area, would not choose to print a mere copy of a european legal text, translating it into persian and adding a personal status code (ahwal shakhsiyya) for familiar and personal issues, but would build its entire civil system harmonizing it in toto with the islamic system [3]. with this experience, iran faces for the first time the ethical dilemma of the lawfulness of adopting financial tools which very origin is unrelated to the islamic world but rather belonging to the western system. iii. finance and ethics in the iranian civil code of 1928 the very fact that iran was facing a true revolutionary historical period while adopting the civil and commercial codes was clear since the beginning of the parliamentary debate over the issue. in a famous statement at the majlis in 1927, the then representative dr. mohammad mossadegh made clear in front of the assembly that his being a “persian and a muslim” would not let him accept iran to just absorb a mere translation of a european code and make of it a source of its law. in particular, mossadeq stressed the necessity for his country to always keep its islamic foundation, even in moments when the foundation of the country was “mistakenly” identified with “the concept of modernisation” itself. mossadeq, therefore, qualified the modernisation as “false”, stressing the need of not passively accepting it, as it would (to his vision) destroy the country. a clear stance against a school of thought that would have wanted iran in the line of those countries accepting to merely adopt the western system, but in line with ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 those underlying the idea of a need to reform welcoming many orientations and ideas of western origin. in the first book of the code this orientation is made clear while the legislator addresses the issue of gambling and betting, which are both to be considered not conform to islam given the well-known prohibition of aleatory enrichment. therefore, such juristic acts do not find any legitimation in the law. art.645 of the code statutes that gambling and betting are not valid juristic acts, unproductive of effects and for which no legal action shall be admittible. the same norm shall be applied with reference to all obligations produced by illicit juristic acts. iv.the islamic revolution and the current costitutional asset of economics and finance the constitution seeing the light after the revolution of 1979 gives economics and finance a completely new definition and reads them under the light islam provides them with. current constitution does not actually make any difference between financial activities and pure economic ones, such as trade of goods. although in islamic law fair trade is considered a highly valuable activity in the life of a muslim (mohammad used to be a commercial arbiter for a long period of his life), finance presents some difficulties given it is related to production and interchange of services whose value may be determined, in some cases, in an arbitrary way. that is the case of some financial tools, such as derivative obligations, whose output (given market value) may effectively be dependent on factors independent to one’s efforts or work and therefore to deserve his own enrichment. that may make of their profit an illicit (haram, َحَرام) one. art.2, 3 and 4 of the constitution are the main guidance for the exegesist of the iranian legal system wishing to study its main sources and constitute the cornerstone of the entire fundamental chart. art.2 states that all sources of the law shall be consistent with islam (“divine revelation and its fundamental role in setting forth laws”), therefore giving it the qualification of a super-constitutional norm. as we read in the preamble of the constitution itself, “in the view of islam, government does not derive from the interests of a class, nor does it serve the domination of an individual or a group. rather, it represents the fulfilment of the political ideal of a people who bear a common faith and common outlook, taking an organized form in order to initiate the process of intellectual and ideological evolution towards the final goal, i.e., movement towards allah”. after a few lines, the preamble addresses the problem of the qualification of the term “economics” (eqtesad, قتصادا ). it states that while strengthening the foundations of the economy, whose fundamental consideration will be that of fulfilling the material needs of man in the course of his overall growth and development, the new order of the state (which means the islamic republic) will fix a principle in contrasts with other economic systems. the aim would be that of the “concentration and accumulation of wealth and maximization of profit. in materialist schools of thought, the economy represents an end in itself, so that it comes to be a subversive and corrupting factor in the course of man's development. in islam, the economy is a means, and all that is required of a means is that it should be an efficient factor contributing to the attainment of the ultimate goal”. art.3 of the constitution recalls what held in the previous one and, while compiling a list of the duties of the state. the twelfth point reports the “planning of a correct and just economic system, in accordance with islamic criteria, in order to create welfare, eliminate poverty, and abolish all forms of deprivation with respect to food, housing, work, health care, and the provision of social insurance for all”. art.43 of the constitution opens the chapter iv, dedicated to “economy and financial affairs”. it obviously recalls the content of art.2, considering the vision islam has of economy and its main objectives and characteristics. the first paragraph puts, as its objectives, “achieving the economic independence of the society, uprooting poverty and deprivation, and fulfilling human needs in the process of development”. these objectives are to be reached through very social means and are driven by a social and ethical vision: “ensuring conditions and opportunities of employment for everyone, with a view to attaining full employment”. the action of the state is present especially while placing the means of work at the disposal of everyone able to work and lacking the means. the most interesting thing of this article is that it provides the aforementioned means in the form of cooperatives, through granting interest-free loans or “recourse to any other legitimate means that neither results in the concentration or circulation of wealth in the hands of a few individuals or groups, nor turns ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 the government into a major absolute employer”. it also statutes that these steps must be taken with due regard for the requirements governing the general economic planning of the country at each stage of its growth. a constitution is not usually required to specify or regulate in detail its provisions, neither to name expressly the institutions that will be called to make those provisions reality. at the moment of the writing of the constitution, many religious foundations were working in social issues in order to provide the people with an alternative way of development out of shah’s revolutionary means. these foundations were found on one of the very basic principles of islam as a religious system, that of the cooperation towards the realisation of the ummah as a perfect human organisation [4]. as a consequence of the revolution, the entire banking system was turned into a interest-free one, and at the same time a huge reform on capital and financial operators was implemented [5]. . v. bonyad bonyad (foundation, بنیاد) is the term that mostly embodies the concept of ethical finance in iran given it represents the most typical and particular juridical form of a financial actor in the islamic republic’s legal environment [6][7]. founded under the revolutionary process of islamization of the entire imperial iran’s system, bonyads took over the role the shah had given to institutions such as the pahlavi foundation, and their assets were entitled to the revolutionary councils all around the country, keeping them therefore separated from the state’s patrimony (ghanimat system). this has constituted the prodromal act of a series of legislative reforms that would implement the actual structure of the islamic republic’s administration. sundering the public into two spheres, the one of which would be under the strict control of the religious guidance, somewhat escaping from the classical tools of administrative and financial control by the state, is a juridical instrument in full conformity to the principles of "guardianship of the jurisconsult" (velayat-e faqih), regulating the constitutional asset of the islamic republic [8]. bonyads therefore enjoy a wider degree of independence and administrative freedom, being free to manage, hold and constitute business active in almost all possible markets with the exception of the oil one. by a theorical and legal point of view, bonyads shall operate as charity organizations: that would mean, called to address their activities in order to redistribute incomes and not to pursue a profit orientation. nevertheless, the specificity of the institution and the fact that bonyad has become a true nomen juris distinguished from the simple concept of non-profit organisation has made of it a reality difficult to measure, to define and to tailor a specific management regime for. another important aspect of the bonyads is that, competing in market against private business, are often blamed on contributing to the insufficient development and transparency of the market itself, impeding an harmonious development of the country’s economy. bonyads are not subject to the general accounting laws and are not required to pay taxes, while their actual monetary consistence remains substantially impossible to be defined. unaccountable to the central bank governor as well, there is a lack of proper oversight and control of these foundations. there is no doubt that the current system has awakened many criticism from inside and outside the country: a particularly interested eye on the issue has been put by the incumbent iranian executive, following the steps of the previous reformist khatami government of the ‘90es. a structural reform of the entire iranian economic law, in light of a long-awaited liberal revolution would help the country to address in a better way the challenges the country is facing and to diversify its way of developing a truly wider economy. that may allow an actual opening to modern experiments of ethical finance, today still restricted into the bonyad system and the provisions of art.3, 43 of the constitution. conclusion the ethical finance in iran is witnessing the last stage of development started around one hundred years ago: as a country, iran always featured very advanced characteristics of social development and attention to the needs of a society in evolution. by the other side, belonging to ja’fari school made the country a centre for a “national” school of thought in this sense and the constitutional provisions of social justice and ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 protection were, of course, seen as to boost to the development of such a perspective, but the challenge now seems to be that of sustainability. more than being a pure economic issue, we shall now understand how the paradigm of a state-driven economics can coexist with a mixed system of state + market and who is the one who is in charge of that references [1] aa.vv., le shi’isme imamite, 1970, parigi, presses universitaires de france [2] abrahamian e., storia dell'iran. dai primi del novecento a oggi, 2009, roma, donzelli [3] papa m., introduzione al codice civile della repubblica islamica dell’iran, 2015, roma, eurilink [4] cilardo a., teorie sulle origini del diritto islamico, 1990, roma, ipocan [5] shari’ati a., l’individuo, il marxismo, l’islam, 1985, roma, centro culturale islamico europeo [6] michalak l.o., salacuse j.w., social legislation in the contemporary middle east, 1986, berkeley, institute of international studies, university of california [7] abdolmohammadi p., cama g., l’iran contemporaneo, 2015, milano, mondadori università [8] whefner w.r., islamic law and society in the modern world, 2011, bloomington, indiana university press ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 the displaced commercial risk and islamic banks laboratory for entrepreneurship, finance and audit (larefa) encg agadir, university ibn zohr (morocco) abstract— this islamic finance has attracted an ever-increasing interest over the last forty years and has undergone a remarkable expansion in asset value. nevertheless, the peculiarity of islamic financing modes proposed by these institutions may present certain limits in their execution which exposes these banks to risks that emanate from the characteristics of their particular modes of operation. the aim of our article is to analyze the main risk specifically to islamic financial institutions namely the displaced commercial risk. this risk arises from participatory investment accounts. in other words, this situation occurs when the banks, under pressure from the environment, are forced to give up part of their profits to pay the depositors, in order to prevent massive withdrawals that can be translated into a liquidity crisis later. in order to avoid such a situation, islamic banks highlight income smoothing mechanisms on participatory investment accounts. keywords-component: islamic banks; risk; participatory investment accounts; competition. i. introduction this template, since the first experience of islamic finance in pakistan in the 1950s, followed by egyptian experience in the 1960s, islamic financial institutions are present in almost 30 countries with rapid growth in the arabian gulf countries persique (65 banks), malaysia (17 banks) and the united kingdom (5 banks) . thus, the amount of assets held by these banks exceeds 1.650 billion dollars [15] with an average annual growth rate of 15% [14]. indeed, according to al-jarhi and iqbal (2002) [9], the islamic bank is an institution that receives deposits and conducts all banking activities except the interestbearing loan and loan operation. while these banks, like conventional banks, rely on their financial intermediation business models by collecting deposits and distributing credits. however, islamic banks have a number of notable differences with conventional banks which explains their existence [6]. these banks then proceed to the collection of funds and their reallocation by making investments in the framework of the shari'ah. as a result, islamic banks have a different understanding of financial intermediation as the denial of usury in transactions is a key pillar in the work of islamic banks. in this context, and facing of these different challenges, islamic banks should be immune to the interest rate risk. that said, according to luis miotti and dominique plihom [13]: « interest rate risk is defined as a significant risk that arises because interest rates can vary significantly over time, while banking involves intermediation that generates exposure to maturity mismatches ». it seems obvious that for conventional finance, interest rate risks are frequent because the interest-bearing loan is the basis of the financial intermediary mechanism. however, since interest is prohibited in islamic finance, does the variation in the interest rate have a direct influence on the performance of islamic banks? indeed, a multitude of empirical studies carried out especially in malaysia and indonesia explicitly affirm the exposure of islamic banks to the risks of interest . the first study is conducted in malaysia for the period between 1999 and 2006 through which kassim et al. (2009) [11] demonstrate that islamic banks are more sensitive to changes in monetary policy than conventional banks. for these authors, the fluctuation of interest rates on conventional deposits causes the variability of rates of return on investment deposits in islamic banks. as a result, the increase in interest rates causes the increase in the volume of conventional deposits and the decline in the volume of islamic deposits. these results seem consistent with findings from other studies, such as those conducted by kader and leong (2009) [2] and haron and ahmad (2000) [7] on the malaysian banking market and by kasri and kassim (2009) [11] on the case of indonesian banking market. some studies also show that islamic banks adjust their rates of return up (down) when this rate is lower (higher) than conventional rates. the purpose of this article is to study in detail the nature of the risk generated by the participative investment accounts, the reasons for this exposure and its impact on the activity of islamic banks. then we will expose the various risk management methods developed by these institutions to control the risk associated with investment accounts. s. drissi, (ph.d student), k.angade (ph.d.) ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ii. interest rate identification among islamic banks with the exception of iran and sudan islamic banking institutions have coexisted with conventional banks for several years. the former are based on the crowdfunding system where interest is prohibited while the second on interest credit [16]. nevertheless, the duality of the two systems faces some difficulties since the target clientele of the two banks remains common, which constitutes a belt of transmissions between the islamic and conventional spheres [19]. in other words, in view of the competitive environment in which islamic banks operate, customers have the opportunity to change banks easily in case of dissatisfaction. moreover, a low rate of return on the participative investment accounts could lead to dissatisfaction among depositors. the latter therefore risk withdrawing their funds to place them in a competing bank, thus seeking a higher remuneration on other alternative investments [18]. in this context, the clientele that seeks to maximize its gains by seeking to arbitrate between the offer of conventional banks and those of islamic banks expose the latter to the displaced commercial risk which mainly concerns the management of non-restrictive participative investment accounts. thus, the islamic bank is exposed to a risk of massive withdrawal of funds and must face a liquidity problem. under commercial pressure and to avoid this risk, islamic banks will try to increase their rate of return on participatory investment accounts when it is low and take a portion of the income from these accounts to feed a reserve when it is high. trade pressure prompts islamic banks to smooth investment account revenues to mitigate displaced commercial risk [18]. in this logic of behaviour of the holders of these accounts, islamic banks align their practices with those of traditional finance, to reduce the risk of volatility of its client’s [1]. by adjusting the returns of psia (profit sharing investissement accounts) accounts to the credit rates of conventional banks, islamic banks therefore resort to the use of certain rates such as london inter-bank offering rate (libor) and euribor as reference rates faults of alternatives [8]. this situation could seriously affect the liquidity of an islamic bank, or even its solvency. to summarize, this is a transfer of risk, associated with deposits, to the shareholders of the bank. this situation occurs when banks, under pressure from the environment, are forced to yield part of their profits to pay depositors, to prevent massive withdrawals caused by low rates of return [12]. this displaced commercial risk implies that, despite the bank's compliance with the shari'ah injunctions, the latter is unable to pay competitive rates of return in comparison with their counterparts or other competing institutions. this can cause deposit resubmission. to prevent this situation, shareholders of the bank will have to take a puncture from them in profits for the benefit of depositors / investors. iii. modality of management for dispolaced commercial risk in order to limit the damage caused by the displaced commercial risk, the islamic bank can engage in a set of practices that serve to guard against this type of risk. a. investment risk reserves (irr) under the prudential framework, the islamic financial services board (ifsb) and the accounting and auditing organization for islamic financial institutions (aaoifi) recognize the exposure of islamic banks to the displaced commercial risk and respect of certain prudential reserves such as the constitution of investment risk reserves or irr. indeed, it is a reserve for investment risk to protect the holders of investment accounts against possible losses [3]. the irr is deducted from mudaraba's income which represents the share of the profit attributed to the owners of the investment accounts. it is levied after the calculation of the bank's remuneration as mudarib. however, according to c.karim (2008) [5], the use of this type of reserve may present some obstacles from the islamic point of view as they increase the risk of manipulation of financial information and reduce the transparency of islamic banking institutions. b. profit equalization reserves (per) unlike the irr, the per is deducted from the gross profit of the islamic bank before the allocation of profits between the shareholders of the bank and the owners of the investment accounts. this type of reserve reduces the funds actually attributable to investment account holders and shareholders. at a time when the rate of return on investments is higher than that of comparable investments in the market, the islamic bank can maintain a remuneration comparable to that retained in the market while taking a portion of the income to feed the per [17]. the amount of the reserve belongs to the holders of the participative investment accounts and to the shareholders according to the same profit sharing ratio fixed in the mudarabah contract and it will be used to smooth the rate of return, which is admittedly low but positive. to summarize, we can divide the situation in two scenarios. the first scenario, the rate of return on participatory investment deposits is very low compared to the reference rate but it still remains positive. in this case, the islamic banking institution uses the share of the per which is normally returned to the owners of the investment accounts in order to smooth the rate of return. if it turns out that the share of the holders of the investment accounts is not sufficient, the bank in this case can use the share of shareholders' per. in the second scenario, the rate of return on participating investment deposits is negative. the islamic bank uses two types of reserves. firstly, the irr to absorb the losses. then, the per to increase the depositors' remuneration up to the reference rate to guarantee a competitive remuneration to the holders of the investment ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 accounts compared to their competitors. however, the major challenge in dealing with this type of risk is the proper evaluation of the amounts of per and irr reserves to be withdrawn. iv. prudential regulation and displaced commercial risk a. basel ii agrements and islmauc banks despite the rapid and dramatic growth experienced by islamic banks in recent years, international prudential regulation has not provided for special treatment of this category of banks. indeed, basel ii prudential banking regulations do not recognize the specificity of islamic banks, especially participatory investment accounts [8]. by applying the basel ii agreements, some islamic banks tend to account for off-balance sheet investment accounts. by applying the basel ii agreements, some islamic banks tend to account for off-balance sheet investment accounts [4]. this practice can hinder the smooth operation of these financial institutions. moreover, if we try to map the islamic banking risks and the basel ii agreement, typically, the first pillar refers to credit risk, market risk and operational risk. as for the second pillar, it will include the steps of the prudential supervision process by the regulatory authorities through governance and capital management risks. however, a significant number of risks related to the activity of islamic banks are not taken into consideration or are poorly taken into account by the basel ii guidelines, which include the displaced commercial risk and other categories of risk as securities. we quote as an example: the risk of interpretation of religious rules or good compliance with shari'ah. b. internatioanl islamic regulatory authorities for the international islamic regulatory authorities, like the aaoifi and the isfb, they seek to fill the gap left by the basel agreements by putting in place global risk management and reporting mechanisms to evaluate the potential impact of market factors affecting asset rates of return, compared to the expected rates of return for investment account holders [10]. whether for the aaoifi and the ifsb, the retention of per and irr as prudential reserves is not mandatory but just highly recommended. for the aaoifi, share the per share reserved for the shareholders as an unavoidable component of the total reserves and integrate it at the equity level. on the side of the irr, the aaoifi recommends to consider it as a component of the capital of the holders of the investment accounts, which is quite the opposite for the ifsb which recommends not imputing the two prudential reserves with the equity. however, the majority of the regulatory authorities do not indicate the methods for calculating the rate of return on the participatory investment accounts as well as the calculation of the per and the irr. in this context, islamic banking institutions are forced to develop their own internal models to quantify the displaced commercial risk. in some cases, the regulatory pressure to smooth the rates of return on participatory investment accounts is subject to the diversity of regulatory environments in the countries in which islamic banks operate. for dual banking systems, central banks use a protective approach to participatory investment account holders. in such a situation, islamic banks are forced to smooth the rates of return on investment accounts with the only difference is the fact that instead of exposing islamic banks to commercial risk moved under the constraint of competition, this practice becomes mandatory according to the regulations. it therefore appears that under commercial or regulatory pressure, islamic banks that operate in a regulatory environment that does not take into account their particularities may not be able to comply with the principle of sharing profit and loss in accordance with the principles of shari'ah law. thus, in seeking to promote a fair situation between conventional banks and their islamic counterpart’s regulatory authorities risk falling into a dilemma to ensure the development of this expanding industry ensure their roles as religious regulators. v. conclusion in this work, we have focused on the problem of the exposure of islamic banks to the commercial risks and the impact of this exposure on the performance of these islamic banking institutions. this risk, which seems specific to islamic banks, results from the mobilization of funds by the islamic bank in the form of participative investment accounts. in other words, this risk specifically sends to the behaviour of the holders of these accounts who, dissatisfied with the remuneration offered by their bank can withdraw their funds by running the bank at a serious risk of liquidity; it derives more specifically from the behaviour. islamic banks found under commercial or regulatory pressure are forced to resort to revenue smoothing techniques on participatory investment accounts which may put the islamic bank in a delicate situation of non-compliance with the principle of sharing profits as stipulated by the principles of shari'ah. existing arrangements, including those of the ifsb, is not yet effective despite the efforts that have been made in view of their arbitrary and undifferentiated contribution to the determination of the displaced commercial risk. to summarize, it must be said that islamic banks, like other banking institutions, are required to respect certain financial recommendations to ensure their survival and continue to operate. however, unlike conventional finance, islamic finance has defined a set of extra-financial criteria that must be met in order to be in full compliance. in such a situation, islamic banks are in an emblematic position to adopt a particular strategy in order to compete with their rivals or to find themselves in a situation of non-compliance with the principles of shari'ah. ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 references [1] aaminou, mohamed wail, and aziz moutahaddib. 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"the effects of conventional interest rates and rate of profit on funds deposited with islamic banking system in malaysia." international journal of islamic financial services 1, no. 4 (2000): 1-7. [8] hassoune, a. "la finance islamique dans le système financier international et dans la mondialisation." la finance islamique à la française: un moteur pour l'économie, une alternative éthique (2008). [9] iqbal, munawar, and david t llewellyn. islamic banking and finance: new perspectives on profit sharing and risk. edward elgar publishing, 2002. [10] jedidia, k ben. "l'intermédiation financière participative des banques islamiques." etudes en economie islamique 6, no. 1 (2012): 17-31. [11] kasri, rahmatina, and salina hj kassim. "empirical determinants of saving in the islamic banks: evidence from indonesia." (2009). [12] martens, andré. "la finance islamique: fondements, théorie et réalité." l'actualité économique 77, no. 4 (2001): 475-98. [13] miotti, luis, and dominique plihon. 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"le risque lié aux comptes d'investissement participatifs: un risque propre aux banques islamiques." la revue des sciences de gestion, no. 1 (2013): 131-42. [19] zainol, zairy, and salina kassim. "an analysis of islamic banks' exposure to rate of return risk." journal of economic cooperation and development 31, no. 1 (2010): 59-84. http://halalfocus/ ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 social finance and unconventional financing alternatives: an overview department of management, university of turin, italy, paolo.biancone@unito.it department of management, university of turin, italy, maha.radwan@unito.it abstract— the economic crisis, the increment of poverty and unemployment, the emergence of several social problems, and the limitations of the public spending have all called for exploring innovative and alternative ways of social financing. such enterprises face many challenges in accessing finance due to that high risk regarding generating profit, problems of governance model, and lacks of performance measurement valuations especially when it comes to measuring social value. there is a need for finance impact driven businesses and this requires the reinforcement of current funding alternatives and usage of innovative financing alternatives. islamic finance with its unconventional wide range instruments represents a possible potentiality for offering innovative financing alternative. the paper is exploratory and should give insights to the emerging interest in both social impact finance and islamic finance with its innovative tools that focus on risk sharing and social impact. this paper argues that unconventional financing alternatives could positively impact international economies and be a viable potential alternative for financing with its diversified instruments for social enterprises development. the paper explores the different unconventional instruments of financing as well as the criteria of accessing them. the paper provides insights for researchers, decision makers, and practitioners of how could be unconventional financing used as valid financing tool for social impact businesses. keywordssocial finance; impact finance; social entrepreneurship; islamic finance; sustainable development goals sdgs i. introduction recently, blending a social objective with businesses turned to be of a great importance after the economic crisis, increment of poverty and unemployment, emergence of several social problems, limitations of public spending, and the environmental changes problems. governments lately have dedicated many efforts for supporting entrepreneurship and entrepreneurs as this impact positively the whole economy. social entrepreneurship is not limited to creating employment opportunities and improving economic growth; but it contributes to the well-being of the community [1]. according to [2], [3] entrepreneurship accelerates the economic development. it also contributes to increasing wealth and income, and linking of the domestic economy to the international one. policy makers around the globe are giving high attention to social impact investments on the basis that enterprises goals are to have both economic and social benefits to the community and the relevant stakeholders. “impact investing means investing money with a positive social impact”. blended finance, in the words of the oecd, is defined as “the strategic use of development finance for the mobilization of additional commercial finance towards the sustainable development goals (sdgs)”. this strategic use shall lead to positive results for both investors and communities.” using various islamic financial instruments like zakat, waqf, microfinance and sukuk could be a potential solution and fitting perfectly with this type of investments for achieving sustainable development goals. all these instruments are possible tools for poverty alleviation, enhancing financial inclusion and maintaining sustainable growth. islamic finance industry has experienced progressive growth in the last years whether for muslims or non-muslim countries [4]. according to the [5] islamic finance assets have a compound annual growth rate of 12.7%. worth mentioning that; uk and switzerland were listed in the top 20 largest countries in total sharia-compliant assets. conventional financial institutions have extended their operations to provide islamic financial products targeting islamic investors. it was referred that entrepreneurs financing by banks has been gradually increasing in most of the countries where islamic banks operate and this is because of more awareness and greater supply where entrepreneurs who would previously have used conventional financing have now started demanding islamic products. the dynamically increasing importance of the culture and religion in developing impact finance can be seen especially when religion has a positive approach towards it [6]–[8]. muslims counts for around 24% of global population and islam paolo pietro biancone1 and maha radwan 2 mailto:paolo.biancone@unito.it mailto:maha.radwan@unito.it ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 is the world’s second-largest religion with the fastest growth rate [9]. although of the high expectations and the positive outlook, the islamic finance full potential is not yet realized. expanding to new innovative financial tools is required for achieving the sustainable development goals. this could be reached by achieving the optimal linkage for bridging from theory to practice with developing tools that can take into consideration the aspects of both risk-sharing and social impact [10], [11]. a plenty of researches have been conducted on impact finance from different prospective, there has been very few literature and studies that takes into consideration the connection between islamic finance and impact finance [12]. the motivation of this paper comes from the global progressive interest supporting social impact investments, where a research on the linkage between islamic finance and impact finance is intensively needed and particularly important. this paper is exploratory and conceptual in nature that provides insights for researchers, decision-makers, and practitioners of how could be islamic finance used as a valid financing tool for social impact finance. this paper is organized as follows: section two starts with an overview of islamic finance in a way that explores its principles and its relation with social impact finance. in section three we provide the criteria of having businesses sharia compliant and give insight on the possible mechanisms of financing. section four investigates the potential of the islamic finance industry. section five discusses the instruments of islamic financing and exploring how it could be valid for supporting impact investments. finally section six concludes. ii. islamic finance: an overview islam as a religion emphasizes the betterment of society and goodwill among humans; therefore all activities of muslims are to be centered on upholding the highest ethics and social responsibility. islamic teachings emphasize the duties of muslims towards humanitarian and social welfare [13]. it urges for maintaining social justice, equity, and poverty alleviation [14], [15]. islamic finance with it various financial products is not limited to muslims but on the contrary available to everyone [16], [17]. what makes islamic finance attractive to the western countries is that this financial system operates in an ethical way that is very close to the socially responsible investments [18]. islamic finance is considered one of the fastest growing areas of the global financial industry and its diffusion in the western markets illustrates how it is attracting the attention of the investors, financial institutions and regulators as a valid alternative to conventional one [19]. islamic finance instruments requires that all financial transactions following the sharia doctrine. sharia is the set of rules derived from the primary sources (quran and sunna) and secondary sources (ijma and qyias) covering all aspects of a muslim’s religious, political, social, and economic life [20], [21]. these sharia principles have a fundamental concept that god is the owner of the whole world as well as the whole wealth. muslims have the right to enjoy their wealth providing that it is realized or invested in a way that is adhering to sharia principles. referring to these sharia principles it consists of prohibitions and obligations. as for the prohibitions ; 1) prohibition of riba (usury/interest), 2) prohibition of gharar (speculation/uncertainty), 3) prohibition of maysir (gambling), 4) prohibition of investing in haram (unpermitted) activities and business like alcohol, tobacco, pork-related products, adult entertainment (pornography), and weapons [18], [22]. adding to all previous prohibitions there are some obligation principles; 1) investments should be asset-backed or identified to an underlying tangible assets, 2) application of the profit and loss concept (pls) where risk should be shared among all business involved parties [23] , 3) the obligation of zakat (charity) where a specific percent declared by sharia should be dedicated to the poor and needy which really reflects a strong linkage between islamic finance and impact finance and investing. in light of the above, the islamic financial instruments can be considered in line with the same objectives and requirements social impact investments that generate social and economic benefits. iii. sharia compliance criteria and financing mechanisms the strong correlation between business and sharia principles has strong consequences on the business activities where investments or earnings should be sharia compliant [24]–[26]. the ownership of any share of a company or investing in a business or being a partner in a business within the sharia concept should be done in a full adherence to the sharia principles in other words to attract muslim investor the business should be sharia compliant. sharia compliance signifies that businesses are prohibited from being engaged in activities like alcohol, tobacco, pork-related products, adult entertainment (pornography), and weapons as well as their financial structure should be free of interest (usury), speculation, gambling, and uncertainty. moreover, the level of interest, the level of liquidity, and the level of leverage in any enterprise that muslims should invest in should not exceed certain threshold. islamic financing mechanisms have different alternative forms and transactions from the conventional financial institutions in which they do not deal with interest. there are two alternative mechanisms of financing; equity financing or debt financing. starting by the equity financing there are two famous financing structures that are considered shariacompliant financing mechanisms namely mudaraba (partnership) and musharaka (joint venture) where those contracts are based on the profit and loss sharing a principal. as for the debt financing alternative that are all sale contracts ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 are murabaha (cost plus markup), ijara (leasing), istisna (construction). iv. potentiality of islamic finance according to pew research center, islam is the world’s second-largest religion with the fastest growth rate and muslims are also considered to have the youngest population and the highest fertility. muslims represented almost 24% of the world population in 2010. as for muslim population in europe, had reached 44 million in 2010 [9]. estimations for 2050 indicate that muslims will reach almost 30% of the worldwide population, and as for europe they will reach 71 million [27]. islamic finance could bring high liquidity into the financial mainstream and possibilities of raising capital from muslim countries should not be under-evaluated [28]. traditional financial institutions have expanded products and services to provide islamic financial products. the islamic finance have a various array of products from islamic micro lending and microfinance to the issuance of “sukuk” (islamic bonds) [29], [30]. the islamic finance industry has an accelerated growth rate globally where; islamic finance assets have a compound annual growth rate of 12.68% with sharia compliant assets totaling $1.273bn [4]. islamic markets also provide various instruments that serve as the base for developing a wide range of sophisticated financial instruments that are highly innovative [31]. v. islamic finance and impact investing muslim communities have some ways that might solve the problem of finding innovative ways of financing specially for infrastructure that are majorly capital intensive which is the development of instruments like waqf, zakat, sukuk waqf, sharia compliant crowd funding , and microfinance as an efficient instruments to secure sustainable financing for the growing needs for impact investments. the adoption of zakat and waqf instruments for example aims to combine both religious duty of charitable spending and economic development. there is incomparable opportunity to alleviate poverty using the untapped potential of islamic finance. alleviating poverty is one of the goals of the sustainable development goals (sdgs) as long as reducing inequalities and many other social goals in addition to other economic and environmental goals. the islamic development bank (idb) and the undp issued a report “i for impact: blending islamic finance and impact investing for the global goals” that is considered a key step forward in conceptualizing islamic finance-based impact investing, and building an ecosystem in support of this idea. the strategies and approaches to leverage islamic financial instruments, like sukuk and micro-takaful and other relevant instruments were highly praised by investors. however, between us$3 trillion and $4.5 trillion is needed annually to achieve the sdgs, while current investment in relevant sectors is around $1.4 trillion, creating a financing gap around $2.5 trillion. governments alone cannot fulfill sdgs goals and increased needs for accessing the opportunities of social finance and private sector investments. islamic finance has various array of social instruments demonstrated in waqf, microfinance, and sukuk and many others that are able to offer a possibility of achieving the sdgs, by embodying socially responsible development, and by bridging opportunities for economic growth and social welfare, particularly for the poorest and most vulnerable. striking commonalities exist between zakat and other forms of islamic finance, and the sdgs, with their common focus on alleviating poverty and hunger and reducing inequality by redistributing wealth. zakat is an annual obligation of charity of giving comprising at least 2.5 percent of income or wealth that is paid by all muslims having their income or wealth above a certain threshold. zakat can have a key important role in reducing and preventing poverty by redistributing wealth to all parts of society. the worldwide value of zakat alone is potentially us$200 billion to us$1 trillion annually. however, this extraordinary potential has yet to be fully realized, even in the world's largest muslim-majority country, because informal giving of zakat remains much larger than contributions made through formal islamic organizations. thus, a model shift is needed in the management of zakat, moving from a focus on the charitable act of giving to its impact in expanding the rights of the recipients. a shift is needed as well from individual spending on consumption for basic needs, to broader focus on productive activities. zakat can combine with other sources of islamic finance to support entrepreneurship and expand financial inclusion through the following sharia compliant instruments and mechanisms: (1) redistribution of wealth, through zakat, sadaqa, waqf and qard hasan, and (2) usage of risk-sharing based financing via microfinance of small and medium enterprise [32]. microfinance aims to combat the exclusion of the most deprived from the conventional banking system through the creation and development of microfinance institutions. indeed, it is an alternative for low income households to create income generating activities, to raise assets and to improve their socioeconomic status. in other words, microfinance is designed to combat the different dimensions of poverty. obviously, the microfinance concept referred to microcredit. nevertheless, it extends beyond credit to cover financial services adapted to the specific needs of the poor who represent its main target (savings, insurance, money transfer). the islamic financial system is based on principles of social solidarity and equity that coincides with the objectives of microfinance. [33]. according to the consultative group to assist the poor (cgap), the supply of islamic microfinance is very limited, with a high concentration in east asia and the pacific at 92%, the middle east region at 64%. these institutions allow this category to have access to the various financial services on a micro level by enabling them to improve their living conditions and fight against poverty [34]. ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 islamic microfinance offers interest-free contracts that are sharia compliant and can support the poor by contributing to productive activities, increasing revenues and savings, and allowing the generation of capital. there are three sources of finance: 1) donations based on tabarru (a voluntary charitable action) can include zakat, sadaqa, waqf (an endowment made by a muslim to a religious or charitable cause) and hibah (gift); 2) deposits including wadiah (safekeeping/custody/trust), qard hasan (benevolent loan); and 3) equity including mudarabah (a partnership where one party provides capital and the other party provides expertise and musharakah (a partnership where each party contributes to the capital). funds can be collected by the islamic responsible institution from members of the community in the form of zakat and sadaqa, and to redistribute the funds to those entitled to receive them, or to loan to members who need them due to financial distress, through qard hassan financing products (benevolent loan or zero-percent interest). moving to another tool from the vast array of instruments that islamic finance can provide is; crowd-funding which could be described by obtaining small portion of money from high number of people for funding particular project through an online platform with providing that the whole process, project and transactions are all sharia compliant. crowd funding has a potential to be the next successful financial innovation in islamic finance. the islamic crowd funding could be based on one of the following tools: (1) zakat-based, (2) sadaqa-waqfbased, (3) qardhasan-based, (4) equity-based (mudharabah and musyarakah) and (5) lending-based (murabaha, ijarah, istishna, etc) [35]. islamic crowd funding cost effective way for sharia-compliant equity financing [36]. equity-based crowd funding provides access to capital to wide range ofto finance to entrepreneurs, provide a valid alternative for financing smes, reduce the risk through diversification of multiple projects, and finally promotes innovation, and reduce unemployment. based on alonso (2015) the first sharia compliant crowd funding services in the world are based in egypt, namely; shekra.com as an equity based model and yomken.com as a microfinance model [37]. islamic financial instruments face several challenges requires both strengthened accounting standards and more expertise and qualified people , and many efforts are needed to raise the awareness of such instruments [29], [38]–[41] while the potential role for zakat is increasingly being harnessed for sustainable development, the role of waqf is not of a less importance. waqf is also a charitable form is more flexible than zakat with long term duration, and can be used for economic growth and income generation. generally, waqf involves donating a land, building or any asset for religious or charitable purposes, with no intention of reclaiming this asset. lately in a undp innovative financing discussion; there was a consideration of using waqf as a social impact financing tool. the word waqf in arabic refers to the “stopping” (one basic meaning of the arabic root verb, waqafa) of some piece of property. certainly, it is not permissible to set up a waqf for purposes that are not sharia compliant. on the other hand, there is consensus among sharia scholars that it is permissible for non-muslims to both start a waqf and also be considered for receiving benefits of a waqf endowment. waqf have several benefits like; the development of a social capital market and increase social investment, raising awareness of rich people on their responsibility for social development, and enhancing the integration between social security and social welfare [13]. while zakat, islamic microfinance and waqf are largely charitable forms of funding, sukuk (islamic bonds) are a commercial instrument to attract financing. unlike conventional bonds which are a debt obligation, the presence of underlying assets in sukuk is compulsory for it to be compliant with sharia. as sukuk grant partial ownership in the underlying assets proportional to its value. the issuance of sukuk is usually intended for general funding purposes or for financing infrastructure projects, such as power plants, ports, airports, hospitals and toll roads [29]. sukuk can leverage private finance for investment in infrastructure in areas where sme development is taking place thereby providing a local economic environment where smes are more likely to thrive. it could be implemented under the scheme in which waqf lands are used for underlying sukuk issuance [42] in addition, the return of the sukuk could also be utilized for financing msmes through islamic microfinance. vi. conclusion recently, blending a social objective with businesses turned to be of a great importance after the economic crisis, increment of poverty and unemployment, emergence of several social problems, limitations of public spending, and the environmental changes problems. governments lately have dedicated many efforts for supporting entrepreneurship and entrepreneurs as this impact positively the whole economy. the need for new strategies that are innovative in terms of models, tools, and instruments is necessary. one of the new innovative financial resources is the impact investments, where funds are allocated from investors who are seeking investments that generate both social and economic value. islamic teachings emphasize the duties of muslims towards humanitarian and social welfare [13], and the unconventional financing alternatives can be considered in line with the same objectives and requirements social impact investments that generate social and economic benefits. the dynamically increasing importance of the culture and religion in developing impact finance can be seen especially when religion has a positive approach towards it [6]–[8]. although of the high expectations and the positive outlook, the islamic finance full potential is not yet realized. expanding to new innovative financial tools is required for achieving the sustainable development goals. this could be reached by achieving the optimal linkage for bridging from theory to practice with developing tools that can take into consideration the aspects of both risk-sharing and social impact [10], [11]. the paper had explored the various arrays of the unconventional financing alternatives provided by islamic finance that can be used in impact investing. the undp in an ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 exploration of islamic finance potential in impact investing assured that impact investing and islamic finance are highly complementary as both of them uphold rigorous moral and social criteria for investments and emphasize on inclusiveness. the paper had shed the light on the wide range of islamic financial products like equity based financing based on profit or loss sharing (musharakah and mudarabah) , debt financing tools, charitable instruments like (zakat, waqf, sadaqa, and qard hassan), more over micro credit loans, microfinance, crowd funding. accessing such financing instruments requires that business core activities and financial transactions and business model all fully compatible with the sharia principles. references [1] t. cooney, j. manning, a. arisha, and p. smyth, “muslim entrepreneurship in ireland,” 2011. 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[42] a. raghibi and l. oubdi, “sukuk-waqf: the islamic solution for public finance deficits,” eur. j. islam. finance, no. 9, 2018. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 shariah compliant international entrepreneurship: a study of islamic finance in europe (*) university of turin, italy – vahid.jafarisadeghi@unito.it (**) university of turin, italy – paolo.biancone@unito.it abstract— islam is the second largest religion in the world. muslims are the target of most of the homeland and foreign businesses in their market. islamic finance is also is an international solution to promote the entrepreneurship. the objective of this paper is to explore the international entrepreneurship from islamic view. this study argues shariahcompliant entrepreneurship in international context. for doing so, we explore entrepreneurship in islam, offer potential opportunities for conducting islamic-oriented business and investigate the performance european countries in islamic finance and entrepreneurship. keywords-component; international entrepreneurship; islamic finance; shariah; entrepreneurship; internationalization i. introduction international entrepreneurship is a multi-perspective discipline which discusses internationalization and entrepreneurship and incorporates judgmental decision-making about the coordination of rare resources through international borders [1]. it involves ideas shifting, discoveries and connections in order to facilitate change [2]. in recent years, international entrepreneurship has been studied throughout scholar literature by multiplicity approaches [3]–[9]. research about international entrepreneurship has centered in the last decade to concentrate inborn globals or international new ventures to well-established companies [2]. as a research line, international entrepreneurship assimilates a number of business areas including accounting, marketing, management, finance, and economics [10]. however, in the dynamic environment of internationalization, it is necessary for emerging ventures and managers/ entrepreneurs to stand against the intensive global competition. in such condition, if they are willing to thrive alongside international firms, they are required to learn about global business and internationalization. the most successful firms are probably to be ones that perfectly identify the international opportunities and develop their qualities in order to respond them in the shortest possible time. in this while, the dynamic international business environment is increasingly giving importance to culture and religion in developing a business relationship [11]. a religion that has a positive approach towards work and productivity is more likely able to facilitate the creation of effective business entities and the advancement of a favorable entrepreneurship environment [12]. therefore, in order to conduct a business in an islam-oriented place/ people, as one of the most following religions in the world, it is necessary to comply with the culture and regulation of shariah (islamic law) [13]. this paper performs the strategic and market analysis for the entrepreneurial activities within islamic territories of with muslims. we initially outstrip the concept of international entrepreneurship, and then reveal islamic perspectives of entrepreneurship. finally, we explore of the islamic finance opportunities in europe in which we analyze the economic sectors for conducting a successful business. ii. international entrepreneurship in recent years, the transnational market has been involved with a rising trend in internationalization among firms [14]. international entrepreneurship is an interdisciplinary line of research that placed at the intersection of entrepreneurship theory and internationalization theory [15]. however, the primary literature on international entrepreneurship was connected to as the uppsala internationalization process [16] which represented that enterprises internationalize on a step by step process by exporting in order to strengthen their business activities [17]. nevertheless, the uppsala or stages model of internationalization demonstrated not as relevant as previously considered due to some firms entering foreign markets in a fast and prompt process [17]. as a significant theoretical development, oviatt & mcdougall discussed the limitation of this topic and developed the prior theory of internationalization-related to as the uppsala view by representing that some firms internationalize quickly [18]. this meant that the previous research on the stages model and also internalization theory that argued firms go abroad to exploit their internally developed knowledge no longer applied to all enterprises [19]. however, depending on the type of organization the internationalization process can begin early in their evolution (global born or international new ventures) whilst others internationalize after a while to react the market trends [20]. iii. entrepreneurship in islam islam, as the second-largest religion in the world [21], is defined in the holy qur’an as the capitulation to the will of god who is islam is called allah [22]. islam is vahid jafari sadeghi*, paolo pietro biancone** mailto:vahid.jafarisadeghi@unito.it ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 originated from the god’s last messenger, the prophet muhammad (pbuh) [23]. islam has a positive insight on the extrinsic aspects of work [24]. the islamic work ethic clearly declares that it is an obligation to effectively participate in economic activities [25]. therefore, work, in islam, is the source of livelihood and independence and the means prosperity to obtain a satisfactory life [24]. moreover, qur’an discusses the islamic ethics in favor of legitimate profit and free trade till it does not exploit others [23]. more precisely, islam countenances prosperity due to the proper employment of the resources given by allah [24]. this kind of resources is considered as crucial to providing for basic physical and survival needs as well as an agglomeration of capital [26]. thus, it is obvious that muslim employees are likely to look for extrinsic values of work such as the ones are compliant with islamic thoughts. we, therefore, envisage that muslim employees will also positively consider the extrinsic perspectives of their work as for ‘muslims, economic life is thus believed as a means to a spiritual end, where prosperity means the living of a virtuous life’ [26]. the islamic thoughts also represent a positive interaction between intrinsic values of work and islam [24]. as an islamic adherent, people are most likely to positively inquire the intrinsic aspects of work (e.g., having a productive job), as ‘work is considered as means of self-fulfillment, self-respect, personal growth, and satisfaction [25]. therefore, the islamic ethic of work promotes adherents to positively see the intrinsic perspectives of work. as mentioned before, intrinsic perspectives concern to being open to change and the trace of creativity and initiative at work. the ethic islamic work vividly confirms productive work as a significant resource of accomplishment [27], [28]. islam speaks about on co-operation, generosity, and benevolence to discuss the concept of entrepreneurship [24]. for this reason, islam really promotes unilateral contract, ‘uqud al-tabarruat, or such as loan, al-qard, so as to expand collaboration and instill a sense of brotherhood amongst muslims [24]. in the meantime, exploitation, monopoly, fraud or usurious transactions are extremely prohibited in islam. in the other hand, each entrepreneur ought to avoid the evil such as being honest, fair, and accurate in every transaction and always preserve the good deeds [29]. islamic finance is as old as islam and its roots go back to almost 1500 years ago, and its practices have been really used throughout those years across the muslim world [30]. in another perspective, the role of islam in entrepreneurship is based on the interlinkage between the textual sources and contextual setting [31]. the primary sources are the quran and sunnah. for muslims, the quran contains the words of god in 114 surahs (chapters) with over 6,000 ayahs gradually revealed over a period of 23 years around 600 ad [32]. the sunnah is the deeds, sayings, and silent or tacit approval of the prophet muhammad (pbuh) [32]. secondary sources and practices are ijma’ (consensus) and qiyas (analogy). ijma’ is the unanimous agreement among a certain group of people like religious scholars or the entire muslim community depending on the madhhab that is the specific school of jurisprudence [31]. qiyas is a form of analogical reasoning, somewhat contested among scholars. for some scholars, there exist potentially certain tertiary sources such as the value of the public good [32]. iv. islamic sectors economy based on dinarstandard reports [33], the global muslim population expenditure on islamic economy identified sectors (besides finance) are: a. food market according to mauro et al [34], global muslim spending on food and beverages (f&b) has increased 10.8% to reach $1,292 billion in 2013. this takes the potential core halal food market to be 17.7% of the global expenditure in 2013 compared to 16.6% the year before. this expenditure is expected to grow to a $2,537 billion market by 2019 and will account for 21.2% of the global expenditure. top countries with muslim consumer food consumption are indonesia ($190 billion), turkey ($168 billion), pakistan ($108 billion) and iran ($97 billion) based on 2013 data. meanwhile, malaysia, uae, and australia lead the halal food indicator that focuses on the health of the halal food ecosystem a country has relative to its size. a special focus report on halal food logistics estimates logistic costs for the potential global halal food market to be $151 billion in 2013. "islamic finance and capital are ready to pull europe and italy, in particular out of the crisis," according to participants at the world halal food council (whfc) in rome [35]. halal products are a global market worth 13 trillion euros per year, growing 15% annually and reaching two billion muslims, event organizers said [36]. b. clothing and fashion market global muslim consumer spending on clothing and footwear has increased 11.9% to reach $266 billion in 2013. this makes the muslim clothing market to be 11.9% of the global expenditure and is expected to reach $488 billion by 2019. top countries with muslim consumers clothing consumption based on 2013 data) are turkey ($39.3 billion), united arab emirates ($22.5 billion), indonesia ($18.8 billion), and iran ($17.1 billion). meanwhile, uae, china, and italy lead the modest fashion indicator that focuses on the health of the modest fashion ecosystem a country has relative to its size. given the importance of digital platforms to this space, a special muslim fashion e-commerce focus report looks at these modest fashion segment developments and hotspots across the globe. dinarstandard estimates put muslim consumers’ e-commerce expenditure at $4.8 billion in 2013. globally, muslims spent $266 billion on clothing and footwear in 2013. that’s more than the total fashion spending of japan and italy combined, according to a recent report from thomson reuters. the report also notes that that figure is expected to balloon to $484 billion by 2019 [37].travel market ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 global muslim spending on travel (outbound) has increased 7.7% to reach $140 billion in 20135 (excluding hajj and umrah). this is 11.6% of the global expenditure and is expected to reach $238 billion by 2019. top source countries of muslim tourists based on 2013 expenditure were saudi arabia ($17.8 billion), iran ($14.3 billion), united arab emirates ($11.2 billion), qatar ($ 7.8 billion), kuwait ($7.7 billion), and indonesia ($7.5 billion). meanwhile, malaysia, uae, and singapore lead the halal travel indicator that focuses on the health of the family-friendly/halal travel ecosystem a country has relative to its size. a special focus report, hajj and umrah travel, estimates there were a total 5.7 million hajj and umrah pilgrims (not including domestic) with a total expenditure on hajj and umrah at $16.2 billion (including air travel) in 2013. whad (halal world development), the italian halal certification body, presented during arabian travel mart, the first italian project for bringing in muslim tourists to italy. the muslim travel index 2014 shows italy as the second tourist destination in the wish list for saudi tourists, the third for malaysians and the fifth for the uae. the potential for italian tourism is evaluated by the same index in several billion euros [38] c. media and recreation market global muslim spending on recreation and culture has grown 7.3% to reach $185 billion in 2013. this represents 5.2% of the global expenditure and is expected to reach $301 billion by 2019. top countries with muslim consumers’ recreation consumption (based on 2013 data) are turkey ($30.3 billion), indonesia ($9.4 billion), united states ($9.1 billion), iran ($9 billion), and france ($8.4 billion.) meanwhile, singapore, uae, and the united kingdom lead the halal media and recreation indicator that focuses on the health of the family-friendly/ halal media and recreation ecosystem a country has relative to its size. a special focus report, islamthemed broadcast media, highlights the ramadan-drama series (musalsalat) and various broadcast channel developments are driven by much higher (9.9%) projected tv advertising growth for oic countries between years 2013-18 than the global average of 5.5% for the same time period. d. pharmaceuticals and cosmetics market global muslim consumer spending on pharmaceuticals has increased 2.1% to reach $72 billion in 2013. this makes the muslim pharmaceuticals market to be 6.6% of the global expenditure and is expected to reach $103 billion by 2019. top countries with muslim pharmaceuticals consumers are turkey ($8.9 billion), saudi arabia ($5.9 billion), indonesia ($4.9 billion), and iran ($3.7 billion.) global muslim spending on cosmetics increased 1% to reach $46 billion in 2013. this spending is 6.78% of the global sector expenditure and is expected to reach $73 billion by 2019. top countries with muslim cosmetics consumers are united arab emirates ($4.9 billion), turkey ($4.4 billion), india ($3.5 billion), and russia ($3.4 billion) based on 2013 estimates. malaysia, egypt and singapore lead a combined halal pharmaceuticals and cosmetics indicator that focuses on the health of the halal pharmaceutical and cosmetics ecosystem a country has relative to its size. e. real estate market islamic finance has used real estate as an investable, tangible asset class on which to base its financial structures. in fact, real estate has been a primary focus of the islamic finance industry since the 1990s. the focus has tended to be in particular on prime or trophy assets: for example, hotels or large office headquarter buildings. however, since 2010 islamic funds and islamic banks providing mezzanine finance have multiplied and investments, which began in the residential housing sector, quickly moved to the commercial real estate and commercial property investments now play a large role in this sector throughout the world. the islamic funds represent about 4% of the islamic financial industry but are observing a rapid growth. of these funds, 39% of assets are invested in equity instruments, 15% in commodities, 12% in fixed income instruments, about 10% in real estate and 9% in money market instruments. italy has already seen a significant flow of investment in real estate (hotels, commercial and residential properties and trophy assets in general) coming from muslim countries and qatar in particular) and it expected that, also due to the substantial repricing of italian assets, this flow might even increase in the near future. v. key opportunities islamic sectors based on the analysis of various islamic economy sector activities, global sector trends, and industry player inputs, the following have emerged as the most prominent opportunities within individual islamic economy sectors. a. halal food key areas of opportunities include investment opportunities across the halal food value chain; halal food smes seeking islamic financing for working capital, trade financing, and expansion needs; m&a opportunities; organic and pure/ wholesome (tayyab) new products; halal ingredients; building global or regional brands that deliver on halal integrity. b. islamic finance key areas of opportunities include: convergence of islamic finance/ capital with halal food and lifestyle sectors; socially responsible investment (sri) funds as well as wider impact investment and social entrepreneurship financing; hajj/umrah savings and funds; expansion markets of tunisia, azerbaijan, india, morocco, and indonesia; infrastructure spending across large oic markets; crowdfunding and sme financing. c. halal travel key areas of opportunities include family-friendly and business travel cross-over appeal to muslim-friendly services; luxury muslim market segment; halal travel as a commercial ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 real-estate investment opportunity; hajj funds; halal-themed packages; muslim heritage gifts/souvenirs; e-commerce, mobile, social media marketing platforms. d. modest fashion key areas of opportunities include digital/e-commerce platform; expansion of online startup brands with retail outlets, physical stores, franchising, and distribution partnerships; western muslim markets as the largest segment; better target marketing platforms; oic-based exporters; cross-sell to other faith-based, modest-conscious consumers, with global brand positioning. e. media and recreation key areas of opportunities include broadening the genre; gaming; marketing partnerships with other halal lifestyle sectors; western muslim markets; digital media content; integrating technology/new media, social media (google glass for apps, oculus for virtual/ augmented reality); develop globally branded halal media and celebrities or regional icons. f. pharmaceuticals and cosmetics key areas of opportunities include western muslim markets; halal vaccines -especially for hajj/ umrah; ingredients manufacturing; oic-based manufacturers should own this opportunity; partner with major retailers and overcome political stigma over halal brands. vi. islamic finance in european countries the overall magnitude of islamic finance is still limited in europe, with there being some notable difference between countries; a point clearly demonstrated by the country reports presented below. a. france according to mauro et al [34], the enhancement of islamic finance in france is linked to the great support from the french authorities, who have created a proper environment for such kind of finance in this nation. the europlace as the organization that encourages the role of the city as a financial center established the islamic finance commission in december 2007. since then, the french financial markets regulator, the autorité des marchés financiers (amf), has granted two positions allowing sukuk listings and shariahcompliant investment funds. as such, the bourse de paris (paris stock exchange) has built a sukuk segment, and four tax regulations (regarding the ijarah, murabahah, sukuk, and istisna) have been published that confirm a parity of tax treatment with conventional financial products. in the last decade, the regulatory authorities of france have taken a number of steps to promote islamic finance. the first initiative, which involved significant tax and regulatory changes aimed at boosting islamic finance in france, was announced in july 2008. more specifically, these changes were related to the admission to listing of sukuk on a french regulated market, the tax treatment of islamic financial transactions and, to a lesser extent, reforms of the fiducie (french trust). under these variations, compensation paid by sukuk issuers is, for tax purposes, treated just like the interest on a traditional bond offering and is deductible from taxable income. in addition, the compensation paid to non-resident sukuk investors is exempt from withholding tax in france, regardless of whether an offering is governed by french law or the laws of another country. in july 2010, the french government made certain amendments to its laws in order to facilitate sukuk issuances. the amendments removed double stamp duty, the payment of a capital gains tax on property and streamlined the regulations governing estate agents. in june 2011, france witnessed the introduction of the first islamic deposit scheme operated via the islamic window of an existing conventional bank. following this successful launch, an islamic home finance product, a 10year murabahah contract, was introduced. this was met with strong demand due to the fact that home financing has been a key expectation of french retail clients. currently, there are plans to launch a similar shariah-compliant deposit scheme aimed at small and medium-sized enterprises. the french tax authorities are also planning to issue additional guidelines dealing with other islamic finance concepts, including musharakah and mudarabah, in the near future. there are presently six shariah-compliant funds in france with total assets under management of usd 147.2 million, which is split relatively evenly between money market (47%) and equity (53%) assets. b. germany according to mauro et al [34], germany was the first european country to absorb funds from islamic markets when, in 2004, the sukuk bond (as an islamic bond) the federal state of saxony-anhalt issued. the paper absorbed a strong request and was completely authorized, with remaining 40% to of the issue going to investors in europe, especially ones in germany and france, and the remaining 60% investors in bahrain and the uae. the €100 million ijarah sukuk (islamic sale-andleaseback debt instrument) was fully redeemed in 2009 [34]. in 2009, bafin, germany’s federal financial supervisory authority, approved the foreign institution’s request to perform banking operations within the country in accordance with islamic principles. however, without a full banking license, the range of offerings remained limited. a follow-up conference on islamic finance was organized by bafin in may 2012, which had a special focus on shariah-compliant capital market products (islamic funds, sukuk, and asset-backed securities). the german market has also witnessed the offering of a new shariah-compliant investment product that is benchmarked to the westlb islamic deutschland index. this is comprised of shares of ten german firms whose business activities are conducted in line with the shariah. in 2015, a fully-fledged islamic retail bank, the frankfurtbased kt bank ag, owned by kuveyt turk, the largest ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 islamic banking institution in turkey was established and has opened its affiliates in mannheim and berlin. c. italy italy is one of the most rapidly developing markets in europe. a number of initiatives have been taken by italian authorities to study the issues related to an expanded presence of islamic finance. the banca d’italia, for example, has hosted a number of conferences on the subject. abi, the italian banking association, is currently coordinating a working group related to the issuance of a corporate or sovereign sukuk. meanwhile, simest (a financial institution supporting the development and promotion of italian enterprises abroad) is working on the possibility of launching a “mediterranean partnership fund”, part of which would be shariah-compliant. this initiative, dedicated to promoting small and medium-sized enterprises in the mena region through equity or semi-equity instruments, may involve the union of arab banks, several arab governments, and islamic multilateral development banks – hence the proposal to introduce a shariah-compliant component to this fund. furthermore, in december last year the president of the finance commission of the house of parliament, maurizio bernardo, has appointed a group of experts to draft a bill of law to facilitate from a tax point of view recourse to islamic finance contracts and techniques avoiding that the same are penalised in respect to conventional products, whilst on the capital market side an italian law firm is currently working on the adaptation of the conventional products provided by the existing mini-bond legislation to include islamic contracts and has hired shariah advisors to develop and certify a shariahcompliant product. d. united kingdom the united kingdom has one of the most advanced islamic financial markets in the western world and is quickly becoming a key destination for foreign shariah-compliant institutions. the country is center to the west's first fully-fledged shariahcompliant retail bank and currently, has five real islamic banks. london, is a significant financial center, with great international organizations. in addition, the biggest middle east originated traditional banks are active in london. in the 1980s, when the london metal exchange provided shariah-compliant overnight deposit facilities based on the murabahah principle islamic financing activities started in the uk [34]. in 2005, the sanctuary building sukuk was launched; the first corporate sukuk in europe and the first from the uk. based on the same structure, the second corporate sukuk was issued by international innovative technologies (iit) ltd in 2010 [34]. the bank of england and the financial services authority (fsa), the two banking regulators, have been open to the development of islamic finance in the uk. the islamic finance sector operates under a single piece of legislation that applies to all sectors, namely the financial services and markets act 2000. hence, there is a level playing field for islamic and conventional financial products, allowing the market to cater to the needs of ethnic minority consumers. the uk government is enabling a fiscal and regulatory framework for islamic finance includes the following [34]:  the abolishment of capital gains tax and stamp duty (land tax) for sukuk issuances and shariah-compliant home mortgages;  the reform of arrangements for bond issues so that returns and income payments are treated in a similar manner to interest;  fsa initiatives to ensure that the regulatory treatment of islamic finance is consistent with its statutory objectives and principles. in 2014 britain became the first country outside the islamic world to issue sovereign sukuk with its gbp 200 million issue maturing on 2019. e. luxembourg luxembourg is considered as one of the greatest financial markets in europe; based on the incentives, competitive pricing, and availability to european clients. luxembourg has become the first european economy to list a sukuk since 2012, there has been a total of 16 sukuk listed on the exchange. now, luxembourg is strongly being encouraged by its government to absorb more investments from islamic territories like oil-rich nations and emerging rich countries. it turned to the first european jurisdiction to be compliant with ucits iv at the december 2010, and as a significant residency for conventional as well as islamic investments, it had a first-mover advantage. in december 1982, the country established the islamic life insurance operator. luxembourg has a great traditional life assurance industry, although inspired by international business. nevertheless, considering the small homeland muslim residence in luxembourg, any islamic insurance operator’s strategy was likely to be an international policy for their government. luxembourg is the center of the second largest investment fund organizations in the world after the united states. as concerns islamic finance with usd 1 billion islamic aum, they are hugely equity funds domiciled in luxembourg, promoted and managed by international investment organizations. luxembourg, currently, is the leading nonmuslim country for shariah-compliant investments. in sukuk, the luxembourg securitization law, 22 march 2004, built an efficient and flexible framework for securitization vehicles. since then, luxembourg implemented a number of shariah-compliant sukuk structures. in 2009, the position of luxembourg in islamic finance was overwhelmingly promoted with the admission of its central bank as the first european central bank joined the ifsb. ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 moreover, that year a major german bank launched a trading platform, al-miyar, in luxembourg to ease the issuance of islamic securities. other eu members, following luxembourg, have been looking to do the same procedure to absorb foreign funds. the favorable legal framework combined with the ucits qualification allows islamic funds domiciled in luxembourg to be a successful tool for investors from gulf willing to access the eu market. in 2014 luxembourg issued the first 5-year term € 200 million euro-denominated sovereign sukuk. i. conclusion the function of religion on international entrepreneurship is getting completely prevalent in the post-secular societies. the ongoing promotion of islamic financing, banks, and markets through the world, enhance the development of islamic entrepreneurship [39]. islam has frequently seen entrepreneurship the most productive source of prosperity. the criterion of business and providing the opportunity of employment is regarded as a form of giving or spending in the way of the almighty allah [31]. in this regard, conducting a business with muslims or within islamic territories requires respecting the culture and regulation of islam. however, to make a business successful in which at least one of the beneficiaries are islam-oriented, it is urgent to understand the islamic regulation (shariah) and culture. in the paper, we opened views on the entrepreneurship in islam, focusing on the islamic finance activities. more precisely, the potential sector for islamic finance is introduced. finally, the most recent activities in islamic finance in the most islamicinteracting european countries are represented. this paper has suffered from the lack of scientific literature regarding the export control and compliance in the international business field. future lines of research can explore the different 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[39] m. s. oukil, “entrepreneurship and entrepreneurs in an islamic context,” j. islam. hum. adv. res., vol. 3, no. 3, pp. 111–131, 2013. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 consumption of family takaful affected by microeconomic factors: a case study of islamic insurance takaful in pakistan aprof. dr. omar masood;bkiran javaria, csyed alamdar ali shah a&quaid-e-azam school of management sciences pakistan, cinceif,malaysia abstract—this study empirically verifies the link between macroeconomic variables (i.e. income per capita, savings, inflation, stock and index) with the demand for family takaful in the context of pakistan using time-series data from 2006 to 2016 of pak-qatar family takaful company and dawood family takaful company. it was concluded from this study that per capita income is a strong forecaster of family takaful demand in pakistan, while other macro-economic factors such as kse composite index has significant and positive relationship with takaful demand in pakistan. the other three variables i.e. saving, interest rate and inflation are having insignificant relationship with family takaful demand in pakistan. keywords: takaful demand, per capita income, stock (kse index), saving, interest rate and inflation i. introduction: over the period of time islamic finance has grown into two main segments i.e., islamic insurance and islamic banking [1]. though islamic banking has taken off a bit in but islamic insurance is still in its adolescence [3,28]. islamic form of insurance i.e., takaful is based upon assistance and cooperation amongst members against some specified loss [30]. muslims in various parts of the world are now increasingly inclined towards takaful to face life uncertainties. in islamic settings takaful operators function as management agents for risk coverage of policy holders who contribute premium for such services. this serves as financial security to policy holders in case of loss, for which the takaful operator has legal responsibility [19,21,32,37]. however, if case of no loss during the tenancy of takaful policy the accumulated amount is distributed amongst members. [ibid]. as pakistan insurance sector has grown to a sizeable segment of economy over time consisting of 27 general, 7 life and 5 takaful and re-takaful companies therefore it has become imperative to initiate a research study aiming at factors that affect insurance and takaful business in pakistan. literature review: a. islamic insurance takaful: the concept of takaful insurance ages back to the time of holy prophet (sawwm) when it was prescribed by the system of “aaqilah”, which was an arrangement of mutual assistance or indemnification customary in some tribes [1]. it was practiced by receiving contributions from community [5,6]. aaqilah concept also has applications in respect of distribution of blood money where whole tribute is obliged to blood money [7,19]. takaful can therefore be termed as a system of mutual financial assistance shared by a group of people called policyholders who also borne the respective risk [12,22]. the surplus, if any, arising out takaful process is distributed amongst all policy holders according to pre agreed sum, however, any deficit is borne by the takaful operator in the form of an interest free loan [12,19,22,35]. summing up, takaful is a type of joint insurance mechanism [38,41]. most of the takaful operators use mudarabah and wakalah models where they are also required to meet religious and country standards [2,26]. mudarabah is a profit sharing contract between provider of capital and entrepreneur whereas wakalah is an arrangement where a principal authorizes a “wakeel” to manage its affairs and funds for a fee payment. conducting and investing in business of takaful, shareholders may also be entitled to share a sum from surplus business [10,16]. there are some types of takaful which are explained hereinbelow: a. .family takaful under this takaful arrangement the contract with the insured has a maturity. the insured also makes periodic payments in the takaful fund to meet individual savings targets and to assist needy families [2,9 &10]. this takaful arrangement also serves as a long-term savings and investment arrangement under which a financial guarantee is also provided for financial assistance in the event of death to the contributor [4]. the main objective of this plan is to ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 save regularly over a fixed period of time, to earn profit on contributions paid in installments from sharia compliance investments and to gain takaful protection in case of death of the participant prior to the maturity of the plan [8,22,40]. b. general takaful (non-life insurance) under general takaful insurer acts a trustee of funds received from the insured. the funds so received are invested in some profitable ventures alongwith any profits earned thereupon. the surplus is normally distributed after the expiry of each insured contract maturity [19]. if, however, the sum of the premium and investment income is insufficient to meet the claims the exaggerated may be levy for additional premiums [12]. in short general takaful is a n arrangement to compensate participants aganis financial loss [31]. the contribution under such arrangement is termed as tabarru [19,39]. c. re-takaful (re-insurance) re-takaful is in fact an arrangement to reduce risk of the original takaful insurer, the difference being only the fact that in re-takaful insured is a takaful operator instead of an individual [16,20]. in retakaful the retakaful operator receives a part of premium originally received by takaful operator and invests such receipts into profitable avenues [20]. retakaful has to parties, the insured (ceding company/takaful operator) and the insurer (re-takaful operator)[23]. it is a contract between professionals rather individuals[15,18]. the re-takaful activity helps in reducing risk of original takaful operator and thereby helps in takaful promotion. re-insurance assures that takaful funds are managed to meet the insurance commitments of the insured and re-insured to continue the takaful business [5]. b. takaful insurance in pakistan pakistan is characterized with low adult literacy, low gdi, though present increased with cpec, and moderate per capita which all result in low purchase power [34]. the share of takaful in pakistan’s in global takaful premium is estimated to be around 1% which is very small as compared with other countries like malaysia, indonesia and usa. however, keeping in view a population of more than 200 million in pakistan it is expected to increase in future takaful companies incorporate as financial institutions in pakistan under the laws of securities and exchange commission of pakistan applicable to limited liability companies doing business of insurance. the first takaful company to operate in pakistan was pak kuwait takaful company limited, who began its takaful operations in the year 2005. whereas, currently there are five takaful operators comprising of three general takaful and two family takaful companies, namely. a) general takaful companies i. pak kuwait takaful company limited ii. pak qatar general takaful limited iii. takaful pakistan limited b) family takaful companies i. pak qatar family takaful limited ii. dawood family takaful limited c. impact of microeconomic factors on takaful consumption per capita a. income it has been established through literature that insurance and level of income has positive relationship [11,17]. also per capita income and its variants have also been used in many research studies for gauging level of income, therefore we also use per capita income measured as ratio of gdp to the population to represent income per capita[18].we formulate the following hypothesis for this variable: hypothesis i: there exists positive relationship between demand for family takaful and level of income in pakistan. b. interest rate according to literature there exists a +ve relationship between interest rates and takaful [13]. this relationship exists in such a way that increased real interest rates lead to increased returns on investment of insurer which ultimately benefits the insured through higher gains [14].we formulate the following hypothesis for this variable: hypothesis ii: there exists a positive relationship between demand for family takaful and the level of interest rates in pakistan. c. inflation inflation occurs when prices rise sharply. this scenario reduces purchases and ultimately the demand of goods and services in the country [24]. as inflation reduces purchasing power therefore it also leaves negative effect of the demand of life insurance [5,29]. an account of theories on the aspect of insurance also establishes relationship between inflation and demand of life insurance is negative [27]. similarly various researches also reveal –ve relationship between life insurance and inflation [29]. the hypothesis for this variable there is : hypothesis iii: there exists a negative relationship between demand for family takaful and inflation. d. savings ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 in studies exploring the relationship between the demand for life insurance and savings it has been recommended that if the return on insurance policy is favorably greater than the return of other saving instruments, life insurance would look more attractive to potential savers, given its other features like the protection it provides [33]. similar to other studies, this variable is measured by the rate of return of savings accounts offered by commercial banks in a country [34]. we formulate the following hypothesis for this variable: hypothesis iv: the level of savings is negatively related with the demand of family takaful. e. stock researchers suggest that life insurance has competitive relationship with stock sales in financial markets in such a way that higher stock prices will allure investors to channelize its funds towards it ultimately adversely affecting life insurance sales [11]. many researches have taken place relating stock market behavior with life insurance which suggest that life insurance sales declined during the periods of higher stock prices [10,40]. accordingly we formulate our hypothesis hereunder: hypothesis v: there exists a negative relationship between the demand for family takaful and stock prices. the overall conceptual framework as described above can be presented in the form of a functional relationship describing dependent and independent variables as under: demand= f (income, interest, inflation, savings, stock) + ε a simple theoretical framework can be describes diagrammatically as under: ii. methodology a. statistical tools this research study is descriptive in nature which is typically structured with clearly stated hypothesis followed by finding associations among different variables. secondary data has been collected from different journals, research case studies, articles and financial reports of state bank of pakistan and different takaful companies operating in pakistan. a general multiple regression model is designed to test the relationships between the dependent variable (demand for family takaful) and independent variables (level of income, interest rate, inflation rate, savings rate and stock composite). the regression model is expressed as a linear equation as follows: demand = α + β1 (inc) + β2 (inf) + β3 (stk) + β4 (sav) + β3 (ir) + e b. data family takaful does not have deep roots in pakistan as it started only about 10 years ago. the data about takaful premium was taken from annual reports of respective companies as described above for the period starting from 2006 to 2016. the relevant economic data had been extracted from reports of pakistan economic survey state bank of pakistan, world development indicators, financial review of pakistan and pakistan stock exchange for the span of 11 years period under study i.e. from 2006 to 2016. at the end of 2016 total assets of pak-qatar family takaful and dawood family takaful were at rs.9 billion. it was only 6.5% of the total assets of private conventional life insurance companies, which equaled rs139.1 billion in 2016. iii. results & discussion a. regression analysis table 1 var std coef t sig β const -12.348 0.000 stk 0.291 -4.744 0.000 inf -0.061 -1.619 0.109 inc 0.652 15.064 0.000 ir -0.153 -1.793 0.076 svr 0.148 2.481 0.150 independent variables  income  interest rate  inflation  savings  stock dependent variables (consumption of family takaful)  contributio n per capita ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 the estimated coefficients indicate that the income and stock variable are highly significant as its value is 0.00 and standardized beta value shows that there is positive relationship between stock, income with family takaful demand, therefore, it can said that income and stock are a strong predictor of family takaful consumption. other variables inflation, interest rate and savings significant value is 0.109, 0.076 and 0.15 respectively which shows that these entire three variables have no impact on family takaful. iv.explanation of results: table 2 table 2 shows the values of r, r2, adjusted r2, and the standard error of the model. this is used to explain how perfectly a regression model fits behavior of data. table shows that r2 is 93% which means 93% variation in dependent variable in the model is explained by independent variables. this relationship is also very significant as depicted by highly significant p value. table 3 : hypothesis accept/reject hypothesis i: there exists positive relationship between demand for family takaful and level of income in pakistan. accepted hypothesis ii: there exists a positive relationship between demand for family takaful and the level of interest rates in pakistan. rejected hypothesis iii: there exists a negative relationship between demand for family takaful and inflation. rejected hypothesis iv: the level of savings is negatively related with the demand of family takaful. rejected hypothesis v: there exists a negative relationship between the demand for family takaful and stock prices. accepted v. conclusion this study uses per capita contribution as dependent variable to gauge demand for consumption of family takaful in pakistan. the results suggest that per capital income has positive and significant relation with demand of family takaful along with stock prices which has strong significant negative relationship. all other variables in the model revealed insignificant relationship. we can infer from the results that as income of the people rises the demand for family takaful arises due to increase in purchasing power of the masses. on the other hand, stock price movements leaves negative impact on demand for family takaful because masses recognize family takaful as an investment opportunity in a sense but prefer it only as a last resort in case long term downward trend in falling stock prices. this study suggests that family takaful operators and policy makers can augment the family takaful in pakistan by direct interventions of macroeconomic variables. references: [1]. abdou, h. a., ali, k., & lister, r. j. 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(2013). what drives consumers to participate into family takaful schemes? a literature review. journal of islamic marketing, 4(3), 264-280. [31]. newaz, f. t., fam, k. s., & sharma, r. r. (2016). muslim religiosity and purchase intention of different categories of islamic financial products. journal of financial services marketing, 21(2), 141-152. [32]. qureshi, a. a. (2011). analyzing the sharia'ah compliant issues currently faced by islamic insurance. interdisciplinary journal of contemporary research in business, 3(5), 279-295. [33]. redzuan, h., rahman, z. a., & aidid, s. s. s. h. (2009). economic determinants of family takaful consumption: evidence from malaysia. international review of business research papers, 5(5), 193-211. [34]. riaz, s. (2009). car islamic insuranceinfluence of age, education & income in pakistan and uae: a comparative study. international review of business research papers, 5(4), 457-467. [35]. salman, s. a. (2014). contemporary issues in takaful (islamic insurance). asian social science, 10(22), 210. [36]. salman, s. a., & htay, s. n. n. (2013). nomination and hibah issues in malaysian takaful (islamic insurance) industry. international journal of multidisciplinary research, 1(12), 5-8. [37]. saputra, j., kusairi, s., sanusi, n. a., & abdullah, y. (2016). an analysis of determination for life insurance premiums: the concept and practice of conventional and islamic life insurance (family takaful). malaysian journal of applied sciences, 1(2), 41-51. [38]. shah, s. a. a., & masood, o. (2017). input efficiency of financial services sector: a non-parametric analysis of banking and insurance sectors of pakistan. european journal of islamic finance, (6). [39]. shamsuddin, n. e., eng, t. h., & lajim, s. f. (2016). the preferences of the muslim consumers between takaful and conventional policy: a study on motor insurance consumers. in regional conference on science, technology and social sciences (rcstss 2014) (pp. 225-236). springer singapore. [40]. sherif, m., & azlina shaairi, n. (2013). determinants of demand on family takaful in malaysia. journal of islamic accounting and business research, 4(1), 26-50. [41]. yusofa, a. y., laub, w. y., & osmanc, a. f. (2016). a critical analysis of the malaysian risk-based capital framework: a comparison between general insurance and takaful. institutions and economies, 8(4). ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france http://www.ojs.unito.it/index.php/ejifi ssn 2421-2172 1 corporate governance and corporate social responsibility in islamic banking: the case of the moroccan banks in italy abstract— this paper aims to analyze the model of the islamic bank with a business economics perspective. in particular, the author analyzes the topic of corporate governance in the islamic bank. starting with an overall analysis of the peculiarities and religious principles underlying the model of the islamic bank, as well as the similarities present in the field of corporate social responsibility, we will address the theoretical aspect of corporate governance, the relationship between corporate governance and the islamic bank stakeholders with specific regard to the possible connotations of the active or passive role of savers and investors in the decisions of management and governance related to the selected projects and funding recipients. finally, given the current absence of islamic banks in italy, we propose a case study concerning the possible introduction of islamic shari’ah-compliant financial products by moroccan banks operating in italy, after the introduction of the recent moroccan law n° 103.12, approved on 25 november 2014, relating to the credit institutions, envisages the establishment of “participative banks” and the offering of shari’ah-compliant financial products. keywords: islamic bank, corporate governance, corporate social responsibility, corporate governance in morocco, moroccan banks in italy, participatory depositor. i. introduction and literature review in a global economic and social context in which enterprises play a key role in contributing to the growth and well-being of society, we cannot talk about social economic success of an enterprise without taking into account the issue of good corporate governance. since the nineties, the debate on corporate governance developed by bringing out the emergence of several factors analysis. among the main factors were the aggressive use of debt leverage, the increasing impartiality of corporate strategies with devastating effects in terms of scandals and bankruptcies of several large international enterprises, and the activism of institutional investors. aside from these factors, we can also add the globalization of economy and finance, as well as the speed of movement of news in the world, thanks to new technologies of communication. to talk of corporate governance means to talk about the subjects and/or bodies to whom the task of managing and administering the activities pursued by the enterprise is entrusted. in fact, the term corporate governance identifies the summit activity developed by specific organs with primarily administrative and supervisory functions (i.e. board of directors, board of management, managing director, board of statutory auditors, supervisory board, audit committee) [5]. corporate governance involves implementing rules and verification processes, and using information and guidelines that have been issued over the years by different countries of the world. in this regard, we quote the definition of sir adrian cadbury which emphasizes the aspect of the modalities by which the management directs and conducts business with shareholders and lenders: «corporate governance is the system by which companies are directed and controlled. it covers the way the board should behave towards, and deal with, its shareholders, auditors, staff and financiers». directing and controlling an enterprise-wide corporate governance inevitably passes through relationships that are triggered between the different actors involved and which are essential in achieving the predefined objectives. in this way, a key feature of corporate governance emerges, that is, the attention to the actors who are in some way related to the success or failure of the enterprise. in this direction, the organization for economic co-operation and development (oecd) (1999) defined corporate governance as: “a set of relationships between a company’s management, its board, its shareholders and other stakeholders”. in this definition, we focus on the relationship of interrelations that must exist between the enterprise and asma ait allali* *ph.d. candidate in business and law, department of management, university of brescia (italy), e-mail: a.aitallali@unibs.it mailto:a.aitallali@unibs.it ejif – european journal of islamic finance no 4 ,march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 its stakeholders. the focus on the relationships that the enterprise must have towards all the actors who are in some way directly or indirectly involved and/or affected by activities carried out by it; beyond the main partners of reference (the shareholders, management and the board of directors) the firm must consider the stakeholders. according to the stakeholder theory (freeman, 1984) [6], [7], [8] the enterprise has to work for a larger set, which includes not only shareholders, but also employees, customers, communities and other stakeholders. it is the representation of the enterprise in an environment with which it interacts, bearer of legitimate interest towards the enterprise itself [5]. the enterprise in fact is not an entity in its own right, but it flows into a multiplicity of expectations, of desires which are often conflicting, that those who are called to lead an enterprise must always take into account and reconcile in the best possible way. for the enterprise, the advantage that can be drawn from this approach is the increase in knowledge and recognition of its legitimacy in the environment; the consolidation of its ability to meet the expectations, as well as internal and external demands; and above all, in the improvement of its reputation. therefore, there has been a shift from a vision of the stakeholders as “passive” subjects, who suffer the consequences of the business, towards a progressive conception of stakeholders as “active” subjects, who relate to the enterprise and who participate with it in the process of value creation by transforming from mere spectators into actors of that process. in this aspect, the “active” role, which the saver/investor should have, is inserted in the model of the islamic bank. the impact of the business on the system of stakeholders does not end with the fulfillment of economic expectations, but also of social and environmental ones. this perspective of the interconnection between business and the environment is part of the concept of corporate social responsibility (csr), which is understood as a form of management that aims at respecting the environment, promoting safety and improving the quality of life of workers, consumers and society. the european commission has defined csr as “the voluntary integration, by enterprises, of social and environmental concerns in their business operations and in their interaction with interested parties, such as the stakeholders” (green paper , 2001) [4]. this concept emphasizes the fact that companies, in addition to respecting the laws, must also build relationships of trust and fairness with stakeholders, as well as protection of the environment in which it operates. consequently, to behave in a socially responsible way means that the enterprise should go beyond mere legal obligations by investing more in human capital, environment and relations with stakeholders. in this respect, corporate governance can be understood as an activity of high administration whose decisions and actions are directed at finding the right balance between the different interests that converge in the enterprise, and who determines the procedures for the establishment of durable relations with all stakeholders while aiming to achieve socio-economic success and enduring consensus in the environment in which it is embedded. corporate governance in its broad definition of reconciliation between economic and social interests connects directly to the ethical religious underpinning the model of the islamic bank which will be developed in the next section of this paper. ii. the corporate governance of islamic bank: the position of the participatory depositor the islamic bank, like conventional banks, are enterprises that implement a series of activities with the aim of achieving an adequate return on their investment, with the only connotation to not charge interest on loans and that funded activities have as a base a real asset. in fact, according to the religious precepts of islam, the payment of passive or active interest (rib’ah), fixed or determinable on funds lent, is forbidden; since it is considers the money a means of exchange and not a traded economic good. next to the prohibition of rib’ah, there are a number of prohibitions of economic practices that are contained in the concepts of gharar (irrational uncertainty), maysir (speculation), and other behaviors and activities haram (not permitted as tobacco, pornography, arms trade, alcohol, pork, and gambling). instead of the interest as a source of remuneration of its financial intermediation activities of conventional banks, islamic banks have the basic principle of sharing the risk of losses and profits “profit and loss sharing” (pls) in financed transactions. for these reasons, the islamic bank in addition to performing the financial intermediation, in certain operations, plays the role of investor and then shares the risks of loss related to the funded projects from which it is a participant. the same principle of sharing profits and losses is valid for the class of investors who deposit their savings at the bank and which together with the bank invest in various projects. ejif – european journal of islamic finance no 4 ,march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 in particular, there are several shari‟ah-compliant contracts which can be divided into two main categories: participatory contracts and nonparticipatory contracts (table i). table i. the diverse shari’ah compliant contracts. participatory contracts (pls)* *(that respond best to the founding principles of the islamic economic system) non participatory contracts (non-pls) ** **(called “trade based” and used in shortand medium-term and for consumer credit) musharakah: similar to the joint venture contract; the bank and the customer confer certain shares of capital to invest in a particular project. counterparties share the profits and losses in proportion to the investment made and after payment the agreed honorarium for management. murabaha: the bank buys a machine for the customer and sells it to the customer by installments without interest but at a higher price previously agreed (mark-up). mudarabah: the bank invests funds on behalf of the customer and is entitled to a percentage of the profits from the investment. this contract is used mainly in bank deposits to avoid the qoranic prohibition to apply the interest rate. ijara: similar to the leasing contract. the bank finances the purchase of machinery, buildings or other equipment and then leases them to the customer who pays the rent agreed upon; ijara-wa-iktina: a lease that gives the customer the right to purchase the asset at a time when payments have accumulated to a level equal to the sale price agreed upon. istisna: the bank finances the production of a machine and the customer pays the installments as the good goes through the various stages of production. source: own elaboration. the differences between the two contracts are: 1) the mode of financing the investment: in mudarabah, capital is entirely given by the bank, while in musharakah both the bank and the entrepreneur participate financially in the project); 2) investment management: in the first case, it is responsibility of the mudarib (the entrepreneur or the bank in case of indirect financing), while in the second, it is shared; 3) and the ownership of the assets purchased through the investment: in mudarabah, they remain the property of the bank; while they are in shared ownership in musharakah) [2]. in addition to these types of participatory contracts, there are other forms of lending, which are free-ofcharge, which have as their ultimate goal, mutual assistance in society, or mere charity, as in the case of qard hasan, and zakat (islamic ritual or giving alms). added to these are the sukuk, one of the tools of modern islamic finance, which are bonds that have an underlying asset of goods or real assets that generate usufruct returns for their owners. from these types of contracts, we can deduce that the fundraising of the islamic bank will have unprofitable deposits and other deposits of a participatory nature. for unprofitable deposits, the bank provides a safe custody of money and aid in the management of payments. these deposits do not provide remuneration nor payment of expenses, and the bank guarantees the return of these sums, and they amount to a contract of current account (wadi’ah) or as savings deposits with a passbook [10]. with participatory deposits that are completed, the bank acquires the availability of funds conferred with the obligation to repay at maturity to the part that has not suffered a loss and agreed remuneration based on the percentage of participation in the profits and losses of funded activities. at this point, it is clear that if the bank uses the amounts deposited to fund equally all their projects, then participatory deposits take the form of deposit accounts or unrestricted mudarabah; but if the money collected is intended to finance specific activities, this is called investment accounts or restricted mudarabah with remuneration linked to participation in the profits or losses of the project or the financed investment. regarding the position of the participatory depositor, it has an obvious similarity with the shareholder of the bank‟s capital, but unlike the latter, specifically when it comes to investment accounts, it does not have management powers nor on the borrowing enterprise, nor on bank [16]. it is for this ambiguity that from the perspective of corporate governance of the islamic bank that we should pay serious attention to the involvement of the participatory depositor in the management of projects and activities that s/he contributed to financially. this is to ensure greater transparency and confidence in the islamic bank, but above all, to give the opportunity to a stakeholder who is so important and vital for the islamic bank, to be an insider in corporate governance and the bearer of innovations and ideas. this possible participation of the participatory depositor in the management of projects and/or financed enterprises also implies the possibility of establishing enduring relationships that go in the direction of careful management, not only to fulfill its economic responsibility, but also the social responsibility it has towards its stakeholders. the same concept of corporate governance, which is considered as an intrinsic aspect and feature of the modern enterprise, is detectable in the peculiarities and religious principles that are the basis of the islamic financing instruments. we can speak, therefore, of a code of ethics designed in the holy quran that is the basis of the concept of good corporate governance and ejif – european journal of islamic finance no 4 ,march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 protection of the stakeholders of the islamic bank [1]. good corporate governance of the enterprise implies for islamic financial institutions to respect the religious precepts, and therefore, compliance with the expectations of all stakeholders. considering the definition of corporate governance of the islamic bank as “a set of organizational arrangements whereby the actions of the management of a corporation are aligned as possible with the interests of its stakeholder” [17], we notice the convergence of corporate governance principles set out by the various definitions already discussed in this work for the conventional bank and the ones pursued by islamic bank in terms of prudence, transparency and accountability to stakeholders. in support of this convergence, in 2006 the ifsb (islamic financial services board) designed several “guidelines on corporate governance” [11], that in addition to providing directions and recommendations for adjustments to the islamic financial environment, recall the application of international principles regarding corporate governance elaborated by the oecd and by the basel committee for islamic banks. in particular, the ifsb recommends the establishment of a special committee of governance, “governance committee”, intended mainly for the protection of the stakeholders, other than the shareholders. this governance committee should monitor and ensure that the management, administrative and accounting procedures, the system of internal controls and disclosure policies, are carried out in accordance with the interests not represented in the organs of the enterprise, with particular attention to holders of participatory deposits. this committee, following the recommendations of ifsb should be composed of at least one member of the board of directors with executive duties, an expert member of the shari’ah, possibly from the shari’ah board, a member of the audit committee and an independent director. also worth noting is the significant weight that the recommendations of the ifsb attribute to the governance committee of framing it as a reference body for the supervisory authorities because it is responsible for policies to guarantee depositors. according to the standards of the ifsb [11], the islamic banks must provide the holders of participatory deposits: o the right to monitor the progress of their investments and related risks; o adequate internal procedures for the selection of investments; o professionalism of the operators; o proper management of relationships with participatory depositors starting from the pre-contractual phase; o adequate information (concerning the characteristics of the relationship, how to participate in the profits and losses, investment policies). from these recommendations emerges the important role played by the depositor in the participatory system of relations that the islamic bank has with its group of stakeholders. therefore there is a need to try to implement the methods and innovative mechanisms that go in the direction of strengthening this relationship and to make it a source of expansion and growth of the interest shared with these subjects, which unlike the conventional model in which their economic expectations are related to the accrual of interest on money deposited and then on the lack of sharing of risks and results, we have a hybrid entity that is configured as a saver-investor, who with respect to such characteristics should have a recognition of a formal representation in the governance structure of the islamic bank. so to achieve the ifsb‟s objectives recommendations directed to protect the stakeholders than shareholders, it is necessary that within the governance committee there sits a representative of this category, such as in the case of the german model of governance through which the german system of co-management or codetermination guarantees to workers and their union representatives an active and important role in the governance of the enterprise. this possibility of active and effective participation of the participatory depositor by means of a specific representative implies for the islamic bank the establishment of shared management more characterized by the sharing of investment policies that are more strategic and trusted, and which are implemented on stable and long-lasting relationships over time with its customers. in addition to the prevision of the corporate committee, the document articulates ifsb corporate governance guidelines relating to procedures for monitoring compliance with the distinctive religious precepts of the islamic bank. given the existence of different religious interpretations by islamic law schools, the development of international standards in compliance with the religious precepts is often difficult in the face of a constant development of new shari’ah compliant financial products and services. add to this the fact that you should not limit freedom of conscience and interpretation of islamic scholars who should enjoyed the exercise of their functions. islamic banks must therefore adopt an internal shari‟ah board or external consultants to supervise ex ante and ex post of the religious legitimacy of the activities carried out. the members of these bodies should have proven skills on the knowledge of the subject; should be able to protect their reliability and transparency, the ifsb recommends that the islamic bank disclose the ejif – european journal of islamic finance no 4 ,march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 religious motivations taken to legitimize or not the shari‟ah compliant products and services offered. the recommendations and the guidelines articulated by ifsb and by other international organizations regarding corporate governance is a fundamental and essential objective that the islamic bank must reach in order to create the conditions of good governance to ensure its development in the international economic environment, to meet the expectations of all stakeholders, with specific regard to participatory depositors that in addition to sharing with it the risk of loss resulting from the management of investments financed, rely on it to invest their savings in the observance of their religious beliefs. iii. the participative banks in morocco and corporate governance specificities the economic and financial growth over the last decade, which has characterized the islamic finance industry in the world, has brought with it an opening to this banking model, even in muslim countries, where in the days of colonization there was the traditional economic system. for several years it has postponed integration at the legislative level of this model in their own banking law. in between these countries, falls the case of morocco. morocco is one of the most important countries of the mena region, favored for its strategic geographical position, its interesting economic social relations inside the arab world, africa and europe, and with a strong economic growth (4.4% of gdp in 2014). in november 2014, after years of preparation and discussion (table ii) [18], the moroccan parliament approved the new law no. 103.12 relating to credit institutions and assimilated organizations, which introduced the model of islamic banks that the moroccan legislature has decided to call “participative banks” (as in turkey). the term “participative” attributed to islamic banks in morocco emphasizes the legislature's intention to strengthen the use of financial instruments islamic participatory (mousharakah and moudarabah) based on the principle of profit and loss sharing and therefore better reflects the aims of reliability, integrity, cooperation, justice and the social responsibility of islamic finance. various studies and surveys indicate a long-awaited openness from moroccan citizens concerning much interest to the islamic finance model (according to the empirical study conducted by the islamic finance advisory and assurance services (2012): 94% of moroccans are interested in islamic finance, 70% desire financial savings products and islamic investment, the 88% desire operate with products shari‟ah compliant). in addition, according to several institutions and experts in islamic finance surveys and opinions, this legislative openness will take away new foreign investment from the gulf countries and asian countries interested in investment opportunities in morocco and sub-saharan countries to which morocco is today a bridge of economic transactions to europe (the introduction could take with it more than 70 billion dirham with a percentage between 3 and 5 of the total banking business by 2018) [19]. table ii. main stages of the integration of islamic banks in morocco year towards establishing the participative banks 1985 presentation of first request for establishment of an islamic bank to the moroccan central bank by two international groups 1987 establishment of the moroccan association for islamic economics (asmeci ) 1991 presentation request for opening shari‟ah compliant windows by the alwafae banking group 1996 opening a shari‟ahh-compliant investment fund by the banking group alwafae and the establishment of a legislative commission (shari‟ahh) 1997 opening of a foreign islamic financial subsidiary in casablanca (faisal finance) 2007 publication of a note from the moroccan bank that provides for the opening of branches for the financial alternatives transactions at existing banks 2010 the opening of the first institution for alternative operations linked to the attijariwafa bank under the name “dar assafa” 2011 opening of “al murabaha” transactions by the moroccan bank for foreign trade (bmci) and moroccan popular bank (bpm) in the french market 2012 emanation proposal draft law for the amendment of financial system that provides the possibility of the establishment of the participative banks and shari’ah compliant windows at traditional banks 2013 awaiting approval of the draft law after the presentation of amendments by the parliament november 2014 approval of the law 103.12 introducing the participative banks source: own elaboration. in terms of corporate governance, since the nineties, morocco has implemented a review procedure of corporate legislation and regulation of the moroccan financial system. later, from 2000 and beyond he became interested in the elaboration of its own selfregulatory rules, introducing in the month of march 2008, its first corporate governance code best practice «code marocain de bonne pratiques de gouvernance d’entreprise»: a self-regulatory rules that must take into account the specificities of good corporate governance of the participative bank. good corporate ejif – european journal of islamic finance no 4 ,march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 governance in which there must be an integration with respect to good audit practice and the suggestions from the participative bank. the new moroccan banking law 103.12 devotes the third title (comprising three chapters relating to the scope, instances of compliance and other provisions) to participative banks. in particular, the law allows the opening of participative banks, which do not receive or give interest (riba’) on loans and the possibility of opening windows offerings shari’ah compliant product by conventional banks. the shari’ah compliant product envisaged and defined by law 103.12 (article 58) are the mourabaha, the ijara, the moucharaka, the moudaraba, the salam and istisna’a. besides these products, the legislation provides for the possibility of introducing other shari‟ah compliant products respecting the conditions provided in article 54 of this law and the directions of the circular issued by the governor of the moroccan central bank, as well as the acquisition of a positive opinion from the oulema higher council that takes care of all the interpretations regarding religion at national and regional level (in morocco also there is a ministry dedicated to religious affairs at national level). the products technical characteristics and customers presentation methods are set by circular issued by the moroccan central bank „governor following the acquisition of the credit institutions committee and the oulema higher council conformity opinions. is important to underline how the legislature has assigned to the oulema higher council relevant functions at the level of participative bank‟s corporate governance, as well as, decisive for the birth or not of these kinds of banks and for their continuity over time. in fact, this last one is the only authority competent and authorized to issue the islamic religious activities, products and services accordance notice offered by participative banks in morocco. this approach reflects the special decision by morocco that sets it apart from other countries, where the responsibility for the control of religious conformity of the operations of islamic banks is entrusted to committees whose members are appointed by the same banks. in this way, there is the advantage of having a single reference national religion (according to the last census conducted in 2014, the legal population of morocco has 33,762,036 citizens and 86,206 foreigners; 98% of the population is muslim and the law religious school tracked is al maliki guidance) for participative finance, that will surely help in getting a coherent development of the sector. according to article 63 of the law 103.12, the participative banks, at the end of each financial year, have the obligation to transmit the oulema higher council, an evaluation report on the compliance of transactions and activities undertaken with respect to indications of conformity issued by the oulema higher council. at the level of corporate governance of the oulema higher council, with regard to participative banks, with a royal decree dahir no. 1-15-02 of 20 january 2015, the prerogatives of the oulema higher council have been revised, according to which the establishment of a committee within the board “shari’ah commission for participatory finance” is planned. this will be composed of a coordinator and nine scholars, who are members of the same oulema higher council. these scholars, who must be chosen for their skills recognized by the oulema higher council‟ general secretary, have the task of declaring at a national level the compliance of the participatory financial products, created by the moroccan central bank, from commercial banks, the securities market and insurance agencies, as well as offer them advice and materials on means of creating them. the commission, in the end, has the right to make use of outside experts on technical accounting matters and financial engineering, not mastered by the same oulémae (the scholars of the religious sciences). banking law relating to participative banks has introduced the two types of islamic financial products: 1) participatory products based on profit and loss sharing (mousharaka and moudaraba), and the 2) non-participatory products based trade (mourabaha, ijara, salam and istisna’a). again for participatory depositors, it is necessary to have a perspective of good corporate governance and social responsibility oriented towards the protection of stakeholders, different than shareholders, with their greater involvement in the management and monitoring activities and funded projects with the contribution of the savings deposited by this category of stakeholders, so that to some extent, this will be the category of subjects on which the participative bank must rely on, those who are willing to share the risk of possible losses arising from investments linked to the real economy underpinning islamic finance. for these reasons, it is suggested that the oulema higher council, together with the governor of the moroccan central bank, must find and implement mechanisms and procedures to ensure empowerment and involvement, through representation in the governance organs of this category of stakeholders, that in addition to the normal function custody of their money at the participative bank have the ambition to invest in business projects with the aim to reap profits conform to islamic religious principles. therefore, the possibility of including in the composition of the governance committee (organ required by the ifsb) the representatives of these categories of depositors participatory is proposed, in order to ensure greater transparency and their involvement in the management and monitoring of projects in which they are partners. this participation will lead to an increase in confidence towards the bank by participatory depositors and thus contributes to the creation of a climate of collaboration ejif – european journal of islamic finance no 4 ,march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 and a lasting relationship with its customers by sparing investors (figure i). it is therefore important that moroccan participative banks, in addition to observing the rules of the oulema higher council and moroccan central bank, they should pay attention to the principles of corporate governance internationally recognized and prescribed by the oecd and the ifsb in a perspective of convergence, internationalization, and openness of its business to other economic realities of mediterranean europe, the gulf countries and sub-saharan africa which in recent years have shown a strong interest in the moroccan market, and also the directions dictated by the corporate governance code to promote the protection of the environment and stakeholders reference enterprise. figure i. corporate governance organs and shari‟ah control of the moroccan participative bank *suggestion. source: own elaboration. iv. the moroccan banks in italy: the attijariwafa bank case between perspectives and criticalities in developing shari’ah compliant products in the previous section, we focused on the case of participative banks (islamic) introduced by the new banking law n. 103.12 dated november 2014, which saw for the first time in morocco the recognition and formal integration of islamic finance in its financial and banking system. the success or failure of this newly introduced aspect in terms of domestic and foreign investment volume in the moroccan financial market can only be verified in the coming months or years. the purpose of this work is to analyze the experience of moroccan banks present in italy with a view towards a future introduction of these shari‟ah-compliant financial products. we take as a case study the attijariwafa bank in italy (there are other banks such as moroccan foreign trade bank and moroccan popular bank ), which has subsidiaries in six italian cities (milan, brescia, padua, turin, bologna and modena) characterized by a strong moroccan community presence (the most number community of non-eu nationals legally residing in italy (524 775 people, the13.5% of total non-eu population in italy, the majority of which (72.5%) is in north) [14]. given the socially important presence of muslims in italy (4,922,085 people, the 33.1% of foreign residents in italy) [3], there will surely be a clientele interested in investing their savings in shari‟ah-compliant financial products. we decided to consider the case of attijariwafa bank [20] because it was the first bank in morocco that since 2010 has dedicated its branch “dar assafa”, before the new law 103.12 in 2014, in offering alternatives financial products (shari‟ah compliant). italy is one of those european countries less open to this model of islamic finance, unlike britain, france and germany, even though in reality, given the geographical location and economic interests manifested by the countries of north africa and the gulf characterized by demand for infrastructure investment and very liquid markets, the implementation of this financial model could help create real opportunities for economic growth and exit from the economic stagnation that the country needs. this hoped openness towards the islamic finance by italy will be carried out by moroccan banks that have been operating for several years in italy and may therefore play a crucial role in the promotion and diffusion of the retail islamic finance in italy only through the extension of their range of products to the islamic finance instruments as well as permitted by the new moroccan law on participative banks. at the regulatory level, this prospect of developing islamic finance in italy through moroccan banks, already present and operating in the area for several years, is objectively more feasible since they are banks that already have the necessary authorizations and requirements set by text banking act (tub) art. 14 and the consolidated law on financial intermediation (tuf) [9] for non-european union financial intermediaries. italy follows the line drawn by the international organization of securities commissions (iosco) that in its reports [12], [13] says that in general, there is no problem of compatibility between the conventional finance principles and islamic financial products with the consequent choosing to not draw up specific rules for islamic banks. specificities and peculiarities that still exist are also to be considered in particular as regards the financial board of directors audit and compliance committee nomination committee credit committee remunaration committee governance committee *participatory depositor representative shari'ah committee oulema higher council (nazional) shari'ah commission for participatory finance ejif – european journal of islamic finance no 4 ,march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 products religious conformity‟s supervision, as well as the aspect of corporate governance and protection of the islamic bank stakeholders. this is an issue in which directive 2014/65/ce (directive mifidi) has intervened, affirming the need for predisposition of adequate safeguards and procedures by banks to ensure and enhance the characteristics of the islamic finance instruments, in terms of transparency and adequate shari‟ah compliance disclosure. therefore, whatever the prospect of transposition of islamic finance signifies for italy the need to implement a legislative, accounting and taxation framework in which banks can find a formal legal recognition which can integrate the specificities and religious principles that underpin the tools of islamic finance [15]. attijariwafa bank is a moroccan banking group, with several branches in africa and europe. in january 2006, attijariwafa bank europe was created a subsidiary of the moroccan banking group that operate under french law, and which has branches operating in belgium, germany, great britain, holland, spain and italy. among the main objectives pursued by the group is to become a partner of choice for moroccans and tunisians living abroad for the management of their money at home, for offering transfer solutions and signing banking products in morocco and tunisia in their european country of residence, as well as offering the same products and services of the traditional italian bank. this direct relationship with the arab-muslim community could be a key factor for the development of shari‟ah compliant financial products in italy with the implementation by the last of the new banking law 103.12 and therefore a possible affirmation of this islamic finance model in italy. attijariwafabank in italy, a branch of attijariwafa bank europe, is one of the cases of banks already licensed and operating in an eu country and which benefit from mutual recognition of banking licenses and therefore meet the requirements of italian law. hence, the offer of shari‟ah-compliant products of this bank depends on managerial and strategic choices by the transposition of the 103.12 moroccan law and expansion of their range of products and services to shari‟ah-compliant financial instruments. since may 2010, attijariwafa bank in morocco through its 100% branch “dar assafa”, has specialized in shari‟ah-compliant alternative financial services (to finance buildings projects, to acquire a new or old vehicle, for the purchase of products and services, to furnish the house) based on murabaha contract. this experience, even if it was not very successful due to the high cost of the products created by double taxation and poor marketing policy, remains a valuable experience for the moroccan market. the main products offered are related to real estate for the acquisition of properties, with halal manner and without riba’, and consumer goods such as furniture and automobiles. dar assafa is aimed to meet the needs closer to the moroccan consumer facilitating, on an ethical-religious, the access to goods and services that the muslim may obtain without using the traditional mutual conventional interest-based banks. in view of the law 103.12 introduction, its ceo, mohamed kettani said in a press conference on 30 january, “that despite the many applications already received, the group‟s intention to expand the capital (estimated at 18,40 millions) of the subsidiary dar assafaa, without the need to build alliances with foreign partners, adding the intention to transform its subsidiary into an islamic bank with a view of developing this new financial halal market in morocco”. the financial products that the arab-muslim communities are looking for in italy are very similar to those sought by the people of the maghreb countries, namely the acquisition of houses and consumer goods of medium-long term (home furnishings, cars). therefore, a possible extension of this experience of dar assafa by attijariwafabank in italy will surely provide an economic and social success in terms of integration between the different cultures of immigrants, considering that we are now in the third generation of immigrants and therefore the transfer of money in the country of origin happens less and this means more local investment and growth of the italian economy. the prospective occurrence of a participative moroccan bank in italy is linked to the development of several factors: 1) those related to the opening of the italian financial market to the model of the islamic bank, 2) an italian taxation which takes into account the peculiarities of the participative banks, the corporate governance and compliance monitoring religious specifies and the marketing policies aimed at making known the shari‟ah-compliant products, 3) managerial and strategic choices by the transposition of the 103.12 moroccan law and expansion of their range of products and services to shari‟ah-compliant financial instruments, and finally, 4) the availability of human resources with adequate training on the instruments of islamic finance. this research is a work in progress in which we are carrying out the analysis of these factors by collecting data du, by administering a questionnaire directed to the branch managers of attijariwafa bank in italy, the results of which will be developed and published successively. v. conclusion in this paper, we analyzed the model of the islamic bank, focusing on the aspect of corporate governance and the responsibilities that this undertaking entail in ejif – european journal of islamic finance no 4 ,march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 relation to its stakeholders, particularly depositors participatory willing to share the risk of possible losses arising from investments related to real economy underpinning islamic finance. the involvement of the latter in the participation in management and monitoring activities and financed projects with the contribution of their savings deposited, through representatives in the its corporate governance will lead to a greater appreciation of the economic and social success of the islamic bank. we focused on the case of participative banks (islamic) introduced by the new banking law n. 103.12 dated november 2014, with the aim to draw a perspective of the transposition of this legislation even by moroccan banks present in italy and in the near future may offer its customers shari‟ah compliant financial products. in particular, it has analyzed the case of the attijariwafa bank in italy, the first bank in morocco since 2010 has devoted his branch “dar assafa”, before the new law 103.12 in 2014, specializing in offering alternative financial products (shari‟ah compliant) present in six italian cities (milan, brescia, padua, turin, bologna and modena) characterized by a strong presence of the arab-muslim community. attijariwafabank in italy, a branch of attijariwafa bank europe, is one of the cases of banks already licensed and operating in an eu country and benefit from mutual recognition of banking licenses and therefore meet the requirements of italian law. therefore, the offer of shari‟ah compliant products of this bank depends on managerial and strategic choices by the transposition of the 103.12 moroccan law and the expansion of their range of products and services to shari‟ah-compliant financial instruments. this prospect of developing participative moroccan banks in italy depends on several factors: 1) those related to the opening of the italian financial market to the model of the islamic bank, 2) an italian taxation which takes into account the peculiarities of the participative banks, the corporate governance and compliance monitoring religious specifies and the marketing policies aimed at making known the shari‟ah-compliant products, 3) managerial and strategic choices by the transposition of the 103.12 moroccan law and expansion of their range of products and services to shari‟ah compliant financial instruments, and finally, 4) the availability of human resources with adequate training on the instruments of islamic finance. references [1] aaoifi – accounting and auditing organization for islamic financial institutions (2010). corporate social responsibility conduct and disclosure for islamic financial institutions. aaoifi, bahrain. [2] bank of italy, “issues of economics and finance islamic finance and conventional financial systems. market trends, profiles of supervision and implications for the activities of the central bank”, occasional paper no. 73, 2010. [3] centro studi e ricerche idos, “dossier statistico immigrazione – rapporto unar”, idos, roma, 2014. [4] commissione europea (2001), promuovere un quadro europeo per la responsabilità sociale delle imprese: un contributo delle imprese allo sviluppo sostenibile, libro verde, luglio. [5] d. m. salvioni (eds) (2009), corporate governance, control and transparency, franco angeli, milan. [6] e. r. freeman, stakeholder theory of the modern corporation. in: beauchamp, t. l., bowie, n. e. eds. (2001) ethical theory and business. prentice hall, upper saddle river, nj, pp. 56-65. [7] e. r. freeman (1984) strategic management: a stakeholder approach. pitman, boston, ma. [8] e. r. freeman (1994) „the politics of stakeholder theory: some future directions‟. business ethics quarterly 4: pp. 409-422. [9] g. gimigliano and g. rotondo (eds) (2006), the islamic bank and the european banking legislation, giuffrè, milan. [10] hamaui r., mauri m. (2009), economia e finanza islamica, il mulino, bologna. [11] ifsb, guiding principles on corporate governance for institutions offering only islamic financial services (excluding islamic insurance (takaful) institutions and islamic mutual funds), 2006. [12] iosco, report of the islamic capital market task force (icmtf), islamic capital market fact finding report, july 2004. [13] iosco, report of the islamic capital market task force (icmtf), analysis of the application of iosco‟s objectives and principles of securities regulation for islamic securities products, september 2008. [14] italian labour and social policy ministry, annual report on the presence of immigrants in italy, january 2014. [15] massimo mariani (2012), islamic business and finance, milan, egea, p 159. [16] montanaro e., “the islamic bank: a challenge for the basel rules”, studies and notes of economy, n. 3, 2004. [17] s. archer, “corporate governance of islamic banks”, a public lecture delivered at international islamic university malaysia on 14 april 2004. [18] the source of this section refer to books and articles written in arabic and french : ejif – european journal of islamic finance no 4 ,march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 asmeci (2013), international conference “the islamic banks experience evaluation and horizon” publication no. 2, rabat. asmeci (2014), the participative finance in islamic banks: between the objective of the desired development and the reality seen challenges, publication no. 3, rabat. el omari, m. (2012). la finance islamique au maroc: les voies de la normalization. imprimerie el maarif al jadida, rabat. m. nadif, o. elasri, m. akaaboune (2013), les services financiers islamiques: aspects religieux, juridiques et économiques, el maarif al jadida, rabat. [19] thomson reuters report (2014), morocco islamic finance 2014: unlocking the kingdom‟s potential. [20] http://www.attijariwafabank.com/pages/default.aspx http://www.darassafaa.com/ http://www.agenceecofin.com/finance-islamique/020226259-attijariwafa-bank-veut-faire-de-sa-filiale-darassafaa-une-banque-islamique-a-part-entiere http://www.attijariwafabank.com/pages/default.aspx http://www.darassafaa.com/ http://www.agenceecofin.com/finance-islamique/0202-26259-attijariwafa-bank-veut-faire-de-sa-filiale-dar-assafaa-une-banque-islamique-a-part-entiere http://www.agenceecofin.com/finance-islamique/0202-26259-attijariwafa-bank-veut-faire-de-sa-filiale-dar-assafaa-une-banque-islamique-a-part-entiere http://www.agenceecofin.com/finance-islamique/0202-26259-attijariwafa-bank-veut-faire-de-sa-filiale-dar-assafaa-une-banque-islamique-a-part-entiere ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france financial disintermediation and profitability of global islamic banks 1 lecturer, department of economics, university of management and technology, noman.arshed@umt.edu.pk 2 phd scholar, institute of islamic banking, university of management and technology, riaz.shakeel@yahoo.com 3 associate professor, department of finance, university of management and technology, tehseen.khan@umt.edu.pk 4 bs accounting and finance, university of management and technology, osamaaziz78@hotmail.com abstract-recently islamic banks are experiencing rapid growth in islamic countries as well as non-islamic countries. the profitability of the islamic banks is based on the different instruments as a share of total financing. mainly there are two categories of financing instruments are available, first is the trade based and the second is finance based. modes of trade are instruments having low risk and fixed returns, whereas the modes of finance are instruments having high risk and possibly high returns. this study started with the proposition that both modes have different effects on the profitability as both have different roots in islamic finance. for the analysis the data is collected which comprises of 19 full-fledged islamic banks from 7 countries, the study used sem framework controlling for macroeconomic effects and country effect. the results indicated that modes of finance have positive and modes of trade have a negative effect on the growth of assets and equity of islamic banks. these results reiterate the faith-based model of islamic finance and propose islamic banks to promote the partnership based mode of finance, which is more socially beneficial to the banks and to the economy. keywords: musharaka, mudaraba, ijarah, murabaha, sem, islamic banking. jel classification: g21 1. introduction islamic banks are experiencing global growth of 10-15% annually and it is being introduced in new conventional financial systems such that there are about 51 countries where this system is operational [1]. in the 1970s the market share of islamic banks was increasing at mere 2%, while today it is about 15% [2]. the ample growth of the islamic banking industry is the consequence of realizing that interest based banking is not permissible. almost in all the economies where the islamic banking is introduced, it is working parallel to the conventional banking system. because of this dual banking system, islamic banks are facing challenges in attracting the deposits, a study indicates that islamic banks have to push their return on deposits in order to attract higher deposits as people consider islamic and conventional banks as substitutes [3]. this substitutability becomes problematic when conventional bank guarantees the returns, whereas the islamic bank has to share the outcome which can be negative. similarly, one indicated that since there is a parallel system, the islamic banks tend to opt less risky financing options as compared to profit and loss sharing asset-based investment options in order to avoid discouraging the investors by transferring losses to them [4]. this infers that islamic banks have to be competent in choosing investment options which can enable them to forward competitive returns on deposits. this pressure of investment observed by a study who compared conventional and islamic banks across 13 countries for the years of 2000 to 2006 and deducted that islamic banks are better capitalized and they finance a bigger share of their assets as compared to conventional banks [5]. noman arshed1, shakeel riaz2, tahseen mohsan khan3 and osama aziz4 http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 mailto:noman.arshed@umt.edu.pk mailto:riaz.shakeel@yahoo.com mailto:tehseen.khan@umt.edu.pk mailto:osamaaziz78@hotmail.com ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) currently, islamic banks have two major types of investment options, first is the modes of finance and other is modes of trade. the modes of finance are those instruments where the financial services are taken and paid back by the same person, these instruments are profit sharing based where the returns are variable. most popular financial instruments in islamic banking are musharaka and mudaraba. the modes of trade are those instruments where the borrower of financial service and the person who pays for it can be different, these instruments are fixed return, based on rentals or markup. most popular instruments are ijarah and murabaha. the modes of finance are instruments which are purely designed for the islamic banking, where the capital owners (which is a bank when we are studying the investment options) can use the services of the bank and participate in the business. if there is a positive outcome of the investment the capital owners receive their share, and if there is a loss, then capital owner bears the loss according to pre-decided ratio. contrary to this the modes of trade/sale are adopted by islamic banks as instruments of investment with appropriate modification as per shariah. these modes are regularly used by conventional banks and other private businesses. these modes are rental markup based where the returns are fixed and predetermineable. since it is practiced by conventional banks and non-financial institutions, islamic banks face competition, forcing them to reduce their rents or markups. examining bank islam malaysia and bahrain islamic bank, here the partnership based financing (musharaka and mudaraba) is about 4% of total finance and the markup based financing (murabaha and ijarah) is about 54% of total financing [6]. table 1 below highlights the skewed nature of the investment preferences of the islamic banks, collected data 19 banks reveal that only 3 islamic banks of iran invest 51% of their financing in the mode of finance while all other banks invest predominantly in modes of trade. table 1. share of instruments in financing modes of trade modes of finance country banks murabaha ijarah musharaka mudaraba bahrain 1 42.70 11.40 9.55 3.60 iran 3 0.87 1.39 42.05 9.31 lebanon 1 4.69 0.00 0.00 0.01 malaysia 2 12.54 1.96 0.01 0.00 pakistan 5 30.97 35.56 0.73 0.70 qatar 2 61.56 23.43 0.01 0.00 saudi arabia 2 27.94 0.46 2.84 0.00 uae 3 40.05 29.00 11.47 1.76 source: financial statements (% of total finance) the modes of finance are a pure islamic financial product as the variability in the returns acquires faith in allah. as mentioned in al quran (2:155) that allah will surely test his people with the losses, but he provides more to those who are patient. and provided an example, in al quran (12:67) to diversify the financing strategy to minimize risk. only large banks are willing to increase the share of investment in the variance return based financing. because of this, smaller islamic banks tend to be financially stronger as compared to the larger islamic banks, this is because of the complexity, credit risk and preference of small banks to fixed return or low-risk investments as compared to larger banks which are involved in profit loss sharing based financing [7]. the decision to invest in any particular instrument depends on whether the expected benefits overweigh the potential losses from the banking side. similarly, this decision can vary, based on the nature of the economy like economic growth, the average rate of return on investments, the development of the stock market and the banking sector. considering the dilemma of how much one instrument should be utilized, this study will empirically evaluate the impact of four investment instruments on the performance of the islamic banks while controlling for the macroeconomic effects. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) a. objective of the study the objective of this study is to compare both modes of finance and mode of trade adopted by the full-fledged islamic banks working globally. this study will empirically evaluate the effect of share of discussed instruments as a percentage of total finance on the profitability of islamic banks in expectation to find which one of the mode is more beneficial for the banking industry. 2. modes of finance versus modes of trade nowadays islamic banks are receiving recognition across the globe which is the consequence of expansion and growth. figure 1 shows the trend of increase in assets and equity of 19 full-fledged islamic banks. the fast expansion requires profitable financing using appropriate instruments. the primary model of islamic banking in asset/investment side is based on the idea of partnership and sharing. both of these characteristics are present in the modes of finance. the most popular modes of finance are musharaka and mudaraba. the concept of musharaka is based on the word shirkah meaning partnership and this instrument is derived from al quran (4:112, 38:24). similarly, the concept of mudaraba is based on al-darb fi al-ard which means make a journey or to effort for some objective, and this instrument is derived from al quran (73:20). both of these instruments involve the combination of resources of poor saving1 directly into the business as a partner with the islamic financial institute which provides the financial or non-financial expertise. the advantage of such instruments is that the bank uses its expertise to diversify the risk of loss in such arrangements which help the less fortunate individuals and entrepreneurs in the society to flourish. since society is blossoming, there will be growth in deposits and on the other side businesses will be acquiring bigger partnerships, hence the intermediation of islamic banks will lead to increasing returns [8, 9, 10, 11]. 1 financings available for investment figure 1. growth of islamic banks on the other side, the popular modes of trade are ijarah and murabaha [8, p.65, 110]. these instruments are not originally the part of the model of an islamic bank, they are appropriately modified to comply with shariah rules. the evolution of murabaha is linked to al quran (2:275, 4:29) and ijarah is linked to al quran (28:26-27, 65:6). in both cases, banks provide an intermediary role to deliver products from the seller to the customer. in this case, islamic bank works as an agent or owner of the product which is acquired from the seller and facilitate the sale and purchase (trade) process. so these instruments are only acquired by the well-off buyers and sellers. moreover, these products are used by the banks in efforts to stabilize the returns as these products have fixed returns with minimal risk of loss. the issue with these instruments is that islamic banks will face competition with all conventional banks and non-bank financiers, which will put downward pressure on their rents and profit [8, 10, 11, 12]. table 2. comparison of financing options musharaka & mudaraba ijarah & murabaha partnership based rental or markup based pure finance based trade based financing variable returns fixed returns returns based on value creation returns based on market rate chance of loss no loss 10 15 20 25 % 2005 2010 2015 years asset fitted values equity fitted values assets and equity growth of islamic banks http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) islamic bank facilitates business islamic bank facilitates trade competitors conventional banks competitors everyone table 2 summarizes the both types of asset side investment options which islamic bank commonly utilizes. we can see here that the mode of finance are inheritably creating social benefit2 as well as private benefit. below figure 2 and figure 3 trace the historical association between the different investment modes with the assets and equity of islamic banks. here it can be seen that mode of trade are negatively associated and mode of finance are positively associated with the assets. in the case of equity model of finance have positive association whereas mode of trade has almost no association. figure 2. financing options and assets of islamic banks since both types of instruments are permissible as per shariah, islamic banks make a portfolio of their assets invested mostly within these instruments to ensure their stable returns and profitability. there is a tradeoff here that the mode of finance is riskier with higher returns, whereas mode of trade has fixed returns but with higher competition. there is a need to identify that which one of these modes have a promoting effect 2 there will be a bigger and more stable business as an outcome which lead to higher production and higher employment in the society. on the growth of assets and equity of islamic banks on the basis of empirical data. figure 3. financing options and equity of islamic banks 3. literature review there are few studies which empirically tested the macroeconomic environment on the banking profitability and further very studies compared the different instruments and their impact on the profitability. this study intends to summarize the empirical studies which have worked relevant to the scope of this study. reference [13] used ols approach and reference [14] used co-integration approach to check the effects of internal and external factors on the profitability of islamic banks. this study used three proxies for profitability i.e. total income to total asset ratio (tita), bank’s income to total asset ratio (bita) and net profit to capital and reserve ratio (atcr). this study used a discount rate as an external factor as a proxy for interest rate, and according to the long-run estimates of johansson approach, discount rates have a positive impact on the profitability of islamic banks. the reason is that higher interest rate represents a higher demand of financing in the economy, this 10 15 20 25 a ss et s % 0 20 40 60 80 murabaha % asset fitted values 10 15 20 25 a ss et s % 0 20 40 60 80 ijara % asset fitted values 10 15 20 25 a ss et s % 0 20 40 60 80 musharaka % asset fitted values 10 15 20 25 a ss et s % 0 5 10 15 20 25 mudaraba % asset fitted values options as % of total financing association with assets financing options of islamic banks 10 15 20 25 e qu ity % 0 20 40 60 80 murabaha % equity fitted values 10 15 20 25 e qu ity % 0 20 40 60 80 ijara % equity fitted values 10 15 20 25 e qu ity % 0 20 40 60 80 musharaka % equity fitted values 10 15 20 25 e qu ity % 0 5 10 15 20 25 mudaraba % equity fitted values options as % of total financing association with equity financing options of islamic banks http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) provides opportunities for the islamic banks to earn a profit. later a study showed that interest rates significantly increases the income of the islamic banks as, they benchmark the interest rate, and with its increase banks increase their charges [15]. reference [16] used deposit returns as a proxy for interest rate and showed that increase in the deposit returns in the conventional banks which represent a major share of banking sector indicate that the majority of banks are earning higher profits, this increase leads to increase in the profitability and deposit returns of islamic banks. there are possibly two reasons for it, first, islamic banks have to increase returns in order to compete secondly, these higher deposit returns do represent higher financial returns in the economy. reference [17, 18] used 14 islamic banks from 8 economies for the year of 1993-1998. this study has used gdp to incorporate the effect of an increase in demand and supply of loans and deposits and market capitalization to incorporate the effect of stock market development. according to this study, gdp growth has an insignificant effect and market capitalization has a positive significant effect on the performance, the case of the insignificance of gdp is also confirmed by the study on all banks in turkey [19]. later reference [20] used a bigger sample of 43 islamic banks (full fledge bank and islamic windows) for the year of 1994-2001 and revealed that gdp growth has a positive impact on the returns on assets. reference [21] evaluated the effect of gdp on performance in terms of roa and roe of an overall banking sector of pakistan. the results show that irrespective of the type of bank (i.e. private, public or islamic), gdp has a positive impact on profitability. similarly [22] showed that gdp has a positive impact on roaa of islamic banks of malaysia. reference [23] used market capitalization as an instrument of economic and financial structure and checked its effect on the profitability of 10 tunisian conventional banks for the years 1980 to 2000. the results showed that market capitalization leads to increase return on asset significantly. the development of stock market increases the potential customers and increases the banking activity. as the stock market develops firms and businesses tend to rely more on the debt as compared to equity and they have easier access to financing to improve information and market functioning hence it provides an opportunity for the banking sector to extend the finances to these firms [24]. reference [25] studied 131 banks, including, conventional and islamic banks from 10 islamic countries to evaluate the impact of banking sector development on the banks’ risk-taking behaviour. the results indicated that development of the banking sector will increase the profitability by decreasing the percentage of non-performing loans and decrease in risk to insolvency. 4. methodology a. sample following table shows the country-wise breakdown of islamic banks with the sample size mentioned for each bank table 3. sample banks country banks sample pakistan meezan bank 2004-2014 pakistan dubai islamic bank 2008-2014 pakistan burj bank 2008-2014 pakistan bank islami 2006-2014 pakistan al baraka bank 2007-2014 malaysia bank islam malaysia berhad 2008-2014 malaysia bank muamalat malaysia berhad 2004-2014 qatar qatar international islamic bank 2009-2014 qatar qatar islamic bank 2007-2014 saudi arabia bank albilad 2008-2013 saudi arabia al rajhi bank 2007-2014 iran bank of pasargad 2013-2015 iran karabarin bank 2011-2013 iran saman bank 2013-2014 uae dubai islamic bank 2007-2015 uae al islamic commercial bank 2010-2014 uae mashreq bank 2006-2014 bahrain bahrain islamic bank 2005-2014 lebanon al baraka bank 2013-2014 http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) table 4. descriptive statistics b. dependent variables the dependent variables used in this study are following. i. total assets (natural log, proxy for roa) ii. total equity (natural log, proxy for roe) c. independent variables independent variables include 4 most popular financing options of islamic banks. these financing options are controlled using the economic environment (instrumented via real gdp), banking sector development (instrumented via domestic credit to private sector) and stock market development (instrumented via value of stock traded). i. murabaha (% of total finance) ii. ijarah (% of total finance) iii. musharaka (% of total finance) iv. mudaraba (% of total finance) v. real gdp (natural log) vi. domestic credit to private sector (natural log) vii. value of stock traded (natural log) viii. interest rate (per annum) d. descriptive statistics in table 4 of descriptive statistics, we can observe that at, all of the variables are non – normal, though central limit theorem makes variable normal asymptotically when the sample is above 30. the data like musharaka and mudaraba their standard deviation is higher than their mean values, showing that these variables are over-dispersed across the banks, secondly most of the variables have kurtosis > 3 showing that there are more than standard outliers in the data; both of these statistics indicate the use of panel data models as compared to the pooled ols model. murabaha ijarah musharaka mudaraba asset equity gdp dcps st interest mean 31.63 20.27 5.81 1.38 17.52 15.68 29.30 3.77 23.88 5.24 standard deviation 19.84 17.40 13.71 3.74 2.16 1.98 3.09 0.53 2.00 4.18 skewness 0.07 0.62 3.64 3.39 1.46 1.83 0.54 -0.57 0.52 0.90 prob.(skewn ess) 0.69 0.00 0.00 0.00 0.00 0.00 0.00 0.72 0.00 0.00 kurtosis 1.97 2.86 16.71 15.56 8.48 8.48 3.16 2.39 2.93 2.87 prob. (kurtosis) 0.00 0.95 0.00 0.00 0.00 0.00 0.48 0.02 0.98 0.86 prob.(norma lity) 0.00 0.02 0.00 0.00 0.00 0.00 0.01 0.06 0.01 0.00 http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) e. estimation equation following two equations are representing the estimation model, these two equations will be estimated simultaneously. 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑖𝑖𝑖𝑖 = 𝛼𝛼𝑖𝑖 + 𝛽𝛽1𝐹𝐹𝐹𝐹𝐹𝐹𝑎𝑎𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 𝑜𝑜𝑜𝑜𝑎𝑎𝐹𝐹𝑜𝑜𝐹𝐹𝑎𝑎𝑖𝑖𝑖𝑖 + 𝛽𝛽2𝑎𝑎𝐹𝐹𝑜𝑜𝐹𝐹𝑜𝑜𝑒𝑒𝐹𝐹𝐹𝐹 𝐹𝐹𝑔𝑔𝑜𝑜𝑔𝑔𝑎𝑎ℎ𝑖𝑖𝑖𝑖 + 𝛽𝛽3𝑎𝑎𝑎𝑎𝑜𝑜𝐹𝐹𝑠𝑠 𝑒𝑒𝑎𝑎𝑔𝑔𝑠𝑠𝑎𝑎𝑎𝑎 𝑑𝑑𝑎𝑎𝑑𝑑𝑎𝑎𝑑𝑑𝑜𝑜𝑜𝑜𝑒𝑒𝑎𝑎𝐹𝐹𝑎𝑎𝑖𝑖𝑖𝑖 + 𝛽𝛽4𝑏𝑏𝑎𝑎𝐹𝐹𝑠𝑠𝐹𝐹𝐹𝐹𝐹𝐹 𝑎𝑎𝑎𝑎𝐹𝐹𝑎𝑎𝑜𝑜𝑔𝑔 𝑑𝑑𝑎𝑎𝑑𝑑𝑎𝑎𝑑𝑑𝑜𝑜𝑜𝑜𝑒𝑒𝑎𝑎𝐹𝐹𝑎𝑎𝑖𝑖𝑖𝑖 + 𝛽𝛽5𝐼𝐼𝐹𝐹𝑎𝑎𝑎𝑎𝑔𝑔𝑎𝑎𝑎𝑎𝑎𝑎 𝑔𝑔𝑎𝑎𝑎𝑎𝑎𝑎𝑖𝑖𝑖𝑖 + 𝛽𝛽6𝐶𝐶𝑜𝑜𝐶𝐶𝐹𝐹𝑎𝑎𝑔𝑔𝐶𝐶 𝐹𝐹𝐹𝐹𝐹𝐹𝑎𝑎𝑑𝑑 𝐸𝐸𝐸𝐸𝐸𝐸𝑎𝑎𝐹𝐹𝑎𝑎𝑎𝑎𝑖𝑖𝑖𝑖 + µ𝑖𝑖 𝑎𝑎𝑒𝑒𝐶𝐶𝐹𝐹𝑎𝑎𝐶𝐶𝑖𝑖𝑖𝑖 = 𝛾𝛾𝑖𝑖 + 𝜃𝜃1𝐹𝐹𝐹𝐹𝐹𝐹𝑎𝑎𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 𝑜𝑜𝑜𝑜𝑎𝑎𝐹𝐹𝑜𝑜𝐹𝐹𝑎𝑎𝑖𝑖𝑖𝑖 + 𝜃𝜃2𝑎𝑎𝐹𝐹𝑜𝑜𝐹𝐹𝑜𝑜𝑒𝑒𝐹𝐹𝐹𝐹 𝐹𝐹𝑔𝑔𝑜𝑜𝑔𝑔𝑎𝑎ℎ𝑖𝑖𝑖𝑖 + 𝜃𝜃3𝑎𝑎𝑎𝑎𝑜𝑜𝐹𝐹𝑠𝑠 𝑒𝑒𝑎𝑎𝑔𝑔𝑠𝑠𝑎𝑎𝑎𝑎 𝑑𝑑𝑎𝑎𝑑𝑑𝑎𝑎𝑑𝑑𝑜𝑜𝑜𝑜𝑒𝑒𝑎𝑎𝐹𝐹𝑎𝑎𝑖𝑖𝑖𝑖 + 𝜃𝜃4𝑏𝑏𝑎𝑎𝐹𝐹𝑠𝑠𝐹𝐹𝐹𝐹𝐹𝐹 𝑎𝑎𝑎𝑎𝐹𝐹𝑎𝑎𝑜𝑜𝑔𝑔 𝑑𝑑𝑎𝑎𝑑𝑑𝑎𝑎𝑑𝑑𝑜𝑜𝑜𝑜𝑒𝑒𝑎𝑎𝐹𝐹𝑎𝑎𝑖𝑖𝑖𝑖 + 𝜃𝜃5𝐼𝐼𝐹𝐹𝑎𝑎𝑎𝑎𝑔𝑔𝑎𝑎𝑎𝑎𝑎𝑎 𝑅𝑅𝑎𝑎𝑎𝑎𝑎𝑎𝑖𝑖𝑖𝑖 + 𝜃𝜃6𝐶𝐶𝑜𝑜𝐶𝐶𝐹𝐹𝑎𝑎𝑔𝑔𝐶𝐶 𝐹𝐹𝐹𝐹𝐹𝐹𝑎𝑎𝑑𝑑 𝐸𝐸𝐸𝐸𝐸𝐸𝑎𝑎𝐹𝐹𝑎𝑎𝑎𝑎𝑖𝑖𝑖𝑖 + 𝜀𝜀𝑖𝑖 5. estimation a. detecting simultaneity below table 4, firstly shows the correlation between assets and equity of banks, we can see that there is very high and significant correlation between these variables, suggesting that models constructed for both variables might be related to each other. this interrelation is confirmed by the significance of correlation of the residuals generated from individual fixed effect models of both variables. both of these significant correlations indicate that there is a need of estimating both models simultaneously. table 4. pairwise correlation coefficient pairwise correlation coefficient equity equity (residuals) assets 0.92 (0.00) asset (residuals) 0.72 (0.00) b. estimation results following is the table 5 of the sem model with country effects, in this model only effect of stock market development and the banking sector development came out to be insignificant on the assets and equity of islamic banks globally, maybe, because the major part of assets are utilized in credit loans and mode of trade which can be seen from the table 1 that mode of trade constitute 40% overall and mode of finance only constitute only 10.2%. first interesting aspect of these results is that for islamic banks, trade based modes like murabaha and ijarah financing instruments have a negative impact and the finance based modes like musharaka and mudaraba investment instruments have a positive impact on the assets and equity of islamic banks. it was expected earlier that the trade based investment support islamic banks to maintain their profitability because of having lower losses to risk, but here the higher returns of modes of finance overweigh the risks of losses that are attached to them. here 1% increase in the financing through murabaha leads to decrease assets and equity by 0.01% and 0.01% respectively, similarly, 1% increase in the financing through ijarah has a negative impact of 0.02 % on assets and 0.01% on equity. on the other side if the banks increase 1% financing through musharaka it will lead to increase the assets and equity by 0.05% and 0.05% respectively, similarly, if 1% financing is increased using mudaraba then the assets and equity grow by 0.11% and 0.10% respectively. the effect of economic growth has a profound effect on all islamic banks such that 1% increase in gdp leads to 2.16% increase in assets and 2.31% increase in the equity, this shows that performance of islamic banks is highly elastic to the size of the economy. here the increase in gdp is because of the increase in production and consumption, which provides an opportunity to be channelled through islamic banks. interest rate being the proxy for the investment market returns, higher interest rate indicates higher expected returns on investment in the economy. if there are higher returns in the economy, businesses will increase demand for financing which may supersede the supply of financing. hence, businesses will be willing to acquire the finance at a higher price to ensure they can proceed with the investment in time. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) this pushing the interest rates upward. here 1% increase in the interest rate does lead to 0.06% increase in assets and 0.06% increase of equity of islamic banks. the negative value of intercept shows that if all the included variables are constant, then the net effect of other non-included variables on assets and equity will be negative in the case of pakistan which is being benchmarked country placed in the intercept. this negative value shows that do face challenge in the world as they have to compete with conventional banks. the other country dummies are interpreted as compared to the base country of pakistan since all are negative, it means that the markets are less favorable to islamic banks in these countries as compared to pakistan. individually the independent variables are explaining the assets and equity by 95% and 96% respectively. and the significance of wald test and the lr test shows that this sem model is significantly explaining the changes in assets and equity and the results simultaneous model is superior to the individual equation model. table 5. estimation results asset equity coef. (prob.) coef. (prob.) murabaha -0.01 (0.00) -0.01 (0.00) ijarah -0.02 (0.00) -0.01 (0.09) musharaka 0.05 (0.00) 0.05 (0.00) mudaraba 0.11 (0.00) 0.10 (0.00) gdp 2.46 (0.00) 2.31 (0.00) st -0.01 (0.88) 0.05 (0.21) dcps -0.14 (0.71) 0.03 (0.93) interest rate 0.06 (0.08) 0.06 (0.04) country effects malaysia -24.40 (0.00) -24.14 (0.00) qatar -15.44 (0.00) -15.49 (0.00) saudi arabia -7.29 (0.00) -9.45 (0.00) iran -12.04 (0.00) -13.29 (0.00) uae -5.02 (0.00) -4.99 (0.00) bahrain -10.22 (0.00) -11.45 (0.00) lebanon -6.35 (0.00) -7.93 (0.00) intercept -42.61 (0.00) -41.26 (0.00) regression diagnostics individual r squared 0.95 0.96 wald test 2555.4 (0.00) 3385.8 (0.00) lr test 91.09 (0.00) c. post regression diagnostics 1) multicollinearity test the presence of multicollinearity in the model is assessed using the eigenvalue, condition index, vif index, tolerance index and auxiliary r square. all of these indicators are below the threshold values indicating that there is not significant evidence for the presence of multicollinearity in the model, so the results are unbiased. table 6. multicollinearity diagnostics multicollinearity diagnostics variable eigen val. c index vif tol. r2xi,x murabaha 2.75 1.00 1.62 0.62 0.38 ijarah 2.00 1.17 1.52 0.66 0.34 musharaka 1.23 1.49 2.42 0.41 0.59 mudaraba 0.88 1.77 2.20 0.45 0.55 gdp 0.47 2.41 4.50 0.22 0.77 dcps 0.30 3.04 2.36 0.42 0.58 st 0.24 3.37 1.77 0.56 0.43 interest 0.12 4.75 4.25 0.23 0.76 2) heteroskedasticity test to check the presence of heteroskedasticity, this study has used the manual approach to breusch pagan godfrey test [26, 27]. it compares the calculated sample size multiplied by an r-squared value to be compared with the chi-square critical value. the calculated test values for the asset model is 23.04 and equity model is 21.76 which are lower than the critical value of 24.99 at 14 degrees of freedom. there is no statistical evidence that there is heteroskedasticity in the individual models. table 7. model heteroskedasticity test model sample r square chi square critical value assets 128 0.18 23.04 24.99 equity 128 0.17 21.76 24.99 3) autocorrelation test the residuals of both models are tested for stationarity using the adf test which is based on fisher critical values [28]. according to the results, it can be said that http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) both of the residuals are stationary hence there is no evidence of the presence of autocorrelation in the model. table 8. residual stationarity test model residuals fisher-adf test p value assets 128.96 0.00 equity 60.24 0.00 6. conclusion islamic banks recently are experiencing fast growth. the increasing recognition and better performance are expected to be the main sources of the growth of islamic banks in islamic as well as non-islamic countries. this study compares two competing modes where banks can finance. first one is the mode of finance (musharaka and mudaraba) which are originally designed for the islamic banks, based on profit and loss sharing. the second one is the mode of trade (ijarah and murabaha) which are adopted by the islamic banks because they are less risky and provide constant returns. the islamic bank earns from the mode of finance by participating in value creation while in the mode of trade islamic bank only facilitate the transferring of goods from seller to buyer. the banks make a portfolio of both modes to ensure stable returns. here the tradeoff is that mode of finance is high risk, high return and the mode of trade are constant return having high competition. this study used the data of 19 full-fledged islamic banks, from 8 countries. this data included the share of financing instruments to total financing, the performance of banks and macroeconomic variables to control the economic environment. this study used a sem model to estimate the effects of banking instruments to the performance. the results indicated that an increase in the mode of finance is performance promoting and the mode of trade has a negative effect on the performance. also, increase in gdp and interest rate has a positive effect on the performance of islamic banks, while the effect of the stock market and banking sector development is insignificant. the results reiterate the faith model of islamic finance that the islamic bank should focus on using partnership based mode, which is a mode of finance (musharaka and mudaraba). this mode eventually creates social benefit. whereas the mode of trade (ijarah and murabaha) which are apparently less risky and earn fixed income are not beneficial for the asset growth and equity growth of the banks. islamic banks everywhere should promote the mode of finance as they designed to create social value, secondly, they are growth promoting for islamic banks and most importantly the use of these instruments will eventually eradicate the usurious practices of the conventional banking system. an increase in the share of the mode of finance will eventually promote the benevolence in relationships and increase welfare as al quran (2:276) state that god destroys the earning of usury and supports the charity. references [1] sole, j. a. (2007). introducing islamic banks into conventional banking systems. imf working papers, 1-26. [2] aggarwal, r. k., & yousef, t. (2000). islamic banks and investment financing. journal of money, credit and banking, 93-120. [3] haron, s., & ahmad, n. (2000). the effects of conventional interest rates and rate of profit on funds deposited with islamic banking system in malaysia. international journal of islamic financial services, 1(4), 1-7. [4] dar, h. a., & presley, j. r. (2000). lack of profit loss sharing in islamic banking: management and control imbalances. international journal of islamic financial services, 2(2), 3-18. [5] ariss, r. t. (2010). competitive conditions in islamic and conventional banking: a global perspective. review of financial economics, 19(3), 101-108. [6] samad, a., gardner, n. d., & cook, b. j. (2005). islamic banking and finance in theory and practice: the experience of malaysia and http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) bahrain. the american journal of islamic social sciences, 22(2), 69-86. [7] čihák, m., & hesse, h. (2008). islamic banks and financial stability: an empirical analysis. imf working papers, 1-29. [8] usmani, m.m. t. (2002). an introduction to islamic finance (vol. 20). brill. [9] al-fawzan, s. (2005). a summary of islamic jurisprudence (volume ii). al daawah foundation al-maiman publishing house, saudi arabia. [10] ayub, m. (2009). understanding islamic finance (vol. 462). john wiley & sons. [11] iqbal, z., & mirakhor, a. (2011). an introduction to islamic finance: theory and practice (vol. 687). john wiley & sons. [12] hassan, a. a. h. (2007). sales and contracts in early islamic commercial law. islamic research institute, international islamic university islamabad. [13] haron, s. (1996). competition and other external determinants of the profitability of islamic banks. islamic economic studies, 4(1), 49-66. [14] haron, s., & azmi, w. n. (2004, december). profitability determinants of islamic banks. in islamic banking conference, union arab bank, beirut, lebanon. [15] haron, s. (2004). determinants of islamic bank profitability. global journal of finance and economics, 1(1), 11-33. [16] kaleem, a., & isa, m. m. (2003). causal relationship between islamic and conventional banking instruments in malaysia. international journal of islamic financial services, 4(4), 1-8. [17] bashir, a. h. m. (2001). assessing the performance of islamic banks: some evidence from the middle east. retrieved from http://ecommons.luc.edu/cgi/viewcontent.cgi?ar ticle=1029&context=meea [18] bashir, a. h. m. (2003). determinants of profitability in islamic banks: some evidence from the middle east. islamic economic studies, 11(1), 31-57. [19] anbar, a., & alper, d. (2011). bank specific and macroeconomic determinants of commercial bank profitability: empirical evidence from turkey. business and economics research journal, 2(2), 139-152. [20] hassan, m. k., & bashir, a. h. m. (2003, december). determinants of islamic banking profitability. in 10th erf annual conference, morocco (pp. 16-18). [21] ali, k., akhtar, m. f., & ahmed, h. z. (2011). bank-specific and macroeconomic indicators of profitability-empirical evidence from the commercial banks of pakistan. international journal of business and social science, 2(6), 235-242. [22] wasiuzzaman, s., & tarmizi, h. a. b. a. (2010). profitability of islamic banks in malaysia: an empirical analysis. journal of islamic economics, banking and finance, 6(4), 53-68. [23] naceur, s. b. (2003). the determinants of the tunisian banking industry profitability: panel evidence. universite libre de tunis working papers. [24] demirgüç-kunt, a., & levine, r. (1996). stock markets, corporate finance, and economic growth: an overview. the world bank economic review, 10(2), 223-239. [25] srairi, s. (2013). ownership structure and risktaking behaviour in conventional and islamic banks: evidence for mena countries. borsa istanbul review, 13(4), 115-127. [26] breusch, t. s., & pagan, a.r. (1979). a simple test for heteroskedasticity and random http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 http://ecommons.luc.edu/cgi/viewcontent.cgi?article=1029&context=meea http://ecommons.luc.edu/cgi/viewcontent.cgi?article=1029&context=meea ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) coefficient variation, econometrica, 48, 1287– 1294. [27] godfrey, l. g. (1978). testing for multiplicative heteroscedasticity, journal of econometrics, 8, 227–236. [28] fisher, r. a. (1932). statistical methods for research workers, 4th edition, edinburgh: oliver & boyd. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 11 mailto:noman.arshed@umt.edu.pk https://www.researchgate.net/profile/noman_arshed?ev=hdr_xprf&_sg=q2fje3m344-bc4-syuyabopm6-ezybfvq3eb2v5iy50njl5tri_vv_ocrodat6hb https://www.researchgate.net/profile/noman_arshed?ev=hdr_xprf&_sg=q2fje3m344-bc4-syuyabopm6-ezybfvq3eb2v5iy50njl5tri_vv_ocrodat6hb mailto:riaz.shakeel@yahoo.com mailto:tehseen.khan@umt.edu.pk http://sbe.umt.edu.pk/dof1/academics/faculty/tahseen-mohsan-khan.aspx mailto:osamaaziz78@gmail.com ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, portsmouth university, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france editorial_board.pdf editor in chief editorial board paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 house price index as an alternative pricing benchmark for islamic home financing: evidence of malaysia nur harena redzuan 1 , salina kassim 1 1 institute of islamic banking and finance (iiibf), international islamic university malaysia (iium) abstract— the pricing benchmark is usually used as a guide to calculate the rate of return of the financing. in the case of malaysia, it is not known whether residential property values have significant relationship with the general performance of the economy. we propose that the house price index to be a viable benchmark of the real values of property to determine the price of islamic home financing product. this study compares two models; the existing pricing benchmark which relies on interest rate and the alternative pricing benchmark which relies on the house price index. it examines the long-run relationship of the two benchmark rates with selected macroeconomics variables. by comparing the interest-based benchmark with the non-interest benchmark, this study attempts to highlight the sensitivity of the two benchmarks to the real economic conditions. focusing on quarterly data covering the period from 2001 to 2014, the study finds that the non-interest benchmark, house price index have significant long-run relationships with the macroeconomic variables. it shows that this alternative benchmark has the connection to the economic movements that lead to the stability of the non-interest financing instruments. the findings of this study would provide important insights on the viability of the housing price index as the alternatives to benchmark of the islamic financing home financing product. this study contributes to the empirical evidence for the feasibility of adopting interest-free benchmark to price islamic home financing product. keywords – pricing benchmark, islamic home financing, house price index. i. introduction in the current socioeconomic setting, home ownership is considered as a form of basic need for human being to enable them to lead a decent life. however, due to the high cost of housing, not everybody can realize the dream of owning a house. the process of home ownership can be relatively more challenging for the observing muslims who refrain from the conventional banking arrangement which is based on the prohibited element of interest rate. despite this, the conventional banking home financing products have been adopted for so long in many countries since the money lending model of conventional finance is simple. in facilitating home ownership, the conventional banks play the role as an intermediary, collecting funds from the surplus units, then allocating the funds to those who wish to purchase a home. the bank generates revenue by requiring payment of the principal with a certain amount of interest, and as a precautionary measure, the bank keeps the house as the collateral until the loan is fully paid by the customer. for the muslims, this credit arrangement is prohibited based as interest on money-based loan is not permissible. for the muslim home purchasers who adhere to the principles of shariah, the conventional home financing is not a choice for them as islam prohibits the payment and collection of riba. in the contemporary system, riba is commonly interpreted as interest. the shariah also prohibits gharar, generally interpreted as excessive uncertainty. in response to these prohibitions, the islamic financial institutions developed several concepts of contracts for carrying out interest-free home financing transactions. however, the islamic financial institutions face the challenge to be creative and innovative in providing a home financing product that is both appealing (in terms of pricing) to the muslim customers as well as able to fit into the requirements (in terms of free from the prohibited elements or, shariah-compliant) of the observing muslims. islamic home financing has been the primary business of the retail islamic banks [22]. over the years, consumers have realized the benefits of using islamic home financing, which include shariah-compatibility, convenience and competitive pricing [4,2]. for the islamic banks, this facility is one of the main sources of income and an important growth indicator. based on the practices of the islamic financial institutions globally, islamic home financing is offered based on the concepts of sales (murabahah), diminishing partnership equity financing (musharakah mutanaqisah) and lease purchase model (ijarah muntahiya bittamlik). however, in all these contracts, the interest rate has been adopted as the pricing benchmark amid the absence of an islamic benchmark rate. the paper aims to assess the viability of alternative pricing benchmarks for islamic home financing. the benchmarks should be acceptable from a shariah perspective as an alternative to interestbased rates to determine the profit margins. this paper would specifically determine the long run relationship of lending rates and house price index with key macroeconomic variables using the auto-regressive disctributed lag (ardl) model. the paper is organized in the following manner; the immediate section examines the islamic home financing industry and then discusses the issue of pricing benchmark of financial product. the next section examines the empirical evidence among the lending rate and house price index as the alternative rates to benchmark the pricing of islamic home financing. http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ii. literature review a. overview of malaysia’s home financing market in malaysia, the mortgage financing industry has expanded at a fast rate due to the strong demand from the home buyers. the development in the housing market is due to the high demand for houses in the market for the residential sector. malaysia is the largest islamic finance markets with islamic assets amounted to usd365 billion as at first half of 2014, of which the islamic home financing has been a major contributor. over the years, islamic home financing contributes to 24.5 percent to islamic banking’s total financing according to bank negara malaysia report on november 2014. most financial institutions in malaysia offer the mortgage loan by direct borrower-lender relationship. while there are more than fifteen islamic home financing products offered in malaysian market, the majority of the islamic banks offer sales-based islamic home financing products and infact, malaysia has been well known for offering the murabahah type of home financing over the years. this concept, however, has been accused of merely replicating the conventional home loan by replacing interest rate with profit rate. critics have labelled this replication as a sort of manipulation carried out by islamic banks [10]. figure 1 below shows the islamic financing by purpose as at november 2014. it is important to highlight that financing for residential purpose comprised of a major portion of total financing in malaysia at 24.5 percent. figure 1. islamic financing by purpose in malaysia as at november 2014 source: mifc (2015) b. pricing benchmark for islamic home financing i. lending rate in the current practice of the financial market, interest rate is used as the benchmark rate to determine the pricing of financial products. the benchmark is used as an indicator or a guide to determine the price of the financing products. using the lending rate to benchmark the pricing of financial products has been practice of the conventional ever since the existence of the financial institutions. currently, major interest rates such as the base lending rate (blr) and kuala lumpur interbank offered rate (klibor) are widely used as reference rates by the islamic financial institutions to benchmark a broad range of financial products and contracts. the islamic financial products benchmarking the same comparisons as the term used is financing rate. using the interest rate as a pricing benchmark for the islamic financial products is permissible (halal) but not desired [24]. similarly, according to taqi usmani [15]: “although not ideal, it is certainly halal to use the prevailing interest rate as a benchmark for this rate. the criterion for acceptability by the shariah is that the transaction be compliant with the shariah, regardless of the price of the goods or how that price is determined”. the islamic financial providers acknowledged that the use of multiple sales mimic the amortization schedule of a conventional mortgage. the transaction is deemed no different from an interest-bearing loan and as argued by elgamal [25], the transaction is not materially different from secured lending. there have been many criticisms against islamic banking and finance for depending on the conventional interest rate benchmark. many contemporary muslim scholars have been calling to initiate an independent benchmark pricing for islamic banks [12,15]. the oic fiqh academy during the 8th conference in jeddah on 10-11 april 1993 has unanimously passed resolutions to promptly create a new benchmark which is acceptable from a shariah perspective as an alternative to interest based rates to determine the profit margins. ii. house price index the fundamental reason for introducing a new benchmark as an alternative to interest based borrowing and lending benchmark is the prohibition of riba itself. usmani [15] advocates that islamic banks and financial institutions should not be relying on the practice of using the conventional interest rates to benchmark financial products as soon as possible. he argues that using interest rates as a benchmark for halal business is not desirable. his further argument that the interest rate does not advance the basic philosophy of promoting islamic economy, whereby making it no impact on the system of distribution. the alternative pricing benchmark should be based on the risk profiles of the real economic ventures. it must be tied to the movement of the real economy and based on productivity and profitability of assets [17]. thus, this study analyzes the viability of employing the house price index (hpi) as an alternative pricing benchmark to interest rate for islamic home financing. the hpi represents the movement of house price and overall performance housing market. it indicates how much the house price changes over time. several studies have been conducted to study the relationship between the macroeconomic factors with respect to house prices. the researches explore the relationship based on macroeconomic factors that affect the movement of housing prices [26, 5]. the finding reveals the gross domestic product rate has significant relationship with the movement of hpi. therefore, the study is aimed to examine the dynamic interactions of the two models, lending rate and house price index with macroeconomic factors. comparing these models would reveal the most suitable indicator for a pricing benchmark of islamic home financing, or simply which indicator has a significant relationship to the movement of the real economy. http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 figure 2 below illustrates the plots of the benchmark rates, namely the base lending rate (blr) and hpi, as well as the selected macroeconomic variables, namely gross domestic product (gdp), consumer price index (cpi), and 3-month treasury bill rate (tbr). the blr shows fluctuation of rate from year to year, and showed significant decline in 2008 during the asian financial crisis. the tbr also shows the similar pattern as the blr with large fluctuations particularly in 2008. comparing the blr with the hpi, the plots show that the hpi has been less volatile and more stable as compared to the blr. figure 2. plots of blr, hpi and selected macroeconomic indicators iii. methodology a. data specification in order to achieve the objective of comparing the conventional interest rate and hpi in benchmarking the islamic home financing, this study considers two models: the first model with the blr as the dependent variable and the second model with hpi as the dependent variables. the selected macroeconomic indicators are included as the independent variables and the objective of the analysis is to determine which of these two indicators are more reflective of the macroeconomic indicators. the study employs quarterly data for the period 2001: q1 to 2014: q4, a period of 14-year, with a total of 56 data frequency. the hpi data are sourced from the valuation and property services department of malaysia’s ministry of finance through its quarterly publication; malaysia property market. the report is available in annual and quarterly data with the aggregate house price index. while another model in this study employed the lending rate, which is measured by the blr. the blr data are sourced from bank negara malaysia’s quarterly bulletin and of various issues. there are three selected macroeconomic variables in this analysis, namely gross domestic product (gdp), 3-month treasury bill rate (tbr), and consumer price index (cpi). the data are gathered from bank negara malaysia’s quarterly bulletin and of various issues. real gdp is used as a measure of real income while cpi is used as a measure of inflation condition. finally, the study employs the tbr as a measure of the market interest rate. these data are obtained from bnm monthly statistical bulletin of various series. all variables are expressed in natural logarithm except for blr and tbr. table 1 provides descriptive statistics of quarterly changes in lending rates and real house prices, real gdp, real cpi and in tbr. the simple correlations are also provided. blr has high variability as the mean shows 6.380 as compared to hpi 4.88. the blr is positively correlated to tbr (0.862) and negatively correlate to cpi (-0.415). note that blr is not significantly correlated to hpi and gdp. while the correlation analysis shows that the hpi is highly correlated to gdp (0.948) and has a moderate correlated to cpi (0.444). blr hpi gdp cpi tbr mean 6.380 4.880 11.949 4.675 2.861 max. 6.79 5.37 12.58 4.76 3.49 min. 5.51 4.58 11.32 4.61 1.90 sd 0.365 0.227 0.387 0.039 0.393 blr 1 hpi 0.136 1 gdp 0.078 0.948** 1 cpi -0.415** 0.444** 0.574** 1 tbr 0.862** 0.231 0.254 -0.167 1 notes: (1) blr is base lending rate, hpi is real aggregate house price index, gdp is real gross domestic product, cpi is consumer price index, tbr is 3-month treasury bill rate (2) * and ** denote significance at the 5% and 10% levels, respectively table 1. result of descriptive statistics and correlations 5.2 5.6 6.0 6.4 6.8 7.2 2000 2002 2004 2006 2008 2010 2012 2014 blr 11.2 11.4 11.6 11.8 12.0 12.2 12.4 12.6 2000 2002 2004 2006 2008 2010 2012 2014 lgdp 4.60 4.64 4.68 4.72 4.76 2000 2002 2004 2006 2008 2010 2012 2014 lcpi 1.6 2.0 2.4 2.8 3.2 3.6 2000 2002 2004 2006 2008 2010 2012 2014 tbr 4.4 4.6 4.8 5.0 5.2 5.4 2000 2002 2004 2006 2008 2010 2012 2014 lhpi 11.2 11.4 11.6 11.8 12.0 12.2 12.4 12.6 2000 2002 2004 2006 2008 2010 2012 2014 lgdp 4.60 4.64 4.68 4.72 4.76 2000 2002 2004 2006 2008 2010 2012 2014 lcpi 1.6 2.0 2.4 2.8 3.2 3.6 2000 2002 2004 2006 2008 2010 2012 2014 tbr http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 b. methodology time series analysis explains the patterns or behavioral data throughout the period of observation with ‘stochastic process’, which the sample randomly taken and represents the series of data. this study employs multivariate time series analysis based on auto-regressive distributed lag (ardl). the regression model includes the current and also the lagged (past) values of the explanatory variables (the x’s) which called a ‘distributed-lagged model’. and the model includes one or more lagged values of the dependent variable among its explanatory variables which called an ‘autoregressive model’ [9]. the ardl approach can be applied regardless of the stationary properties, whether i(0) or i(1) of the variables in the samples and allows for inferences on long-run estimates which is not possible under the alternative co-integration procedures [19]. the model selects using the model selection criteria, such as the adjusted r2, schwartz-bayesian criteria (sbc) which known as the parsimonious model (selecting the smallest lag length). finally, the ardl approach provides robust results for a smaller sample size of the co-integration analysis. the ardl models used in this study can be written as the following general models: (1) (2) where lr and hpi are the lending rate respectively, while the macroeconomic variables employed are real gdp, consumer price index (cpi) and interest rate (three-month tbr). the error correction model (ecm) integrates the shortrun dynamics with the long-run equilibrium, without losing the long-run information. the error-correction representation of the ardl models can be written as: where: blr : base lending rate lnhpi : natural logarithm of house price index lngdp : natural logarithm of gross domestic product lncpi : natural logarithm of consumer price index tbr : interest rate (three-month tbr) the second model, hpi is tested with real, aggregated house price index. the terms with the summation signs in the above equation represent the error-correction dynamics, while the second part (terms with ns where s=1, 2,3,4) corresponds to the long-run relationship. in the ecm model, the null hypothesis (h0: n1= n2= n3= n4=0), which indicates the non-existence of the long-run relationship, is tested against the existence of a long-run relationship. the calculated f-statistics of the h0 of no co-integration is compared with the critical value. if the computed f-statistic falls above the upper-bound critical value, the h0 of no cointegration is not accepted. however, if the test statistic falls below a lower bound, the h0 accepted. finally, if it falls inside the critical value band, the result would be inconclusive. once co-integration is confirmed, the long-run relationship between the blr or hpi and macroeconomic variables using the selected ardl models are estimated. the last step of ardl is to estimate the associated ardl ecm. finally, to ascertain the goodness of fit of the selected ardl model, the diagnostic and the stability tests is conducted. iv. finding and analysis prior to the testing of co-integration, a test of order of integration is conducted for each variable using augmented dickey-fuller (adf) and phillip perron (pp) as reported in table 2. the unit root test would indicate whether or not the ardl model is a suitable analysis of the data given [8]. both tests in agreement in suggesting non-stationarity or i(1) property of all variables. base lending rate, house price index, gross domestic product and consumer price index are found to be stationary in first differences by both tests. meanwhile, the adf test establishes the i(0) property of treasury bill rate while pp test suggests its stationary at i(1). the result shows the summary of unit root test which lead to the mixture of i(0) and i(1) of underlying regressors and therefore, the ardl testing could be proceeded. further of the study, the co-integration test is performed on lending rate and house price index with macroeconomic indicators; gross domestic product, consumer price index and treasury bill rate. the equation 3 and 4 are estimated to examine the short-run and long-run relationships among the variables; blr and hpi with macroeconomic variables. as suggested by pesaran et. al. [20] and narayan [11], the maximum order of lag length of 5 is selected in this study since the data employed is in quarterly basis. this study used the schwartz criterion (sc) to determine the optimal number of lags to be included in the conditional ecm (error correction model). the f-statistics are computed for the joint significance of lagged levels of variables as in equation (3) and (4). the critical value is reported together in the table 3 which is based on critical value suggested by pesaran, shin & smith [21] and narayan [11] using small sample sizes between 50 and 60. the long run co-integration hypothesis are tested between lr, hpi, gdp, cpi and tbr. the null hypothesis of no co-integration of blr as dependent variable of model 1, is rejected at the 1 percent level since the computed f-statistic is greater that critical value given by both pesaran et. al. [21] and narayan [11]. the fstatistics of lr is 7.181 which is greater than the critical values (pesaran, shin & smith at 1%: 5.61 and narayan at 1%: 5.25). while for model 2, the null hypothesis of no co-integration is rejected at the 1 percent level. the f-statistics of hpi is 6.83 which is greater that critical values given (pesaran, shin & smith at 1%: 5.61 and narayan at 1%: 5.25). on the other ttbrtcpitgdpthpit ttbrtcpitgdptblrt     0 0   vttbrtncpitngdptnhpitnitbrt p i ei icpit p i digdpt p i ciihpiti p i bhpit vttbrtncpitngdptnblrtnitbrt p i ei icpit p i digdpt p i ciiblrti p i bblrt                     141ln31ln21ln1ln 4 0 ln 3 0 1ln 2 0 ln 1 1 0ln 141ln31ln211ln 4 0 ln 3 0 1ln 2 0 1 1 0   (3) (4) http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 hand, the null hypothesis of no co-integration in regard to other equations with gdp, cpi and tbr as dependent variables is not rejected. the empirical results of the long-run ardl model are presented in table 4. the significant variables which appear to affect the lending rate are gdp, cpi and tbr. level first difference adf pp adf pp blr -2.584 -2.333 -5.668*** -5.669*** hpi 4.042 4.043 -5.944*** -6.288*** gdp 0.048 -0.163 -8.297*** -11.541*** cpi -2.264 -2.270 -7.884*** -7.932*** tbr -2.716* -2.435 -5.546 -5.607*** note: the lag order in the adf and pp tests are based on the sic. ** and *** denote significance at 5% and 10%, respectively. table 2. adf and pp unit root tests therefore, this paper analyzes the viability of non-interest benchmark, namely the hpi as the alternative to lending rate in determining the price of home financing. the result shows both models, lr and hpi are comparable since both are significant. the f-statistics for lr is 7.181 which is more than upper bound value for pesaran, shin & smith and narayan tables. while the f-statistics for hpi is 6.827 also exceed the upper bound value for pesaran, shin & smith and narayan tables. a recent study conducted by ibrahim & law (2014) which examine on the long run behavior of house prices and the dynamic interactions with bank credits, real output and interest rate. the study analyzes co-integration, causality and vector autoregressions (vars) for malaysia environment. the researchers empirically explain that terraced house price index forms a long run relation with bank credits, real output and interest rate. hence, this literature supports this paper on the long-run relationship of house price index with macroeconomic indicators; gross domestic product, consumer price index and treasury bill rate. dependent variables computed f-statistic model 1: lr lr 7.181328*** gdp 0.292545 cpi 1.759570 tbr 6.660070*** model 2: hpi hpi 6.826906*** gdp 0.182439 cpi 1.733310 tbr 3.899489* pesaran, shin & smitha narayan b critical value lower bound value upper bound value lower bound value upper bound value 1% 4.29 5.61 4.068 5.250 5% 3.23 4.35 2.962 3.910 10% 2.72 3.77 2.496 3.346 notes: *, ** and *** indicate significance at 10%, 5% and 1% levels, respectively. a critical values are obtained from pesaran, shin and smith (2001) b critical values are obtained from narayan (2004), table case iii: unrestricted intercept and no trend table 3. bounds test results the result of this analysis support the previous studies on the relationship in short-run and long-run periods between islamic financial development and economic growth. abduh & azmi [1] conducts an empirical study and finds that islamic finance development have a significant relationship with indonesian economic growth in the short-run and the long-run and both has a bi-directional relationship. it is significant to the islamic finance industry to grow with real economic activities. table 4. long-run ardl model estimates model 1: lending rate t-statistics model 2: hpi tstatistics c 13.441 3.442*** 41.212 0.3541 gdp 0.244 2.368*** 3.819 0.417 cpi -2.531 -2.715*** -16.668 -0.366 tbr 0.633 7.572*** -0.791 -0.357 http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 v. conclusion there is enormous demand for islamic banking and financial services. this translates into a potential increasing demand for financial services for homes, automobiles and businesses. in order to succeed in reaching this huge demand for islamic banking and finance, much work should be done to educate the industry players and customers regarding both the need and the demand for such services. the key to reaching the desired level of maqasid shariah is moving away from benchmarking interest/lending rate to an alternative benchmark which this paper is empirically tested the correlation among these variables. although benchmarking against the conventional interest rate is permissible, but it is a need to model an alternative benchmarking for the islamic home financing based on the malaysian case. the main significance of carrying out this research is that it addresses important gaps in current knowledge and existing literature on alternative benchmark of home financing product, which appose to the current practice of benchmark. for instance, the most fundamental level, there is little studies at present on the viability of benchmark to a real economic condition in relation to the movement of trends in real economic activities. therefore, using indices for guidance in measuring the rate of return that relate to real transactions is permissible in shariah. the analysis from this study should help to shed light in these areas. this study would recommend on future studies to adopt four subindices of house price index corresponding to various types of houses, namely, terraced houses (ht), semi-detached houses (hs), detached houses (hd) and high-rise houses (hh) by different location across the study period. it would be more enriching analysis to arrive at more robust findings of the alternative benchmark for pricing mechanism of islamic home financing. references [1] abduh, m., & azmi omar, m. (2012). islamic banking and economic growth: the indonesian experience. international journal of islamic and middle eastern finance and management, 5(1), 35-47. [2] amin, h., abdul-rahman, a. r., & abdul-razak, d. (2013). an integrative approach for understanding islamic home financing adoption in malaysia. international journal of bank marketing, 31(7), 544-573. [3] azli, r. m., othman, r., sahri, m., aris, n. a., arshad, r., & yaakob, a. r. (2011). implementation of maqasid shari’ah in islamic house financing: a study of the rights and responsibilities of contracting parties in bai’ bithaman ajil and musharakah mutanaqisah. journal of applied business research (jabr), 27(5), 85-96. [4] haron, s., ahmad, n., & planisek, s. l. (1994). bank patronage factors of muslim and non-muslim customers. international journal of bank marketing, 12(1), 32-40. [5] ibrahim, m. h., & law, s. h. (2014). house prices and bank credits in malaysia: an aggregate and disaggregate analysis. habitat international, 42, 111-120. [6] iqbal, z. and mirakhor, a. (2007). “an introduction to islamic finance theory and practice”. john wiley & sons (asia) pte ltd. singapore. [7] isra paper 53/2013. challenges in the application of mudharabah and musharakah concepts in the islamic finance industry in malaysia [8] duasa, j. (2007). determinants of malaysian trade balance: an ardl bound testing approach. global economic review, 36(1), 89-102. [9] gujarati, d. n., & porter, d. (2009). basic econometrics mc graw-hill international edition. [10] khan, b., farooq, a., & hussain, z. (2010). human resource management: an islamic perspective. asiapacific journal of business administration, 2(1), 17-34. [11] narayan, p. k. (2004). reformulating critical values for the bounds f-statistics approach to cointegration: an application to the tourism demand model for fiji. australia: monash university. [12] mirakhor, a. (1996). cost of capital and investment in a non-interest economy. islamic economic studies, 4(1), 3546 [13] meera, a. k., & abdul razak, d. (2009). home financing through the musharakah mutanaqisah contracts: some practical issues. islamic economics, 22(1). [14] meera, m., kameel, a., & abdul razak, d. (2005). islamic home financing through musharakah mutanaqisah and albay’ bithaman ajil contracts: a comparative analysis. review of islamic economics, 9(2), 5-30 [15] muhammad taqi usmani (2008). an introduction to islamic finance. idaraisha’at e-diniyat (p) ltd [16] mifc report 2015. islamic finance transformation journey and new windows of opportunity [17] mohd azmi omar, azman md noor, ahamed kameel mydin meera & research team (2010). research paper no. 17/2010: "an islamic pricing benchmark" [18] mohd-yusof, r., h-kassim, s., a-majid, m.s. and hamid, z. (2011). “determining the viability of rental price to benchmark islamic home financing products: evidence from malaysia” benchmarking: an international journal, vol.18, no.1, 2011, pp. 69-85. [19] pesaran, m. h., & pesaran, b. (1997). working with microfit 4.0: interactive econometric analysis;[windows version]. oxford university press. [20] pesaran, m. h., shin, y., & smith, r. p. (1999). pooled mean group estimation of dynamic heterogeneous panels. journal of the american statistical association, 94(446), 621-634. [21] pesaran, m. h., shin, y., & smith, r. j. (2001). bounds testing approaches to the analysis of level relationships. journal of applied econometrics, 16(3), 289-326. [22] sudin, h., & shanmugam, b. (2001). islamic banking system: concepts & applications. [23] valuation and property services department. property market report, ministry of finance, malaysia [24] shahid mohammad khan ghauri , (2015),"why interestrate cannot benchmark for islamic financial product http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 pricing?", benchmarking: an international journal, vol. 22, 7 [25] mahmoud a. el-gamal (2007) incoherence of contractbased islamic financial jurisprudence in the age of financial engineering, rice university [26] ong, t. s., & chang, y. s. (2013). macroeconomic determinants of malaysian housing market. journal of human and social science research, 1(2), 119-127. http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, portsmouth university, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france editorial_board.pdf editor in chief editorial board paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 impact of interest rate, inflation rate, exchange rate and gold prices on karachi meezan index 30 abstract— stock market performance has a significant impact on economic development of a country. stock markets are supposed to be affected by different financial and macroeconomic variables such as gold and oil prices, inflation rate, interest rate, exchange rate and unemployment rate etc. this study is an attempt to find the impact of financial and macroeconomic variables on karachi meezan index 30, the first islamic stock index in pakistan. monthly data from july 2011 to june 2016 of the variables kmi index 30, interest rate, inflation rate, exchange rate and gold price is used in this study to find the impact of selected variables on kmi 30 by using multiple regression model. the empirical result shows that there is a negative relationship of kmi 30 index with interest rate and gold prices whereas a positive relationship exists between exchange rate and kmi 30 index. inflation rate does not show a significant relationship with kmi 30 index in our regression model. keywords-component; shariah compliant stocks, kmi 30, interest rate, exchange rate, inflation rate, gold price, multiple regression i. introduction pakistan is one of those countries where we have witnessed a significant development in islamic banking and finance sector in the last decade. the growth of islamic banking & finance sector fascinated and encouraged the investors to capitalize on the available opportunity of investment in shariah compliant products. the behavior inevitably resulted in the introduction of the first islamic market index known as karachi meezan index 30 (kmi 30) in the month of september 2008. karachi meezan index 30 was created in the year 2008 by the joint effort of pakistan stock exchange, which was formerly known as karachi stock exchange, and al-meezan investment bank. the first islamic index of pakistan measures the performance of shariah compliant equity investment. al-meezan investment bank offers the shariah expertise, guidelines and stock screening while pakistan stock exchange is incharge for upkeeping and spreading help for the index. the index is calculated by using the free float market capitalization method. the level of index at any time indicates the free-float market value of the selected shariah permissible shares in connection to the base period. the index takes 15,000 as the base value and june 30, 2008 as a base period. the index comprises of islamic banks and financial institutions and other companies which are regarded as shariah compliant companies after the stock screening criteria. the stock screening criteria consist of six factors [18]. these factors are briefly explained in the following paragraph. in order to be a qualified shariah compliant company, the core business of the investee company should be halal for e.g. automobile, manufacturing concerns, textile etc. in addition, the interest-bearing debt (e.g. bonds, tfc’s, commercial paper, conventional bank loans, finance lease etc.) to asset ratio should be less than 37 %. also, non-compliant investment (e.g. investment in t-bills, pibs, conventional mutual funds, conventional money market instrument, etc.) to total asset ratio should be less than 33%. further, noncompliant income (e.g. income from gambling, income from interest based transactions, income from gharar based transactions i.e. derivatives, insurance claim reimbursement from a conventional insurance company, any penalty charged on late payment in credit sale etc.) to total revenue (gross revenue + any other income by the company) ratio should be less than 5%. next, illiquid asset (e.g. inventory of raw material, work in process, all fixed asset, stock in trade etc.) to total asset ratio should be at least 25%. finally, market price per share should be at least equal to or greater than net liquid asset per share. the framework of islamic finance is based on islamic shariah or islamic law. the islamic finance rules prohibits interest when lending money to lenders or investment in businesses, prohibits excessive risk and speculation and imposes asset backed security and equity participation. the moral and ethical rules together with the high degree of caution of islamic investments make islamic finance a promising alternative for improved performance [16]. with recent development in islamic banking and finance the islamic syed wajahat haider* *ms islamic banking and finance, ceif, institute of business administration, karachi. lecturer banking & finance, fatimiyah college, karachi ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 financial markets are also growing. there is not enough literature available which specifically focus the impact of financial and macro-economic variables on shariah compliant indices. this study is an attempt to study the impact of financial and macro-economic variables on shariah compliant stock i.e. kmi 30 based on the available literature related to conventional stock market. the study of different financial and macro-economic variables consequences on stock returns was previously done by numerous academicians and economists. it is evident from the literature that the empirical result of the studies varies because of the fact that the behavior of the financial markets is different in different parts of the world. since, the stock markets are considered to be the barometer of economic condition in a country therefore many researchers claimed that the stock prices are affected by the economic and financial variables which are the representative of overall economic condition of a country. investor believed that some elementary macro-economic variables such as interest rates, inflation rates and exchange rate can be used to determine the stock prices. as argued in previous study that monetary policy and macroeconomic factors have a considerable influence on the volatility of the stock prices [10]. in pure islamic economic system, firms would not have interest sensitive assets or liabilities. therefore, the issue of interest rate sensitivity of stock return would not be relevant. however, in a market economy, the value of a firm can be influenced both directly and indirectly by interest rate [22]. in case of conventional market, the relationship is significant as it is supposed to be an inverse relationship between stock prices and interest rate. this is because the interest rate is used to discount the future cash flows of a financial asset and increase in interest rate gives rise to the required rate of return on stock prices. in other words, an increase in interest rate results in increase of required rate of return which consequently decrease the stock price. theoretically, the relationship is depicted in a study by french french, k. r., schwert, g. w., & stambaugh, r. f. (1987). the study claimed that the stock returns responded negatively to both the long term and short-term interest rates [9]. in comparison, allen and jagtianti (1997) in their empirical study claimed that the interest rate sensitivity to stock returns has decreased dramatically since the late 80’s and the early 90’s because of the invention of interest rate derivative contracts used for hedging purposes [5]. naeem and rasheed (2002) claimed that there is no theoretical consensus on the relationship between stock prices and exchange rates either. when the causation runs from the stock prices to exchange rate, there is a negative relationship between stock prices and exchange rate. on the other hand, the price of stock increases when the direction of causation runs from exchange rate to stock prices due to depreciation in domestic currency [17]. as argument by abdalla, i. s., & murinde, v. (1997), changes in exchange rates affect firms’ exports and ultimately affect stock prices. if the foreign investor invests in the stock market he will convert his return to foreign currency [1]. therefore, appreciation in domestic currency will decrease the return of foreign investor which consequently decreases the stock price. by this approach the stock price is negatively related to exchange rate. inflation and stock returns have a negative relationship as higher inflation rate tends to increase the cost of borrowing. this leads to affect the firm borrowing which eventually result in decrease of stock returns. empirically the results are validated the above relationship in numerous studies. for instance, gultekin (1983) used time series regression and claimed that there is consistent lack of positive relationship between stock returns and inflation in most of the countries [12]. geske and roll (1983) argued that there is a positive relationship between the us stock prices and the real economic activity and inflation rate is negatively related to the us stock prices [11]. historically, gold was the safest investment opportunity for the investors. in comparison to stock, bonds or bank deposits, gold was considered more lucrative investment in past. even in present time, in most of the developing countries, investor trusted gold as an attractive investment. especially, during the period when sock markets are crashing, the gold is regarded as an ultimate investment choice for the investors. with the evolution of commodity exchange, gold derivatives are now traded all over the world. therefore, the fluctuation in gold prices can influence the stock prices. empirically, shahzadi & chohan (2010) studied the impact of gold prices on karachi stock exchange 100 index and concluded that there was a negative relationship between gold prices and kse 100 index [21]. above discussion leads us to the conclusion that there are theoretical and empirical evidences that the interest rate, inflation rate, exchange rate and gold prices have a significant impact on the return of conventional stock markets. we use the discussions and empirical findings from the literature as the basis of our study to evaluate the relationship of our selected variables on karachi meezan index 30. ii. literature review a. literature related to global stock indices different theoretical frameworks and statistical methods were used by international researcher to study the impact of macroeconomic indicators on stock returns. for instance, fama (1981) based his empirical study on arbitrage pricing theory and model a short run relationship between the macroeconomic variables and stock return. the empirical test of the model proved that real stock returns are positively related to measure of real activity such as capital expenditure, average real rate of return and output while inflation is negatively related to stock return [8]. chen, n., roll, r., & ross, s. (1986) in their study based on efficient market theory conclude that stock returns are influenced by the spread between long and short-term interest rate, expected and unexpected inflation, industrial production and oil prices. they conclude that unexpected and expected ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 inflation, risk premium and long and short-term interest rate have a significant relationship with stock returns [7]. gan, c., lee, m., yong, h. h. a., & zhang, j. (2006) studied the interaction of seven macroeconomic variables (inflation rate, money supply, long term interest rate, short term interest rate, exchange rate, gross domestic product and domestic retail oil prices) of new zealand economy on new zealand stock market (nzse40). by using granger causality test and johansen multivariate cointegration test on the monthly data from the year 1990 to 2003 they concluded that inflation rate had a negative impact on nzse40 [10]. vector auto regression technique was used by al-mutairi & al-omar (2007) on monthly data of kuwait stock exchange from the year 1995 to 2005 to investigate the relationship of money supply, inflation rate, government expenditure and interest rate on stock returns and find that all four variables have a slight impact on stock returns. they conclude that there is a negative relationship of interest rate and inflation rate on the stock returns. while the both money supply and government expenditures have a positive relationship with stock returns [4]. humpe and macmillan (2009) compare the impact of selected macro-economic variables i.e. industrial production, consumer price index, money supply and long-term interest rate on us and japan market using 40 years monthly data from 1965 to 2005. they claimed that for us market the stock prices are positively related to industrial production and negatively related to consumer price index and long-term interest rate while there is an insignificant relationship of money supply with stock prices. from japanese data, they found that industrial production is positively related to stock prices while stock prices have negative relationship with money supply [15]. (quadir 2012) in his article investigate the effect of treasury bill, interest rate and industrial production on dhaka stock exchange stock returns. by using autoregressive integrated moving average (arima) model on the monthly data from the year 2000 to 2007 he concluded that there is a positive impact of industrial production and treasury bill on stock return [19]. abdullah and hayworth, (1993) in their studies investigate the relationship of trade deficit, budget deficit, short-term and long-term interest rate, and money growth with the stock returns. using vector autoregressive model granger causality on monthly data from 1980 to 1988 found that the stock returns are positively related to money growth and negatively related to budget deficit, trade deficit and short-term and long-term interest rate [2]. herve, chanmalai, & shen, (2011) investigate the role of macro-economic variables which include industrial production index, consumer price index, domestic interest rate, real exchange rate and real money supply on stock prices index of brvm10 of cote d’ivoire stock market. they used quarterly data from 1991 to 2007. they concluded that domestic interest rate and consumer price index are the indicators to predict the stock prices [14]. b. literature related to pakistan’s stock indices similar studies have been done in pakistan to find the relationship and impact of different macroeconomic variables on stock returns of different stock exchange. for instance, khan (2012) use multiple linear regression model on kse 100 index data from 2001 to 2010 to find the impact of inflation rate, exchange rate and interest rate on stock returns [3]. sohail & hussain (2009) in his study use vector error correction model (vecm) on monthly data of lahore stock exchange from 2002 to 2008 and found that there exists a positive impact of money supply, industrial production, and effective exchange rate on stock return while inflation rate on the other hand negatively affect the stock return. rafay (2014) using granger causality test and implemented regression analysis, on the data from 1992 to 2012 and studied the impact of interest rate, import & export, and exchange rate on kse 100 index and found that there is no causal relationship exist between inflation, export and kse 100 index. however, regression analysis indicated a strong positive relationship between imports and kse 100 index. basit (2013) in his study investigate a relationship between oil and gold prices and kse 100 indexes by using simple linear regression model on the monthly data from the year 2005 to 2011 and find out that there is no significant relationship between kse 100 indexes and oil and gold prices. similarly, shahzadi & chohan (2012) find the impact of change in gold price on stock exchange by using augmented dickey fuller test, granger causality test and johansen’s co integration test on data from the year 2006 to 2010. it was found that there is a negative relationship exists between change in oil prices and stock exchange [21]. similar model study has been done by hanif, m., shah, z. a., & iqbal, a. m (2015) on shariah compliant stock return of kse 100 index. by applying co integration test and augmented dickey fuller test on macroeconomic data from 2001 to 2010 and market index he investigated the impact of real sector variables (i.e. export, fdi, gold prices, oil prices, industrial production and worker remittances) on shariah compliant stock return of 97 non-financial companies screened by al-meezan investment management ltd [13]. iii. research design the research process includes the collection of data, formulation of conceptual framework, framing of regression model, formulation of hypotheses and postulating estimation method. the objective of this paper is to find the empirical evidences to answer the following research questions: 1. is there any significant impact of gold prices, interest rate, exchange rate and inflation rate on karachi meezan index 30? ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 2. which variable in this study has more significantly impact the karachi meezan index 30? a. conceptual framework considering the existing literature, following figure will represents the conceptual framework of the study. the kmi 30 is dependent or response variable. on the other hand, gold prices, interest rate, inflation rate and exchange rate are classified as independent or explanatory variables. independent variables gold prices inflation rate interest rate exchange rate kmi 30 dependent variable independent variable b. theoretical frame work: the paper implements the multiple regression analysis to determine the dependence of kmi 30 on gold prices, inflation rate, interest rate and exchange rate. stock markets are supposed to be affected by different financial and macroeconomic variables such as gold and oil prices, inflation rate, interest rate, exchange rate and unemployment rate etc. as far as the investment decisions are considered, inflation rate, exchange rate, interest rate and gold prices play a vital role in an economy which affects the investment decision of an investor. change in interest rate affects the availability of funds in an economy which eventually result in change in investment decision. similarly, appreciation or depreciation of foreign currency with respect to local currency affects the return of foreign investors which result in change in investment decision accordingly. also, unstable inflation rate affects the profit rate which affects the investment decision of investor. during the period in which there is a slump in stock markets the investors consider the gold as the trusted investment opportunity and started to invest in their capital in gold which eventually affect the stock market index. therefore, in this study we classified kmi 30 index as a dependent variable and interest rate, exchange rate, gold price and inflation rate as an independent variable. c. hypotheses following hypotheses are formulated for the study: h0: the relationship between kmi 30 and selected variables (gold price, interest rate, exchange rate, and inflation rate) is not significant. h1: the relationship between kmi30 and selected variables (gold price, interest rate, exchange rate, and inflation rate) is significant. iv. methodology a. statistical method the study uses the multiple regression model to find evidence that the change in financial and macro-economic variable affects the shariah compliant stock market of an economy. this study is a quantitative study which utilizes the empirical data to find the relationship and impact of selected macro-economic variables on kmi 30 index. the relevant data is extracted from the websites of state bank of pakistan, pakistan stock exchange and world bank. b. data secondary data is used to analyze the relationship of the selected financial and macroeconomic variables (i.e. interest rate, inflation rate, exchange rate, and gold price) on kmi 30 index. karachi meezan index 30 is categorized as the response or dependent variable in this study. while, interest rate, inflation rate, gold price and exchange rate are categorized as the explanatory or independent variable. the monthly data from july 2011 to june 2016 is utilized for kmi 30 index, interest rate, exchange rate, gold prices and inflation rate. the discount rate (which represents the interest rate) and exchange rate data is obtained from state bank of pakistan website. the exchange rate will be pkr to usd conversion rate of the defined time period. for inflation rate, we use cpi data from state bank of pakistan website since it is the primary indicator to measure inflation. gold prices data (in troy ounce) is obtained from world bank commodity price data available at world bank website. karachi meezan index 30 monthly data is obtained from pakistan stock exchange website. c. regression model the study employs multiple regression model which is as under: r) + infrgp  where, kmi= kmi 30 index ir= interest rate inf=inflation rate er=exchange rate gp=gold price µ=error term ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 v. result and discussion a. descriptive statistics the descriptive statistics of the variables used in the study is exhibited in the table.1 below. table.1 (1) (2) (3) (4) (5) variables n mean sd min max kmi 30 index 60 40,850 13,595 20,062 66,163 interest rate 60 0.0949 0.0204 0.0625 0.140 inflation rate 60 0.0689 0.0319 0.0132 0.124 exchange rate 60 98.99 5.892 86.12 107.7 gold price 60 136,758 15,207 112,728 166,668 if we look at table.1 we will notice that interest rate and inflation rate data is symmetric but since, kmi 30 index, exchange rate and gold price data are in different units so we should make them symmetric for our model. for this purpose, we will take the natural logarithm of exchange rate, gold prices and kmi data. after taken the logarithm we will calculate the descriptive statics of the variables again. table.2 below depicts the descriptive statistic of the variable after taking the natural logarithm. table 2 (1) (2) (3) (4) (5) variables n mean sd min max log of kmi 60 10.56 0.364 9.907 11.10 interest rate 60 0.0949 0.0204 0.0625 0.140 inflation rate 60 0.0689 0.0319 0.0132 0.124 log of exchange rate 60 4.593 0.0609 4.456 4.679 log of gold price 60 11.82 0.110 11.63 12.02 b. regression result our basic regression model is:  r) + infrgp since we have taken the logarithm of kmi and exchange rate and gold price therefore, after the log transformation we need to modify our regression model. we can rewrite our model as: logr) + inflogrlog gp table.3 below reports the summary of our regression model. table.3 source ss df ms number of obs 60 f( 4, 55) 178.01 model 7.25818067 4 1.81454517 prob > f 0.000 residual 0.560656573 55 0.010193756 r-squared 0.9283 adj r-squared 0.9231 total 7.81883724 59 0.132522665 root mse 0.10096 the prob > f value from above value represent that our regression model is statistically significant and has explanatory power with the r-squared value of 0.9283. we conclude that 92.83 % variation in kmi 30 index is explained by interest rate, exchange rate, inflation rate and gold prices. table.4 below reports the result of our regression model. table.4 (1) variables log of kmi log of exchange rate 2.349*** (0.405) log of gold price -1.171*** (0.175) interest rate -3.869* (1.988) inflation rate -1.400 (1.079) constant 14.07*** (3.239) observations 60 r-squared 0.928 standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1 we observe that the p-values of log of exchange rate and log of gold price are statistically significant. in comparison the p-values of interest rate and inflation rate are higher. this might be because of the collinearity between the two variables. variance inflation factor (vif) is a statistical measure which can be used to identify the multicollinearity between the predictor variables. the results of vif are shown in the table below: vif variable vif 1/vif ir 9.53 0.104982 inf 6.84 0.146116 loger 3.52 0.283903 loggp 2.14 0.466906 mean vif 5.51 the vif value is > 5 for interest rate and inflation rate which shows that the collinearity exist between interest rate and inflation rate. we will now use correlation matrix and check the correlation between our variables. correlation matrix of coefficients of regress model e(v) ir inf loger loggp _cons ir 1.0000 ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 inf -0.806 1.0000 loger 0.6497 -0.3238 1.0000 loggp 0.148 -0.3938 0.3102 1.0000 _cons -0.5072 0.4611 -0.8025 -0.8156 1.0000 the correlation matrix provides the evidence that there is a high correlation exist between the interest rate and inflation rate. because of the collinearity between these two variables the p-values of the interest rate and inflation rate are not significant in our regression model. to deal with this, we either have to exclude interest rate or inflation rate from our regression model and run the regression again. we will exclude the inflation rate from our regression model and test our regression model again. the regression model summary and results of the regression model after removing the inflation rate are given below in table.5 and table.6. table.5 source ss df ms number of obs 60 f( 3, 56) 233.93 model 7.2410282 3 2.41367605 prob > f 0.0000 residual 0.5778091 56 0.010318019 r-squared 0.9261 adj r-squared 0.9221 total 7.8188372 59 0.132522665 root mse 0.10158 the value of r-squared shows that our regression model is significant and has explanatory power. the value of prob > f shows that the 92.61% variation in kmi 30 index is explained by our predictor variables i.e. the interest rate, exchange rate and gold prices. table.6 (1) variables log of kmi interest rate -5.947*** (1.184) log of exchange rate 2.179*** (0.385) log of gold price -1.260*** (0.162) constant 16.01*** (2.891) observations 60 r-squared 0.926 standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1 from above results we conclude that the interest rate, exchange rate and gold prices have significant impact on kmi 30 index. the coefficient of interest rate is -5.947 which represent 100bps increase in interest rate would decrease the kmi 30 index by 5.94 %. also, there exist a positive relationship between exchange rate and kmi 30 index. the coefficient value of exchange rate is 2.179 which employs that with 1% change in exchange rate there is 2.19 % change in kmi 30 index. as far as gold prices are concerned, there is a negative relation between gold price and kmi 30 index. the coefficient value of 1.26 explains that with 1% increase in gold price there is 1.26 % decrease in kmi 30 index. vi. conclusion this paper uses the multiple regression model to estimate the impact of selected financial and macro-economic variables i.e. interest rate, exchange rate, inflation rate and gold price on karachi meezan index 30 of pakistan stock exchange. we use the monthly data from july 2011 to june 2016 for this study. results from our regression model are basis to accept the hypothesis that interest rate, exchange rate and gold prices have a significant impact on kmi 30 index. on the basis of our multiple regression model results, we conclude that, in comparison to other variables used in this study, there is a strong negative relationship between the interest rate and kmi 30 index. we have removed inflation rate from our model because of high correlation between the interest rate and inflation rate. the other two variables (i.e. gold prices and exchange rate) also depict significant relationship with kmi 30 index. the gold prices are negatively related to the kmi 30 index. in comparison, exchange rate has a positive relationship with the kmi 30 index. since, islamic banks and other islamic financial institutions use interest rate as benchmark for their profit calculation. this is one of the reasons that kmi 30 index reflects the strong negative relationship with interest rate. the results support the need of separate islamic interbank benchmark rate. in pakistan, gold is always a safest investment alternative and the empirical result of our model validate the fact that the investors prefer to invest in gold in order to compensate their loss when stock markets are not performing well. as far as the exchange rate is concerned, the policy makers need to stabilize the exchange rate. this will restrain the outflow of capital and improve the confidence of foreign investor. in this study limited variables are used to find their relationship with kmi 30 index. more financial and macro economic variables 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(2002). stock prices and exchange rates: are they related? evidence from south asian countries [with comments]. the pakistan development review, 535550. [18] pakistan stock exchange, karachi meezan index brochure, (2010), retrieve from https://www.psx.com.pk/scripts/communicator.php?f=brochurekmi_id x.pdf&l=txt [19] quadir, m. m. (2012). the effect of macroeconomic variables on stock returns on dhaka stock exchange. international journal of economics and financial issues, 2(4), 480. [20] rafay, a., naz, f., & rubab, s. (2013). causal relationship between macroeconomic variables: evidence from developing economy. [21] shahzadi, h., & chohan, m. n. (2012). impact of gold prices on stock exchange: a case study of pakistan. kse (karachi stock exchange of pakistan), working paper series. [22] shamsuddin, a. (2014). are dow jones islamic equity indices exposed to interest rate risk? economic modelling, 39, 273-281. [23] sohail, n., & hussain, z. (2009). long-run and short-run relationship between macroeconomic variables and stock prices in pakistan: the case of lahore stock exchange. pakistan economic and social review, 183198. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 the impact of non-performing financing (npf) to profitability (return on equity) at sharia bank in indonesia *lecture of islamic banking department, faculty of islamic studies, serambi mekkah university, indonesia muksal@serambimekkah.ac.id abstract— this study aims to analyze the effect of non performing financing (npf) on profitability proxy with return on equity (roe) variable of syariah bank in indonesia period of 2013-2015. the sample population in this study were three banks with sample selection using purposive sampling technique with syariah bank criteria which published periodic financial statements during the observation period that is the period of 2013-2015. the research data is quantitative data obtained from the quarterly financial report of sharia bank. data analysis using simple linear analysis with 5% significance level which aims to obtain how the overall influence of the relationship between npf variable and return on equity (roe). the results showed that the variable non performing financing (npf) has a negative and significant effect on return on equity (roe) with a value t greater than 0.005. high npf ratio in syariah bank can give a picture of the negative effect on profitability of sharia bank.. keywords; non performing financing, profitability, return on equity, syariah banking i. introduction the development of sharia banking in indonesia is quite rapid and has a considerable opportunity, it was felt after the government and bank indonesia gave a big commitment by taking various policies to develop sharia banks. as of 2009, there have been six sharia commercial banks (bus), 25 sharia business units (sharia division), 138 sharia rural banks (bprs) with a total of 1223 sharia banking offices spread throughout indonesia. to be able to know the development of the number of sharia banking and banking offices in indonesia for the last five years can be seen in the table below. table 1 development of sharia bank type 2005 2006 2007 2008 2009 sharia commercial banks  total bank 3 3 3 5 6  total office 304 349 401 581 711 sharia business units  total bank 19 20 26 27 25  total office 154 183 196 241 287 sharia rural banks  total bank 92 105 114 131 139  total office 92 105 185 202 225 total office 550 637 882 1024 1223 source : bank indonesia one of the banking performance measurement ratios is profitability used to measure management effectiveness based on the results obtained from sales and investments. profitability is the percentage comparison between profit with assets or capital that generate profit [4]. banking in this case is required to increase profitability because profitability is one indicator to measure and evaluate the performance of bank management and productivity in managing banking assets as a whole, so with high profitability banks are expected to continue to run the business and improve its performance so that the community needs will be fulfilled. profitability also indicates whether the business entity has a good prospect in the future, so the higher level of profitability of a business entity then the survival of the body will be more secure [9]. the commonly used indicator to measure the performance of bank profitability is return on equity (roe). roe according to pramudhito [12] shows the ability of banks to manage available capital to obtain net income. the roe standard according to pbi no.6 / 10 / pbi / 2004 is 5% -12.5%. the greater the roe, the greater the level of profit earned by the bank that affects the better the bank's position in terms of capital management. the higher the return then the better because it means that the dividends are distributed or reinvested as retained earnings is also greater [11]. the health criteria of sharia banks stipulated by bank indonesia are as follows: table 2 non performing financing rating assessment rating value npf predicate 1 npf<2% very good muksal* ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 2 2%≤npf≤5% good 3 5%≤npf≤ pretty good 4 8%≤npf≤12% not so good 5 npf≥12% not good source : se bi no. 9/24/dpbs october, 30, 2007 non performing financing is a financial ratio that shows the total problematic financing in sharia banking. in conventional banking, the financial ratios that represent problematic financing are known as non performing loans (npls). non performing financing (npf) measures the bank's ability to safeguard the risk of default on the return of debtors. the high level of non performing financing (npf) in a sharia bank shows the quality of an unhealthy islamic bank. noncurrent financing is due to constraints on each financing provided by the sharia bank. the constraint is caused by any financing provided by the bank, not all of the financing can be fully refunded by the customer. so that non performing financing (npf) has a negative effect on return on equity (roe). this study was conducted to test whether non performing financing (npf) has an effect on profitability. profitability is measured by return on equity (roe) to determine the ability of management in managing the available capital to generate net income. this research is different with previous research is population, time, and sample used in this research is sharia bank in indonesia period 2013-2015. ii. literature review this study is based on the research of dendawijaya [4] which suggests the impact of the existence of non performing financing (npf) which is not fair one of them is the loss of opportunity to obtain income from credit given, thus reducing the profit gain and adversely affect profitability. non performing financing (npf) the higher the profitability will be lower and vice versa, if the non performing financing (npf) the lower the profitability will be higher. as stated by abdullah [5] "if the problem loans are very large and the reserves formed are also large, the bank's capital is likely to be negative so that the profit will be disturbed. another study by susilawati [6], which examines the effect of mudharabah financing on non performing financing (npf). in this research, the object studied is bpr syariah baiturridha pusaka bank. the result of this research indicates that there is influence of mudharabah financing to non performing financing (npf). kharisma [8] examines about third party funds and non performing financing (npf) on profitability. this study concludes that simultaneously third party funds and non performing financing (npf) together have a significant effect on profitability. and partially there is a significant influence between third party funds on profitability and there is a nonsignificant influence between non performing financing (npf) on profitability. mutaminah and chasanah [7], this study examines external and internal analysis in determining non performing financing (npf) of sharia commercial banks in indonesia. the result of the research shows that gdp (gross domestic product) has no significant positive effect on non performing financing (npf) of sharia bank, inflation has a significant negative effect on non-performing financing (npf) of sharia commercial bank, exchange rate or exchange have positive but not significant effect to the level of non performing financing (npf) ratio of sharia banks, profit return sharing return on total return is negatively insignificant to non-performing financing (npf) of sharia commercial bank, murabahah financing allocation ratio to the allocation of profit loss sharing to the level of non performing financing (npf) ratio of sharia commercial banks. ardiu [2] examines the effect of non performing financing (npf) and financing to deposit ratio (fdr) tehadap return on equity (roe) in sharia rural bank pnm mentari garut and the results of this study showed that non performing financing (npf) no significant effect on return on equity (roe) where the influence of non performing financing (npf) of -2.076 <2.145 to roe, financing to deposit ratio (fdr) proved no significant effect on return on equity (roe) where the influence of financing to deposit ratio (fdr) of 0.901 <2.145 to roe, non performing financing (npf) proved no significant effect on fdr where the magnitude of non performing financing (npf) effect of -0.3140 <2.145 to financing to deposit ratio (fdr) and the magnitude of fcount is 2.4334 so fcount ≤ ftable, 2,4334 ≤ 3,80 which means accept ho or ha rejected means not significant where there is no p a significant influence simultaneously between non performing financing (npf) and financing to deposit ratio (fdr) to return on equity (roe) at pt. pnm mentari garut. research by tresna asih sekarwangi [10] with the title of effect of non-performing financing (npf) and capital adequacy ratio against islamic bank profitability in indonesia research shows that non-performing financing significant negative effect on profitability (return on equity), capital adequacy ratio significant positive effect on profitability (return on equity). thus the results of the study show non performing financing and capital adequacy ratio has an influence on profitability. another study by lia yuliany [3] concerning the influence of financing to deposit ratio (fdr) and non performing financing (npf) to profitability of sharia commercial bank (empirical study on sharia commercial banks registered at bank indonesia period 2008 2012) and the results of data analysis or regression results indicate that partially, financing to deposit ratio (fdr) has not a significant effect to profitability as measured by return on assets (roa) and return on equity (roe). and then partially, non performing financing (npf) has a significant effect to profitability as measured by return on assets (roa) and return on equity (roe). while simultaneously, financing to deposit ratio (fdr) and non performing financing (npf) have a significant effect to profitability as measured by return on assets (roa) and return on equity (roe). ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 farashita aulia [1] also examined the effect of current asset ratio (car), financing to deposit ratio (fdr), non performing financing (npf) dan bopo to profitabilitas (return on equity) dan the result of this research shows that current asset ratio (car) and bopo had a negative and significantly influence on return on equity (roe). financing to deposit ratio (fdr) had a negative influence on return on equity (roe), but it doen’t significantly influence return on equity (roe). meanwhile, non performing financing (npf) has a positive and significant influence on return on equity (roe). in relation to previous studies, the hypothesis proposed and which will be tested are as follows: h1 : non-performing financing influence negative and significant against return on equity. iii. data and methodology types of research this research uses quantitative approach and uses statistical calculation technique. in this case, the quantitative approach is done by analyzing the non-performing financing (npf) data on the impact on return on equity (roe) in bank syariah mandiri (bsm), bni syariah bank and bank bri syariah period 2013-2015. population and sample based on the data that researchers get that the population in this study is the data of non-performing financing (npf) and return on equity (roe) at bank syariah in indonesia. samples in this study are bank syariah mandiri (bsm), bni syariah bank and bank bri syariah period 2013-2015. source of data obtained in this research is in the form of secondary data. secondary data that writer use is taken from ukdw stock exchange corner period 2013-2015. data analysis technique statistic analysis the results of this data processing is used to answer the problems that have been formulated. this analysis is used to show the relationship between the independent variable (x) with the dependent variable (y). statistical analysis includes: 1. classic assumption test in this study, researchers will perform statistical tests regression in studying the relationship that exists between the variables are not free if the independent variables are known or vice versa. in practice there are four most commonly used classical assumption assays: 1.1. normality test this test is done to see if the distribution of data available is normally distributed / not. one of the statistical tests that can be used to test residual normality is non-parametric statistical test kolmogorov-smirnov (k-s). the k-s test is done by hypothetical: ho : the residual data is normally distributed ha : residual data is not normally distributed decision-making guidelines: a. sig value or significance or probability value <0.05. distribution is not normal. b. b. sig value or significance or probability value> 0.05. distribution is normal. 1.2. multicolinearity test multicollinearity test aims to test whether the regression model found the correlation between independent variables (independent). if independent variables are correlated, these variables are not orthogonal. to detect the presence or absence of symptoms of multicolinearity can be seen from the tolerance and vif (variance inflation factor). if a low tolerance value is equal to a high vif value, then it indicates a high colonierity (because vif = 1 / tolerance). common cutoff values used to indicate the presence of multicolinearity are tolerance values <0.10 or equal to vif value> 10. 1.3. heteroscedasticity test heterocedasticity test aims to test whether in the regression model there is a variance inequality of one observation residual to another observation. to test whether the variant of residual homogeneous use spearman rank test, that is by correlating the five independent variables to the absolute value of the residual (error). if there is a significant independent variable correlation coefficient at error rate of 5%, indicating the occurrence of heterocedastisitas 1.4. autocorrelation test autocorrelation test aims to test whether in the linear regression model there is a correlation between the confounding error in period t with the intruder error in period t1 (previous). the way used to diagnose autocorrelation is by durbin-watson test (dw test). decision-making whether or not there is autocorrelation (imam ghozali, 2007) is: a. if dw is located between the upper bound (upper bound / du) and 4-du, then there is no autocorrelation. b. if dw is lower than the lower limit (lower bound / dl) then there is a positive autocorrelation. c. if the dw value is greater than (4-dl), then there is a negative autocorrelation. d. if the dw value lies between (4-du) and between (dldu) then the result can not be concluded. 2. simple linear regression test regression can be used to predict how far the value of the dependent variable changes, if the value of the independent variable is changed. regression analysis, in addition to being used to measure the strength of the relationship between two variables, can also indicate the direction of the relationship between the dependent variable and independent variables. the general equation of simple linear regression is: y = α + β x + ε ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 explanation : y= return on equity (roe) α = constant, is the value of y when x = 0 β = the direction of the regression coefficient, which states the change in the value of y if there is a change of x value. if (+) then the direction of the line will rise, and if (-) then the value of the line will drop x = non-performing financing (npf) ε = other factors affecting variable y 3. hypothesis testing the statistical test t basically shows how far the influence of a partially independent variable in explaining the dependent variable. this test is a two-way test with the hypothesis: h0 : β1=0 meaning there is no influence from independent variable to dependent variable. ha : β1<0 or β1>0 meaning there is influence from independent variable to dependent variable. to calculate the value of t arithmetic used the formula: t hitung = β1 se(β1) wherin: β1 = correlation coefficient se (β1) = standard error regression coefficients testing criteria: a. h0 is accepted and ha is rejected if t count <ttabel, meaning that independent variable has no significant effect to dependent variable. b. h0 rejected and ha accepted if tcount> ttable, meaning that independent variables significantly influence the dependent variable. another alternative to see the effect of partial is to see the significance value, if the value of significance formed under 5% then there is a significant influence of independent variables partially to the dependent variable. conversely, if the significance is formed above 5% then there is no significant effect of independent variables partially to the dependent variable. iv. result and discussion analysis 1. classic assumption test result 1.1. normality test the results of normality test (kolmogorov-smirnov test) can be seen in table 3 below: table 3 normality test results (kolmogorov-smirnov test) sample significance result 36 0.000 h0 accepted source: data processed result of normality test (kolmogorof-smirnov test) in table 1 above shows that asymp value. sig. for 0.000, this shows that the sig value is greater than the trust value (a = 0.05). therefore it can be concluded that ha is rejected and receives h0 so that the residual data is normally distributed. 1.2. test multicolonearity multicollonierity test results (vif test) can be seen in table 4 below: table 4 multicollonearity test results (uji vif) independent variable tolerance vif npf 1.000 1.000 source: data processed multicollonierity test results (vif test) in table 2 it shows that vif value is less than 10 and tolerance is more than 0.1 which means that the regression model does not contain multicolonierity. 1.3. heteroscedasticity test the results of heteroscedasticity test (glejser test) can be seen in table 5 below: table 5 heteroscedasticity test results (uji park) variable significance result npf 0.008 non heteroskedastisitas variabel dependen: res_2 source: data processed the result of heteroscedasticity (glejser test) in table 4.6 above shows that the independent variable has a sig value under α (0.05). therefore it can be concluded that the regression model there are no symptoms of heteroskedastisitas on npf variables. 1.4. autocorrelation test the autocorrelation test results can be seen in table 6 below: table 6 autocorrelation test results (run test) sample significance conclusion 36 1.398 h0 accepted 2. simple linear regression test result table 7 simple linear regression test result variable t significance result npf -2.501 0.017 h1 accepted ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 based on the results of simple linear regression testing the effect of non performing financing (npf) (x) on return on equity (roe) (y) by using spss program obtained tcount -2.501 with p value 0.017, so it can be concluded h1 accepted. this shows that there is a negative and significant influence of non performing financing (npf) (x) on return on equity (roe) (y). the influence of non performing financing (npf) to return on equity (roe) based on the results of the test using a simple linear regression the effect of non performing financing (npf) on return on equity (roe) using spss program obtained tcount -2.501 with p value 0.017. h1 hypothesis built on this variable is non performing financing (npf) has a negative and significant effect on the variable return on equity (roe). because the value of p value 0.017> 0.05 can be concluded h1 accepted. this shows that non performing financing (npf) has a negative and significant effect on return on equity (roe). the influence of non performing financing (npf) on return on equity (roe) shows the high level of non performing financing (npf) in a syariah bank can show the quality of unhealthy islamic banks. the constraint is caused by any financing provided by the bank, not all of the financing can be fully refunded by the customer. thus, causing high non performing financing (npf) in sharia banks can give a negative impact on the profitability of sharia banks. this is in line with that submitted by dendawijaya [4] which suggests the impact of the existence of non performing financing (npf) is not unusual one of them is the loss of opportunity to earn income (income) from credit given, thus reducing the profit and adversely affect profitability. the result of this research is supported by tresna asih sekarwangi [10] where research shows that non-performing financing significant negative effect on profitability (return on equity), as well as research by lia yuliany [3] where the research result is non performing financing (npf) have a significant effect to profitability as measured by return on equity (roe). however, it is slightly different in the farashita aulia study [1] where it was found that non performing financing (npf) has a positive and significant influence on return on equity (roe). this study is inconsistent with findings of research conducted by charisma [8], where there is a non-significant influence between non performing financing (npf) on profitability. similarly, research from ardiu [2] which indicates that non performing financing (npf) proved no significant effect on return on equity (roe). v. conclusion the result of non performing financing test (npf) also has a significant effect on profitability measured by return on equity (roe) in sharia banking period 2013 2015. regression coefficient result shows negative relationship, that means if non performing financing (npf) increases then profitability of sharia banks will decline. the influence of non performing financing (npf) on return on equity (roe) shows the high level of non performing financing (npf) in a syariah bank can show the quality of unhealthy islamic banks. thus, causing high non performing financing (npf) in sharia banks can give an illustration will negatively affect the profitability of sharia banks. vi. recommendation in order to maintain the stability of the number of problem financing (npf), the bank should always be proportional in applying prudential regulation (prudential regulation). that is, the bank should not be too easy and also not too tight in providing financing. so the amount of non performing financing (npf) does not jump sharply that if it happens can disrupt the profitability of sharia bank.. references [1] aulia, farrashita, pengaruh car, fdr, npf dan bopo terhadap profitabilitas (return on equity), skripsi, fakultas ekonomika dan bisnis, univesitas diponegoro, semarang 2015. [2] muhammad agatho ardiu, pengaruh non performing financing (npf) dan financing to deposit ratio (fdr) terhadap return on equity (roe) pada bank pembiayaan rakyat syari’ah pnm mentari garut, skripsi, fakultas syariah dan hukum universitas islam negeri sunan gunung djati, bandung, 2014. [3] lia yuliany, pengaruh financing to deposit ratio (fdr) dan non performing financing (npf) terhadap profitabilitas bank umum syariah (studi empiris pada bank umum syariah yang terdaftar di bank indonesia periode 2008 – 2012), skripsi, fakultas universitas widyatama, bandung 2014. [4] dendawijaya, lukman. 2005. manajemen perbankan. jakarta: ghalia indonesia. [5] abdullah, m. faisal. 2005. dasar-dasar manajemen keuangan. malang: umm press [6] susilawati, susi. 2011. pengaruh pembiayaan mudharabah terhadap non performing financing (npf) pada bank pembiayaan rakyat syariah (bprs) baiturridha pusaka. jurnal manajemen dan perbankan. [7] mutaminah dan siti nur zaidah chasanah. 2012. analisis eksternal dan internal dalam menentukan non performing financing bank umum syariah di indonesia. jurnal bisnis dan ekonomi. vol.19, no.1: 49-64. [8] kharisma, dea naufal. 2011. pengaruh dana pihak ketiga dan non performing finance terhadap profitabilitas perbankan syariah. jurnal ilmiah akuntansi. [9] rivai, veithzal dan arviyan arifin. 2010. islamic banking: sebuah teori, konsep, dan aplikasi. jakarta: bumi aksara [10] tresna asih sekarwangi, 2014 pengaruh non performing financing dan tingkat kecukupan modal terhadap profitabilitas bank syariah di indonesia (studi empiris pada bank umum syariah yang terdaftar di bank indonesia selama tahun 2009 -2013), skripsi, fakultas ekonomi universitas widyatama, bandung . [11] kuncoro, mudrajad, suhardjono. 2002 "manajemen perbankan: teori dan aplikasi, yogyakarta : bpfe. [12] r. ade sasongko pramudhito, 2014. skripsi, analisis pengaruh car, npf, bopo, fdr, dan ncom terhadap profitabilitas bank umum syariah di indonesia (studi kasus pada bank umum syariah di indonesia periode 2008-2012) fakultas ekonomika dan bisnis universitas diponegoro semarang ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france microsoft word 1043-3967-3-ed.doc http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 islamic accounting; history, development and prospects * center for islamic banking, finance and economics university of sarajevo; university of bolton + heriot-watt university; politecnico di milano; umea university abstract— the main objective of this paper is to discuss the history of islamic accounting from its emersion to its subsequent development and expected growth in the future. in doing so, the paper will analyze the historic influence of islamic accounting over its conventional counterpart which dominates the industry today. moreover, it will provide an analysis of the similarities and differences between islamic and conventional accounting today from both a theoretical and practical perspective. based on this comparison the need for an islamic accounting system, in light of the developing islamic economic system and the specific needs of its financial institutions which are governed by the shari’ah, is discussed. finally, it will look at the prospects of such an accounting system as well as the challenges it faces moving forward. despite the many strides taken towards developing a comprehensive islamic accounting system, there are still many challenges which need to be overcome. nonetheless, the prospects are significant, namely in providing an alternative to the conventional accounting system making it a field worth contributing to. keywords-component; history, accounting, islamic accounting, finance i. introduction with the emergence and subsequent development of islamic economics, including the islamic financial system and its institutions, there became a need for islamic accounting. the concept of an islamic accounting system and processes is not a new one by any means as there is significant historical evidence to show the use of islamic accounting practices as early as the time of the second caliph, umar, in the islamic state. not to mention that the qur’an provides the basis for accounting, with significant ayahs (verses) demanding that accounting practices be developed and implemented in society. although the first scholarly writing of such practices in the english language did not occur until the 1980s, there was significant material in other languages [1]. the problem, however, is that many archives were destroyed over the centuries making it difficult to trace the real influences of islamic accounting on the conventional accounting practices. nonetheless, there are some scholars who argue that islamic accounting influenced the development of double-entry accounting in italy, home of the father of modern accounting. thus, the historical evidence of islamic accounting is significant. yet, this does not mean that there are not issues facing its development and implementation in the modern economic system which is heavily influenced by western practices. ii. history of islamic accounting it is widely accepted that the origins of organized accounting, in the form we use today, can be traced back to italy and luca pacioli, the father of modern economics. his book, summa de arithmetica, geometria, proportioni et proprotionalita, published in 1494 ce (common era) is considered the first text on accounting [2]. although, it must be said that luca pacioli is not accredited with inventing the accounting system but for being the first individual to codify and publish the system. this is because merchants had been using an accounting methodology for years, one which is claimed to have been developed and used in trade and commerce around the middle ages [2]. accounting in the islamic world can be traced back even farther than these above mentioned claims. the nation living in arabia during the time of the prophet muhammad, peace be upon him (p.b.u.h), was one whose entire economic system was more or less reliant on trade and commerce. even the prophet p.b.u.h worked as a merchant. the arrival of islam through the revelation of the qur’an provided instructions on every aspect of life, including economic transactions [3]. in fact, the basis of the islamic economic system comes from the qur’an itself which provides examples of how to conduct business in a permissible manner. the creation of an islamic accounting system was, therefore, both necessary and inevitable. in fact, the qur’an also provided guidance on how to conduct accounting activities and seeing as the divine revelation began around 610 ce, this would mean that islamic accounting was present some 800 years before pacioli’s book [4]. this fact is not surprising as the writing of accounting history is dominated by english writers who focus and discus private-sector accounting in english-speaking countries of the 19th and 20th century [1]. the scope of accounting history, however, is much wider than this, both from a geographic point of view as it was not limited to the english-speaking world, and from a time point of view as accounting existed prior to the modern era. thus, as islam grew so did the islamic economic system and all activities therein. the expansion in trade within and beyond the muslim world promoted the development of a mechanism which would ensure the acceptable accountability of cash, goods received and distributed [5]. this became specifically important with the introduction of zakat in 624 ce, where it was necessary to have accounting for the purpose of calculating and paying zakat. it was also important for those amela trokic*+ ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 individuals conducting business, specifically entrepreneurs, to develop a bookkeeping and writing system to ensure that their ventures were shari’ah compliant. the qur’an, as mentioned earlier, stresses the need for an accounting system by stating the importance of writing and recording debts as well as business transactions. examples of such revelations can be seen in surah 18: ayah 30 and surah 2 (al-baqarah): ayah 282-283. ayah 282 of surah al-baqarah is also known as ‘the debts ayah’ and is the longest ayah in the qur’an, specifying all the requirements for writing and recording debts as well as business transactions. the formal introduction of accounting books, concepts and procedures occurred during the time of the second caliph, umar bin al-kattab, who ruled between 634644 ce [4]. a. development of islamic accounting since the development of accounting in the islamic state was associated with zakat, its formal establishment was initiated for government purposes. namely, it was implemented for the recording of public treasury revenues and expenses [6]. the accounting systems developed and practiced in the islamic state can be divided into 7 types:  stable accounting (accenting for livestock);  construction accounting;  rice farm accounting (agricultural accounting);  warehouse accounting;  mint accounting (currency accounting);  sheep grazing accounting;  treasury accounting. the development and implementation of accounting systems in the islamic state was also supported by mandatory recording procedures. although these ranged, some examples of recording procedures developed and applied by government authorities, as well as individual entrepreneurs, include [7]:  transactions had to be recorded immediately, as soon as they occurred.  transactions had to be classified according to their nature.  receipts were recorded on the right hand side of the page (sources of these receipts also needed to be disclosed) while payments were recorded on the left hand side (with explanations).  no spaces were to be left between transactions.  corrections, overwriting or deleting recorded transactions was prohibited.  monthly and yearly reports had to be prepared.  yearly reports were reviewed and compared to prior year reports (auditing) as we can see, these procedures attempted to diminish the risks of fraud and manipulation and offer some form of control. proper classification of transactions was stressed and integral to the various accounting systems. monthly and yearly financial statements were mandatory while budgeting was used as an internal control procedure and a tool for analyzing and interpreting these financial statements. as can be seen, auditing was also practiced and was even deemed mandatory to ensure the proper implementation of a complete accounting system. it is also important to note that while accounting was practiced in the early stages of the islamic state, the terms accounting and accountant were not present. it is unknown when exactly these terms came into use, however, it is probable that their appearance coincides with the influence of colonization and introduction of western culture in the 19th century. iii. modern islamic accounting with the fall of the islamic state, islamic economics also diminished and played second fiddle to the conventional system which dominated world economics. colonization of muslim dominated countries by western empires left significant influences on the culture and every aspect of societal life. this included accounting practices which became implemented in these countries. even those majority muslim populated countries which were not colonized, they still had significant western influence; the ottoman empire was influenced by german accounting principles and even the wahhabi influenced saudi arabia borrowed its accounting practices from the west [8]. after the second world war, the post-colonial period, muslims around the world were left with a dilemma; should they keep the western practices already engrained in their society or bring back the islamic practices of the religion’s golden age? [9] nonetheless, islamic economics began to develop in the modern era alongside conventional economics, particularly due to the ‘islamisation’ of some countries like pakistan and iran, as well as the significant and continued wealth transfer to the middle east after oil prices rose in the early 1970s [9]. the need for islamic banking and financial institutions rose and with it the need for an accounting system which would be appropriate for said institutions, namely one which understood the required shari’ah compliance objective. this is particularly so since conventional accounting was inadequate in ensuring that islamic financial institutions meet their socio-economic objectives as required by the shari’ah. the first mentions of islamic accounting in scholarly literature, in the english language, can be traced back to 1981. this year, abdel-magid proposed a tentative theory for the accounting practices of islamic banks [9]. hence, islamic accounting in its modern context can be defined as the accounting process which provides the necessary information to stakeholders enabling them to ensure that their entity is continuously operating under islamic or shari’ah law, while fulfilling its socio-economic objective [10]. islamic accounting, unlike conventional accounting, serves a large group of stakeholders as oppose to only serving the interests of a particular group, therefore it is concerned with the interests of society as a whole. ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 a. islamic accounting vs. conventional accounting to better understand islamic accounting, it is necessary to compare it with conventional accounting – its similarities and differences. one of the biggest differences between conventional and islamic financial institutions (specifically banks), and the way in which accounting would differ, can be seen by comparing their balance sheets (table 1). while islamic financial statements in general share the same broad classification as conventional financial statements, although they differ in form, substance and oftentimes purpose [11]. the set of financial statements of an islamic financial institution can be grouped in the following manner [11]:  financial statements reflecting islamic bank’s function as an investor: o statement of financial position o statement of income o statement of cash flow o statement of retained earnings or statement of changes in owners’ equity.  financial statement reflecting changes in restricted investments managed by islamic bank for benefit of others.  financial statements reflecting islamic bank’s role as fiduciary of funds made available for social purposes when such services are provided through separate funds: o statement of sources and uses of zakah and charity fund o statement of sources and uses of funds in the qard fund while an islamic accounting system does not dictate a specific form of accounting that must be implemented and followed, it does mandate that whatever form is used meet the islamic requirements. there are three general principles which should be incorporated in an islamic accounting system, namely (i) accountability; (ii) justice; and (iii) truth. other differences can be observed starting from the foundation of the two concepts; islamic accounting having a religious base while conventional accounting is secular-based. islamic accounting is, therefore, governed by islamic law which is derived from the qur’an and sunnah while conventional accounting is governed by modern commercial law which makes it a product of culture. this very foundation thus contributes to other differences such as the objectives of providing information. accounting is meant to provide accurate information pertaining to the financial and oftentimes operational situation of a financial institution or business entity. yet, while conventional accounting is primarily concerned with presenting information about the efficient allocation of scarce resources, islamic accounting is further concerned with the entity’s shari’ah compliance and whether islamic objectives are being met (i.e. social-economic aspects of economic events and transactions). for example, islamic accounting looks to ensure that certain forbidden elements were not present during economic transactions, namely: (i) riba or ursury/interest; (ii) gharar or uncertainty; and (iii) maysir or gambling (including elements of gambling). similarly, there are differences regarding users of accounting information where conventional accounting mainly concerns shareholders and creditors. islamic accounting on the other hand concerns a broader range of shareholders which includes society as a whole, particularly due to the need to ensure a fair distribution of wealth among individuals. in this sense, it can also be said that islamic accounting is accountable towards all human beings as well as god (allah s.w.t) while conventional accounting requires personal accountability towards the individuals in control of the resources *and to some extent other shareholders). the main issue today is that the accounting policies adopted by islamic banks in preparation of their financial statements are largely unregulated [10]. this is why almost every islamic financial institution has developed its own accounting policy for the various contacts governing their work resulting in significant variations. these differences unfortunately make it difficult to compare the financial statements of islamic financial institutions, as well as make them look less credible in the eyes of international market players [10]. this will be discussed further when we look at the challenges facing islamic accounting in the next section. b. accounting and auditing organization for islamic financial institutions (aaoifi) in light of the need for standardization in islamic accounting, islamic financial institutions and other interested parties established the accounting and auditing organization for islamic financial institutions (aaoifi) in the early 1990s [10]. aaoifi is based in bahrain and operates as an independent international organization with support from some 200 institutional members coming from about 45 different countries [12]. however, the standards are implemented globally even in non-member states as they are applicable to ifis worldwide. the aaoifi’s main objective is to prepare and develop shari’ah compliant standards for ifis pertaining to their accounting, auditing, governance and ethical activities [12]. thus far, they have published some 85 standards, namely [13]:  26 accounting standards  5 auditing standards  7 governance standards  2 ethics standards  45 shari’ah standards the aaoifi also continuously works on developing new standards for ifis. this is important, particularly because the organization acts as an important player in the regulation of islamic banks, who are encouraged to adopt the standards which research suggests are relevant and of great use to ifis [14]. the aaoifi (2014, [13]) currently finances its activities from the proceeds of: (i) a waqf (endowment); (ii) charity ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 fund developed from the membership fees which every institution joining the aaoifi pays; (iii) annual subscription fees; (iv) grants; (v) donations; (vi) bequests; and (vii) other sources. iv. prospects of islamic accounting as is expressed in the previous sections, the contemporary experience of islamic accounting is minimal, not surpassing three decades. yet, it has managed to have a global impact proving to be a groundbreaking approach with much to offer. it is clear that there exists a well-developed body of thought on how islam can be applied in order to create a practical system for accounting or financial reporting. not only does the qur’an emphasize the need for such recordings, but historical evidence from previous islamic empires further acts as proof of this. some scholars have even suggested that the accounting practices used in the historical islamic state influenced the double entry accounting system developed in italy [9]. not to mention the fact that islamic accounting provides an alternative to conventional accounting practices. both are concerned with providing information and defining how that information is measured, valued, recorded and ultimately communicated. yet, islamic accounting is not only concerned with money as it provides a more holistic approach by analyzing transactions in both financial and non-financial terms in order to ensure no harm comes to society [15]. nonetheless, going forward, islamic accounting faces many challenges. a. challenges ahead the challenges faced by islamic accounting are, unfortunately, plenty namely due to the fact that western conventional systems have dominated the global scene making it difficult for islamic practices to incorporate. some of the major challenges include: 1) issues pertaining to historical evidence of islamic accounting here we have two aspects to consider. the first is that significant historical evidence from islamic societies has been destroyed over the centuries either as a result of the climate, which makes the preservation of historic documents difficult, or as a result of conflict. consider, in iraq alone there was the attack on baghdad by the mongols and, more recently, the destruction of the national library of iraq in 2003 [9]. the second issue is the presence of language barriers. modern academia is widely influenced by scholarly works produced in the english language while evidence of islamic accounting is found in eastern languages such as arabic and persian. what’s more, significant evidence is also found in written languages which are no longer in use today such as that used in the ottoman period. this limits the number of individuals who are able to analyze what archives remain. 2) lack of knowledge and understanding, prejudices many individuals unfortunately know very little about islam let alone islamic economics or accounting. furthermore, there is much stigma in the west associated with islam meaning anything associated with it carries the same negative connotation. much of these biases and prejudices stem from a lack of knowledge and understanding pertaining to islam and islamic practices, or are fueled by negative media. the biggest concern is the spread of the belief that islamic accounting is only for muslims. this is definitely not the case as islamic accounting only provides an alternative to conventional accounting, where islamic accounting is more holistic in its approach. 3) regulatory issues as discussed earlier, islamic financial institutions must abide by shari’ah so they require an accounting system which accommodates this need. the difficulty in this lies in the fact that accounting academics and practitioners are not accustomed to this and do not know how to implement it into their accounting practices. this is why today the accounting policies put into place by islamic banks are largely unregulated leading to a multitude of varying accounting policies [10]. for example, islamic financial institutions use at least six methods to recognize profit generated from murabahah transactions. these differences can be associated with the different views on shari’ah, depending on the school of thought followed in the country. either way, these differences make it difficult to compare the financial statements of islamic financial institutions, also making them less credible and legit in the eyes of international market players [10]. v. conclusion it is clear that the need for an islamic accounting system is immense, particularly in meeting the socio-economic objectives based on shari’ah which islamic financial institutions must abide by. as is laid out in this paper, there is a clear historical presence of islamic accounting from revelations in the qur’an to the practices of the prophet p.b.u.h and the second caliph, umar. although it is difficult to specifically identify the historical influence of islamic accounting, particularly due to the loss of archives over the centuries, evidence suggests that islamic accounting influenced western accounting, including the double-entry system still used today. with the arrival of islamic financial institutions, which abide by the shari’ah, came the need for the revival and reformation of islamic accounting. as expected, differences between islamic accounting and its conventional counterpart exist and are mainly concerned with the prohibition of interest, and other non-shari’ah complaint activities, as well as the socioeconomic objectives such as the betterment of society (or not causing harms to others through your business). despite these differences, islamic accounting has been able to re-develop and grow in the modern economic markets with its greatest development arguably being the establishment of the accounting and auditing organization for islamic financial institutions (aaoifi). not only did this provide islamic financial institutions with accounting policies helping harmonize accounting practices, but it also gave it more credibility in the views of international market players. yet, it can be concluded that islamic accounting still faces many challenges which it should overcome in order to move forward. nonetheless, its prospects and ability to offer an alternative to the conventional system are significant, making it a field worth investigating and contributing to. ejif – european journal of islamic finance no3, dec (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 vi. references [1] r.h. parker, ‘the scope of accounting history: a note’. abacus, vol. 29, iss. 1, pp. 106-11, 1993. [2] n. ramachandran, and r. kakani, ‘financial accounting for management’. new delhi: tata mcgraw-hill pub, 2005. [3] m. chapra, and r. whaples, ‘islamic economics: what it is and how it developed’. eh. net encyclopedia, 2008. [4] o. zaid, ‘accounting systems and recording procedures in the early islamic state’. accounting historians journal, vol. 31, iss. 2, pp. 149170, 2004. [5] z. iqbal, and a. mirakhor, ‘an introduction to islamic finance’. singapore: john wiley and sons (asia), 2011. [6] r. haniffa, m. hudaib, and a. mirza, ‘accounting policy choice within the shariah islamiiah framework’. discussion papers in accountancy and finance, sobe, university of exeter, vol. 2, pp. 4-19, 2004. [7] m. ambashe., and h.a alrawi, ‘the development of accounting through history’. international journal of advances in management and economics, vol. 2, iss. 2, pp. 95-100, 2013. [8] k. naser, and r. nuseibeh, ‘quality of financial reporting: evidence from the listed saudi nonfinancial companies’. the international journal of accounting, vol. 38, iss. 1, pp. 41-69, 2003. [9] c. napier, ‘defining islamic accounting: current issues, past roots’. accounting history, vol. 14, iss. 1-2, pp. 121—144, 2009. [10] r. abdel-karim, ‘accounting and auditing standards for islamic financial institutions’. in proceedings of the second harvard university forum on islamic finance: islamic finance into the 21st century, cambridge, massachusetts: center for middle eastern studies, harvard university, pp. 239-241 , 1999. [11] b. shanmugam, v. perumal, and a. ridzwa, ‘issues in islamic accounting’. serdang: universiti putra malaysia press, 2005. [12] a.m. sarea, and m.m hanefah, ‘adoption of aaoifi accounting standards by islamic banks of bahrain’. journal of financial reporting and accounting, vol. 11, iss. 2, pp. 131-142, 2013. [13] aaoifi, ‘aaoifi structure about aaoifi’. retrieved 22 may 2014, from http://www.aaoifi.com/en/about-aaoifi/aaoifi-structure.html [14] t. vinnicombe, ‘a study of compliance with aaoifi accounting standards by islamic banks in bahrain’. journal of islamic accounting and business research, vol. 3, iss. 2, pp. 78-98, 2012. [15] h. elasrag, ‘principals of the islamic finance:a focus on project finance’. (phd). munich personal repec archive, 2014. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france a comparative study of stability & consumer confidence between islamic & conventional banks in bangladesh sisili rahman, university of asia pacific abstractthis study exhibits a comparative analysis of consumer confidence and bank-level stability factors between islamic and conventional banks in bangladesh. the study finds that despite having lower liquidity islamic banks are able to provide higher consumer confidence levels than conventional banks. islamic banks have reported very small non performing asset (npa), and shown a positive and significant relationship with liquidity implying that during the crisis islamic banks tend to take rigid risk strategies compared to conventional banks. cost income ratio (cir) is inversely and insignificantly related in both types of banks. as increase in cost decreases the stability of the bank, profit before tax (pbt) gives expected positive and significant relationship in all cases. increase in pbt increases the stability and consumer confidence level but the level of significance is higher in case of islamic banks. cc represents consumers’ confidence and shows positive result in all cases but with an exception with conventional bank in tq factor. keywords: islamic bank, conventional bank, stability, consumer confidence, unit root test, random effect regression i. introduction the stability of the banking sector is instrumental in ensuring the steadiness of the entire financial system of an economy. banks are the key players in payment system, money creation, savings, investment and ensuring overall economic goal. bank’s stability is normally reflected by liquidity (lq), return on asset (roa), value (tq), and consumers’ confidence (cc) measured by the percentage of deposit in the total liability. islamic banks have a different and unique form of product mix which protect their stability in case of financial crisis. generally, there is a distinctive characteristic of liquidity management of islamic banks compared to conventional banks. similarly, the unique product mix is complied with the requirement of basel accord. it often impacts different level of risk capital and credit risk. while being exposed to same market conditions of an economy, whether the product mix of islamic banks has analogous consequence towards prevailing stability and confidence of the consumers like conventional banks is salient to determine. an econometric approach has been used for the comparison of stability and consumer confidence using actual data rather than any perceived or established outcome. it is done by examining the stability factors of bank performance (roav volatility) and firm value (tobin q ) both in the islamic and conventional commercial bank because the level of non-performing assets (npa) as a result of bad loan screening lending to sub-prime borrowers (reflected in loan-loss provisioning). finally, through sensitivity to deposit (consumer confidence) over total liabilities it is examined that http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 ejif – european journal of islamic finance no13, august (2019) whether the results are different or same in the two banking sectors. ii. literature review several researches have been conducted on the stability factor of various types of banks and financial institutions. with the emergence of islamic banks and its outstanding contribution to the financial market and country’s economy, authors have also conducted a number of studies to compare between these two major types of banks in many countries. this paper has been prepared based on the knowledge of previously conducted researches and similar result has been found in most cases. rochet (1992) noted that capital regulations cannot control the risk taking behavior of the banks [14]. so effectiveness is largely dependent on whether the banks are maximizing their value. banks often shift their product mix to riskier asset with higher leverage ratios. so to correct it they should use solvency ratio rather than leverage ratios. many of the islamic scholars believe that sphere of profit in islamic banking is interrelated. among other more recent studies, alaro, razzak and hakeem (2011) found that in terms of risk management islamic banks are more competent than conventional banks [2]. another study of malaysia’s financial stability report (2011) found that the countries where islamic banks are major and key player of the economy are less instable than those which are managed by conventional banks. hadeel abu loghod (2010) noted that the major reason behind the higher deposits and liquidity of islamic banks are their specialized products such as mudaraba, musharakah, murabahah, ijarah, and profit and loss sharing mechanism [11]. in bangladesh islamic banks are adapting new techniques both quantitative and as well as qualitative to manage their credit risk and uphold the consumer confidence in their banking mechanisms. hasan and dridi (2010) found that the asset growth of islamic banks was double than that of other conventional banks in 2007-2009 [18]. again, higher loan to asset ratio negatively impacts the stability. biancone & radwan (2016) stated that variety is the financial instruments offered by islamic finance has not only depicted a positive growth but also is recognized as a lucrative investment opportunity [26]. size of the ban and net working capital have positive but insignificant relation with the liquidity risk in islamic banks whereas negative relation s found in case of conventional bank for size of the bank [23]. competitive condition could not define any significance in relationship between the weighted assets ratio and islamic bank behavior. cost income ratio is another measure of efficiency. the lower the ratio the higher the profitability will be. and it is negatively related to z-scores. banks often think that their poor financials maybe improved with higher loan disbursement [17]. the prohibition of predetermined income (interest income) with the commands of quran is another prominent cause of lower non performing loans of islamic banks compared to their counter parties [18]. many studies [7,18 & 21] have found superior performance by islamic banks and their larger contribution in keeping the economy stable. iqbal and molyneux (2005) have used frontier approach to conduct their study while others have used simple ratios, z-scores and regression model [20]. (berger, hunter & timme, 1993) by focusing on cost management by the two types of banks and it was found that the revenue sides held most inefficient forces [4]. the studies have proved that islamic banks are more efficient and profitable than conventional banks in other countries as well. the http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ejif – european journal of islamic finance no13, august (2019) practice of islamic banking in bangladesh is in its mid 30s with the emergence of islami bank bangladesh limited in 1983. several since then several studies have conducted to decide upon its performance and significance of the country’s financial sector. this paper is one to find out the recent stability factor and level of confidence of the consumers of the two major types of banks operated in bangladesh. iii. methodology based on the availability of data 7 islamic banks (listed) and 24 conventional banks are taken into consideration for conducting the study. the period of data set is 2007 to 2017. the data are collected from the annual reports of the banks listed in the country’s stock exchange for the above mentioned period. the variables are: return on banks average asset (roa), non performing asset proxied by loan loss provision over total asset (npa), liquid asset over total asset (liq), equity over earning (tq), consumer confidence proxied by deposit over total liabilities and equity (cc), cost income ratio (cir), profit before tax (pbt), loan loss provision over total loan (llp), equity to asset ratio. (eta), net loan over total asset (nlta). here, roa, npa, li and tq are the dependent variables while rest others being the independent variables [15]. a. unit root testaugmented dickey fuller accurate result cannot be derived from a nonstationary time series data set. so, the precondition of running any econometric analysis is to conduct a unit root test. apart from that, according to engle and granger (1987), a long-run relationship exists only when there is a similar order of integration between the variables [29]. the augmented dickey-fuller (adf) test is extensively used for testing stationarity of the variables (dickey, fuller, 1979, 1981) [32]. later on a modification was incorporated by phillips and perron (1988) to give it a more comprehensive look [33]. the test is conducted at individual variables in level log form and the first differenced log form. if the log forms or first differenced log forms reject the null hypothesis (h0: series has a unit root), the time series is stationary. the unit root test is run on the basis of the following model: ∆yt = ∂ + by(t-1) -1 + et (1) here, ∆ = 1st difference operator ∂ = constant/intercept et = error term sometimes variables have auto correlation. to deal with this problem dickey fuller had developed the following three models: 1. type 0=no intercept, no trend 2. type 1=intercept but no trend 3. type 2=intercept and trend ∆yi = β1yi-1+ � yj p j=1 ∆yi-j+ εi (2) ∆yi =β0+ β1yi-1+ � yj p j=1 ∆yi-j+ εi (3) ∆yi =β0+ β1yi-1+β2i+ ∑ yj p j=1 ∆yi-j+ εi (4) to make the data set stationary differentiation is required. ho= variables is not stationary or got unit root. h1= variables is stationary or does not have unit root. b. granger causality being proposed in 1969 by clive granger, granger causality is used to test the appropriateness of one time series data for another. it tests the “predictive causality”. regression may reveal a mere causality only. stationary data set s a prerequisite for testing granger causality and var model. a series of thttp://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 ejif – european journal of islamic finance no13, august (2019) test and f-test on lagged values of x can determine whether x variable granger cause y variable (y value is also lagged). if the time series is already stationary then level data is used for this test. if the data set is non-stationary then first differentiation is used and then 2nd differentiation f required. h0: null hypothesis: variable x does not cause variable y h1: alternative hypothesis: variable x causes variable y. iv. results and interpretations a. descriptive statistics here (table 01) the mean of pbt is for islamic bank (2480) is higher than that of conventional banks (2060). this difference is attributed to two main factors. first, to some extent the nature of accounting treatment of pbt in profit loss sharing arrangement may be counted as a financial cost, and second but to a great extent islamic banks earn high pbt owing to its prices. another difference is shown in npa because islamic banks show npa under profit loss sharing adjustment. the mean value of cost income ratio, cir for islamic bank is 0.32 and for nonislamic banks is 0.45. 1) islamic banks table 01: descriptive statistics of islamic banks particulars cc ci eta li nl npa pb ro tq mean 0.8 0.3 0.02 0.1 0.7 0.03 24 0.02 5.92 median 0.8 0.3 0.07 0.1 0.7 0.03 18 0.01 5.97 maximu 1.0 1.2 0.13 0.2 8.5 0.08 12 0.24 37.0 minimum 0.6 0.0 0.0 0.02 -0.10 -8.56 std. dev. 0.0 0.3 0.16 0.0 1.0 0.01 32 0.04 6.28 skewness 0.8 0.2 7.0 1.13 1e 2.46 1.88 kurtosis 4.0 3.2 8.90 2.5 53. 4.15 5e 19.13 12.4 sum 51. 32. 1.06 11. 48. 2.14 2e 1.06 372. sum 0.2 7.1 1.67 0.1 64. 0.01 7e 0.10 2446 2) conventional banks table 02: descriptive statistics of conventional banks particula cc ci eta liq nlt np pbt roa tq mean 0.74 0.4 0.075 0.26 0.680 0.05 2060 0.0114 8.320 median 0.80 0.4 0.073 0.24 0.702 0.05 1.82e+ 0.0122 6.024 maximu 0.90 0.8 0.154 0.6 1.044 0.17 7.11e+ 0.0323 37.49 minimu 0.02 0.2 0.03 0.068 0.01 std. 0.21 0.1 0.033 0.08 0.129 0.03 1.86e+ 0.0162 6.759 skewnes 1.4 0.58 1.38 -3.69e 2.112 kurtosis 9.88 6 18.09 5.14 9.288 4.66 3.539e 98.211 9.513 sum 106. 64. 10.83 37.5 98.02 8.46 2.97e+ 1.6474 1198. sum sq. 6.32 1.6 0.160 0.94 2.404 0.21 4.92e+ 0.0377 6532. adf test is conducted to test the stationary of the data set. if there is a trend in data set then 1st differentiation is needed to be conducted to remove the nonstationary property. if not fully removed then 2nd differentiation is applied. in this study all the variable are already stationary. the probability for roa is 0.00, tq is 0.01, cir is 0.00, cc is 0.002, pbt is 0.003, nlta is 0.03, liq is 0.004. that means variables do not have any unit root. table 03: granger causality test null hypothesis: f-statistic probability cc does not granger cause liq 11.3918 2.00e-05 cc does not granger cause npa 0.12935 0.0788 cc does not granger cause roa 0.07598 0.0269 cc does not granger cause tq 8.41658 0.0003 cir does not granger cause liq 0.11311 0.02931 cir does not granger cause npa 0.26278 0.07693 cir does not granger cause roa 21.1024 8.00e-09 cir does not granger cause tq 0.24811 0.03806 eta does not granger cause liq 0.77133 0.0342 eta does not granger cause npa 0.94309 0.00916 eta does not granger cause roa 4.005 0.0201 eta does not granger cause tq 1.93172 0.0483 nlta does not granger cause liq 0.44216 0.0434 nlta does not granger cause npa 1.40924 0.02474 nlta does not granger cause roa 20.5199 1.00e-08 http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 ejif – european journal of islamic finance no13, august (2019) nlta does not granger cause tq 2.7111 0.0696 pbt does not granger cause npa 0.64837 0.0243 pbt does not granger cause roa 0.02564 0.05247 pbt does not granger cause tq 3.08221 0.0487 pbt does not granger cause liq 0.44744 0.0401 as the value of the almost all of the probability is less than 0.05 so there is a causality relation between them. but few variables show the opposite outcome. b. fixed vs. random effecthausman test the probability of the hausman test is derived as 1.00 and it indicates that random effect model is best suitable for this data set to conduct regression model. 90% confidence level is considered and 10% level of significance is allowed in conducting the regression model. c. random effect regression table 04: coefficients of the independent variables with roa islamic bank conventional bank all bank cons 0.141295 0.004964 0.026824 cc 0.145595 0.003866 0.003138 cir -0.024832 -0.025941 -0.053455 pbt 2.80e-12 7.01e-12 2.98e-12 eta 0.127956 -0.007491 0.002977 nlta 0.014979 0.016668 -0.010159 table 05: coefficients of the independent variables with tq islamic bank conventional bank all bank cons 17.56869 0.80658 10.41641 cc -28.93446 -9.349169 -9.584313 cir -4.688297 -19.01269 -9.9664 pbt -5.43e-10 1.12e-09 -6.86e-10 eta -11.75549 112.2729 -29.33747 nlta -1.708535 1.995513 -0.578676 table 06: coefficients of the independent variables with liq islamic bank conventional bank all bank cons 0.036708 0.227645 0.20999 cc 0.144223 0.002817 -0.017617 cir 0.039501 0.082031 0.05965 pbt 2.41e-12 -1.24e-12 1.22e-12 eta 0.157697 -0.217199 0.204524 nlta 0.004615 -0.025824 0.007305 table 07: coefficients of the independent variables with npa islamic bank conventional bank all bank cc 0.046574 0.088268 0.083362 cc 0.019791 0.027896 -0.058131 cir 0.000376 0.044299 0.011664 pbt 7.22e-13 2.66e-12 1.71e-12 eta 0.001104 -0.168077 0.039833 nlta 0.001963 -0.068857 0.000984 these tables (4,5,6,7) give the comparative results of the four regressions, which shows how the two types of banks are impacted by changes in financial conditions. roa which is the return on average asset is one stability factor. cir is inversely and insignificantly related in both types of banks. a rise in cost decreases the stability of the bank. eta is significantly and positively related in case of islamic bank. but it shows inverse and insignificant result for conventional banks. pbt gives expected positive and significant relationship in all cases. increase in pbt increases the stability and consumer confidence level. furthermore, islamic banks reported very small npa, and have shown a positive and significant relationship with liquidity. nlta shows expected inverse relation with liquidity factor but it is insignificant in case of islamic banks. cc represents consumers’ confidence. and positive result in all the cases but with an exception with conventional bank in tq factor has been found. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 ejif – european journal of islamic finance no13, august (2019) and the result is more significant with the islamic banks than conventional banks. the effect of instability is measured by tobin’s q model. it also assesses whether there is similar impact on conventional and islamic banks. tobin q for all banks is inversely, but significantly, related to bank specific factors of pbt, eta, nlta, cc, cir for all banks. this indicates that the bank value increases with the decrease in stability factor. on the other hand, a positive relationship for pbt is found for conventional banks indicating that profitability factors posit significantly for bank values. d. significance of model table 8: significance test islamic bank roa tq liq npa f-statistics 4.368033 3.71891 2.02392 0.53405 prob (f-stat) 0.001957 0.00555 0.08889 0.047 conventional bank roa tq liq npa f-statistics 57.08982 14.0647 0.47745 4.64342 prob (f-stat) 0.05 0.01 0.09 0.0006 all bank roa tq liq npa f-statistics 11.11861 10.6274 1.04802 3.13205 prob (f-stat) 0.005 0.002 0.039 0.00957 as it is known that if the p value of f statistics is less than 0.10 then the model is significant. the lesser the value the more significant the model become. it is seen that in most of the cases p value of f statistics is less than 0.10 so the regression models are significant enough to describe the relationship among dependent and independent variables. v. findings and conclusion conventional banks charge average fixed interest rate regardless of the profitability of the project. islamic banks charge proportional cost of financing in according to the profitability of the project which is totally contrary to the system of conventional. conventional banks do not always utilize their full investment opportunities. some portion is remained unused. on the other hand, islamic banks make the best use of their investment opportunities which were untapped in the economy. this leads to a direct linkage between the success of the project and the income of islamic banks. in other words, the rise and fall in the projects’ return financed by a bank effects its net income. thus the islamic banking system is very much concerned about the performance of the project for which financing has been provided. productivity is hampered in two folds in conventional banks. first of all, the capacity and resources are not used to recover non performing loans rather these are being involved in choosing new projects. loan loss provision also hampers profitability. on the other hand, islamic bank practice profit-loss-sharing mechanism which is a fruitful way to recover loans. the borrower faces a fixed or nonflexible loan payment schedule in conventional banks. it burdens them with an uncertainty in cash flows. consequently, the economy with more of conventional banks faces a cyclical volatility in its performance. this instability continues because of the fixed payment schedule. but the islamic banks receive a certain portion of the income derived by its investments in addition to the principal payment. and it is not obligatory to make payment when there is no earning. loss is also shared by the islamic banks in proportionate basis. this mechanism encourages the entrepreneurs to a good extent. they need not http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 ejif – european journal of islamic finance no13, august (2019) to pay a higher (fixed) amount when lower profit is earned. in this way the gap or spread between profits and payment commitment is lessened by large margin. all this issues have uphold the consumers’ faith in islamic banks more than conventional banks. and thus deposit is also higher in case of islamic banks. as it is said before that stability and performance comes hand in hand with consumer confidence, islamic banks have managed to outperform in stability factor as well. references [1] ai-abdullatif, s. abdullah, “the application of the aaoifi accounting standards by the islamic banking sector in saudi arabia”, doctoral dissertation, durham university, 2007. [2] alaro, a. razzak., & m. hakeem, “financial engineering and financial stability: the role of islamic financial system”, journal of islamic economics, banking and finance, vol. 7(1), 25-38, 2011. [3] a. levin, c. f. lin, and c. s. j chu, “unit root tests in panel data: asymptotic and finite-sample properties”, journal of econometrics, vol. 108(1), pp. 1-24, 2002. [4] a. n. berger, w. c. hunter, and s. g. timme, “the efficiency of financial institutions: a review and preview of research past, present and future”, journal of banking & finance, vol. 17(2-3), pp. 221-249, 1993. [5] a.q.m. s. arif, secretary general, central shari‘a board for islamic banks of bangladesh, an interview, 16 april, 2014. [6] azad, m. a. kalam., and â. m. r sir, “prospects analysis of an islamic capital market in bangladesh”, global journal of management and business research, 2013. [7] bader, m. i. khaled, s. mohamad, m. ariff, and t. h. shah, “cost, revenue, and profit efficiency of islamic versus conventional banks: international evidence using data envelopment analysis”, 2008. [8] f. allen, d. gale, “competition and financial stability. journal of money, credit and banking”, vol. 36(3), pp. 453-480, 2004. [9] g. bekaert, c. r. harvey, c. lundblad, and s. siegel, “global growth opportunities and market integration”, the journal of finance, vol. 62(3), pp. 1081-1137, 2007. [10] g. l. kaminsky, and c. m. reinhart, “the twin crises: the causes of banking and balance-of-payments problems”, american economic review, vol. 89(3), pp. 473-500, 1999. [11] h. a. loghod, “do islamic banks perform better than conventional banks? evidence from gulf cooperation council countries”, journal of management, vol. 7(3), pp. 56-72, 2010. [12] h. i. mobolaji, and a. r. a. alaro, “financial engineering and financial stability: the role of islamic financial system”, journal of islamic economics, banking and finance, vol. 113(464), pp. 1-14, 2011. [13] i. s. drissi, and k. angade, “islamic financial intermediation the emergence of a new model”, european journal of islamic finance, vol. 12. pp. 1-7, 2019. [14] j. c. rochet, “capital requirements and the behaviour of commercial banks”, european economic review, vol. 36(5), pp. 1137-1170, 1992. [15] k. hussein, “bank-level stability factors and consumer confidence—a comparative study of islamic and conventional banks’ product mix”, in islamic finance, pp. 86-104. palgrave macmillan, cham, 2016. [16] k. mukminin, “profit maximization in islamic banking: an assemblage of maqasid shariah conception”, european journal of islamic finance, vol. 12, 2019. [17] s. kwan, r. a. eisenbeis, “bank risk, capitalization, and operating efficiency”, journal of financial services research, vo. 1;12 (2-3), pp. 117-31, 1997. [18] m. ariff, “islamic banking, a variation of conventional banking”, monash business review, vol. 4(3), pp. 1-8, 2006. [19] m. hasan, and j. dridi, “the effects of the global crisis on islamic and conventional banks: a comparative study”, journal of international commerce, economics and policy, vol. 2(02), pp. 163-200, 2011. [20] m. iqbal, p. molyneux, and s. conermann, “thirty years of islamic banking. history, performance and prospects”, bankhistorisches archiv, 32(2), 155-158, 2006. [21] m. k. hassan, m. and a. h. m. bashir, 2003 “determinants of islamic banking profitability”, 10th erf annual conference, morocco, vol. 7(1), pp. 2-31, 2003. [22] m. k. hassan, and m. f. dicle, “basel ii and regulatory framework for islamic banks”, journal of islamic economics, banking and finance, vol. 1(1), pp. 1-16, 2005. [23] m. l. rahman, and s. h. banna, “liquidity risk management: a comparative study between conventional and islamic banks in bangladesh”, journal of business and technology (dhaka), vol. 10(2), pp. 18-35, 2015 [24] m. rahim, s. rohaya, and r. h. zakaria, “comparison on stability between islamic and conventional banks in http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 ejif – european journal of islamic finance no13, august (2019) malaysia” journal of islamic economics, banking and finance, vol. 113(915), pp. 1-19, 2013. [25] m. u. chapra, “the future of economics: an islamic perspective”, kube publishing ltd. vol. 21, 2016. [26] p. p. biancone, and m. radwan, “european companies: evaluation for sharia compliance “opportunities and challenges”, european journal of islamic finance, vol. 5, 2016. [27] p. p. biancone, and m. radwan, “social finance and unconventional financing alternatives: an overview”, european journal of islamic finance, vol. 10, pp. 1-6, 2018. [28] r. ameer, r. othman, and n. mahzan, “information asymmetry and regulatory shortcomings in profit sharing investment accounts”, international journal of islamic and middle eastern finance and management, vol. 5(4), pp. 371-387, 2012. [29] r. f. engle, and c. w. granger, “co-integration and error correction: representation, estimation, and testing, econometrica” journal of the econometric society, pp.251-276, 1987. [30] s. kwan, and r. a. eisenbeis, “bank risk, capitalization, and operating efficiency”, journal of financial services research, vol. 12(2-3), pp. 117-131, 1997. [31] t. beck, demirgüç-kunt, a., and o. merrouche, “islamic vs. conventional banking: business model, efficiency and stability”, the world bank, 2010. [32] a. d. dickey, d. p. hasza, and w. a. fuller, “testing for unit roots in seasonal time series”, journal of the american statistical association, vol. 79(386), pp.355-367, 1984. [33] p. v. phillips, and p. perron, “testing for a unit root in time series regression”, biometrika, vol. 1;75(2), pp. 33546, 1988. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france i. introduction ii. literature review iii. methodology a. unit root testaugmented dickey fuller b. granger causality iv. results and interpretations a. descriptive statistics 1) islamic banks 2) conventional banks b. fixed vs. random effecthausman test c. random effect regression d. significance of model v. findings and conclusion references islamic and traditional corporate finance: http://www.ojs.unito.it/index.php/ejifi ssn 2421-2172 1 islamic and traditional corporate finance: a comparative study on wacc nicola miglietta and enrico battisti* * nicola miglietta, department of management, university of turin, italy, nicola.miglietta@unito.it enrico battisti, department of management, university of turin, italy, enrico.battisti@unito.it abstract— the paper represents a first exploratory study based on the comparison between the weighted average cost of capital (wacc) of a sample of companies listed on malaysian stock exchange, classified and shared according to the principles of islamic finance (i.e. riba, risk sharing, haram). in particular, the main aim of the analysis is to provide some evidences of the potential effect on the risk (measured by beta) on the wacc as result of the principles used to divide the companies between shari’ah compliant and not shari’ah compliant. generally our findings are focused on a greater level of wacc related to the lcsc that belong to the majority of selected sectors and, according to the principles of islamic finance, they have shown a leverage ratio lower than that of companies not shari’ah compliant. keywords: weighted average cost of capital (wacc); islamic corporate finance; traditional corporate finance; risk; listed companies. i. introduction the traditional principles of corporate finance postulate that each firm carries out some choices related to where to get the funds (investment decision), how to invest it (financing decision) and when to return the excess cash (dividend decision). the same choices can be referred to an islamic firm. we can therefore assert that the financial goal of the firm is to maximize the shareholder value. this goal is widely accepted in both theory and practice (e.g. copeland, weston & shastri, 2004; van horne and wachovicz, 2008; damodaran, 2011; vernimmen, quiry, dallocchio, le fur & salvi, 2014; brealey, myers & allen, 2014) and can be applied to islamic firms (e.g. aggarwal & yousef, 2000; habib, 2007; nagano, 2010; salvi & miglietta, 2013). what is different and what is the impact on value creation? the principles that a shari’ah compliant company must follow with reference to its capital structure diverge from a traditional firm. in particular, profit and loss sharing (pls) and markup financing, in addition to legal-religious principles, could play a significant role on the system of capital structure puzzle and, consequently, on the weighted average cost of capital (wacc). as known in the corporate finance, wacc represents the minimum acceptable hurdle rate of return within the investment decision. finally, the hurdle rate should be higher for riskier projects and reflect the financing mix used (debt or equity) (damodaran, 2011). the aim of the paper is to present some evidences of the potential effect on the risk (measured by beta) on the wacc as a result of the islamic finance principles used to divide the companies between shari’ah compliant (lcsc) and not shari’ah compliant (lcnotsc). the paper is organised as follows. first, we introduce a theoretical background of the islamic finance principles and their effects on the capital structure. after the main differences between the cost of capital in the traditional and islamic corporate finance, we develop a comparative study on wacc. ii. islamic finance: a theoretical background islamic finance is a financial institution and product designed to comply with the central principles of shari’ha (a legal framework of islam). it is one of the most growing segments of the global finance industry (gait & worthington, 2007). in particular, islamic financial markets have gained impulse over the past few decades, as demonstrated by the global proliferation of islamic financial institutions. this proliferation has been accompanied by parallel increases in islamic financial products. the principles of islamic finance have been analyzed by muslim and not-muslim researchers alike (e.g. dar & presley, 1999; warde, 2000; iqbal mailto:nicola.miglietta@unito.it mailto:enrico.battisti@unito.it ejif – european journal of islamic finance no 4,march (2016) http://www.ojs.unito.it/index.php/ejifi ssn 2421-2172 2 & molyneux 2005; metwally, 2006) but the number of literatures focusing on islamic finance from the point of view of corporate finance is scant (e.g. aggarwal & yousef, 2000; habib, 2007; nagano, 2010). notably, islamic finance is based on the legalreligious principles of shari’ah, geared mainly to illustrate what not to do rather than on what is lawful to do (biancone, 2012). islamic financial system requires transactions to be linked to the real sector, leading to fruitful activities that produce income and wealth (kfh research, 2014). in particular, the aim of shari’ah is to promote actions that do not affect people and society adversely through the violation of religious bans. the main principles of islamic finance are (gait & worthington, 2007): the prohibition of riba and the exclusion of debt-based financing from the economy; the prohibition of gharar encompassing the full disclosure of information and elimination of any asymmetrical information in a contract; the prohibition of maysir encompassing the exclusion of financing and dealing in sinful and socially irresponsible activities and commodities such as gambling, drugs and pork or the production of alcohol and other games of chance (i.e. casino-type games, lotteries); materiality that is a direct or indirect link to a real economic transaction. islamic finance supports people to invest their cash effectively without any wrongdoing for those who are either borrowers or lenders; justice, a financial transaction should not lead to the utilization of any part to the transaction. islamic finance rejects that it can be realized a gain without taking a risk. the funding to the business entity is permitted, but the return must be tied exclusively to the results linked to the use of capital (gomel, 2010). this is the base of the profit and loss sharing (pls), that is a form of partnership, where partners share profits and losses based on their capital share and work. in particular, the concept of pls is the method utilized in islamic banking to comply with the prohibition of interest and it is a contractual agreement between two or more transacting parts, which allows to bring together their resources to invest in a project to share in profit and loss (dar & presley, 2000). iii. the effects on the capital structure the literature on capital structure started with the contributions of franco modigliani and merton miller (modigliani & miller, 1958), whose propositions are, even today, the theoretical and explanatory keys for proper framing of the issues related to funding choices. for modigliani and miller (1958), there is not a relation between capital structure and the value of the firm. these studies also allow to understand the evolution of the theories developed in the following years (harris & raviv, 1991): starting from the a) trade-off theory (theory that capital structure is based on a trade-off between tax savings and cost of bankruptcy), through the b) pecking order theory (theory stating that firms prefer to issue debt rather than equity if internal finance is not sufficient) until the c) agency theory. as observed in the introduction, the studies on islamic finance from the point of view of capital structure are not frequent. according to the traditional corporate finance, the weighted average cost of capital (wacc) and the theories on the capital structure and its relationship with the creation of shareholder value have featured countless research and determined the principles that underpin the system of the financial decisions for the traditional firm (e.g. fama & french, 1999; damodaran, 2011; dallocchio & salvi, 2011; tardivo, schiesari & miglietta 2012; brealey, myers & allen, 2014) and, also, for the islamic firm (e.g. habib, 2007; mohamad & saad, 2012; shafizal & mansur, 2013). the financial manager (anyone responsible for an investment or financing decision) of a traditional firm must choose a composition of sources (debt and equity) that maximizes the value of investments and which is in line with the strategic profile and risk; from these decisions derives its capital structure. for an islamic firm, the financial decisions system is not substantially different from that of a traditional firm (salvi & miglietta, 2013). as known, the principles of islamic finance have direct impact on the choice of capital structure. the financial contracts that can be compared with the equity are: musharakah: it is an agreement under which the islamic bank provides funds, which are mingled with the funds of the business companies and others (www.islamic-banking.com). mudarabah: it is similar to the concept of silent partnership which financial capital is provided by a partner and the other partner (ahmed, 2007) executes the work. for the islamic finance, the financial contracts that can be compared with the debt are: murabahah: it is a sale contract at a markup; the seller adds a profit component to the cost of the item being sold (ahmed, 2007). http://www.islamic-banking.com/ ejif – european journal of islamic finance no 4,march (2016) http://www.ojs.unito.it/index.php/ejifi ssn 2421-2172 3 salam and istisna: it is one of the basic conditions for the validity of a sale in shari’ah that the commodity must be in the physical or constructive possession of the seller; salam is used to finance agricultural like goods and istisna is utilized to finance manufactured like goods (www.blomdevelopment.com). ijarah: it is an agreement that permits one party (the lessee) to use an asset or property owned by another party (the lessor) for an agreed-upon price over a fixed period of time (www.financialislam.com). iv. the cost of capital for islamic and traditional corporate finance according to the traditional corporate finance, the company’s cost of capital is usually estimated as a weighted average cost of capital that is the average rate of return that a firm expects to compensate all its different investors; the weights are the fraction of each financing source (debt and equity). this is the company’s cost of financing and the minimum return its investments must generate in the medium term (vernimmen, quiry, dallocchio, le fur & salvi, 2014). the formula is: a) wacc = ke (e/e+d) + kd (d/e+d) where: e = market value of the company’s equity d = market value of the company's debt e+d = total market value of the company ke = cost of equity kd = cost of debt to calculate the wacc it is necessary an estimate of the cost of equity and debt. in particular, the hardest part of estimating the wacc is to understand the cost of equity that is the expected rate of return to investors in the company’s common stock; many traditional firms look to the capital asset pricing model for an answer (brealey, myers & allen, 2014). the capital asset pricing model (capm) asserts that the expected rate of return is equal to the risk free interest rate plus a risk premium, that depends on beta (measure of market risk) and the market risk premium. 4.1 cost of capital for traditional corporate finance the cost of debt is defined as the remuneration requested by third parts that finance the company according to the risk endured. the formula is: b) kd = i × (1– t) where i = interest rate (risk free interest rate plus default spread) t = tax rate the cost of equity is the return required to invest capital in a risky activity and it represents the opportunity cost of capital incurred for failing to invest the capital in another activity of the same degree of risk. the formula is: c) ke = rf + betalevered × mp where rf = risk free interest rate mp = market premium betalevered = measure of market risk 4.2 cost of capital for islamic corporate finance as above-mentioned, the cost of capital for islamic corporate finance based on mark-up tends to assume a structure similar to the traditional corporate finance. the process of estimating of the cost of debt in islamic finance provides a mechanism based on a benchmark derived from the traditional finance and equivalent to the “base cost” of the same source on which, through the application of the mark-up, it forms a “cost complement”. although in the process of estimating the cost of equity in islamic finance can be associated a “hurdle yield of return” that the lender is expected from the investment. by connecting the return with a situation of “minimum risk”, the cost of equity can be determined using a mechanism similar to that of the capm. in this sense, the application of capm in islamic finance implies some different considerations about the principles that govern the basics: not interest (riba) and profit and loss sharing. v. a comparative study on wacc a. research methodology referring to the shari’ah advisory council (sac) of the securities commission malaysia, we consider not shari’ah compliant all the firms involved in the following core activities: a) financial services based on riba (interest); b) gaming and gambling; c) manufacture or sale of non-halal products or related products; d) conventional insurance; e) entertainment activities that are non-permissible according to shari’ah; f) manufacture or sale of tobacco-based products or related products; g) stock broking or share trading on shari’ah non-compliant securities; h) other activities deemed nonpermissible according to shari’ah. for companies with activities comprising both permissible and nonpermissible activities, the sac measures level of mixed contributions from permissible and nonpermissible activities towards turnover and profit before tax of a company (securities commission of malaysia, 2014). the sac uses benchmarks based on ijtihad. in particular, the shari’ah advisory council applies a two-tier quantitative approach in http://www.blomdevelopment.com/ http://www.financialislam.com/ ejif – european journal of islamic finance no 4,march (2016) http://www.ojs.unito.it/index.php/ejifi ssn 2421-2172 4 determining the shari’ah compliant status of the listed securities: 1. business activity benchmarks; 2. financial ratio benchmarks. the activities are classified as shari’ah compliant if they are within the business activity benchmarks and the financial ratio benchmarks. in other words, if the contribution of non-permissible activities exceeds the benchmark, the securities shall be classified as not shari’ah compliant. 1. business activity benchmarks the contribution of not shari’ah compliant activities to the group revenue and group profit before taxation of the company will be computed and compared against the relevant business activity benchmarks as follows: a. 5% benchmarks (activities: conventional banking and insurance; gambling; pork and pork-related activities; shari’ah noncompliant entertainment; liquor and liquorrelated activities; tobacco and tobaccorelated activities; interest income from conventional accounts and instruments). b. 20% benchmarks (activities: stockbroking business; hotel and resort operations; share trading; rental received form shari’ah noncompliant activities). for these activities, the contribution of not shari’ah compliant businesses to the group revenue or group profit before taxation of the company must be less than 5% (a) and 20% (b). 2. financial ratio benchmarks a. cash over total assets; b. debt over total assets. each ratio, which is proposed to evaluate riba and riba-based elements within a company’s statements of financial position, must be less than 33% (www.bursamalaysia.com). in order to provide some preliminary evidences of the potential effect on the risk as result of the principles used to divide the companies between shari’ah compliant and not shari’ah compliant, we followed three research phases. first, we have identified stock markets that contained shari’ha compliant and not shari’ah compliant firms. in this sense, bursa malaysia offers a dynamic platform for issuers by supporting and assisting companies in fulfilling their capital raising needs and operates a fully-integrated exchange that offers a comprehensive range of products which includes equities, derivatives, offshore and islamic products as well as exchange related services such as trading, clearing, settlement and depository services. second, the companies on bursa malaysia listed under the main market are 814 (march 2015). in this second phase, we have recognized 598 listed companies shari’ah compliant (lcsc) and 216 listed companies not shari’ah compliant (lcnotsc). third, we have defined some items (filters) relevant to the purpose of our comparative analysis on wacc. we have considered the three following selection criteria of the listed companies: company profile: macro sector. key statistics: beta levered. financial health: debt/equity ratio. in this phase, we have evaluated as “not relevant”, and consequently excluded from the final dataset, the listed companies that do not have at least two of the three parameters mentioned above or some listed companies in which it was not possible to identify a single sector of belonging. consequently, 779 listed companies were our eligible target: 569 lcsc and 210 lcnotsc. this first result of the research is summarized in the following figure. figure 1: the percentage of listed company analysed b. data analysis from the sample of firms analysed, which corresponds to 96% of the universe of listed companies operating in the malaysian stock market, we have divided the undertakings for macro sectors: eight for the listed companies shari’ah compliant and nine for the listed companies not shari’ah compliant. for the lcsc sectors are real estate, basic materials, industrial, consumer, healthcare, energy, communication service, technology. for the lcnotsc these sectors are real estate, industrial, consumer, healthcare, energy, utilities, technology, financial service, basic materials. this second result of the research is summarized in the following two figures. http://www.bursamalaysia.com/ ejif – european journal of islamic finance no 4,march (2016) http://www.ojs.unito.it/index.php/ejifi ssn 2421-2172 5 figure 2: sectors for listed companies shari’ah compliant figure 3: sectors for listed companies not shari’ah compliant both for shari’ah compliant listed companies and for those not shari’ah compliant, the macro sector that has a higher number of listed companies is that of “consumer”, this last divided in “consumer cycling” and “consumer defensive”. in order to provide some preliminary evidences of the potential effect on the risk (measured by beta) as a result of the principles used to divide the companies between lcsc and lcnotsc, we have decided to analyse for each listed companies the following elements needed to calculate the average wacc of the sector: beta levered; debt/equity ratio. starting from these two elements, considered a malaysian tax rate of 14,50% (damodaran, 2015), we have calculated for each sector the levered and unlevered beta. the formula of beta levered is: d) beta levered = beta unlevered*[1 + (1 – t)*d/e] where t = tax rate d/e = debt/equity ratio. according with the previous formula, the beta unlevered is: e) beta unlevered = beta levered/[1 + (1 – t)*d/e] the third result of the research is summarized in the following two tables. real estate basic materials industrial consumer healthcare energy technology communication service beta levered 1,3980 1,3044 1,0827 0,8533 0,894 1,3052 1,0338 1,0516 beta unlevered 1,1128 1,0271 0,9315 0,7097 0,8015 1,0907 0,9399 0,8446 tax rate (damodaran, 2015) 14,50% 14,50% 14,50% 14,50% 14,50% 14,50% 14,50% 14,50% d/e 0,2997 0,3158 0,1898 0,2366 0,1350 0,2300 0,1168 0,2867 d/(e+d) 0,2306 0,2400 0,1595 0,1913 0,1189 0,1870 0,1046 0,2228 table 1: beta levered and unlevered of lcsc real estate basic materials industrial consumer healthcare energy technology utilities financial service beta levered 0,9273 1,2404 0,8933 0,994 1,42 1,2229 0,9289 0,9267 1,0372 beta unlevered 0,6426 0,9963 0,7066 0,6970 1,2126 0,7818 0,5777 0,3971 0,7871 tax rate (damodaran, 2015) 14,50% 14,50% 14,50% 14,50% 14,50% 14,50% 14,50% 14,50% 14,50% d/e 0,5183 0,2865 0,3090 0,4983 0,2000 0,6600 0,7111 1,5600 0,3716 d/(e+d) 0,3414 0,2227 0,2361 0,3326 0,1667 0,3976 0,4156 0,6094 0,2709 table 2: beta levered and unlevered of lcnotsc the results of comparative analysis on beta levered and unlevered are the following: ejif – european journal of islamic finance no 4,march (2016) http://www.ojs.unito.it/index.php/ejifi ssn 2421-2172 6 lcsc lcnotsc lcsc lcnotsc real estate 1,3980 0,9273 1,1128 0,6426 lcsc lcsc basic materials 1,3044 1,2404 1,0271 0,9963 lcsc lcsc industrial 1,0827 0,8933 0,9315 0,7066 lcsc lcsc consumer 0,8533 0,9940 0,7097 0,6970 lcnotsc lcsc healthcare 0,8940 1,4200 0,8015 1,2126 lcnotsc lcnotsc energy 1,3052 1,2229 1,0907 0,7818 lcsc lcsc technology 1,0338 0,9289 0,9399 0,5777 lcsc lcsc higher beta unlevered beta levered beta unlevered higher beta levered table 3: a comparative analysis on risk for the sectors of real estate, basic materials, industrial, energy and technology, the beta levered and unlevered of lcsc are higher than beta of lcnotsc. for healthcare, the beta levered and unlevered are lower than beta of lcnotsc. for consumer, the beta levered of lcsc is lower than the beta of lcnotsc, while the beta unlevered of lcsc is higher than the beta of lcnotsc. this shows that listed companies shari’ah compliant are generally more risky than those not shari’ah compliant. the diversity in the results in the sector of “healthcare” is justifiable, in part, for the small number of not shari’ah compliant firms that operate in the sector. finally, starting from these results, we have calculated for each sector the wacc. the results are the following. real estate basic materials industrial consumer healthcare energy technology communication service number of listed companies shari'ah compliant 66 87 119 213 10 21 47 6 country risk premium (damodaran, 2015) 1,80% 1,80% 1,80% 1,80% 1,80% 1,80% 1,80% 1,80% risk free rate (damodaran, 2015) 3,85% 3,85% 3,85% 3,85% 3,85% 3,85% 3,85% 3,85% market premium (damodaran, 2015) 7,55% 7,55% 7,55% 7,55% 7,55% 7,55% 7,55% 7,55% cost of equity 14,40% 13,70% 12,02% 10,29% 10,60% 13,70% 11,66% 11,79% cost of debt 4,83% 4,83% 4,83% 4,83% 4,83% 4,83% 4,83% 4,83% beta levered 1,3980 1,3044 1,0827 0,8533 0,894 1,3052 1,0338 1,0516 beta unlevered 1,1128 1,0271 0,9315 0,7097 0,8015 1,0907 0,9399 0,8446 tax rate (damodaran, 2015) 14,50% 14,50% 14,50% 14,50% 14,50% 14,50% 14,50% 14,50% e/(e+d) 76,94% 76,00% 84,05% 80,87% 88,11% 81,30% 89,54% 77,72% d/(e+d) 23,06% 24,00% 15,95% 19,13% 11,89% 18,70% 10,46% 22,28% d/e 0,2997 0,3158 0,1898 0,2366 0,1350 0,2300 0,1168 0,2867 d 1 1 1 1 1 1 1 1 e 3,337 3,167 5,269 4,227 7,407 4,348 8,562 3,488 wacc 12,20% 11,57% 10,88% 9,25% 9,91% 12,04% 10,94% 10,24% table 4: wacc of lcsc on bursa malaysia. real estate basic materials industrial consumer healthcare energy technology utilities financial service number of listed company not shari'ah compliant 30 24 30 60 2 7 18 3 36 country risk premium (damodaran, 2015) 1,80% 1,80% 1,80% 1,80% 1,80% 1,80% 1,80% 1,80% 1,80% risk free (damodaran, 2015) 3,85% 3,85% 3,85% 3,85% 3,85% 3,85% 3,85% 3,85% 3,85% market premium (damodaran, 2015) 7,55% 7,55% 7,55% 7,55% 7,55% 7,55% 7,55% 7,55% 7,55% cost of equity 10,85% 13,22% 10,59% 11,35% 14,57% 13,08% 10,86% 10,85% 11,68% cost of debt 4,83% 4,83% 4,83% 4,83% 4,83% 4,83% 4,83% 4,83% 4,83% beta levered 0,9273 1,2404 0,8933 0,994 1,42 1,2229 0,9289 0,9267 1,0372 beta unlevered 0,6426 0,9963 0,7066 0,6970 1,2126 0,7818 0,5777 0,3971 0,7871 tax rate (damodaran, 2015) 14,50% 14,50% 14,50% 14,50% 14,50% 14,50% 14,50% 14,50% 14,50% e/(e+d) 65,86% 77,73% 76,39% 66,74% 83,33% 60,24% 58,44% 39,06% 72,91% d/(e+d) 34,14% 22,27% 23,61% 33,26% 16,67% 39,76% 41,56% 60,94% 27,09% d/e 0,5183 0,2865 0,3090 0,4983 0,2000 0,6600 0,7111 1,5600 0,3716 d 1 1 1 1 1 1 1 1 1 e 1,929 3,490 3,236 2,007 5,000 1,515 1,406 0,641 2,691 wacc 8,80% 11,35% 9,23% 9,18% 12,95% 9,80% 8,36% 7,18% 9,82% table 5: wacc of lcnotsc on bursa malaysia. the results of comparative analysis on wacc are the following: ejif – european journal of islamic finance no 4,march (2016) http://www.ojs.unito.it/index.php/ejifi ssn 2421-2172 7 lcsc lcnotsc real estate 12,20% 8,80% lcsc basic materials 11,57% 11,35% lcsc industrial 10,88% 9,23% lcsc consumer 9,25% 9,18% lcsc healthcare 9,91% 12,95% lcnotsc energy 12,04% 9,80% lcsc technology 10,94% 8,36% lcsc wacc higher wacc table 6: a comparative analysis on wacc vi. findings and conclusions we carried out a comparative study on wacc of listed companies on the malaysian stock exchange, rare example of financial market that includes companies classified in shari’ah (lcsc) and not shari’ah compliant (lcnotsc). in order to estimate the wacc of the selected companies, we have calculated for each one the cost of debt, the cost of equity and the market capitalization. according to the study of damodaran (2015), we have considered a 1,80% as country risk premium of malaysia, a 3,85% as risk free rate and a 7,55% as market premium. excluding the sectors not comparable due to lack of companies lcsc and/or lcnotsc (utilities, communication service, financial service), the findings of our analysis (as shown in table 6) are generally based on a systematic value of lcsc’s wacc greater than lcnotsc, for each group of companies that belong to real estate, basic materials, industrial, consumer, energy and technology sectors. in conclusion, we can assert that, for the sample analyses, listed companies shari’ha compliant collected using the application of the principles of islamic finance, shows a higher level or risk, measured by beta levered, and higher value of the wacc. as a final point, what is the impact on value creation? the lcsc of our sample analyzed starts their business management from a greater minimum acceptable hurdle rate. more research is necessary to examine the potential effect on the risk. in particular, it may be interesting to understand why the listed companies shari’ah compliant, while presenting a debt over total assets below 33%, appear to be riskier of not-shari’ah. in this sense, the principles of traditional corporate finance postulate that a higher level of leverage suggests a high level of risk, but in our exploratory study, we have observed that in malaysian stock exchange the lcsc haven’t a lower level of risk. other future researches should be based on the extension of this analysis to other financial markets, implementing the use of statistical tools in order to verify the significance of what introduced in this preliminary and comparative study. vii. references 1. aggarwal, r.k. & yousef, t. 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(2010). islamic finance and the theory of capital structure. mpra paper, 24567, 1-18. 22. salvi, a. & miglietta, n. (2013). principi di finanza islamica. cacucci editore, bari. 23. securities commission of malaysia (2014). list of shariah-compliant securities by the shariah advisory council of the securities commission malaysia. scm paper, 28 november, 1-34. 24. shafizal, b.s. & mansur, m. (2013). determinants of cost of equity: the case of shariah-compliant malaysian firms. mpra paper, 62364, 1-53. 25. tardivo, g., schiesari, r. & miglietta, n. (2012). corporate finance. isedi, torino. 26. van horne, j. & wachovicz, j.m. (2008). fundamentals of financial management. 13/e. prentice hall, new york. 27. vernimmen, p., quiry, p., dallocchio, m., le fur, y. & salvi, a. (2014). corporate finance: theory and practice. 4/e. wiley finace, new york. 28. warde, i. (2000). islamic finance in the global economy. edinburgh university press, edinburgh. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 takaful practice in nigeria: history, present and future abubakar aliyu ardo a , buerhan saiti a,* a institute of islamic banking and finance, international islamic university malaysia, kuala lumpur, malaysia * corresponding author at: email: borhanseti@gmail.com abstract the development of a robust financial system is an important objective especially for a country like nigeria, being a formidable force on the african continent. as the country aspires to become a major international financial centre in the continent by the year 2020, the development of takaful as a major segment of islamic finance remains paramount. despite government’s effort and the huge potentials for such a unique service, the growth in takaful operations is still at a nascent after over a decade of existence. takaful ought to have recorded great success in nigeria considering several positive factors, unfortunately, which has not been the case. using a qualitative library research method, this paper provides an overview of takaful with emphasis on its practice in nigeria over the years. the paper also further explores the challenges hindering the development of takaful in nigeria especially on the legal aspect. consequently, certain recommendations have been made to reverse the ugly trend. as a matter of urgency, the issues raised need to be addressed to facilitate accelerated development of takaful operations and contribute towards achieving the much-needed revitalization of the nigerian financial system. keywords: islamic finance; takaful; conventional insurance; nigeria 1. introduction nigeria is the most populous nation in africa with the population of about 186 million, 50% of whom, are muslims [9]. international monetary fund (imf) projection predicts that the population will increase to about 210 million by 2021 [21]. furthermore, nigeria emerged as the largest economy in africa in 2015 with an estimated gdp of $1.1 trillion [8]. as far back as 2007, the central bank of nigeria (cbn) unveiled the financial system strategy 2020 (fss 2020) as a blueprint aimed at repositioning the country to become africa’s major international finance centre (ifc) by the year 2020 [6]. this move was greatly motivated by the optimistic “next 11” forecast by goldman sachs which reported nigeria as one of the 11 countries with enormous growth potentials that will possibly rival the g7 in future [5]. a robust financial system is essential to support nigeria’s quest for a vibrant economy. accordingly, the insurance industry witnessed a recapitalization exercise in 2007 aimed at repositioning the sector for greater efficiency and effectiveness. takaful being an integral part of the islamic financial system is therefore an important component that needs to be captured in this development. the cbn in 2012 initiated the national financial inclusion strategy to serve as a road map towards significantly increasing the access and use of financial services by the year 2020 due to the realization of severe financial exclusion especially in the muslim dominated northern region [7]. consequently, the national insurance commission of nigeria (naicom) issued takaful-insurance operational guidelines in 2013 to facilitate the development of the takaful industry to enhance financial inclusion. however, despite the large market potentials and governments commitment, the growth of takaful operations in nigeria has not been impressive. as such, this paper aims at exploring the history, present status as well as challenges impeding the development of takaful industry with a view to proffering effective solutions to the problems. takaful operation in nigeria has not grown as much as desired considering the great prospects it holds. despite the large population, legal provisions for mandatory insurance in several product classes and severe financial exclusion in predominantly muslims regions, the viability of takaful has not translated into practice. the market trend shows an evident apathy for insurance products as policy holders comprise mainly of corporate clients and few retail customers subscribing to the compulsory insurance products [13]. in-spite of the numerous indicators suggesting nigeria as a good market for insurance business, the huge potentials in the sector remain largely untapped with insurance density (insurance premiums as a percentage of gdp) of only about 0.225% in 2015 [23]. similarly, gross written premiums in the country in the year 2015 was worth less than 1% of gdp [26], a huge chunk of which were from the south mailto:borhanseti@gmail.com ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 west region, specifically lagos state leaving out the muslim dominated northern region with barely any form of insurance services. this ought not be the case almost 15 years after the introduction of takaful operations in the country in 2004. moreover, only one (1) takaful subsidiary, two (2) windows and a recently licenced full-fledged takaful operator are in the market uptil now. this ugly scenario deserves to be explored to assess the situation and identify the major problems being encountered so far with a view to unlocking the great prospects that remain untapped in the nigerian takaful industry. this study was necessitated by the apparent lack of scholarly literature on takaful operations in nigeria. it aims to arouse peoples’ curiosity thereby initiating much needed brains-storming on the reasons and solutions for the slow growth with a view to facilitating rapid development of takaful operations in the nigeria. moreover, takaful operations in nigeria is an interesting topic because takaful operators carried out their activities without any specific legal framework guiding their operations for the entire first decade of their existence. as such, it is important to review the takaful operations now that some regulatory guidelines have been in place for about four (4) years. research objectives  to provide a basic explanation of the nature of takaful operations  to present an overview of the history and current-status of takaful operations in nigeria  to analyse the problems hindering rapid development of takaful in nigeria with emphasis on evident legal flaws in the regulations the research is important in furtherance of the development of awareness for takaful operations among the general populace in nigeria. the research is also important to the government agency in charge of regulating the operations takaful in understanding the reasons behind the slow development of the sector despite its potentials considering impressive performance it has recorded in other jurisdictions. similarly, the research is important to takaful operator in having a better understanding of the environment in which they operate to guide them in making sound decisions that will promote their services. most importantly, this research highlights legal and other issues hindering the development of takaful in nigeria with recommendations for a way out. 2. overview of takaful 2.1 definition and general overview of takaful takaful is an arabic word derived from the word kafala. basically, takaful refers to an arrangement of joint guarantee by a group of participants based on mutual-agreement to indemnify one another in the event of a defined loss. investopedia website defines takaful as islamic insurance which entails members contributing money into a pool of funds to be utilized in mutually guaranteeing members against loss or damage [14]. takaful concept is based on shariah provisions aimed at fulfilling the responsibility of individuals in cooperating to protect one another. according to the accounting and auditing organisation for islamic financial institutions (aaoifi), takaful otherwise called islamic insurance is an arrangement whereby a group of persons undertake to manage injuries resulting from a specified to risk to which all members of the group are vulnerable. to facilitate this arrangement, members of the group donate in form of contribution to establish a common insurance fund as a legal entity with independent financial liability to be utilized in indemnifying participants in the event of injury subject to certain stipulated conditions. in carrying out this task, the fund is managed by a group of the participants or a joint stock company that manages the fund for a specific fee [1]. similarly, the national insurance commission of nigeria (naicom) defines takaful-insurance as a form of insurance that is compatible with shariah provisions based on the principles of tabarru (donation/contribution) and ta’awun (cooperation) [17]. the development of takaful became necessary in view of the gross violations of shariah principles concerning riba (interest), gharar (excessive uncertainty) and maisir (gambling) inherent in the operations of conventional insurance. takaful serves as a shariah compliant alternative to conventional insurance just as islamic banking serves as an alternative to the conventional interest based banking system. ideally, muslims are supposed to give unconditional patronage to takaful as it thrives to uphold the noble virtues of brotherhood and cooperation. several provisions of the shariah encourage cooperation and solidarity in helping those in difficulty as practiced in takaful. despite muslims unwavering believe in destiny, they are highly encouraged to take precautionary measures within their power to minimize the effects of tragic events through mutual-cooperation and high spirit of brotherhood. this is contrary to the erroneous ideology of believing in destiny without making conscious effort to mitigate risk. as such, good understanding of the shariah would lead to a ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 stronger sense of brotherhood which would imply the practice of takaful principles. the operation of takaful is in line with the command in quran 5:2 quoted below: “…and cooperate in righteousness and piety, but do not cooperate in sin and aggression…” similarly, ample evidence from the hadith of the prophet imply the significance of many noble attributes inherent in a takaful arrangement. some of such hadiths as cited in [29] are presented below: “allah will always help his servant for as long as he helps others” (narrated by imam ahmad and imam abu daud) “the place of relationship and feelings of people with faith, between each other, is just like the body: when one of its parts is afflicted with pain, then the rest of the body will be affected”. (narrated by imam al-bukhari and imam muslim) “one true muslim (mu’min) and another true muslim (mu’min) is just like a building whereby every part in it strengthens the other part”. (narrated by imam al-bukhari and imam muslim) “by my life, which is allah’s power, nobody will enter paradise if he does not protect his neighbor who is in distress”. (narrated by imam ahmad) for effective compliance with the commandments of these hadiths, it is certainly important to establish and promote takaful institutions. the shariah as a comprehensive guide to man has as part of its objectives (maqasid ashshariah) the preservation of property (hifz al-mal). in this regard, takaful plays a vital role in promoting the shariah objective of property preservation. 2.2 shariah violations in conventional insurance the prohibition of conventional insurance in islam and the resultant need for takaful stems from the obvious shariah violations inherent in conventional insurance. despite having the same noble objective of providing protection against losses, the mode of operation of conventional insurance contains fundamental shariah violations. these include riba (interest), gharar (excessive uncertainty) and maisir (gambling) as explained in table 1. table 1. prohibited elements in takaful operation elements description riba this is considered as one of the greatest sins in islam being the only sin allah which categorically declared war upon. several verses of the quran (2:275-279, 3:130, 4:161 and 30:39) and quotations from the hadiths of the prophet forbid engaging in transactions that have elements of riba. conventional insurance companies invest premiums in interest bearing investments in violation of shariah whereas takaful contributions are only invested in shariah compliant activities. gharar basically, gharar refers to excessive uncertainty which can lead to adverse effects to the parties involved in a contract and increase in the chances of conflict. when conventional insurance is contracted, neither the insurance company nor the policy holder knows the outcome of the contract. excessive uncertainty is more clearly seen in the case of life assurance whereby compensation amount depends on the time of death of the insured thereby leading to ambiguity. the element of tabarru in takaful eliminates the possibility of such uncertainty maisir this refers to gambling, the prohibition of which is contained in quran (5:90). in conventional insurance, there is a clear manifestation of this prohibited element. the outcome of a conventional insurance policy is always a zero-sum game with no chance of a mutually beneficial result. the outcome is either in favour of the policy holder alone in the case where he makes a claim or in favour of the insurance company when no claim is made by the policy holder. therefore, a policy holder is engaged in a sort of gambling as the outcome of the contract may either favour him completely or he loses his premium completely. the element of tabarru in takaful effectively solves this problem. 2.3 comparison between takaful and conventional insurance in this section, we are going to compare and construct the similarities and differences between conventional insurance and takaful. in order to provide a clear picture about them, we have summarized the differences between takaful and conventional insurance in table 2. [30] and [3] also cited similar features of takaful. table 2. summary of differences between takaful and conventional insuareance takaful insurance contract shariah contract. a combination of tabarru contract and agency or profit sharing. an exchange contract. the sale and purchase of policy cover between the insurer and the insured. responsibility of participants/ policy holders participants contribute to the scheme and mutually guarantee each other with the pool of funds. policy holder pays premium to the insurer liability of the operator/insurer takaful operator manages the pool of funds and makes payment of claims from the pool. if the pool of funds is inadequate to settle claims, the operator offers an interest free loan. insurer is liable to pay claims from its assets ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 investment of funds takaful operator is bound to invest only in shariah compliant avenues. insurer not compelled to invest in shariah compliant avenues. risk treatment takaful is based on mutuality so risk is spread among participant not transferred to the takaful operator. risk is transferred from the policy holder to the insurer in exchange for premiums paid. surplus any surplus from the pool of funds belongs to the participants. surplus belongs to the insurer. shariah noncompliant elements strict prohibition of shariah noncompliant elements such as riba, gharar and maisir no restriction on shariah non-compliant elements. governance requires shariah governance in addition to corporate governance no requirement of shariah governance. 2.4 history of takaful practice the practice of takaful concept pre-dates the time of the prophet. during the jahilillyah (before the coming of prophet muhammad) period, the arab society practiced a similar concept as part of their culture and tradition. they were found of mutually collaborating mostly to help the family of a deceased person in fulfilling funeral rights and provide financial assistance to such families. in some cases, it involved contributing towards the payment of compensation for the murder of a member of another tribe. after the coming of the prophet, some of the jahiliyyah practices were upheld provided they did not violate principles of islam. the practice of mutual help in mobilizing compensation for murder was among the practices that were maintained as it was a virtuous idea which significantly contributed in reducing tension among arab tribes who were initially more inclined to revenge rather than accept compensation [30]. eventually, the concept of mobilizing compensation (diyat) by the relatives (aqilah) of the culprit and making the payment to the heirs of the victim became more organised. furthermore, the process was recognised in the constitution of medina [28]. with the growth of muslim economies due to expansion of trade networks, the practice of takaful became more like the modernday practice as merchants engaged in mutual assistance to protect their merchandise against any mishap while on transit through the seas. 3. overview of insurance sector in nigeria despite the lack of a unified framework for mandatory insurance in nigeria, the government supports the insurance sector through several laws enacted to serve as market development strategies by making certain insurance products compulsory. such provisions are presented in table 3. table 3. market development strategies in nigerian insurance industry provision details group life insurance policy section (4) sub-section (5) of the pension reform act 2014 makes this insurance product mandatory by the following clause: “every employer shall maintain a group life insurance policy in favour of each employee for a minimum of three times the annual total emolument of the employee and premium shall be paid not later than the date of commencement of the cover” (national pension commission, 2014). employers liability the employees’ compensation act 2010 was enacted to make mandatory provisions for compensations in case of death, injury, disease or disability arising out of or in the course of employment; and for related matters (nigeria social insurance trust fund, 2010). buildings under construction section 64 (1) of the insurance act 2003 makes provision for compulsory insurance of certain category of buildings under construction as stated: “no person shall cause to be constructed any building of more than two floors without insuring with a registered insurer his liability in respect of construction risks caused by his negligence or the negligence of his servants, agents or consultants which may result in bodily injury or loss of life to or damage to property of any workman on the site or of any member of the public” (national insurance commission, 2003). public buildings section 64 (1) of the insurance act 2003 makes insurance mandatory for public buildings as stated: “every public building shall be insured with a registered insurer against the hazards of collapse, fire, earthquake, storm and flood” (national insurance commission, 2003). third party property damage section 68 (1) of the insurance act 2003 makes provision for compulsory insurance against third party property damage in the case of motor vehicle as stated: “no person shall use or cause or permit any other person to use a motor vehicle on a road unless a liability which he may thereby incur in respect of damage to the property of third parties is insured with an insurer registered under this act” (national insurance commission, 2003). health care professional indemnity insurance sequel to the enactment of the national health insurance scheme (nhis) act, health care professional indemnity insurance becomes compulsory for health care providers as stated: “a health care provider (medical centre, institution or professional) shall be required to take a professional indemnity cover from an insurance company approved by the council” (national health insurance scheme, 1999). agricultural insurance the nigerian agriculture insurance corporation decree n0. 37 of 1993 imposes a mandatory insurance requirement for beneficiaries of agricultural loan as stated in section 13: “…where the farmer is also a beneficiary of an agricultural loan or credit from the government, a bank or other financial institution (in this decree referred to as "lending institution") he shall take out an insurance cover under the scheme” (nigerian agriculture insurance corporation, 1993). in view of the aforementioned legal provisions, it is apparently clear that the nigerian government has duly exercised its powers in facilitating the development of the insurance industry by enacting several laws which create a market for insurance. ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 4. takaful in nigeria: history and current-status unlike the experience of most countries where takaful is established after the introduction of islamic banking, the story is unique in nigeria where takaful preceded islamic banking by about a decade [2]. the history of takaful in nigeria began in 2004 when african alliance insurance company limited introduced takaful services to the public in addition to its conventional insurance services. being the oldest life assurance company in the country, african alliance insurance company offered family takaful package comprising of protection and savings element as a shariah compliant alternative to conventional life assurance scheme [15]. eventually, niger insurance plc and cornerstone insurance plc followed suit in view of the great potentials for takaful operations in the nigerian market. very recently, noor takaful obtained license to commence full-fledged operations. unconfirmed reports indicate that several other companies have signified interest and many have reached advanced stages in the process of obtaining license to establish takaful in nigeria. major motivating factor for the takaful operators is the huge untapped potentials for takaful due to its uniqueness in fulfilling the needs of conscious muslims and also the opportunity to increase insurance penetration which has been very poor [31]. niger insurance plc provides family takaful services. due to its dominance in the nigerian market, niger insurance plc has been able to offer a variety of services through a range of innovative products under niger mutual halal plan. the plan provides a savings and investment package specially designed to cater for events future events such as marriage, pilgrimage, eid, retirement etc. [22]. another takaful operator, cornerstone insurance plc, provides takaful services through its subsidiary. the subsidiary, halal takaful nigeria, serves the needs of muslims and non-muslims alike. halal takaful stands out from the other takaful window operators as the only independent subsidiary focused on takaful business. this takaful operator was the first to obtain a composite licence as far back as 2013 thereby offering both family and general takaful [11]. the national insurance commission of nigeria (naicom) is vested with the responsibility of administering and enforcing the provisions of the 2003 insurance act as stated in section 86 of the act: thereby being the regulatory body for takaful and insurance generally. unfortunately, there is a glaring omission of the express mention of takaful or islamic insurance in the entire document. in 2013, naicom launched the “2013 takafulinsurance operational guidelines”. this serves as the first national guideline for the operation of takaful in the country. the guideline serves as the legal basis and reference for all matters concerning takaful operations. it clearly spells out prudential, operational, governance and basic shariah standards to be adopted by all operators in this line of business [17]. albeit belated, coming after about a decade of takaful experience in the country, it is a great milestone that has potentials to reinvigorate the takaful market. the guidelines specify duties and responsibilities of all parties involved in a takaful contract in addition to disclosure standards and other basic requirements. the guideline specifies the requirement of takaful operators to constitute a shariah advisory committee (advisory council of experts) as well as an internal shariah unit to ensure strict adherence to the provisions of the shariah in the discharge of their duties. in the meantime, naicom undertakes to provide shariah consultation services to takaful operators yet to find credible and duly qualified persons to serve as members of their advisory councils of experts through the regulators own shariah advisory council. the guideline presents three business models (mudharabah, wakala and hybrid wakalahmudharabah) to be adopted by takaful operators [15]. takaful promises to serve as an effective avenue for enhancing financial inclusion and promotion of savings and investments in nigeria especially in the muslim dominated northern region which has been faced with enormous security challenges and resultant impoverishment of the people. takaful holds great potential in the nigerian market especially in northern nigeria where majority of the population are muslims. according to the cia world-fact book, muslims constitute 50% of the nigerian population of about 186million [9]. moreover, the muslim dominated northern region is expected to patronise takaful in-view of the apathy for conventional insurance which aggravates financial exclusion in the region. the muslim population is projected to grow faster due to the prevalence of polygamy in the northern region. due to religious reasons, conventional underwriters and other intermediaries find it difficult to market their products in the muslim dominated northern region. information from the website of naicom shows that 54 out of the 60 currently registered insurance and re-insurance companies have their headquarters in the southern region, lagos state precisely [19]. this skewed distribution is largely due to religious reasons which constraints muslims from participating in conventional insurance. therefore, it is expected that the introduction of takaful will go a long way in attracting customers who hitherto abhor conventional insurance. takaful operators have ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 developed unique marketing strategies to create a niche in the nigerian market through alliances with islamic organisations and hajj tour operators to protect their various risk exposures [31]. 4.1 takaful legislation in nigeria takaful operations in nigeria are governed by the 2013 operational guidelines for takafulinsurance operators effective march 2013 unveiled by naicom. this document provides a detailed structure for all matters concerning takaful operations in the country. section 1 of the document features a general overview which includes introduction, objectives, scope, implementation and concept of takaful-insurance. primarily, the guidelines seek to increase insurance penetration and financial inclusion in nigeria through takaful. the guideline provides a framework within which takaful operators shall successfully carry out their business efficiently and effectively. the scope of the guidelines covers the regulation of commercial takaful activities and all related operations conducted within nigeria [17]. section 2 of the guidelines presents the general provisions and procedure for adopting an operating model by prospective takaful operators in either of the two classes of business; family takaful or general takaful. furthermore, this section specifies three (3) operating models; mudharabah based, wakalah based and a hybrid wakalahmudharabah model comprising of both wakala and mudharabah. documentation and disclosure requirements relating to the operating model adopted by the takaful operator is also contained in this section of the guidelines [17]. in section 3, the guideline presents governance standards for takaful operators. this entails the requirement for takaful operators to have an advisory council of experts (ace) as well as their required competency and code of conduct. similarly, it includes the duties and responsibilities of the ace and the takaful operator, inclusion of the ace opinion in annual report, disclosure requirements by the takaful operator, accessibility of the ace to the public, the regulators takaful advisory council (tac), shariah compliance and other relevant requirements [17]. the 2013 takaful-insurance operational guidelines provide three (3) business models for takaful operators. these include mudharabah contract (profit sharing), wakalah contract (agency) and hybrid wakalah-mudharabah contract (agency-profit sharing). these models are explained in table 4. for effective oversight, takaful operators must obtain approval from the naicom after the approval of their aces and board of directors for the business model they intend to adopt. to promote innovation and product development, takaful operators may propose to adopt a different model apart from the three models provided subject to final approval by naicom. table 4. three business models of takaful operations contract explanations mudharabah contract (profit sharing) in this structure, the takaful operator functions as the mudarib (entrepreneur/manager) while the participant is the rabbul-maal (owner of capital). the takaful operator manages the fund and carry out investments and underwriting activities. pre-agreed profit sharing ratio is decided by the two parties and financial losses are solely borne by the participant except in case of proven negligence or breach of contract terms by the takaful operator. otherwise, the losses for the takaful operator will be limited to his wasted time and effort. wakalah contract (agency) in this model, the takaful operator manages investment and underwriting activities as an agent (wakeel) of the participant (muwakkil) for a fee (wakalah fee) mutually agreed upon at the beginning of the contract. depending on the details of the contract, the takaful operator may be entitled to a performance related incentive (jualah) for effective management of the fund. hybrid wakalahmudharabah contract (agency-profit sharing) this model is a combination of wakalah (agency) and mudharabah (profit sharing) between the participants and takaful operator. in this case, wakalah is applied for managing underwriting activities while mudharabah is applied in the investment activities. 4.2 takaful development in nigeria: issues and recommendations the following points are the problems hindering rapid development of takaful in nigeria as cited by [4], [27], [12], [2] and [31]. 4.2.1 legal/regulatory flaws the slow development of takaful operations in nigeria can be attributed to ambiguity and apparent lack of synergy between major regulatory provisions such as insurance act 2003 and 2013 operational guidelines for takaful. it is important to note that the insurance act has become obsolete in-view of several transformations that have taken place in the insurance sector since its enactment. the legislation has failed to evolve accordingly to accommodate significant changes particularly regarding takaful. a glaring discrepancy noticed in the 2003 insurance act is the omission of an express mention of takaful or islamic insurance in the insurance act. takaful has gained much prominence in the global financial system such that it becomes necessary to accord it due recognition in the insurance act being the supreme legislation for the nigerian insurance sector. this obvious regulatory gap gives room for ambiguity and legislative uncertainty thereby discouraging serious investors due to the resultant legal risks. a manifestation of the consequences of omitting takaful in the insurance act is seen in section 10 (1-2) of the act which requires a prospective insurer to deposit 50% of his paid-up share capital with the central bank of nigeria (cbn) as statutory ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 deposit. upon successful registration, the cbn returns 80% of the statutory deposit with interest to the insurer within 60 days from registration date. the act failed to specify any exception to this provision which violates the fundamental requirements of takaful operations being an end to end shariah compliant activity. another regulatory issue is the capital requirement for takaful operators. although the takaful guidelines scaled down the minimum paid up capital for takaful operators, a problem arises considering the provisions of the insurance act in section 9 (4) which limits the powers of naicom to upward review of paid up share capital only and not downward review. therefore, a controversy still lingers as to whether the power of naicom to implement an upward review also implies a discretion to effect a similar downward review when the need arises. the 2003 insurance act holds supremacy over any other enactment concerning insurance practices in nigeria as stipulated in section 100 of the act. by implication, the provisions of the act prevail over any provision in other enactments which contradict it. as such, it is important to ensure harmony between the insurance act and takaful guidelines. these problems and many others relating to legal provisions can only be solved by putting in place a comprehensive takaful act as in more established takaful markets such as malaysia. in the absence of a distinct takaful act, the current insurance act should be adequately amended to cater for takaful. this will ensure effective regulatory certainty and entrench confidence in the market. furthermore, a distinct takaful act is paramount in the quest to gain acceptance among the populace and attract competent market players [27]. 4.2.2 inadequate manpower shortage of skilled manpower poses a great challenge to the development of takaful in nigeria. the availability of competent personnel with knowledge in both shariah and islamic finance, particularly takaful is limited. shortage of competent manpower is a global phenomenon which nigeria also faces in staffing and ace membership of takaful operators [31]. most staff are only conversant with conventional insurance while ace members who are mandated to ensure shariah compliance are mostly weak in insurance operational matters. due to the apparent shortage of skilled manpower for ace membership, naicom undertakes to provide shariah guidance to takaful operators through its takaful advisory council until the takaful operators find eminently qualified people to serve as members of aces. an effective solution to address the manpower shortage in takaful would require much more than the current practice of organizing in house trainings for takaful operators staff. a better solution would entail collaboration between regulators, takaful operators and leading tertiary institutions to introduce specially tailored takaful courses for both staff and ace members. this measure will serve to complement their knowledge of conventional insurance or pure shariah as the case maybe. furthermore, the establishment of a takaful association will help in enhancing knowledge sharing between takaful operators for the benefit of the industry. 4.2.3 acceptability of islamic finance product and services by non-muslims just as the introduction of islamic banking faced stiff opposition from a section of non-muslims, takaful is not an exception to this primitive ideology of opposing noble ideas based on religious sentiments. phobia for anything tagged islamic by non-muslims due to the activities of several terror groups falsely using the name of islam in their heinous activities also contributes to the problem [12]. this negative attitude poses a threat to the growth of takaful despite the immense viability of the concept. such a problem bothering on wrong perception requires much sensitisation by all stakeholders in islam. beyond sensitisation, a more effective approach is the exhibition of noble character traits by muslims to discredit the erroneous notion. 4.2.4 low consumer awareness in-spite of government’s commitment to increase financial inclusion by deepening the penetration of financial services such as insurance and takaful, lack of basic understanding of the operations and benefits of takaful still prevails. takaful services are often wrongly considered as being meant for wealthy people. this is due to the ignorance of the fact that family takaful incorporates a savings and investment element capable of reducing the effects of poverty. the belief also indicates lack of understanding of the nature of tabarru as a shariah concept. similarly, a segment of the society hold a wrong notion of relying on allah and accepting destiny without making conscious effort to cushion the effects of a likely misfortune. the development of insurance in general is hindered by limited awareness and scepticism; and distrust from enlightened people especially urban dwellers due to several cases of failure to pay genuine claims [13]. the average nigerian suffers from lack of awareness about insurance process [27]. the problem of consumer awareness can only be solved through concerted efforts by the regulator and takaful operators to hold enlightenment ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 campaigns aimed at reversing the deeply rooted negative notion of insurance among the populace. the uniqueness of family takaful which incorporates an investment element for the participants can be a good selling point especially when advertising to lower income segment of the society who mostly view insurance as a luxury due to their ancient belief: “if you have nothing, you have nothing to lose” which discourages them from participating in any form of insurance. more importantly, there should be more sensitisation on the underlying principle of tabarru being the bedrock of takaful operations. 4.2.5 limited shariah compliant investment avenues takaful operators are required to ensure end to end compliance with shariah as much as possible. this means they can only invest in shariah compliant avenues. the availability of such avenues is still very limited due to slow development of the islamic capital markets in nigeria. the dominance of interest based investment options over shariah compliant alternatives limits the investment options for takaful operators to mostly shariah compliant stocks listed on nigeria’s lotus islamic index [31]. this problem is a serious one as it affects the profitability and subsequent continuity of takaful operations. to achieve the much-needed end to end shariah compliance, there needs to be a revitalization of the financial markets to provide efficient and profitable shariah compliant investment alternatives for takaful operators and other non-interest financial institutions. 4.2.6 inadequate re-takaful capacity effective functioning of takaful requires support from re-takaful operators who provide cover for the takaful operators. lack of adequate re-takaful services significantly limits the capacity of takaful operators as they need such services to attain optimal operation capacity and function effectively. a major challenge for present and prospective takaful operators is the lack of re-takaful services to protect their risk exposure and absorb shocks in the industry [2]. because of this problem, takaful operators are compelled to patronise conventional re-insurance companies as a last resort. this inhibits the ideal practice of ensuring end to end shariah compliance. therefore, the establishment of re-takaful companies is a matter of urgency for the growth and development of takaful operations. 5. conclusion this research provides an overview of takaful operations in nigeria. generally, the potentials for growth are very impressive although the actual growth has not been as impressive. the research identified several challenges as the factors inhibiting takaful operations in nigeria. although the challenges have persisted over the years, effective implementation of the proffered solutions will certainly contribute significantly to enhancing the efficiency and viability takaful operations in the country. notably, there is an urgent need for a comprehensive regulatory framework, attractive incentives, awareness creation and shariah compliant investment products among other necessities. the need for concerted effort to promote takaful is paramount considering the potential benefits it holds for the nigerian populace and its vital role in making the financial system strategy 2020 a reality. nigeria as a country arguably referred to as the giant of africa needs to take proactive measures to ensure that it indeed remains the giant of africa. this requires keeping up with developments in the global financial system of which islamic finance generally is gaining prominence. as such, nigeria should not be left out especially in view of the need for a robust financial system that will support the country’s quest to attain greater heights. despite the slow growth experienced in the takaful sector over the years, the future holds great prospects for takaful operations in nigeria. references [1] accounting and auditing organisation for islamic financial institutions. (2015). shariah standards. manama: dar al-maiman publishing and distributing. [2] ado, a. (2014). nigeria: where are we? in s. thiagaraja, a. morgan, a. tebbutt, & g. chan, the islamic finance handbook: a practitioners guide to the global markets (pp. 355-367). singapore: john wiley & sons singapore pte ltd. [3] ali, e. r., & odierno, h. s. (2008). essential guide to takaful (islamic insurance). kuala lumpur: cert publications sdn. bhd. [4] aliyu, m. b., & ahmad, i. m. (2014). shariah compliant insurance product: an overview of problems and prospects of takaful-insurance in nigeria. unilorin shariah journal. [5] beyond the brics: a look at the "next 11". (2007). in s. lawson, d. heacock, & a. stupnytska. [6] central bank of nigeria. (2007). financial system strategy 2020. central bank of nigeria. [7] central bank of nigeria. (2012). national financial inclusion strategy. central bank of nigeria. retrieved february 23, 2017, from https://www.cbn.gov.ng/out/2012/publications/repor ts/dfd/cbn-summary%20report%20offinancial%20inclusion%20in%20nigeria-final.pdf [8] central intelligence agency. (2016). retrieved february 22, 2017, from central intelligence agency web site: ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 https://www.cia.gov/library/publications/the-worldfactbook/geos/ni.html [9] central intelligence agency. (2016). retrieved november 28, 2016, from central intelligence agency web site: https://www.cia.gov/library/publications/theworld-factbook/geos/ni.html [10] central intelligence agency. (2016). cia world factbook; nigeria. retrieved november 23, 2016, from central intelligence agency: https://www.cia.gov/library/publications/the-worldfactbook/geos/ni.html [11] cornerstone insurance plc. (216). subsidiaries: cornerstone insurance plc. retrieved december 5, 2016, from cornerstone insurance plc web site: https://cornerstone.com.ng/corporate/subsidiaries.php [12] dewa, n. (2013). the introduction of takaful in nigeria. retrieved november 13, 2016, from academia web site: https://www.academia.edu/5539219/the_introd uction_of_takaful_in_nigeria_09132013 [13] dias, d., garand, d., & swinderek, d. (2013). towards inclusive insurance in nigeria: an analysis of the market and regulations . access to insurance initiative. [14] investopedia. (2016). takaful. retrieved december 5, 2016, from investopedia web site: http://www.investopedia.com/terms/t/takaful.asp [15] ismail, e. (2015). takaful: the great potential in nigeria. retrieved december 2, 2016, from meinsurancereview.com [16] national health insurance scheme. (1999). national health insurance scheme act 1999. [17] national insurance commision of nigeria. (2013). 2013 takaful insurance operational guidelines. abuja: national insurance commission. [18] national insurance commission. (2003). insurance act 2003. [19] national insurance commission. (2016). retrieved december 5, 2016, from national insurance commission of nigeria web site: http://naicom.gov.ng/companies [20] national pension commission. (2014). pension reform act. retrieved february 27, 2017, from http://www.pencom.gov.ng/docs/1448643400_pra_ 2014.pdf [21] national population commission of nigeria. (2016). retrieved november 5, 2016, from national population commission web site: http://www.population.gov.ng/ [22] niger insurance plc. (2016). niger mutual halal plan. retrieved december 5, 2016, from niger insurance plc web site: http://www.nigerinsurance.com/index/general/produc tdetails.php?id=3&subid=4&pid=4 [23] nigeria reinsurance corporation. (2016). insurance industry outlook for 2016. nigeria reinsurance corporation. [24] nigeria social insurance trust fund. (2010). employees compensation act 2010. retrieved february 27, 2017, from http://www.nsitf.gov.ng/ecs3/eca%202010.pdf [25] nigerian agriculture insurance corporation. (1993). nigerian agricultural insurance corporation decree no. 37. [26] oxford business group. (2017). low insurance penetration rates in nigeria suggest growth for local players. retrieved february 23, 2017, from oxford business group web site: https://www.oxfordbusinessgroup.com/overview/eye s-prize-low-penetration-rate-suggests-future-growthlocal-insurers [27] saleh, m. m., balan, s. a., & ruslan, m. k. (2016). learning from the malaysian experience: overcoming the regulatory challenges in the nascent takaful practice in nigeria. journal of politics and law, 9, 142-159. [28] tahir-ul-qadri, m. (2012). the constitution of medina. london: minhaj-ul-quran publications. [29] takaful ikhlas. (2016). the concept and benefits of takaful. retrieved february 23, 2017, from takaful ikhlas web site: http://www.takafulikhlas.com.my/corporate-info/concept-benefitstakaful [30] yusuf, t. o. (2012). prospects of takaful's (islamic insurance) contributions to the nigerian economy. journal of finance and investment analysis, 217230. [31] yusuf, t. o., & babalola, a. r. (2015). takaful in nigeria: penetration challenges and the way forward. journal of islamic economics, banking and finance, 11(2), 133-148. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) islamic microfinance: locomotive in the service of financial inclusion abstract— the exclusion of poor people within the society from the conventional banking system was the starting and focal point for the creation and development of microfinance institutions. the implementation of a new financial inclusion policy has become the priority of several public programs by encouraging microfinance institutions to diversify their products range in order to meet the deprived populations’ needs. emerged as a new market niche, islamic microfinance represents the confluence of two fast growing sectors: microfinance and islamic finance. indeed, it has the potential of not only suggesting financial and non financial services of proximity to individuals operating in the informal sector, but also supporting excluded ones from the banking sector because of their low income and lack of payment guarantees. as mentioned above, due to limited financial resources or an incompliance of conventional products with the ethical financial principles set in islamic law, excluded individuals and entrepreneurs from conventional microfinance are not taking advantage of their country’s economic growth and development. therefore, the purpose of this paper is to put into perspective the relevance of islamic microfinance to broadening access of financial services for low-income populations, and also to present the potential barriers that can block the growth and development of islamic microfinance institutions whether they are economic, social or structural. keywords-component: microfinance; islamic finance; industry; sharia; financial inclusion; i. introduction microfinance aims to combat the exclusion of the most deprived from the conventional banking system through the creation and development of microfinance institutions. indeed, it is an alternative for low income households to create income generating activities, to raise assets and to improve their socioeconomic status. in other words, microfinance is designed to combat the different dimensions of poverty. obviously, the microfinance concept referred to microcredits. nevertheless, it extends beyond credit to cover financial services adapted to the specific needs of the poor who represent its main target (savings, insurance, money transfer ...). that said, according to pierre forestier [7]: " microfinance is based on motivations such as freeing people from a compulsory informal system (usurers), contributing to the emancipation of a category of population (women, young people, etc.), to provide financial services essential to the success of broader development programs it is then structured and embedded in a broader ambition to be an effective tool in the fight against poverty" . as surprising as it may seem, there is a strong correlation between microfinance and islamic finance. the islamic financial system is based on principles of social solidarity and equity that converge towards the objectives of microfinance. furthermore, many element of microfinance could be considered consistent with the brother goals of islamic banking. both system advocate entrepreneurship and risk sharing and believe that poor people should take part in such activities [4]. moreover, the microfinance sector in the middle east and north africa region, with a predominantly muslim population, still lags behind the lowest rate of access to financial services: % represents the financial inclusion rate in the middle east and north africa region compared to 40% of the poorest households. obviously, this decline may be due not only to the absence of financial services but also to the voluntary obstinacy of the muslim population to resort to these products if they are incompatible with the « sharia law ». according to the consultative group to assist the poor (cgap), the supply of islamic microfinance is very limited, with a high concentration in east asia and the pacific at 92%, the middle east region at 64% [6]. these institutions allow this category to have access to the various financial services on a micro level by enabling them to improve their living conditions and fight against poverty. through this article it is appropriate to understand how islamic microfinance can overcome the various obstacles faced by the traditional microfinance sector in order to become a more efficient tool contributing to economic development. ii. emergence and development of microfinance a. birth of microfinance it is true that economists are unanimous that the microfinance industry experienced a spectacular boom in the early 1980s on a global scale, particularly for the poor in developing countries. however, the history of microfinance did not develop until the 1970s under the impetus of muhammad yunus (nobel peace prize 2006), economist bengal and founder of the organization grameen. at that time bangladesh was experiencing a chaotic situation (a fierce war followed by pakistan's independence in 1971, two circumstances s.drissi (ph.d student), k.angade (ph.d.) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 laboratory for entrepreneurship, finance and audit (larefa) encg agadir, university ibn zohr (morocco) ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) precipitating 80% of the population living in poverty and famine) explained the results of the survey of the "statistical office of bangladesh" published in 1992 [1]. the founder of the grameen organization granted microcredit’s to the villagers whose objective was to institutionalize these informal loans to help these people later led to the birth of grameen bank, the first modern microfinance bank. however, it seems that microfinance, often referred to as an innovative device, with a logic of substitution for the banking system, is nothing more than a formalization of informal practices when examining the phenomenon of microfinance collective action of the cooperative or mutualism type. it is a very old and narrowly extended phenomenon [8, 19]. nowadays, the microfinance institutions’ main a central objective was not the achievement of a financial equilibrium since it would seem almost impossible for an mfi to function without receiving financial support from the government or the international financial institutions [3]. in the late 1980s, microfinance activity experienced a period of euphoria. indeed, bancosol is an example that would completely change the microfinance industry .being at the base a bolivian ngo, nongovernmental organization, created in 1986. bancosol introduced itself into the microfinance industry; it was successful, reflecting a high reimbursement rate and the emergence of a new social class of entrepreneurs and micro-enterprises. nevertheless, since the 2000s, many microfinance organizations have emerged, marking the beginning of a series of persistent challenges in the microfinance industry. between 1997 and 2006, 121 million people benefited from microcredit’s, granted to more than 150 million microfinance clients worldwide in 2006, 84% of whom were women, through 10000 microfinance institutions (imfs) the world [1]. b. a more concrete definition historically, microfinance has been built as a tool for the inclusion of those excluded from the traditional banking system, providing services to "non-bankable", those who cannot offer physical guarantees or who live in remote, landlocked areas and isolated financial services. in general, this lack of financial services for this unbanked person is due to the immediate risk of profitability that the banks think they risk confronting by managing small deposits and offering loans with low interest rates. however, the diversity of practices and arrangements put in place about the concept of microfinance do not allow for a definition that can be unanimously agreed on. besides, if the "finance" aspect presents itself as more or less simple to define, this is not the case for the "micro" aspect. in this context and through the literature review of the concept of microfinance, it appears that the definition of the microfinance phenomenon can be analyzed under three headings: quantitative definitions, institutional definitions and normative definitions [20]. i. the quantitative definition in this definition, microfinance, which is associated with the notion of microcredit, is also a concept that is difficult to define [10]. it is, in fact, a semantic shift in the notion of microfinance usually confused with the concept of microcredit. it is an amount which is lower than that sought by a business or household from a bank often for low-income people. however, what does a lower sum mean? for the world bank, the amount granted should not exceed a ceiling of 30% of gnp per capital, but the amount may vary from one country to another. for others, the amount of credit is in the range of us $ 162 to us $ 768 according to the gender criterion, and us $ 1014 to us $ 3410 depending on the chosen intermediary [13]. for the emn (european microfinance network), according to a european-wide survey in 2007, the average value of a microcredit may vary from one country to another, e.g. € 15,941 in germany to € 7,907 € for france depending on the size of the market and the size of microfinance institutions. ii. institutional definition institutional definition of microfinance refers to a particular system of financial intermediation considered to be innovative and providing financial services to populations excluded from the so-called classic financial system. it can take different legal forms such as ngos, mutual institutions, specific financial institutions or intermediary financial institutions [18]. however, the particularity of this intermediation system is the mobilization of solidarity, proximity and in particular trust in order to reduce the risk of insolvency for poor households. iii. normative definition in the search for a so-called normative definition of microfinance, there is a risk of sowing disorder in a way that it is possible to classify the activities of its institutions in the field of "solidarity finance" or "social finance" [17] . however, the financing institutions that grant credits to fight poverty or improve the welfare of a social category living in precariousness are part of the solidarity economy by encompassing an even broader field than the so-called " social sector, which is based on mutualism and cooperative values while the mfis must aim, with the exception of social motives and participation in economic development, to realize benefits in order to achieve the effectiveness, efficiency and sustainability of the institution. iii. islamic microfinance:confluence of two fastgrowing sectors many economists believe that microfinance and islamic finance have much in common. islam insists on ethical, moral, social and religious values in order to promote equality and equity for the good of society as a whole. the above values seem to correlate with the principles of microfinance that have been developed by cgap. in this perspective, the financial model of microfinance seems to find new impetus in the emergence of the phenomenon of microfinance [16]. indeed, in a global economic context, the problems of eliminating extreme poverty, reducing inequalities and accelerating economic growth are major challenges for our http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) countries. access to financial services should be seen as a primary objective to be achieved. since the eradication of poverty and the promotion of income-generating activities are part of the ultimate objectives of microfinance and islamic finance, microfinance thus seems to be a favorite sector of islamic finance [16]. after presenting a general overview of the concept of microfinance in the first part of this article, the next section will be devoted to a thorough examination of the merger of these two financial phenomena. this analysis will be carried out in two phases, the first of which deals with the analysis of the islamic microfinance model and its different aspects with regard to the second one, it aims to study the main obstacles hindering the development of this new growing niche. it is estimated that the muslim population in the world is growing by 2.9% per year, a growth rate more significant than that of the world population which grows with an annual rate of 2.3%, in other words 1.57 billion of muslims in the world at present, according to the pew. nevertheless, by conducting a survey of a sample of 64 countries comprising almost 75% of the adult muslim population worldwide, researchers noted that the muslim population is less likely to use financial services in formal institutions [5]. this is not due to the absence of these services or to the existence of a difference between the needs of the poor in muslim countries and those of their peers in nonmuslim countries, but this obstinacy is sometimes due to the incompatibility of these products with the principles of sharia. it is therefore permissible to admit that islamic microfinance is the confluence of two growing industries, namely microfinance and islamic finance. these two industries have the potential to respond not only to unsatisfied demand but also to combine the religious principles of islamic sharia with the social objectives of microfinance development to provide financial access to the poor. this potential could be the key to providing financial access to millions of poor muslims who are currently rejecting microfinance products that do not comply with islamic law. in a survey published by cgap in 2007 on the development of islamic microfinance institutions, based on 125 institutions and a team of financial experts from 19 muslim countries, it was found that the number of clients benefited from islamic microfinance does not exceed 380,000 people, or about 0.5% of total clients of conventional microfinance . it is therefore important to mention that the supply of islamic microfinance is highly concentrated, 80% of the total supply comes from only three countries: bangladesh, afghanistan and indonesia [14] . iv. the products of islamic microfinance in his book "islamic finance for micro and medium enterprises", economist mohammed obeidullah distinguishes two types of instruments that help eradicate poverty in muslim countries [15]. a first category based on the principle of charity and a second based on the mechanisms of the financial market. a. category of products based on charity zakat and alms are two principles which occupy a central position in the islamic religion. for zakat, it is the third pillar of islam. in fact, the gift of zakat is obligatory on the basis of the wealth of each muslim, according to clear criteria. for many researchers, zakat is a tool for income redistribution and public funding; it is one of the most important development mechanisms for poverty reduction [2]. the sharia imposes clear and detailed rules to determine the nature of the cost and the gift of the beneficiaries of the zakat. we can also cite in this category the waqf also called sadaka jaria, it is a mode of charity that can be offered for religious purposes such as the establishment of a mosque or for social purposes such as the donation of land, property or physical assets due to charity. these forms of charity can be used as financing funds for microfinance institutions. however, to ensure the sustainability and vitality of these institutions, they need to shift from a charitable to a more structured system that can cover the costs of financial transactions and provide services with a good price / quality ratio, especially since the lower the loan amounts, the higher the relative operational costs. currently, several islamic microfinance institutions use qard hassan's contract (benevolent loan) to introduce it to the list of products offered in islamic microfinance. the qard-alhassan contract focuses on the fundamental axiom of islamic development, namely the fight against poverty [12]. the particular structure of qard-al-hassan makes use of the distinct characteristic of property rights as prescribed by the islamic economic system by granting property rights, even to those who do not resort to the principle of distribution and redistribution [11]. b. category of products based on financial market mechanisms the islamic approach to the fight against poverty cannot be based solely on the modeling of charity. indeed, islam does not prohibit the creation of wealth on some conditions that are not studied in this article. it is very easy to notice the existence of a category of poor being able to create wealth for themselves and contribute to the development of their societies just by offering them financing products .hence, the use of for-profit microfinance products; the remainder of the article will be analyzed. i. the products of micro-savings in the institutions of islamic microfinance micro-saving is a crucial financial service for the poor and those excluded from the conventional financial system. poor people are looking for both secure and convenient deposit services to save small sums and provide easy access to their funds. however, microfinance institutions around the world tend to neglect this product by placing undue emphasis on microcredit. it is a service that occupies a primordial place in securing the lives of poor households. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) in general, it should be noted that several factors encourage micro savers to deposit their savings into microfinance institutions in general. among these factors, the following examples: safety, comfort, efficiency and personalized services [15]. various contractual options for the design of savings products exists namely wadia, qard hasan and accounts based on the mudaraba. ii. microcrédits products in islamic microfinance insitutions islamic microfinance is an industry in full extension; it is at the same time a niche of innovations of the financial products. this innovation can be designed for religious reasons, specifically to be compatible with islamic sharia. these products are at the origin of products of islamic finance. there are several products developed by traditional islamic financial institutions involving murabaha, bai-muajjal, ijara, baisalam, bai-istisna, bai-istijrar, etc. v. potential barriers to the growth of islamic microfinance in 2011, the consultative group to assist the poor (cgap) conducted a global study on the development of islamic microfinance, gathering information on more than 63 institutions and contacting lawyers from 19 muslim countries. this section contains the main findings of this global study on the performance and scope of islamic microfinance. according to the cgap study, mfis serve nearly 1.28 million customers in 19 countries with a fairly concentrated supply in countries such as bangladesh (445,000 customers), sudan (426,000 customers) and indonesia (181,000 customers), or 82% of the total number of islamic microfinance customers [6]. according to the study, bangladesh is the most active in terms of islamic microcredit with more than 445,153 clients and two dynamic institutions. indeed, in islamic countries, the overall supply of islamic microfinance remains relatively small and represents only a very small part of the entire microfinance sector. e.g., there are approximately 255 financial service providers offering sharia-compliant microfinance products globally, concentrated in two regions: east asia and the pacific with 164 beneficiaries, all providers. the middle east and north africa have 72 suppliers, which represents nearly 28% of all suppliers. for other countries, microfinance is still in its infancy, no major institution offers its services on a regional and national basis. for most countries, the average amount of islamic microcredit (mainly murabaha) is similar to that of conventional microcredit [9]. islamic microfinance institutions generally offer only one or two products that are compatible with sharia .their activities, which essentially involve the financing of assets limiting the sector and depriving it of sufficient diversity to meet the different financial needs of the poor. certainly, thanks to islamic microfinance, access to finance could be considerably improved and even reach levels unprecedented in all muslim countries. however, the sector remains to be demonstrated that it can provide financial services that meet the needs of the poor on a large scale. despite this potential, several obstacles could hinder the development of islamic microfinance. economic models of islamic microfinance have not yet been developed and no performance benchmarks have been established. vi. conclusion by way of conclusion, islamic microfinance remains a very wide area, requiring a great deal of research and studies based not only on the economic and financial sciences compatible with islamic sharia, but also on the sociology, psychology, politics and culture. an effort has been made through the previous pages to present this still growing industry through a definition of the basic concepts for a grouping together of these notions in order to conceive a clearer idea on islamic microfinance. it is true that islamic microfinance suffers from a number of direct and indirect obstacles that block its development, such as the high operating costs and the fragility of the supply, which comes mainly from non-financial agents such as ngos or cooperatives. however, it has strengths that can transform its previous threats into assets to add to the already existing opportunities, especially since one of the strengths of islamic microfinance is its dynamism and its ability to adapt to the surrounding environment whether muslim or not. indeed, it is enough to see the potential and development of islamic finance in general and competitiveness between european countries to be the center of islamic finance on a global scale. references [1] armendáriz, b., & morduch, j. (2010). “the economics of microfinance”, 2nd edn , cambridge , ma: mit press. [2] boyé, s., hajdenberg, j., & poursat, c. (2009). le guide de la microfinance: microcrédit et épargne pour le développement, groupeeyrolles, editions d’organisation, paris. [3] boyé, s., hajdenberg, j., poursat, c., munnich, d., & pinel, a. (2011). le guide de la microfinance. editions eyrolles. [4] demigürç-kunt, asli, ed., (2014), global financial development report 2014: financial inclusion, the world bank. [5] demirgüç-kunt, a., klapper, l., & randall, d. (2013), “islamic finance and financial inclusion: measuring use of and demand for formal financiel services among muslim adults” , word bank policy research working paper, no. 6642? word bank , wachington. [6] el-zoghbi, m., & tarazi, m. (2013). “trends in sharia-compliant financial inclusion”. cgap focus note 84: washington, dc. [7] forestier, p. (2005). les nouveaux enjeux de la microfinance. techniques financières et développement n°78, 24. [8] gentil, d., fournier, y., & doligez, f. (1993). les paysans peuvent-ils devenir banquiers?: épargne et crédit en afrique: paris, syros, coll. « les ateliers de développement », 271p. [9] international trade centre, u. w. (2009). le système bancaire islamique : guide à l'intention des petites et moyennes entreprises. genève: centre du commerce international (itc). http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 ejif – european journal of islamic finance special issue: islamic banking & finance no7, july (2017) [10] kalala tshimpaka, f. (2007). " la restructuration de l'espace microfinancier du kivu (rd congo): pistes d'une intermédiation efficace. ucl. [11] mirakhor, a., & bao, w. y. (2013). epistemological foundation of finance: islamic and conventional.in iqbal and mirakhor ed. economic development and islamic finance, the world bank , 25-60. [12] mohieldin, m., iqbal, z., rostom, a. m., & fu, x. (2011). the role of islamic finance in enhancing financial inclusion in organization of islamic cooperation (oic) countries.islamic economicstudies, 20(2),55-120. [13] mondiale, b. (1995). rapport sur le développement dans le monde 1995, le monde du travail dans une économie sans frontières. banquemondiale, washington, dc. [14] nimrah, k., michael, t., & xavier, r. (2008). islamic microfinance: an emerging market niche. focus note, 49.wachington, d.c:cgap. [15] obaidullah, m., & mohamed-saleem, a. (2008). innovations in islamic microfinance: lessons from muslim aid's sri lankan experiment. [16] ould-bah, m. f. (2011). les systèmes financiers islamiques: approche anthropologique et historique: karthala editions. [17] soko, c. (2001). finance informelle, micro-finance et financement du developpement en afrique a travers la mobilisation de l'epargne et l'organisation du micro-credit: pratiques des acteurs et viabilite des institutions. etude de cas en cote-d'ivoire. paris 1. [18] soko, c. (2009). les modèles de microfinance en côte d'ivoire: origine, organisation et impact: editions l'harmattan. [19] soulama, s. (1995). analyse économique des organisations du secteur non marchand de type coopératif. université de ouagadougou, faculté des sciences économiques et de gestion (faseg). [20] soulama, s. (2005). micro-finance, pauvreté et développement: archives contemporaines. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, portsmouth university, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france i. introduction ii. emergence and development of microfinance a. birth of microfinance b. a more concrete definition i. the quantitative definition ii. institutional definition iii. normative definition iii. islamic microfinance:confluence of two fast-growing sectors iv. the products of islamic microfinance a. category of products based on charity b. category of products based on financial market mechanisms i. the products of micro-savings in the institutions of islamic microfinance ii. microcrédits products in islamic microfinance insitutions v. potential barriers to the growth of islamic microfinance vi. conclusion references editorial_board.pdf editor in chief editorial board paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 the challenge of social impact bond: the state of the art of the italian context abstract— this paper aims to investigate social impact bond (sib), as a specific social finance tool able to involve various stakeholder groups in generating social value. the theoretical framework is the study of the outcome-based commissiong models of anglo-saxon origin and rapidly spread throughout europe. the research question concerns the main opportunities and challenges posed by the sibs in the perspective of italian public decision-makers. the results of the research consist in clustering of the various roles that the pa can assume in an sib and in the analysis of the strengths and weaknesses of the italian context with respect to the development of this tool. keywords: social impact bond, pa, italian context, social finance i. review of the literature and theoretical framework: new outcome-based geographies the financial crisis, the consequent policies to contain public spending, the attempted spending review and the slowdown in economic growth have heavily stressed the financial management and the pa welfare policies with a significant reverberation on the economic and financial management of third party organizations. sector. the increasing scarcity of public resources has led to an innovation in economic relations between public bodies and private organizations: we have thus moved from subsidies and public funding, to interventions dedicated to specific projects and specific results achieved, or through public-private partnerships based on the level of performance achieved (payment by results). sibs represent a research field within the broader area of social finance and impact investing, though there is little published research in this area compared with the body of research existing for foundations, observatories and government agencies. this paper is unique in that it attempts to analyse the function of sibs from the perspective of possible innovations of the pa. meneguzzo and galeone (2016) state that since the economic crisis, more studies have explored impact finance for social enterprises, new welfare systems, and contemporary social challenges. in the oecd’s report on "new investment approaches to meet the social and economic challenges" (wilson, ke, 2014), they found that impact investing has declined as a result of the changing relationship between finance and philanthropy. they have also found that social investment has had an impact on public spending, and that private resources continue to be given to strategic sectors that have general interest. these changes present a challenge in the form of a hybrid market, with unexplored potential, involving financial intermediaries and local bodies, small-medium sized enterprises (smes) and large enterprises, social enterprises and civil society (brown and swersky, 2012). the social impact bond is one of the finance tools that has the greatest impact, and originated in the uk impact market following the establishment of a social investment task force by the government. the so-called social impact bond (sib) is configured as a partnership between different actors dedicated to raising private capital to promote social initiatives in the public and non-profit sectors (oecd 2014). before in-deepen the discourse it is important it is important to point out that the evidences about sibs are still very few since this tool has been fully experimented in very few cases. as pointed out by christian berndt and manuel wirth (2018, 28): “the scholarly debate about sibs is still only in its infant stage, observers being largely interested in technical issues and focusing on how to improve a promising market for more socially inclined investors. by and large, academic and more policy-oriented contributions paint a positive picture. sibs are represented as a powerful tool that is capable of overcoming “inefficient” state intervention, bureaucracy and “unreliable” social service provision. against this, sibs are celebrated for their rationalized, evidence-based approach and their promise to introduce financial discipline and entrepreneurial spirit to public service delivery (liebman, 2011; mair and milligan, 2012, p. 27)”. burand (2013) claims that sibs are obligations that arise essentially for two reasons: a) an attempt by the public sector and non-profit organisations to access the resources they need to finance projects with a social impact; b) the request of investors who desire responsible and transparent investment instruments. l. corvo, l.pastore ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 gustaffson-wright, gardiner and putcher (2015) define sibs, in their survey of 125 global investors, as "a contract with the public sector or governing authority, whereby it pays for better social outcomes in certain areas and passes on part of the savings achieved to investors”. in contrast, the oecd (2017) defines sibs as "a mechanism that harnesses private capital for social services and encourages outcome achievement by making repayment contingent upon success”. the government outcomes lab (golab)1 of the university of oxford defines sibs as “one form of outcome based commissioning. what differentiates sibs from other forms of outcome based commissioning is the involvement of social investors to cover the upfront capital required for a provider to set up and deliver a service. the service is set out to achieve measurable outcomes established by the commissioning authority, for example a local authority or a central government department, and the investor is repaid only if these outcomes are achieved”. from these three definitions, it would appear that the essential elements of social impact bonds are: a programme of interventions in the social field capable of generating a social impact and saving public expenditure; a loan with return of principal and remuneration only if the programme is successful. it is important to note that service providers, both social enterprises and other companies, can count on reliable resources over a period, from a minimum of three to a maximum of 10 years, considerably longer than that foreseen by traditional programmes that ranged from 1 to 3 years. the sib is like other forms of "payment for results" contracts in that it is a financing mechanism in which the return for the investor is determined by the positive impacts generated by a certain social activity (burand 2013). the performance of the sib changes according to the performance achieved by the social enterprise. in this case, the remuneration is linked to the results of the activity financed in terms of value created for society (brown and swersky, 2012). it is a sophisticated financial instrument that is born to promote social innovation. the complexity of the instrument in this case is not linked to the difficulty of being able to predict the success or failure of an investment, but to the network of relationships between the actors taking part in the process. these are in fact linked by a partnership, recognised under the contractual profile, where the perceived variable of ‘financial risk’ of a traditional investment is added to the variable of trust between partners who participate in the game. the investor believes in the ability to a certain social service provider to achieve a certain result. the public administration believes that the innovative service has value in economic terms as well, and all the actors trust in the validity and certainty of statistical surveys that measure the performance of a certain service, and which are carried out by an independent third party. 1 golab https://golab.bsg.ox.ac.uk/ figure 1. the sib model. source: so, i., & jagelewski, a. (2013). figure 1 shows the process of sibs. the intermediary, in agreement with the public body, issues a social bond placed with private investors, who provide the necessary capital to support a social project. in turn, the intermediary transfers the funds obtained through the sibs to non-profit organisations who provide the services required by the project. the evaluation of the effectiveness of the results obtained from the project is entrusted to a third party. this third party, along with the intermediary, defines the system for monitoring and measuring final performance. if the project meets the quality standards established at the time of issuance of the obligation, the public body is required to pay the amount due, giving the intermediary a percentage of the costs avoided due to the reduction in public expenditure determined by the programme, plus a predetermined additional percentage to the intermediary, who will in turn pay the investors who provided the initial capital2. sibs are characterized by an outcome oriented approach, that is, they aim to maximize social impact through appropriate interventions and are instruments characterised by a set of complex contracts in a multi-stakeholder partnership (golab 2018). whilst sibs have been well-researched, it is only since 2016 that their effectiveness has generated critical debate. the main criticisms to the use of sibs concerns the effect of transformation that might generate on the third sector and social enterprises (neil mchugh at al 2013), the effect on the public bodies (berndt c., wirth m.,2018), the effect on the services users, such as a distortion in the selection of the beneficiaries. the oecd report (2016) describe this distortive phenomenon as ‘cherry piking’ or ‘“cream skimming’. the criticisms to sibs lies on the idea that the actors involved in the process cannot have the same interest and to merge it some of them have to modify its nature as maier f. and meyer m. (2017) pointed out in their paper “social impact bonds and the perils of aligned interests”. anyhow, qualitative and quantitative studies on this effectiveness are still missing, even if it is starting a lively debate on technical issues as mentioned 2 www. socialimpactbond.it https://golab.bsg.ox.ac.uk/ ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 by roy at al. in their paper “a critical reflection on social impact bonds” (2018). ii. the italian context and the research question the research question focuses on the italian context and the perspective of public decision makers regarding the adoption of the sib tool. in italy, sibs are in an embryonic state of study and experimentation. as of today, it is not possible to report a complete sib initiative, but only for signs of interest from various still not systemic experiences. in 2017, two feasibility studies were conducted on social impact bonds: fondazione sviluppo e crescita crt and human foundation have drawn up a feasibility study on the profitability of a pay by results contract in the field of social and work reintegration of former prisoners; finpiemonte, next level, forum of the third sector and the piedmont regional government conducted a feasibility study to establish the first social impact bond to counter the abandonment of migrant students. the study was conducted during the "sib for growth" project, funded by the easi european program. the results are a model contract in compliance with the italian public regime and the design of a tender procedure. it is also worth noting that the impact measurement and its management, which is a key aspect of the implementation of the sib, is rapidly spreading in italian social policies adopted by public authorities and in important private organizations, for instance the social enterprise public-private impresa sociale con i bambini. in december 2017, a social innovation fund of 25 million euro was set up through the finance act, with the aim of supporting impact agreements. considering this evolving scenario, the research question concerns the public decision-makers. more generally, regards the pa's perspective the use and implementation of this tool, or similar, in the italian context: what are the strengths and weaknesses of the adoption of this tool for the italian pa? trying to answer this first research questions has emerged as an implicit one, i.e. what is the role of the pa in an sib? iii. methodology the research was carried out using qualitative-ethnographic methodology (bales 1950, hammersley 1989; corbetta, 1999). this was selected as it comprises documental analysis (bowen ga, 2009), workshops with key actors (breen 2006) and semistructured interviews (kvale, 1996). the research was launched in july 2017 and is currently underway. this article is part of a wider research project involving the study of the alpine regions of five countries: italy, france, germany, switzerland and slovenia. as a research group government and civil society (gcs)3, we have been involved in a project that has been questioning 3 http://gcs-group.it/ the financing of social impact and projects and sibs. the european project, alpsib 4 , focuses on five countries in the alpine area of central europe. the project aims to identify a common methodology for social impact investing (sii) policies, adapting social finance approaches to the organizations involved. this contribution summarizes and analyzes the research results with respect to the italian context. the methodological phases related to this contribution were three: 1) document analysis of sib models in europe, with particular attention to the role of the pa; 2) focus group with italian public decision-makers called to discuss the sib device, with particular attention to the challenges and opportunities offered by this tool; 3) european workshop with research centers specialized in impact finance and experts in which to compare and validate the results of individual countries. the document analysis (phase 1) involved the study of 14 sibs carried out in europe and described through specific reports. they were chosen starting from the most complete impact bonds database available, using the open source data provided by the social finance platform. on 17/06/2018 the platform certifies 108 sibs active in the world, in the period related to data collection the active sibs were 98, but there were no significant variations from a distribution point of view that interfere with the methodology used. the analysis was initially restricted to the 62 european sibs, among which there is a high number of english experiences (40), and then the choice of the 14 sibs based on criteria of territorial distribution and social area of intervention. below is the table with the references of the 14 sib analyzed: table i: sib for document analysis n country intervention area region 1 uk socio-occupational reintegration of former prisoners peterborough 2 uk services sanitised for minors birmingham 3 holland socio-occupational reintegration of former prisoners amsterdam 4 holland training for professional retraining utrecht 5 belgium socio-occupational insertion of migrants bruxelles 6 germany social assistance to families osnabruck 7 germany job placement of neets augsburg 8 france socio-economic integration of rural areas (national policy) 9 switzerla nd socio-occupational insertion of migrants berna 10 austria socio-economic support for women subjected to violence upper austria 4 http://www.alpine-space.eu/projects/alpsib/en/home http://gcs-group.it/ http://www.alpine-space.eu/projects/alpsib/en/home ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 11 sweden contrast to educational poverty norrkšping 12 finland socio-occupational insertion of migrants (national policy) 13 finland organisational wellbeing of public employees helsinki 14 portugal contrast to educational poverty lisbona source: own processing. this analysis made it possible to compare the key dimensions taken into consideration in european experiences and to map which public administrations are involved as outcome funders. this document analysis showed that, considering that some sibs have designated more pas as outcome funders, there is a prevalence of involvement of local (5) and regional / federal administrations (3). in the case of central administrations (5), essentially two types of ministries prevail: justice and economy/labour. on the basis of this analysis it was decided to involve public decision makers through a focus group (phase 2) trying to have a correspondence between the public key players highlighted in the european experiences and the italian champion. the focus group was held on october 26, 2017 in turin and was a moment of deepening and reflection aimed at understanding the perspective of public decision-makers with respect to sibs. the workshop participants were selected according to the following criteria for adherence to the european champion: policy makers and main pa managers involved in areas of possible application of the sib (welfare area); homogeneous representation between local and central pa (compared to the proportion found in the analysis of the european sample); inclusion also of non-public but strategic actors with respect to the management of an sib. in total, 90 subjects were selected throughout italy and invitations were sent one month before the event. 32 people, comprising, attended the seminar: • 20 pa policy makers, managers and officials, from: o four regions piemonte, friuli venezia giulia, valle d'aosta, puglia, with two representatives per region, almost all of whom were managers at the time except one, who was a decision maker in the valle d'aosta region. o one faculty of economics, university of rome "tor vergata" in the department of management and law, and three members of the research group of government and civil society. o two city: the metropolitan city of turin, including two representatives – one political and one technician, and the city of pordenone, again, including two representatives – one executive and one official. o one representative of the regional agency for social housing (regione piemonte). o one consultant from a private company for the public administration on the european structural funds. o one official from a cohesion agency. o one official from the ministry of labour. o two representatives of the association of local governments (anci) and the financial institute for local governments (ifel)  five experts on the topic from the università della svizzera italiana one participant, the university of rome ‘tor vergata’ two participants, and from the human foundation giving and innovating two participants.  seven representatives of three partners of the alp sib project: finpiemonte – four participants, and the next level association three participants, and the municipality of pordenone (already listed). the program of the day was divided into two parts: the first dedicated to the study of the sib tool and the presentation of european cases, with particular attention to the role of the pa involved; the second part consisted in the analysis of possible opportunities and challenges regarding the implementation of the sibs in the italian context. following the day of the focus group, a discussion paper was prepared containing the main results that emerged from the debate among the public decision-makers that was submitted to the group involved to have a validation of the results. furthermore, the discussion paper was presented in ljubljana (5 december 2017), where the european workshop was held including the 5 countries of the alpsib project. the european workshop involved 40 people: project partners (european municipalities and regions of the alpine space), academics (including 2 representatives of golab university of oxford), and practitioners (consultants in the economic-financial and legal fields). on this occasion, the results that emerged in each country were presented and were compared and systematized thanks to the feedback of the academics present and the involved practitioners. iv. research results and critical discussion the results of the research are divided into 3 sections emerged from phase 1 and 2 of the research (presented and validated in phase 3 of the european comparison): 1) analysis of the roles of the pa in an sib: • pa as producer-investor • pa as controller-controller • pa as enabler-facilitator 2) analysis of the weaknesses / limits of sibs from the perspective of the pa, divided into objective (or system) and subjective (or cultural) weaknesses; ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 3) analysis of the strengths / opportunities of sibs from the perspective of the pa. during the analysis of the results, it was tried to cluster the categories of analysis with respect to the roles that a pa can have, very often simultaneous, on which pa-pa relationship problems depend. the analysis of the roles of the pa refers to the possible application of an sib, although it could also be extended to other contexts. the role of pa: not just a payer in order to grasp the role of a pa in the sib process, it is necessary to first analyze the value chain of the underlying project or service that is the intended recipient. the first distinction concerns the willingness to pay the recipients of the project or service. where there is no willingness to pay, or where such availability is limited, by not allowing the project or service investment to be remunerated, the role of the pa becomes central to ensuring economic and financial sustainability. in the case of the willingness to pay recipients, however, the pa assumes a different role. in this instance, the pa enables the initiative and facilitates the reproduction of the initiative in other areas. an sib requires more than one type of process to occur within the pa, and in this, we find the root of the complexity discovered during the turin workshop. there are two levels of such complexity: multifunction and multilevel, with the latter concerning the complexity of collaboration between different areas of institutional competence within the central and local pas. the first element of orientation is marked, as anticipated, by the willingness to pay the recipients. the willingness to pay creates a fundamental bifurcation that determines a different intensity of the pa's intervention. the first question that must be asked, therefore, is: does the considered sib concern a project or service for which the recipients have the willingness to pay? who can remunerate the investment? this differentiation enables us to understand the role that social finance investors have in the specifics of a sib. the extent to which sibs can develop in the italian context is determined by the weakness of the coordination mechanisms that exist between different public actors, functions and roles that a pa assumes in an sib initiative. the main complexity of the role of pa in a sib model can be seen in the plural configuration of its processes, which reflects the plural configuration of its functions. according to rebora (2015), the pa macro-processes can be classified as follows: 1) direct services; 2) indirect services; 3) allocation functions; 4) remote regulation; 5) power regulation; and 6) general administration services. where it is able to reimburse the sib's investment base, the pa will assume less involvement in processes related to direct, indirect and allocation services and a greater coordination burden in regulatory and power processes. in contrast, where there is no willingness to pay by the recipients, the pa will emphasize the direct delivery processes, and, consequently, indirect processes and allocations, but it cannot reduce the effort in terms of coordination and adjustment. availability to pay, therefore, determines what pa intervention is required. the first question that is addressed is whether the sib is considered a project or service for which recipients are willing, or able to, pay in return for the investment. this differentiation enables us to better understand the role of private actors in the field of impact finance, specifically with sibs. svc funds are allocated to projects that are willing to pay as beneficiaries, while philanthropic funds tend to finance projects where there is less willingness to pay for results. differences arise around willingness to pay based on the nature of the project and on target recipients. a co-housing project, for example, has greater chances to find willingness to pay from the recipients than a project on immigrants where recipients are unable to pay. a sib targeted at a central school and higher-income families will see greater willingness to pay than a sib targeted at schools in peripheral or internal areas. the pa may thus focus its efforts on securing funding itself in instances of reduced or absent remuneration of the sib investment through market logic. a second orientation element is represented by the plurality of roles that the pa performs in a sib, due to the plurality of processes that characterize it. by crossing these processes with the needs of an sib initiative, three pa role configurations emerge: a. producer-buyer; b. regulator-controller; and c. enabler-facilitator. the pa as producer-investor the pa plays a role in producing and delivering services where value generated, in its plural sense, by the direct intervention of the state is higher than the value that the market would be able to generate. in many direct intervention areas, service beneficiaries do not have the economic viability to pay for the service. therefore, public service is considered crucial to re-balance the distribution of value among citizens through resources collected by general taxation. in this case, sibs are an important tool for redesigning public spending towards an "outcome-based commissioning" approach. the pa as regulator-controller above all, the pa has a role in regulating social relations in order to ensure compliance with shared rules and conditions of social cohesion. a particularly important aspect emerged during the workshop: the risk of fracture within the public system. indeed, several involved actors and regional policy makers referred to the major criticalities of sib experimentation on the difficulty of dialogue with other actors, which, in the specific case of italy, are the court of auditors and the anac. during the debate, it appeared as if these two bodies were not part of the same pg system as the regions ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 involved, as if they were talking about entities separate from them. this dynamic indicates ineffectiveness in pg systems and draws attention to the need to understand not just "societygovernment" relations, but also government-government relations. to this end, the topic of the governance arrangements needed to enable sib experiments has been introduced. sibs, by their nature, require a significant shift in regulation and control. for the effective management of a sib, the regulatory function should be accompanied by a significant programming capability, and the control function should be guided by an important evaluation capability. both steps refer to a shift first to cultural governance, and therefore to managerial governance. it is, therefore, necessary to move from a perspective oriented to formal aspects, namely accounting-administrative, to an outcome-based management perspective. this latter perspective should be integrated into the cycle throughout the sib process, from initial programming to final evaluation. the pa as enabler-facilitator in the italian context, the least considered function of pa is that of enabler-facilitator. as an enabler, the pa should simulate new relationships from which innovative projects can emerge, including sibs. the pa’s role extends beyond that of one who merely funds initiatives and decides the legitimacy of an initiative. the pa is primarily the subject that works to generate value, so it has an intrinsic interest in all projects that can generate social impact. this aspect, which can be technically defined as the pa's multiple outcome of governance and impact, is the basis for the pa's enabling role. regardless of the ability of a pa to support, from a financial point of view, a sib, it is necessary to understand whether that same pa is primarily concerned with social impact. too often, we concentrate almost exclusively on the demand for social impact assessment, ignoring the first lever of the process, that is, the significance of the impact through which we are going to generate the proposed sib initiative. this step is crucial to creating the necessary commitment conditions to stimulate multifaceted and complex governance. the italian case shows that such a passage is often overlooked, which, in turn, creates a rebound in terms of the continued emergence of interventions related to the socioenvironmental dimension. in some cases, the commitment required becomes automatic due to dramatic events, such as at times of natural disaster, hydro-geological disasters with their obvious damage and casualties, collapse in cultural sites, and sudden increases in poverty. a pa must have both a qualifying role and the ability to be a knowledgeable director of a sib. there are three benefits that emerge from the emergence of the pa in this defined role of helping to direct sibs: the public entity is intrinsically concerned with the generation of social and environmental impacts, because they contribute to the achievement of the institutional goals of the pa itself; 1. the role of the institutions is, therefore, re-qualified, more efficiently responding to crisis of trust that is evident and well-measured by the oecd and other such observers; and 2. through the incorporation of poorly utilized assets of the pas, the pa are able to generate positive impacts in the form of public assets and common assets at large. limitations in implementing sibs in the italian context the weaknesses and limitations in the italian context were divided into two categories: a. objective, or systemic, limitations. these were further divided into four sub-categories: a1. poor flexibility of the formal legal framework focus on formal aspects inhibits the possibility of experimenting with sibs. an example of inconsistency is the concept of public utility described in the procurement code. according to the code, public utility is the ability to generate accounting savings in the same year of the project. therefore, for the implementation of a sib, it should be able to demonstrate public utility, and not just the ability to generate positive impacts in a broader, albeit measurable and quantifiable sense. a2. short-term orientation the short-term tension imposed by public finance constraints is in radical contradiction with sib philosophy. social impact, by its very nature, manifests its ability to create value and recalculate spending in terms of medium-term forecasting. linking sibs to the ability to generate savings in the short-term is a limitation that greatly reduces the potential of sibs, especially when considering an apparent contradiction between this trend and the norm, requiring pas to plan multiannual economic and financial cycles. a3. lack of process management procedure considering both a partnership for innovation, co-planning and direct negotiation, there is some confusion about the device to be used to implement an sib. more specifically, there is a lack of guidelines able to guarantee a shared procedure to all the subjects involved, including the court of auditors. a4. poor integration of the sib process into the economicfinancial planning cycle in the post-2008 crisis, continuous logics of cutback management were applied, improperly called spending review, making linear cuts in spending. in italy, the logic of basing decisions on public spending, and on spending reviews, on the impact of spending, and not on immediate savings, is still far away. for this reason, it is difficult to implement innovative tools that have, as their logical matrix, outcome based commissioning and pbr. the second set of limitations in the italian context was deemed ‘subjective or cultural limitations’(b). these were also further divided into four sub-categories: b1. weak managerial skills in the pa ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 these range from strategic planning to performance management, and impact management. while it is true that the pa sets a formal control on spending and short-term performance, it is also true that there is a lack of managerial skills within the pa. there is a lack of critical mass within the pa that can put pressure on transforming the pa and make sure that impact management, obc and pbr are adopted. b2. poor financial literacy in the pa and in the tsos this lack of literacy leads to scepticism and fear for financial players. b3. difficulty in governance of multi-stakeholder processes there is a tendency to fragment the processes and to lose the overall vision. the pa feels unable to manage complex processes in terms of actors involved, timescales and risks accrued. this aspect is partly linked to the objective lack of tested and safe devices and administrative procedures and is compounded by a strong aversion to the risk of pa, leading them to avoid the role of directing sibs, which is crucial. b4. weakness of leadership, partly due to a lack of overall political strategy the lack of leadership is reflected in the lack of coordination mechanisms, and, therefore, in the inability to manage complex processes. this aspect is closely linked to the previous point. the set of elements mentioned above hinders meetings with investors and other stakeholders who, in this context, do not feel guaranteed by a weak and contradictory public interlocutor. opportunities in implementing sibs in the italian context in addition to the limitations identified in the workshop, the workshop also highlighted opportunities that should not be underestimated. the first opportunity to be noted is the interest shown by the participants in the workshop, which, as mentioned, are important public organizations. in particular, regional representatives, engaged in a dual role of coordination upwards with european and national policies, downwards with the municipalities expressed interest in sibs and their willingness to better understand the possibilities of implementation in their contexts. the following three opportunities also emerged from the italian context: 1. availability of the ethical finance system banks, whose purpose is to support the development of the social economy, have shown a strong interest in sibs and, more generally, in various sii instruments. 2. the third sector reform (2016) during 2017, the decrees implementing the reform were issued, which introduced important changes with respect to the methods of financing social enterprises and the logic of interaction between tsos and the pa. 3. creation of networks and centres of expertise that create greater awareness in italy, there are increasingly more centres of expertise, often started by universities and other research institutes, which aim to create conditions of greater awareness about the financial instruments linked to social innovation processes. v. conclusions, future research developments and policy recommendations during this first year and a half of research on the topic of sib emerged considerations of a transversal nature compared to the italian context that can be useful both as a basis for future empirical research and for policy recommendations with respect to the development of the use of outcome systems based:  there is keen interest in sibs from regional representation, as evidenced by the prevailing participation in the meeting. therefore, there is a willingness to experiment from a certain pa that has direct contact with the effects of the economic and democratic crisis that italy, like other oecd countries, is going through;  there is a diffidence regarding the preparation of the other actors involved in an sib. the concern emerged that neither the pa nor the third italian sector and social finance organizations are prepared to manage the complex processes of sibs; and  government-government relations were identified as the main cause of difficulty in the development of sibs and in any process that requires complex governance. the discrepancy between the directives of various public bodies creates a sense of loss and insecurity, which hinders the implementation of innovative tools such as sibs. in particular, it emerged that the anac (national anti-corruption authority) directives and the decisions of the court of auditors are not, to date, consistent with core elements of sibs, that of multi-stakeholder intervention models and medium-long term economic-financial planning. the issue of government-government relations is noticeable at local administration level, regional level and in the full complexity of the public system and roles that a pa covers. the topic of the outcome based commissiong and the models deriving from it are included in the debate on the creation of shared value between the state, the market and the civil society. sibs can be a collaborative device that contributes to the improvement and intensification of relationships between sectors. in the literature this topic has not yet been included in the public management line of co-creation and co-production because it is currently being addressed by the literature dedicated to impact finance. the broader objective of the research project is to verify, in the 5 countries under study, how much the sibs contribute to improve the coejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 creation of value by the stakeholders involved through the implementation of a formal model that defines the key variables of an sib and their measurement. following this first research, in particular the comparison of the focus group, and numerous other opportunities for debate on the subject with experts and key players in the italian context, we have come up with 4 areas of recommendation for the italian scenario to develop and actually take form: 1. to create a knowledge management system on sibs accessible to pas this would consist of an open source platform in which it is possible to simulate each step of the sib process, with tutorials explaining how to overcome any possible obstacle. 2. to create a process format with accompanying tools for the replication of trials in addition to the platform, it is strongly encouraged that a support and empowerment team of pas who intend to start a sib is created. the mechanism would be similar to that of social incubators, with respect to the creation and development process of start-ups. 3. to allocate a portion of the funds available from public financial institutions to sibs in addition to allocating specific funds, for example, from institutions like cassa, depositi and prestiti, financial institutions would share virtuous experiences and with sibs, matching sibs and institutional programmes who share similar purposes, including urban regeneration, the promotion of active labour policy instruments, and the fight against educational poverty. 4. to promote the creation of networks of tsos these would drive the development of sibs by acting in synergy even in different territorial contexts. a key and delicate role will be the development and management of the social innovation fund, will be instrumental in creating the basis for an outcome-based culture and to help pas to experiment with complex governance models. references [1] alford, j., & o'flynn, j. (2012). rethinking public service delivery: managing with external providers. palgrave macmillan. [2] bales, r.f. (1950). interaction process analysis, a method for the study of small groups. reading, mass.: addison-wesley. [3] belinsky, m., eddy, m., lohmann, j. and g. michael (2014). “the application of social impact bonds to universal healthcare initiatives in south-east asia”. who southeast asia journal of public health, vol. 3/3-4, pp. 219225. [4] borgonovi, e., & mussari, r. (2011). pubblico e privato: armonizzare gli opposti. [5] bozeman, b. (2007). public value and public interest. counterbalancing economic individualism. washington, dc: georgetown university press. [6] brandsen, t., & honingh, m. (2016). distinguishing different types of coproduction: a conceptual analysis based on the classical definitions. public administration review, 76(3), 427-435. [7] brown, a. and a. swersky (2012). “the first billion: a forecast of social investment demand”, boston consulting group, london, september. [8] burand, d. (2013). globalising social finance: “how social impact bonds and social impact performance guarantees can scale development”, journal of law & business, vol. 2013/9, pp. 447-502. [9] corbetta, p. (1999). “metodologia e tecniche della ricerca sociale”, collana strumenti, il mulino. [10] disley, e. and rubin, j. (2014). phase 2 report from the payment by results social impact bond pilot at hmp peterborough. london: ministry of justice. [11] disley, e., rubin, j., scraggs, e., burrowes, n. and d., culley (2011). lessons learned from the planning and early implementation of the social impact bond at hmp peterborough. london: ministry of justice. [12] gustafsson-wright, e., gardiner, s. and v. putcha (2015). potential and limitations of impact bonds. [13] kohli, j., golden, m., coletti, j. and l. bo’sher (2015), from cashable savings to public value: pricing program outcomes in pay for success, center for american progress, lessons from the first five years of experience worldwide, global economy and development. [14] mazzuccato m., rediscovering public wealth creation, live mint – epaper1st january 2018. [15] meneguzzo m., rebora g. (1990). strategia delle amministrazioni pubbliche, utet, torino. [16] milbourne l. & cushman m. (2012). from the third sector to the big society: how changing uk government policies have eroded third sector trust. voluntas. [17] mintzberg h. (2015). rebalancing society. radical renewal beyond left, right, and center. common access on www.mintzberg.org [18] murray r., caulier-grice j., mulgan g. (2010). the open book of social innovation. london, nesta-the young foundation. [19] oecd (2014a). social impact investment: building the evidence base, paris: oecd publishing. [20] oecd (2016). understanding social impact bonds, working paper, the oecd leed programme. [21] oecd (2017). government at glance. http://www.oecd.org/gov/govataglance.htm [22] oecd netfwd (2014b). venture philanthropy in development: dynamics, challenges and lessons in the search for greater impact, oecd development centre, paris. [23] oecd/european union (2015).policy brief on social impact measurement for social enterprises: office of the european union, policies for social entrepreneurship, oecd/european commission, luxembourg: publications program, brookings institution. [24] pestoff, v. a., brandsen, t., & verschuere, b. (2012). new public governance, co-production and the third sector. [25] roy m. j., mchugh n., sinclair s., (2018). a critical reflection on social impact bonds, in standford social innovation review, may 2018. [26] social finance (2012). a new tool for scaling impact: how social impact bonds can mobilise private capital to advance social good. [27] wilson, k. e. (2014). “new investment approaches for addressing social and economic challenges”, oecd science, technology and industry policy papers, no. 15, oecd publishing. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 asset life sukuk to fund utility companies 1 university of turin, italy, paolo.biancone@unito.it 2 university of turin, italy, mohammad.shakatreh@unito.it abstractin response to a growth in the world population, there has been a growth in demand for utilities; in fact government and utility companies are increasingly seeking alternative sources of finance to meet these growing demands. this paper will provide evidence that sukuk is one of the instruments which can help fill funding gaps. a qualitative research approach has been used to examine the main characteristics of investment in the utility sector and compare them with sukuk. the paper explains the process of choosing and developing the sukuk structure to fit the main originator objectives. the paper concludes that sukuk can be used by utility companies, and it is suggesting that utility company can use the sukuk structure with no redemption value, which we term it assets life sukuk; the main difference between the asset life sukuk and other sukuk is that the issuer is not required to repay the amount of principal to the sukuk holders at the end of maturity, as sukuk tenure will be determined according to the useful life of underling assets, and therefore sukuk has no value at maturity date. keywords-component; sukuk ; ustility; redemption value; asset life, infrastructure project i. introduction utility companies aim to access capital at reasonable costs, but these companies face big challenges including constrained public budgets, shortage in lending capacity, high costs of borrowing, long tenor funding needs and more stringent regulation in the banking system. the paper considers utility companies as one of the most important parts in the infrastructure sectors. infrastructure investments are diverse as an asset class; infrastructure encompasses investments in the underlying, essential networks and services that are necessary for the proper functioning of global economies. these include transportation, communication systems, water, energy production, energy distribution, waste management, and public institutions, such as schools, post offices and prisons.[1] the mckinsey global institute estimates that global infrastructure investment would need to increase by nearly 60 percent from the $36 trillion spent on infrastructure over the past 18 years to $57 trillion over the next 18 years, or $3.2 trillion a year between 2013 and 2030, with roads and power accounting for almost half of this need. to keep up with projected global gdp growth, the task of funding the world infrastructure needs is more difficult because of the constraints on public-sector budgets and commercial debt deleveraging in the wake of the financial crisis, higher and more volatile resource costs, and the additional costs of making infrastructure resilient to climate change and less harmful to the environment.[2] a growing number of special products were launched by the financial industry to satisfy the demand for infrastructure as a new asset class with a number of attractive and distinctive investment characteristics. the financial industry presented infrastructure as one of the new “alternative” asset classes (alternative to mainstream equities and government bonds), expected to provide new sources of return and better diversification of risk.[3] historically, governments have funded infrastructure projects through taxes and debt financing; that is changing as governments are slowly allowing private companies to develop, purchase, or lease infrastructure assets. this change in attitude partly reflects the growing reality that most governments no longer have (or are willing to commit) the capital necessary to maintain existing infrastructure or support new infrastructure development.[4] advanced economies face the challenge of maintaining extensive transport, power, water, and telecommunication networks, upgrading and modernizing them as grown flags. in the developing world, countries dedicate a large proportion of their national income just to meet basic human development needs (access to water and sanitation, electricity, and allweather roads, for instance) and still cannot cater to large swaths of their populations. the challenge in these countries is becoming even more daunting as rapid growth on fuels demand for infrastructure to support economic and social development. infrastructure is a corner stone of a stable and productive society. while infrastructure presents unique challenges, it also offers opportunities for both the public and private sectors. [2] many studies have focused on using islamic finance in infrastructure investments, and many others have talked about sukuk structures, but this study focuses on the utility sector and its investment characteristics. the importance of this study is derived from the need for a huge amount of liquidity to fund utility investment in the near future. this paper is looking to sukuk as one of the available solutions to meet utility companies’ demand for finance, this research aims to investigate the possibilities of using sukuk to fund utility companies by answering the following questions: what is the utility sector and what are the main characteristics of investing in this sector? what is sukuk and what are its main characteristics? how can a company adopt a suitable sukuk structure which can satisfy its needs? paolo pietro biancone1 mohammad shakatreh2 http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 the methodology and approach that will be used is a qualitative research approach namely various literatures, financial reports, and the utility sector previous sukuk issuance; the paper takes a comparative approach in exploring the main characteristics of investment in utility sectors and sukuk features. the paper explains the sukuk structure and discusses the most appropriate one that could be used in the utility sector, and how the company can develop the sukuk structure according to its objectives. this paper is organized as follows. section 2 discusses the utility company and investment characteristics. in section 3, the study explores the sukuk type, definition, structure and main characteristics. section 4 focuses on main challenges that could face sukuk. section 5 is the conclusion ii. utility companies according to the north american industry classification system, the utility sector comprises establishments primarily engaged in operating electric, gas and water utilities. these establishments generate, transmit, control and distribute electric power, distribute natural gas, treat and distribute water, operate sewer systems and sewage treatment facilities, and provide related services, generally through a permanent infrastructure of lines, pipes, treatment and processing facilities. the utilities sector encompasses a wide range of services, including water, gas, public sanitation management, and power. depending on the level of market liberalisation, a company may engage in the production, trade, transmission, distribution, or sale of utilities, or any combination of these. utility companies have large tangible assets in the forms of power plants, transmission lines and urban grids, converter stations, sewer and sewage pipes, dams, and storage facilities for fuel and waste. [5] a traditional integrated power entity (utility) generates electricity and sends it around the country or region via highvoltage transmission lines, finally delivering it to customers through a retail distribution network. some utilities also or exclusively transport water and/or gas. the power and utilities industry is highly regulated, with continuing government involvement in pricing, security of supply and pressure to reduce greenhouse gas emissions and other pollutants..[6] according to powerful reporting from pwc (2014), companies in the power and utilities sector have a significant impact on the countries in which they operate. typically high profile and with relatively large market capitalisations, utilities supply the power, water and gas that form an economy’s lifeblood. the utility sector might sometimes be seen as an important but relatively unexciting part of the industrial landscape. it comprises a vast set of highly capital-intensive assets, many of which have an expected lifetime of 30 years or more. investment decisions made today may not result in assets becoming operational for at least 3 years and often much longer. but even in times of high economic uncertainly, decisions have to be made and they will cast their shadow over the next half century. and they affect not only shareholders in those companies but also consumers and other stakeholders, such as governments. so it is important to make the right decisions. [7] investment in utilities has special characteristics; this paper will explore the main investment features of utility companies: a) large initial cost established utility investment is a capitalintensive process; because a utility project is considered as an asset class, with large initial cost, expensive assets and a high technology system. the size of the infrastructure project is considered large, because the assets of these projects are of high investment payment, and according to [8] infrastructure deals are, on average, more than twice the size of non-infrastructure deals. they entail large costs that are recovered over long periods of time through the productive use of these assets. since they tend to provide basic social requirements, and are vital for economic and social growth, governments remain deeply involved in their regulation and administration [9]. generating assets are often large and complex installations. they are expensive to construct, tend to be exposed to harsh operating conditions and require periodic replacement or repair. [6] b) long-term finance building infrastructure requires long-term funding. this reflects both the length of the construction period and the life of the underlying asset that is created [10] infrastructure assets have service life of as long as 100 years or more. there are many historical examples with significant longer life, such as roman aqueducts. in addition to the physical and technical life of an asset, a key factor is its economic life, which may even be less than five years in the case of laboratory or medical facilities. for investors, the amortisation of their investments over the economic life of the asset is important. [11] c) high debt levels large-scale projects require a great amount of capital, utilities carry high debt as their infrastructure requirements make large, periodic capital expenditures necessary. d) low liquidity assets liquidity is likely to be limited for directly owned, projectfinanced infrastructure assets. there is essentially no secondary market for these assets, and most do not lend themselves to conversion to alternate uses.[12] e) key public service. infrastructure assets meet key public requirements in everyday life, such as the provision of water, energy, mobility, communication, education, security, culture or healthcare, making them a basic prerequisite for economic growth, prosperity and equality of life. [11] infrastructure including utility is a means for ensuring the delivery of goods and services that promote prosperity and http://www.ojs.unito.it/index.php/ejif https://www.ic.gc.ca/eic/site/cis-sic.nsf/eng/h_00004.html https://www.ic.gc.ca/eic/site/cis-sic.nsf/eng/h_00004.html ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 growth and contribute to the quality of life, including the social well-being, health and safety of citizens, the quality of their environment as well.[13] f) stable and predictable cash flows utility and power investments generate cash flows only after many years. but, infrastructure provides more stable cash flows than non-infrastructure investments [14]. these kinds of projects often face few competitors; many operate as monopolies in industries with high barriers to entry, significant economies of scale, and few substitutes. user demand is often inelastic and, given the “essential” nature of the projects, cash flows may be expected to exhibit low sensitivity to economic cycles. these characteristics appeal to investors seeking steady and stable cash streams.[12] infrastructure assets that possess the characteristics listed above generally have stable, predictable and in most cases inflationadjusted long term revenues that can weather a storm and economic cycles and support a significant credit burden.[11] utility has a monopoly situation with high barriers to market entry; infrastructure assets are hard to duplicate on account of high start-up investment costs for the construction of water, electricity or telephone networks. for example, after commission the cost of providing each additional service/product unit, a new connection to the water supply or an extra unit of electricity supply is comparatively low. this combination of circumstances means that the barriers to market entry are high. accordingly, these kinds of infrastructure assets have little or no competition. [11] infrastructure assets are often regulated to protect consumers from predatory pricing. water utilities, power utilities, and toll roads are often regulated.[4] in situations with little or no competition, regulatory authorities perform a corrective function on the market, for example by fixed prices or providing minimum payment guarantees. however, a regulated market per se does not necessary eliminate the market risk for the provider. the best example of this is the telecommunication market. [11] infrastructure assets are typically controlled by a government entity, either directly or indirectly. as a result, the privatization of an asset can involve many different stakeholders with potentially different objectives. further, assets that have monopoly or near-monopoly status may face strong regulatory oversight. pricing power in these instances may be limited.[12] g) involve a large number of parties utility and power investment in a power plant project, for instance, involve several parties like contractors, operators, government, lenders, owners and suppliers. iii. sukuk sukuk is a plural of sakk; sukuk is an islamic financial certificate that complies with shariah principle and laws. investment sukuk as defined by aaiofi are the certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity. however, this is true after the receipt of the value of the sukuk, the closing of the subscription and employment of funds received for the purpose of which the sukuk were issued. (aaiofi 2008). this definition includes two important points; the first one is that sukuk holders must have real ownership of the asset of the specific project. the second one is that the project and the sukuk issuance procedure must be consistent with shriah principle.[15] the sukuk is like dough, it can be shaped according to companies needs but within the shariah principle and by using shariah complaint contacts. utility companies can develop the sukuk structure which fit their needs and features. the paper suggests sukuk structure with maturity according to the expected life of the underlying assets, and we called it assets life sukuk, and by this structure:  the spv use the sukuk proceeds to obtain the assets from the originator or from another part, and these assets have long term useful life.  the sukuk maturity will be determined according to the assets useful life.  the sukuk has no value at the end of the maturity; the originator doesn’t have any obligation to redeem the sukuk at the maturity date.  the spv will get the return and principal during the assets life from the real return of these assets.  the spv and the originator should use shariah compliant contracts to utilize these assets, and the originator chooses the contract according to its financial needs and position, a care should be taken into accounting issues and effects of the contract on the financial statement before choosing the contract. the main difference between the asset life sukuk and normal sukuk is that the issuer is not required to repay the amount of principal to the sukuk holders at the end of maturity, because the underlying assets have no value at end; we aim by creating this structure to reduce the debt amount in utility company and to overcome the conflict about the repurchase price of the underlying assets at the maturity date. asset life sukuk will encourage the utility companies to expand their work and establish new projects. sukuk are classified depending on the shariah contract into four types: sales based ( murabahah, istisna), lease based ( ijarah), equity based (musharakah, mudarabah), agency based (wakalah). there are many types of sukuk, and each structure has its own characteristics. in general, issuance corporate sukuk begins with establishing a special purpose vehicle (spv), which has an important role in the sukuk structure, because it issues sukuk and gets the proceeds from the sukuk holder, it’s owned by a sukuk holder and represents them throughout the http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 contract; the spv distributes the profit to the sukuk holder and redeems proceeds at maturity. sukuk can take many forms depending on the contract used between the originator and spv, this contract must be comply with shariah principles, choosing the sukuk structure and the contract depending on some factors like the objectives of the originator, level of debt and credit rate, legal framework and existing law, and tax structure. the originator must obtain approval from a shariah committee on the sukuk structure, because the project can also be implemented based on fatwa from a shariah board. "fatwa" is a religious opinion concerning islamic law issued by an islamic scholar[16]; this fatwa is valid only for specific cases and it must be approved before issuance. this paper will explore some shariah compliant contracts, with real example from utility sector; the most common contracts used in the utility sector are musharkah, ijarah and murabahah. musharakah: also known as partnership or joint venture means an agreement between two or more parties to combine their assets, labour or liabilities for the purpose of making profit.[17]. the musharakah structure uses the mobilized funds for establishing a new project or developing an existing one or financing a business activity; profit generated from the project will be shared between the partners according to the predetermined percentage. in october 2011 the saudi aramco total refining & petrochemical company issued 14 years musharkah sukuk , with an issuance size of us$1 billion and profit rate of 6 month saibor plus 0.95 per cent; the issuance used both ksa law and english law, the structure included other contracts, istisna (construct) and ijara (lease) contracts have been used with the musharaka company, and issue was 3.5 times oversubscribed. mudarabah is a contract between a rabbul mal and a mudarib under which the rabbul mal provides capital to be managed by the mudarib and any profit generated from the capital is shared between the rabbul mal and mudarib according to mutually agreed profit sharing ratio (psr), whilst financial losses are borne by the rabbul mal provided that such losses are not due to the mudarib’s misconduct (ta`addi), negligence (taqsir) or breach of specified terms (mukhalafah alshurut). [18], in 2011 the saudi international petrochemical company issued 5 years mudharabah sukuk with an issuance size of us $480 million and profit rate, floating rate 3 month sibor + margin of 1.75% , the issuance using ksa law, it’s based using a shariah-compliant mudaraba structure., and issue was three times oversubscribed. ijarah: refers to a contract that transfers ownership of a permitted usufruct and/or service for a specified period in exchange for a specified consideration. [18] this structure is the most commonly used, because the lease contract is well known and regular payments throughout the life of the assets, because the rental amount normally depends on a conventional benchmark like the libor indicator. in 2014, the saudi electricity company sec issued 30 years ijarah sukuk with an issuance size of us $1,000 million and profit rate of 5.50 per cent, the issuance used both ksa law and english law, it’s based upon a sale and leaseback approach, the sec sells the right of usufruct of the ijarah assets to spv (saudi electricity global sukuk co 3), the spv leases the assets back to sec under a lease arrangement (ijarah) for 30 years, and issue was five times oversubscribed. murabaha: is selling a commodity as per the purchasing price with a defined and agreed profit mark-up.[17] in most countries sukuk murabahah can’t be traded on the secondary market because shariah does not permit trading in debt instruments, but malaysia allows the trading of sukuk murabahah. on november 2013, the ooredoo tamweel limited company, formerly known as qatar telecom (qtel) issued five years of murabahah sukuk with an issuance size of usd1.25bln and profit rate of 3.039%, using both of english law and qatar law, and the issue was four times oversubscribed istisna: is a contract of sale of specified items to be manufactured or constructed, with an obligation on the part of the manufacturer or builder (contractor) to deliver them to the customer upon completion.[17] istisna structure is especially suitable for financing large infrastructure projects. sukuk istisna has not been that widely used, but istisna contract is used with other contracts in the same structure, the spv entered into an istisna’a arrangement with another party to manufacture or construct certain assets and deliver them, then the spv can enter ijarah agreement with the originator to lease these assets. wakalah refers to a contract in which a party (muwakkil) authorizes another party as his agent (wakil) to perform a particular task, in a matter that may be delegated, either voluntarily or with imposition of a fee. [18] the paper will answer the question that why sukuk is one of the most appropriate sources of funding to utility sector by comparing the main features of investment of utility companies that we discussed before with sukuk features: 1sukuk has the ability to fund large size projects by using variety types of contracts, and there are successful previous large issuances in the utility sector, and under shariah law there is no limitation for the size of deal. 2sukuk has long-term maturity and it ranges from one year to 30 years; in my opinion there is a possibility for more innovation in the sukuk structure development. 3sukuk instrument can be equity or debt depending on the underlying contract, and there are many varieties of sukuk that can be customized to the specific needs of the issuer; for example mudarabah, musharakah, ijarah sukuk. 4tradability of the sukuk depends on the nature of the underlying assets. for example, by using asset backed sukuk and real transfer of the ownership of these assets, the sukuk holders (investors & issuers) are able to trade sukuk (assets) through the sukuk market. 5the issuers of sukuk can be either a governmentrelated entity or a private entity, and investing in utility projects achieves the objectives of maqasid al-shariah http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 (the tenets of islamic law) which includes the goals to preserve the public good. 6sukuk and bonds are considered important channels for governments, companies, and institutions to provide the necessary liquidity to finance its projects at relatively low cost, according to the saudi stock exchange. the sukuk and bonds market will enable investors to diversify their investments and provide financial protection for their portfolios with lower risk tools which ensure a safe and periodic return for the investor. 7sukuk holders are seeking to obtain steady and stable returns, and the characteristic of infrastructure returns appeal to those investors, because in the sukuk structure the return is not linked with interest rates but linked with real return of the investment. 8in some cases, there is no significant difference between bonds and sukuk in pricing because some sukuk, such as ijarah sukuk, is related to interest benchmarks such as libor or sibor, similar to conventional bonds. 9in the sukuk structure, the spv can deal with several parties by using shariah compliant contracts, but all of these parties must be shariah compliant, for example the spv can’t deal with conventional insurance companies or conventional banks and all transactions must be done according to shariah principals. iv. main challenges despite the successes achieved by the previous issuance of sukuk in the utility companies, the sukuk still faces some challenges; the main challenge is being to obtain approval from a shariah committee on the sukuk structure, because the project can be implemented based on fatwa from a shariah board, each contract, pricing, profit and all transactions in sukuk should be approved by a shariah board, this will increase the time and cost to accomplish these transactions. sukuk faces another challenge which is the lack of a unified regulation framework which can govern and regulate the issuance of sukuk, and the lack of a taxation system which can protect the sukuk holder from the double taxation. most taxation systems don’t take into account that muslim investors have to pay zakah (an arabic word means a religious tax in islam) on their income; as well as, the use of an interest benchmark such as libor or sibor to determine the profit rate. the big challenge is the incompatibility between the theoretical and real implementation of sukuk issuance. we create the assets life sukuk for two main reasons, the first one is to reduce the debt amount in utility company and the second one is to overcome the conflict about the purchase price of the underlying assets at the maturity date. by reviewing the previous issuance, we found that all of the issuance considered the principal amount as liability in their balance sheet, and they redeem the sukuk at nominal price. study of [19] use online survey to obtain the accountants’, academic and professional perceptions about several accounting issues in sukuk issuance and it indicate that the ifrs are accepted to account for sukuk transactions, and it showed that sukuk certificate could represent ownership of assets, represent liability or claim on the spv and right of usufruct of assets. but the biggest part of respondents replied that sukuk certificate should appear under liability. we suggest that further research about accounting standards in sukuk issuance and sukuk pricing is needed to overcome these challenges. v. conclusion the findings of this paper provide a reference towards understanding the mechanism and concepts of how the utility companies can use sukuk to meet their financing needs. this paper has used the comparative approach to prove that sukuk commensurate with the investment characteristics of the utility sector, congruence between literature and the real case of previous issuance of sukuk in the utility sector. most of the previous issuance of sukuk in utilities were oversubscribed, which could be a good indicator about the future demand for utilities sukuk, and that will fill the gap between the available funds and utility companies’ demand for finance. the study tried to shed light on the process of improving the sukuk structure which can fit the need of the utilities and investors in the same time, although innovation is still needed in sukuk in areas of structuring and determining the profit rate; the paper considered the asset-backed sukuk with no redemption value and maturity as one of the most appropriate structures to use in the utility sector. i.references [1] c. suisse, “can infrastructure investing enhance portfolio efficiency?,” asset manag. white pap. httpswww credit-suisse comassetmanagementdownloadsmarketinginfrastructurechukluxitasc andinavia pdf, 2010. [2] r. dobbs et al., “infrastructure productivity: how to save $1 trillion a year. mckinsey global institute,” mckinsey co january, 2013. [3] g. inderst, “infrastructure as an asset class,” eib pap., vol. 15, no. 1, pp. 70–105, 2010. [4] m. williams and s. l. nesbitt, “infrastructure investment opportunities,” cliffwater llc, 2009. [5] r.-m. koizumi and f. onisor, “industry analysis: utilities,” sustainalytics, feb. 2014. [6] r. welter, f. trepte, a. allocco, and m. bellantoni, “financial reporting in the power and utilities industry,international financial reporting standards,” pwc, jun. 2014. [7] n. white, k. ingham, m. von bechtolsheim, m. haischer, and r. francis, “the future of energy utilities how utilities can survive the ‘perfect storm,’” arthur d. little. [8] f. bitsch, a. buchner, and c. kaserer, “risk, return and cash flow characteristics of infrastructure fund investments,” eib pap., vol. 15, no. 1, pp. 106–136, 2010. [9] r. j. sawant, “the economics of large-scale infrastructure fdi: the case of project finance,” j. int. bus. stud., vol. 41, no. 6, pp. 1036– 1055, 2010. [10] n. mor and s. sehrawat, “sources of infrastructure finance,” inst. financ. manag. res. cent. dev. finance work. pap. ser., 2006. [11] b. weber and h. w. alfen, infrastructure as an asset class: investment strategies, project finance and ppp. john wiley & sons, 2010. [12] d. w. wallick and j. cleborne, “a primer on infrastructure investing,” vanguard, sep. 2009. [13] r. della croce, “pension funds investment in infrastructure,” 2011. [14] s. ben ammar and m. eling, “common risk factors of infrastructure firms,” university of st. gallen, school of finance, 2013. http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 [15] p. p. biancone and m. z. shakhatreh, “using islamic finance for infrastructure projects in non-muslim countries,” eur. j. islam. finance, no. 2, 2015. [16] p. p. biancone and m. radwan, “sharia compliant ‘possibility for italian smes,’” eur. j. islam. finance, no. 1, 2015. [17] a. aaoifi, sharia standards for islamic financial institutions. bahrain, 2010. [18] bank negara malaysia, “shariah standards.” mifc, 2013. [19] p. p. biancone and m. z. shakhatreh, “accounting issues in sukuk issuance,” int. j. islam. econ. finance stud., vol. 2, no. 3, nov. 2016. http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, portsmouth university, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france editorial_board.pdf editor in chief editorial board paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 analysis the gap between bnm regulation and mm application in islamic banking abstract— bank negara malaysia resolved the utilization of musharakah mutanaqisah on the shariah advisory committee 56th meeting in 2010. in the practice, most of the bank use musharakah mutanaqisah for the home financing purpose. this study examines the gap between the bnm regulation and both the maybank islamic and hsbc amanah practices. the method of analysis is using qualitative study based on the library research. the result has found the gaps whcih consist of one major gap and three minor gaps, the major gap is related to charging early settlement fee by hsbc amanah. in addition, three minor gaps are related to wa’d statement in both banks, pledge statement in maybank side, and default approach compliance in both banks. however, this study does not examine the gap that related to the contract validity. nevertheless, one single gap found might create the serious issue that leads to effect the contract validity of the product. by uncovering one gap that existed in their practices, this study suggests for better monitoring and supervision conducted by all involved parties. bnm shariah advisory council and respective islamic bank committee should verify the practice that may cause the contract to become void. in addition, the islamic financial institutions should strictly follow all the regulation issued by the bank negara malaysia in all their practices and publication in order to make the contracts acceptable according to shariah and to cater public confidence. adhering to guidelines along with the sharia standard of the product further increases accountability and trustworthy of sharia compliancy in particular product. keywords-component; musharakah mutanaqisah, gap, bank practices. i. introduction a. background of the study the scholars and the independent bodies in the field of islamic banking and finance have designed the financial and deposits products using sharia compliant contracts. the musharakah mutanaqisah (mm) which is discussed in this paper is also one of the products suggested for financing purpose. mm is a concept invented by the scholars from musharakah (partnership) as the basis which is one of the nominate contracts (al-‘uqud al-musamma) in fiqh. the aaoifi defined the mm as follows: “musharakah mutanaqisah is a form of partnership in which one of the partner promises to buy the equity share of the other partner gradually until the title to the equity is completely transferred to him. this transaction starts with the formation of a partnership, after which buying and selling of the equity take place between the two partners. it is therefore necessary that this buying and selling should not be stipulated in the partnership contract. in other words, the buying partner is allowed to give only a promise to buy. this promise should be independent of the partnership contract. in addition, the buying and selling agreement must be independent of the partnership contract. it is not permitted that one contract be entered into as a condition for concluding the other” (aaoifi, 2008, shariah standard no.12, 5/1, p.217). from aaoifi definition, it implies that mm comprises three independent contracts e.g. musharakah (joint venture), ijarah (lease), and bay (sale). in addition, it also stated unilateral promise (wa’d) as it comes from the buyer side to buy bank’s portion. accordingly, musharakah mutanaqisah (mm) is basically a partnership contract whereby the share of one partner as an islamic bank diminishes while other partner’s as a customer increases until the later becomes the sole owner. the mm can be arranged for the purpose of financing for asset acquisition as well as for financing for business venture. therefore, according to bnm (2010), if the partnership established for the purpose of acquiring asset, it should be governed by the rules of ‘sharikat al milk’, if it is for the business venture, it should be governed by the rules of ‘sharikat al aqd’. some researches argue that mm for asset acquisition is considered as shirkat alaqad when the intention of one party to generate returns (aif, 2013). however, in malaysia, mm is considered as shirkat almilk as stated in the concept paper, as the own purpose is to jointly own asset rather than profit generation. furthermore, the asset in mm contract can be an already completed or incomplete asset (under construction asset). mm for the completed asset may be arranged with ijarah (lease) and sale and for the asset to be constructed may be arranged with istisna contract, ijarah mawsufa fi zimmah and sale. on the other hand, mm for venture is governed by the rules of ‘sharikat al aqd’ because it is meant for sharing profits even audia syafa’atur rahman, hayathu mohammed ahamed hilmy, adi saifurrahman institute of islamic banking and finance, international islamic university malaysia email: audiasyafaaturrahman@gmail.com, ahamedhilmy@gmail.com, say4m@gmail.com rusni hassan institute of islamic banking and finance, international islamic university malaysia hrusni@iium.edu.my ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 though there are elements of ‘diminishing’ aspect to allow venture capitalist to acquire the business profits. the following diagram summarizes the components of mm: figure 1.1 musharakah mutanaqisah contract scheme b. objective of the study mm is a product approved by bank negara malaysia. according to bnm (2010), shariah advisory committee 56th meeting resolved that musharakah mutanaqisah is “collective usage of contracts of musharakah, ijarah, and sale in one document of agreement is permissible as long as all contracts are concluded separately and clearly”. the resolution considered that “a musharakah mutanaqisah contract that uses both musharakah and ijarah contracts is deemed as one form of contemporary contract (`uqud mustajiddah) recognised by fiqh scholars in order to fulfill the contemporary needs of islamic mu`amalah”. the operational requirement of mm is regulated under a bnm regulation which issued by bank negara malaysia. few islamic banks in malaysia adhere to mm product especially for home financing (lung, 2013). the objective of this study is to examine the regulation of bnm which is represented by shariah standard and exposure draft in comparison with mm which are actually been practiced by the islamic banks in malaysia. besides that, it also to find the gap between bnm regulation and the practices. c. research method and scope according to the research carried out by lung (2013), there are only six banks having mm concept for home financing. maybank islamic and rhb islamic as the representative for the local banks and asian finance bank, hsbc amanah malaysia, kuwait finance house, ocbc al-amin bank, and standard chartered saadiq as the representative of foreign banks. table 1.1.lists of bank in malaysia implemented musharakah mutanaqisah bank home financing products name sharia concept local bank maybank islamic bank home equity-i mmp rhb islamic bank equity home fin.-i mmp foreign bank asian finance bank (min fin amount rm500k) home fin.-i mmp hsbc amanah malaysia home smart-i mmp kuwait finance house mm home fin.-i mmp ocbc al-amin bank manarat home-i mmp standard chartered saadiq saadiq my home-i mmp source: lung (2013) this study examined maybank islamic and hsbc amanah respectively to represent the local bank and foreign bank. likewise, this study focus on the practice of mm for completed asset. the method adopted in this analysis is qualitative based on the library research. the primary resources come from bnm regulations, bnm guidance, concept paper and product disclosure sheets on the respective banks. the secondary resources come from research articles. on the next section, it reviews the literature which consists of musharakah mutanaqisah concept, practical issues, and bnm regulation. ii. literature review a. musharakah mutanaqisah concept musharakah mutanaqisah (mm) is normally utilized for financing the asset acquisition. according to usmani (2004), mm is established by having joint ownership in the property (shirkat al milk). for utilization of the property, the customer leases the asset and subsequently pays the rental to the bank. afterwards, customer promises to the bank that the customer will reduce bank’s unit share by purchasing the bank’s portion. at the end time, customer will be the sole owner of the asset. according to bnm (2010), shariah advisory committee 56th meeting resolved that collective contracts which comprise of musharakah, ijarah, and sale are allowed as long as they are concluded separately and clearly. the musharakah mutanaqisah model can be executed for different kind of usages. however, most of banks use this model for home financing purposes. musharakah mutanaqisah scheme for home financing may be structured as follows: ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 figure 2.1 musharakah mutanaqisah model source: isra (2010): bulletin managing default in musharakah mutanaqisah the steps of mm start, firstly, with the customer by choosing house and apply for financing to the bank. secondly, bank considers to approve or not to approve the customers’ application. once, it has been approved by the bank, bank and customer will incorporated the musharakah agreement. thirdly, customer leases bank’s portion for the house. fourthly, monthly payment must be paid with along with the rental payment in order to purchase the bank’s share. finally, the partnership will be ended by the customer owning 100% of the house and ownership title will be transferred to the customer. b. practical issues in practice, according to meera and razak (2009), musharakah mutanaqisah implementation is not exactly in line with sharia law. several practical issues arise in the mm implementation specifically which influenced the changes on the rental rates, wa’ad, defaults, and early termination of contract. 1) rental rates the rental issue is very important as its utilization in musharakah mutanaqisah home financing could replace interest rate as a benchmark. hashim and hassan (2015) stated that the current practice to determine the lease rental based on the conventional benchmark like klibor and libor. besides, it can also use market price by inventing the market price which has been practiced in us by lariba. in agreement with hashim and hassan (2015), taib et al (2008) and smolo and hassan (2011) stated that mm home financing can solve the use of interest rate as a benchmark through the utilization of the rental income. those scholars opined that benchmarking or setting the rental level with market interest rates is not by itself prohibited. however, certain conditions have to be followed such as (i) the rental since the first period of the contract have to be determined (ii) subsequent periods have to be specified to a certain benchmark on condition which such benchmark build upon a clear formula. the formula is not subject to dispute. in accordance with abovementioned, al-baraka fatwa on inceif (2015) stated related to interest rate benchmarking, “there is no prohibition in relying on the interest rate benchmarking in pricing the islamic products of which such use of benchmark does not contradict the products’ nature of conforming to the shariah upon its usage”. it means that interest-rate benchmarking is allowed for the financial instruments which do not engage in qard. in addition, the absence of representative islamic financial benchmark as one strong reason. syekh taqi usmai warn that “it is however true that the islamic banks and financial institutions should get rid of this practice as soon as possible, because, firstly, it takes the rate of interest as an ideal for a halal business which is not desirable, and secondly because it does not advance the basic philosophy of islamic economy having no impact on the system of distribution. therefore islamic banks and financial institutions should strive for developing their own benchmark”. 2) wa’ad application and its implication wa’ad with the intended effect to guarantee the payment for the share of the other partner raises shariah issue in mm. it is not permitted for one party to establish wa’ad to purchase the other’s party share at the value of the share on the day of the partnership is created. the reason stated that wa’ad become a guarantee to the share of the partner. in mm, unilateral wa’ad is utilized for from sides of the bank or customer. the bank sells its shares on periodical basis to the customer or wa’ad from the customer to purchase the bank’s shares (smolo, 2011). the wa’ad utilization is catered as a risk mitigation tool to evade any financial loss against the bank and show the parties’ commitment to perform their contract as mutually intended (abdullah, 2009; dar, 2010). in the default case, discontinuation of musharakah mutanaqisah can be solved with two methods i.e. without wa’ad or with wa’ad. if it solves without wa’ad, the underlying asset will be disposed to the market and the proceeds will be shared according to the latest ownership share ratio (after all the outstanding costs and payments settled such as outstanding rents and legal fees). if it solves with wa’ad, the customer have to purchase the remaining shares of the bank. wa’ad in the default makes a legal obligation on the customer to purchase all outstanding shares of the bank and to pay outstanding rental and other fees. after that, debt is created and this debt is to be settled by the customer (smolo, 2011). according to hanafi (2012), this practice with wa’ad caters as ‘capital guarantee’ over the bank’s credit risk. the use of purchase undertaking should be done with necessary caution, as itwill contradict the basic principles of profit and loss sharing contract, as it cannot be systematically made dependant on collateral or guarantees to reduce credit risk ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 (sundararajan and errico, 2002; smolo, 2010; naim, 2011). in addition, since mm for asset acquisition based on shirkat almilk, when it comes to the loss, each partner shall bear ownership related expenses/liabilities or loss, on pro rate basis. in addition, the practice of transferring all the obligations on the maintenance and takaful solely to the customer (even has been agreed upon by both parties) may suggest that the bank does not ‘truly’ have ownership risk over the house. hence, such a practice does not render genuine musharakah when one party has superior advantage over the other party. c. bnm regulation compliance with shariah requirement is a prerequisite to ensure the legitimacy of islamic financial products and services. the shariah contract-based regulatory policy is intended to ensure end-to-end compliance with shariah and hence, enhance the integrity and sustainability of the ifi. in policy document, there are two denotations. “s” means a standards, and obligation, a requirement, specification, direction, condition and any interpretative, supplemental and transitional provisions that must complied with. if noncompliance occurs, it may result in enforcement actions. “g” means as guidance which may comprise of statements or information, intended to promote common understanding and advice or recommendations which are encouraged to be adopted. in this research, musharakah and ijarah bnm sharia standards are examined as the main contracts and also relevant concept paper for the supporting contracts such as wa’ad and ta’widh. in addition, guidelines on ibra’ (rebate) for salebased financing is also used. iii. discussion and findings the table below describes the regulations that governed mm and the practices of both banks. since the mm is hybrid contract, this study refers to the bnm sharia standards of musharakah and ijarah. furthermore, for the supporting contracts, we referred to the concept paper on wa’ad, ibra and ta’widh. to find out the banking practices on relevant aspects, the study focuses on their product disclosure sheets (pds), banks’ policy on payment and profit calculation. a. definition application of musharakah mutanaqisah institution information note bnm regulation musharakah may be entered into by two or more parties on a particular asset or venture which allows one of the partners to gradually acquire the shareholding of the other partner through an agreed redemption method during the tenure of the contract. such arrangement is commonly referred to as musharakah mutanaqisah (diminishing musharakah) (bnm regulation, 2015, musyarakah, provision 21.1). guidance – two main essences are shareholding and partners to gradually acquire maybank islamic musharakah mutanaqisah (diminishing partnership). this is an islamic property financing based on a no gap – different terms used combination of shariah contracts of musharakah (partnership) and ijarah (leasing). it is a form of diminishing partnership contract whereby the customer and the bank jointly acquire and own a property. once the bank leases the property to the customer, the installment payments shall gradually transfer the bank’s ownership to the customer. (pds, pg.2). which are jointly acquire and own a property and gradually transfer hsbc amanah the customer and the bank will be in a partnership to purchase a property. the bank’s share of the property will diminish over time during the tenure, while the customer’s share of the property will increase at the same time as a result from the monthly payments to the bank. ultimately, the bank will transfer the full ownership of the property to the customer at the end of the facility or upon early settlement by the customer, whichever is earlier” (pds, pg.1). no gap different terms which are partnership and diminish comment the essence of definitions for bnm and maybank islamic are similar. however, hsbc amanah stated that the full transfer of property ownership can be conducted by the customer either at the end of tenure or upon early settlement, of which maybank islamic only mentioned about transfer of ownership at the end of the tenure. since, the essence of definitions are similar, it does not deviate from the definition which is guided by bnm. b. contract application on musharakah mutanaqisah for asset acquisition purpose institution information note bnm regulation musyarakah mutanaqisah for the purpose of acquiring completed assets may be arranged whereby the partners jointly purchase an asset from a third party. subsequently, one of the partners will lease his share of the asset ownership to the other partner based on ijarah. simultaneously, the partner who is the lessee will purchase the share of the other partner on a gradual basis and ultimately become the sole owner of the asset. (bnm regulation, 2015,musyarakah, provision 22.2) guidance – three contracts: jointly purchase, lease, and gradually purchase the other partner’s share maybank islamic musharakah mutanaqisah (diminishing partnership). this is an islamic property financing based on a combination of shariah contracts of musharakah (partnership) and ijarah (leasing). it is a form of diminishing partnership contract whereby the customer and the bank jointly acquire and own a property. once the bank leases the property to the customer, the instalment payments shall gradually transfer the bank’s ownership to the customer. (pds (1), pg.2) no gap – three contracts: partnership, leasing, and gradually transfer the bank’s ownership hsbc the shariah concept applicable is no gap – 1pds: product disclosure sheet ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 amanah diminishing musharakah (coownership). diminishing musharakah involves three underlying contracts independent from each other, those are: (i) co-ownership: the bank participates as a financial partner in the acquisition of the property. you and the bank contribute the capital to own the property. (ii) lease: the bank then leases its share of the property to you for ‘rental payment’. (iii) purchase: on monthly basis, you purchase a portion of the bank’s shares.this purchase is affected against “purchse price” paid by you (pds: no.1-i,ii,iii) three contracts: coownership, lease and purchase the bank’s share comment maybank islamic and hsbc amanah stated similar contract application of mm as stated on bnm regulation. the terms used by hsbc amanah slightly different but it gives the explanation. c. wa’ad (promise) application on musharakah mutanaqisah institution information note bnm regulation a partner may, at the time of entering into the contract, request other partner to give a promise (wa`d) to gradually purchase the former’s share of the asset over an agreed period of time at market value, fair value or any price to be agreed by the partners. (bnm regulation, 2015, musyarakah, 22.5). guidance – wa’d needed from the customer to purchase bank’s share maybank islamic product disclosure sheet does not stated about wa’d (purchase undertaking) gap – pds does not stated anything about wa’d hsbc amanah product disclosure sheet does not stated about wa’d (purchase undertaking) gap pds does not stated anything about wa’d comment the gap is found since pds of maybank islamic and hsbc amanah does not state anything about wa’ad. however, this gap does not affect product validity and the legal requirement, because wa’d in the contract is only the guidance of bnm regulation. in order to fully comply with bnm regulation, pds should present the wa’d. d. pricing method institution information note bnm regulation the contracting parties may agree for the rental amount a) to be paid in a fixed amount b) to be determined via a reference to a specified benchmark or formula; or c) to be paid using a combination of guidance – 3 types of pricing method i.e. fixed, specified benchmark paragraph 14.3(a) and 14.3(b) above (bnm regulation, ijarah, provision 14.3). or combination maybank islamic the pricing is competitive as per the conventional loan which could be offered under:  fixed rate; or (refer to bnm regulation point a)  floating rate; or (refer to bnm regulation point b)  a combination of fixed rate and floating rate. (mmtfi maybank)(2) (refer to bnm regulation point c) the profit rate used for computation of selling price rate is determined upfront i.e. bfr + 4% or 10.00% whichever is higher upon the offer and acceptance of financing. this selling price or known as ceiling rate provides the customers with maximum capping for the total amount of financing payment regardless of periodical changes in the bfr. (pds, pg.1) no gap – bfr as the benchmark ceiling rate is stated hsbc amanah your monthly payment and total amount to be paid will vary if the br (base rate) changes. (pds, pg.2) the home smart-i profit rate is pegged to base financing rate (bfr) with a spread (pds, pg.1). effective from 2 january 2015, the home smart-i profit rate is pegged to base rate (br) with a spread. no gap – br as the benchmark ceiling rate is not stated comment bnm stated that rental amount of mm can be determined fixed amount, reference to specified benchmarks, or combination of both. maybank islamic and hsbc amanah follow the guidance to determine the rental amount. therefore, there is no gap in term of method between bnm regulation and bank practices. however, maybank islamic and hsbc use different approach for their rate. maybank islamic use bfr and hsbc amanah use br as the recent reference rate. since both banks using br and bfr, question arise which one is better for the customer, bank, and its shareholders. e. pledge institution information note bnm regulation a partner may pledge his ownership share of the completed asset as collateral to the other partners (bnm regulation, 2015, musyarakah, 22.8). guidance – customer pledge his ownership for security purpose maybank islamic this facility is secured against residential or commercial properties. nonetheless, additional security such as fixed deposits, guarantors, etc. may be requested depending on the credit assessment. gap – different approach for pledge hsbc amanah customer are pledging the house as a security for this financing (pds, pg.1). no gap – exactly 2 maybank2u.com musharakah mutanaqisah term financingi (mmtfi) ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 following bnm guidance comment bnm regulation stated guidance (g) that the customer may pledge his ownership share to the bank. hsbc amanah requires the customer to pledge the property as the security in the financing arrangement. however, maybank islamic state some security arrangement at the time of mm contract, not specifically related to pledging of ownership. since, it is only the guidance by the bnm, maybank islamic does not follow strictly. this difference cannot be considered as a major gap. however, it is important to note here that pledging the asset is more useful for the bank because the title ownership of the house registered in malaysia under the customer’s name as the legal owner. it might carry severe problem. f. early payment institution information note bnm regulation where the customer wishes to make an early settlement of the musyarakah financing, the amount to be paid to the ifi shall be the outstanding amount (principal plus accrued profit) (bnm regulation, 2015, musyarakah, 34.1). an ifi shall not claim any penalty charges or impose any other charges on the customer unless the charges represent the costs incurred by the ifi due to early settlement by the customer. the reasonable estimation of costs to be incurred must be in line with the guidelines on ibra’ (rebate) for salebased financing (bnm regulation, 2015, musyarakah, 34.2). standard – islamic bank cannot charge early settlement fee maybank islamic no early settlement fee will be charged (pds, point 7, pg.4) customer will need to pay the outstanding balance, current monthly profit and any amount due and payable to the bank (pds, point 7, pg.4) no gap – no early settlement fee charged hsbc amanah early termination fee = (2% x facility amount x number of remaining months within the lock-in period) / total lock-in period in months (pds, point 6, pg.3) customers can request for early settlement and redeem the financing by providing the bank 1 month written notice or pay 1 month profit in lieu of notice. if home smart-i financing is still within the lock-in period, customers are required to pay the early settlement charges (hsbc faq, point 8, pg.2) gap : early terminati on fee comment based on bnm regulation, bank has no right to charge early settlement fee. maybank islamic comply by not charging early settlement fee but customers have to pay outstanding balance, current monthly profit and amount due and payable to the bank. however, hsbc amanah charges early termination fee as stated in their product disclosure sheet. hsbc amanah needs to follow the standard because it will cause the legal impact and affect contract validity. moreover, it will lead to non-compliance practice in both shariah and regulation perspective. in case the bank already takes the early settlement fee, it is recommended for the respective bank to channel those funds to the charity. g. late payment institution information note bnm regulation compensation (ta’widh) can be charged. however, this amount shall not be more than 1% per annum (table 3.2, regulation and supervision, bnm).  the overdue instalments of the islamic product in the case of default of scheduled payments; or  the outstanding balance of the islamic product where a default results in the entire facility being recalled or brought to court for judgment prior to maturity. for delays occurring after maturity of a financing contract, islamic banks are only allowed to charge ta’widh at a reduced rate based on daily overnight islamic interbank money market rate. the rate 1% for ta’widh maybank islamic overdue installment or scheduled payment : a) 1% p.a. on the installment amount in arrears from the date of the first drawdown of the facility until its maturity date (pds, point 6, pg.4) b) upon maturity date of the facility or upon judgment, whichever is earlier: prevailing daily overnight islamic interbank money market (iimm) rate on the outstanding balance due and payable no gap – the rate is 1% p.a. hsbc amanah during financing tenure: 1% p.a. on the overdue installment example: overdue instalment amount in arrears x 1% x n/365 (n= number of days overdue (pds, point 6, pg.3) after expiry of financing tenure at a rate not exceeding the prevailing iimm-rate, on the outstanding amount financed (after the tenure) (iimm-rate is the daily weighted average overnight rate for islamic financial instruments quoted in malaysia’s islamic interbank money market no gap – the rate is 1% p.a. comment bnm regulation, maybank islamic, and hsbc amanah have similar statement regarding to the ta’widh during the financing tenure. iimm-rate utilization as the rate for outstanding balance stated by bnm, maybank islamic, and hsbc amanah. h. in case of customer default institution information note bnm regulation a) promisee invokes the promise to purchase and where the promisor fails to perform the promise, the partners shall jointly sell the asset to a third party. b) the proceeds of the sale shall be guidance – two different approaches in case of customer ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 allocated to all partners based on the ownership share at the point of sale based on the following options: (i) allocation to all partners is made after deducting all costs related to asset liquidation from the proceeds of the sale; or (ii) allocation to all partners is made without prior deduction of costs related to asset liquidation from the proceeds. under this approach, the cost related to asset liquidation is deducted only from promisor’s share of the proceeds. c) the promisee may claim the rental due (if any) from the promisor’s share of the proceeds. d) the promisee may claim a compensation amount from the promisor’s share of the proceeds. the compensation amount shall be the difference between the agreed purchase price (as promised) and the realised proceeds portion allocated for the promisee. e) in the event that the promisor’s share of the proceeds is inadequate to meet the claim under paragraph (d), the promisee may demand the remaining difference from the promisor. f) in the event that the promisee’s share of the proceeds is equivalent to or higher than the promised purchase price, the provisions on compensation under paragraph (d) and (e) shall not be applicable. g) in the event that the promisee's portion of proceeds exceeds the promised purchase price, the promisee may share his excess proceeds with the promisor (bnm regulation, 2015, musyarakah, point 22.10, approach 1). a) the promisee may invoke the promise to purchase. where the promisor fails to perform the promise, the promisee may sell his remaining ownership share to the promisor on credit based on a price agreed by both parties. b) the promisee may take the asset as collateral to secure the payments of the deferred price as agreed under paragraph (a). c) in the event that the promisee as the creditor liquidates the collateral, the following may be applied: i. the promisee may claim the rental due, the purchase price as agreed in the promise to purchase and costs related to liquidation of the collateral. defaults ii. in the event that the proceeds from the liquidation of the collateral is inadequate to meet the claim under paragraph (i), the promisee as creditor may demand the remaining difference. iii. if there is any excess amount from the proceeds of the collateral liquidation after the deduction of claims under paragraph (i), the excess amount shall belong to the promisor. (bnm regulation, 2015, musyarakah, point 22.10, approach 2). maybank islamic 1. in the event of default (nonpayment) on three consecutive payments of profit pending the commencement of instalment or during the payment of monthly instalment. the bank shall be entitled to convert the agreed rate to bfr+2.5% per annum calculated in the daily balance basis or such other rate as the bank may prescribe from time to time subject always to the selling price (pds, pg.4). 2. right to set-off bank has the right to set-off any credit balance in your deposit accounts maintained with the bank against any outstanding balance (pds, pg.4). 3. right to commence recovery or legal action. legal action will be taken if the customer fail to respond to remainder notices. customer’s property maybe subjected to foreclosure and customer will have bear all the costs. the bank have a right to comments recovery activities (including engaging third party debt collections agencies) foreclosure and bankruptcy proceedings (pds, pg.4). 4. right to review and terminate the facility upon the occurrence any other events of defaults as agreed in terms and condition of the facility (pds, pg.4). gap since maybank does not follow exactly the guidance given by the bnm inconsiste ncy issue hsbc amanah 1. right to set-off: the bank have the right to set-off any credit balance in customer account(s) maintained with us against any outstanding balance in this financing account (pds hsbc, pg.3). 2. legal action will be taken if customer fail to respond to reminder notices issued. customer property may be foreclosed and gap since hsbc does not follow exactly the guidance given by the bnm ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 customer will have to bear all related costs. customers are also responsible to settle any shortfall after your property is sold (pds hsbc, pg.3). 3. legal action against customer may affect the customer credit rating leading to the credit being more difficult or expensive to customer (pds hsbc, pg.3). comment the bnm has given the two possible approaches that the islamic bank can do in case of their customer defaulting, however, in the real practice maybank and hsbc do not follow exactly the recommendation given by the bnm, these different approaches implemented by both banks cannot be considered a major gap, since it is only the guidance and not standard. in maybank practice, in the case of default, the bank converts the agreed profit rate into bfr + 2.5%. or any rate the bank wishes. the question is, this type of practice is considered shariah compliant or not? since the bank already have the agreement with the customer upfront about the profit rate. iv. conclusion and recommendation for future research mm has been implemented in malaysia by several islamic banks. this financing mode is regulated under bnm regulation. along the way, in real practices, banks may perform differently. this study found the gap between bnm regulation and both maybank islamic and hsbc amanah practices related to musharakah mutanaqisah. in the aforementioned eight points, there are four gaps consist of one major gap and three minor gaps, the major gap is related to charging early settlement fee by hsbc amanah. in addition, three minor gaps are related to wa’d statement in both banks, pledge statement in maybank side, and default approach compliance in both banks. furthermore, this study found the possible shariah issue on maybank practice in the default cases where the bank has right to change the already agreed profit rate to whatever they like. however, this study does not examine the gap that related to the contract validity. nevertheless, even a single gap which found in each bank practice, it can be considered the serious issue because this gap affects the contract validity of the product. by uncovering several gaps that existed in their practices, this study suggests for better monitoring and supervision conducted by all involved parties. bnm shariah advisory council and shariah committee of respective islamic bank should verify the practice that may cause the contract to become void. in addition, the islamic financial institutions should strictly follow all the regulation issued by the bank negara malaysia even it was the guidance in all their practices and publication in order to make the practices fully compliant with bnm regulations and to cater public confidence. a. recommendation for future research this study is conducted by identifying two major islamic banks in malaysia which are maybank islamic and hsbc amanah. as this research only found one major gap between the practice and regulations, it still needs further development for future research by analyzing and examining more islamic banks that offers this type of product and also by conducting interviews and field based group discussion. the researchers believe that there are still many gaps to be exposed if the future researcher is willing to do the complex research by comparing multiple banks and interviewing the respective bank for the product that they offer. references [1] abdullah, nurdianawati irwani. (2009). application of promise (wa’ad) in islamic banking and securities: a risk management or unjust management, paper presented at international conference of islamic perspective of management and finance, 1-2 july 2009, leicester university, uk. [2] asian institute of finance (2013). musharakah mutanaqisah home financing. retrieved from http://www.aif.org.my/clients/aif_d01/assets/multimediams/publication/ casestudy_musharakah.pdf [3] bank negara malaysia (2010). shariah resolutions in islamic finance 2nd edition. kuala lumpur, malaysia [4] bnm (2011). regulatory and supervisory framework. retrieved from http://www.bnm.gov.my/files/publication/fsps/en/2011/fs2011_book.pdf [5] bnm (2015). musyarakah sharia standard retrieved from http: //www. bnm.gov.my/ guidelines/ 05_shariah/ musyarakah.pdf [6] bnm (2016). ijarah sharia standard. retrieved from http:// www. bnm. gov. my/ guidelines/ 05_ shariah/ pd_ijarah.pdf [7] bnm (2013). guidelines on ibra’ (rebate) for sale-based financing. retrieved http://www.bnm.gov.my/guidelines/01_banking/04_prudential_stds/upd ated_gl_on_ibra_final_sept2013.pdf [8] hanafi, h.h. (2012). critical perspectives on musharakah mutanaqisah home financing in malaysia: exploring legal regulative and financial challenges (doctoral thesis), university of durham, united kingdom. [9] hashim & hassan (2015). musharakah mutanaqisah (mm) from shari’ah perspectives [10] hsbc amanah (2016). product disclosure sheet home smart-i. retrieved from http://www.hsbcamanah.com.my/1/2/amanah/personal/financing/homes mart-i. [11] inceif (2015). is interest-rate benchmarking good enough?. retrieved from http://www.inceif.org/blog/interest-rate-benchmarking-goodenough/ [12] isra (2010). managing default in musharakah mutanaqisah. isra bulletin, (5), 5-7 [13] maybank islamic (2016). product disclosure sheet. retrieved fromhttp://www. maybank2u. com.my/mbb _info/m2u /public/ personaldetail04 [14] meera, a.k.m. & razak, d.j. (2009). home financing through the musharakah mutanaqisah contracts: some practical issues. islamic economics journal, 22(1), 121-143 [15] naim, asmadi mohamed. (2011). “purchase undertaking issues in musharakah mutanaqisah home financing”. isra international journal of islamic finance, 3(1), 25-47 [16] lung, l.c. (2013). musharakah mutanaqisah partnership in malaysia’s islamic bank: a comparison between theory and practice. american journal of economics and business administration, 5 (3), 95-106 ejif – european journal of islamic finance no8, december (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 [17] smolo, edib. (2010). managing default in musharakah mutanaqisah, isra bulletin, 5, june 2010. [18] smolo, edib, and hassan, mohd kabir. (2011). “the potential of musharakah mutanaqisah for islamic housing finance”.international journal of islamic and middle eastern finance & management, 4(3), 237-258. [19] sundararajan, v., and errico, l. (november 2002). islamic financial institutions and the products in the global financial system: key issues in risk management and challenges ahead: imf working paper. [20] taib, fauziah md, ramayah,t., and razak, dzuljastri abdul.(2008).“factors influencing intention to use diminishing partnership home financing”.international journal of islamic and middle eastern finance and management. 1(3), 235-248. [21] usmani, t. (2004). an introduction to islamic finance. maktab maa’rul quran, karachi, pakistan. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 risk management innovation of islamic financial institutions putri reno kemala sari ma, dr hjh rose abdullah abstract the early of the millennium witnesses fast development in islamic financial institutions. professional practise and islamic financial specialist academics have been breathlessly racing to invent new islamic financial institutions innovation in a rushing attempt to fill in all gaps and satisfy every need that may be thought of. the present paper aims at studying the risk management innovation arrangement in islamic finance as may be derived from the axioms and rulings, especially in relation to the managing the risk. this is necessary to investigate the means and processes of risk management based on the islamic financial paradigm. even though, on average the islamic financial institutions have good risk management practices, there is still enough room for islamic financial institutions to improve their risk management system. the introduction of an effective risk management culture in islamic financial institutions will ensure their competitiveness in the financial industry and financial crises. keywords-component; risk management innovations; islamic financial institutions i. introduction the emergence and rapid growth of islamic finance today is a reflection of the comprehensive and complete of islam as a religion and a way of life. it is really represented as an integrated and holistic worldview covering various aspects of human living, economic activities, political behaviors, and educational development. each of these aspects of human living cannot be treated in isolation from each other. whether at the level of worship(ibadah) or those mundane affairs (muamalah). islam is the carrier of a teaching which is entirely directed towards the collective and social dimension. it is to extend that we can say that there is unreal practice of religion without personal involvement and investment in the community (isra, 2011). in 1960's, islamic finance was said to be in an early stage and thus needed a lot of nurturing and protection for it to see the light of day. less than ten years ago, islamic finance was known as an industry in transition operating as an emerging product in emerging markets. currently, islamic finance has a firm footing in developed markets such as and is expanding its reach to europe, while still growing and experiencing market penetration and product development trends in its stronghold markets in idb (islamic development bank) member countries. islamic finance is effectively an industry that is broadening its ownership base and building a strong value proposition for it to reach wider acceptance and richer value. today, more than 500 islamic financial institutions are operating worldwide, which are claimed to manage assets worth no less than $1.2 trillion. islamic financial institutions registering an unprecedented growth of 20-30 percent in the last ten years (the european financial review, 2014). the objectives of this paper are to discusses the issues arise on risks management of islamic financial institutions and the innovations in manage the risks by focusing on operational risks management. risk management of islamic financial institution are becoming focused on the arrangements in manage risk management at the islamic financial institution in order to maintain the risk at adequate parameters to permit the development of the islamic financial institution activity in best conditions. the remaining of this paper divided into four sections. the first section is discussed about the introduction of innovation risk management in islamic financial institution. the second section, discuss the development of islamic financial institutions. the third section will discuss risk management overview and the key of risk. we will argue that risk management activities themselves can expose islamic financial institutions to risk. in the fourth section; we will discuss operational risk management innovation and their application in islamic financial institution. the last section concludes the paper innovation risk management in islamic financial institutions. ii. an overview of islamic financial institution islamic financial institutions were established three decades ago as an alternative to conventional financial institutions mainly to provide compliant ejif – european journal of islamic finance no 4, march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 investments, financing, and trading opportunities. the islamic financial institutions school of thought can be investigated from 1500 b.c with the advent of islam and teaching of quran. but it is gaining global importance and emerging as an alternative to interest based economic system (satar, 2011). the islamic financial institutions industry has grown impressively during a short period of time. in the early 1960's, islamic financial institutions and finance sector witnessed a steady growth in its different aspects such as size, complexity of the transactions, and internal processes. it has been estimated that the sector is witnessing a 15% annual growth rate (10% of which is in the gulf region (isra, 2011). financial services authority, the financial services regulator in the united kingdom, recently estimated islamic banking was as large as $500 billion. standard & poor‟s, a rating agency, estimates that the sukuk (deed) market has reached $70 billion, and will top the $160 billion mark by the end of the decade. due to islamic shari’ah rules, islamic financial institution cannot be involved in the production or distribution of specific activities which are forbidden by islam such as alcohol, pork, and gambling. in replacement, they should invest in long‐term assets such as profit sharing agreement (mudharabah), cost‐plus‐financing (murabaha), equity participation (musharaka), and leasing (ijarah). these activities are based on real assets rather than financial assets (bahrain monetary agency, 2006). iii. why is risk management needed? one of the major aspects that should be taken into consideration in dealing with islamic finance is risk management and then risk mitigation. with respect to financial institutions, risk management, as defined by finance literature, is the practice of creating economic value in a firm by using financial instruments to manage the exposure to different risks. being involved in the intermediation process, risk management is as important to the islamic financial institutions as it is to the conventional financial institution (a risk management standard, 2002). a growing literature suggested that risk management is even more challenging for the islamic financial institutions compared to the conventional counterpart islamic financial institutions are a risky business and several risk factors have been identified as critical to ensure that the islamic financial institutions position remain intact amid the intense competition in the industry. the survival and success of a financial organization depends critically on the efficiency of managing these risks (khan and ahmed, 2010). more importantly, good risk management is highly relevant in providing better return to the stakeholders (at-tamimi, 2007). in addition, prudent risk management by financial institutions is the hallmark to avoid financial distress that could lead to financial crisis. in view of this, the issue of risk management in the financial institutions is a topic interest not only to the industry players, but also the policy makers. risk is variability and volatility of unpredictable out comes. financial institutions face number of risks these can be classified in different ways such as business risks, operational risks and financial risks. as far as the business risks are concerned they arise from the nature of business while financial risks arise from the possible loss in financial market due to movement in financial variables. financial risks include market risk and credit risk, while non-financial risks are operational risk, regulatory risk and legal risk. having a full furnished risk profile in view, the risk management normally demands some step for each type of risk included in the profile. because of the fact that the importance of risk management, highly recognized international institutions such as the basel committee has suggested a set of principles and rules in order to identify and mitigate different financial risks. for example, basel two, pillar one recommended sets of principles to calculate minimum capital requirements necessary to support the different risks in the business. while pillar two has recommended set of principles to be adopted by the islamic financial institutions supervisory authority in order to have an effective review over the risk management process. islamic financial institutions, being part of the financial sector, aim through risk management to identify, control, and mitigate the different risks they face in order to maximize owner's value and preserve depositors rights. the importance of the risk management system in the islamic financial sector has lead international financial authorities that deals with islamic finance such as the islamic financial services board (2005) to formulate and recommend set of principles for the best practice of the system. this means that risk management is a crucial element of any islamic financial institutions aiming to sustain its operations for the future since it is considered as an important factor in mitigating the probability of failure due to improper risk handling, thus leading to a direct negative effect on the owners, depositors, and consequently the society. ejif – european journal of islamic finance no 4, march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 the key of risk according to financial knowledge (finance) and economics, such as stated heffernan (1995) risk is defined as volatilities or standard deviation of the net cash flow of a company / business unit. risk exists when there is a possibility that the outcome of a not just a single event and its biggest outcome is unknown. risk also changes or movement over outcomes that are not expected (khan and ahmad, 2001). possibility islamic financial institutions loss as a result of change in conditions that affect the value of position among islamic financial institutions including definitions of risk. state islamic financial institution of pakistan document defines financial risk in the islamic financial institutions organization with possibility (probability) that outcome of an activity ".... could bring up adverse impact". it is would cause direct harm to the income or capital position of the islamic financial institution or the islamic financial institution's ability to achieve its business objectives. it will also affect the ability of islamic financial institution conducting business or to obtain advantage and opportunity of extending the reach of its business. the risk associated with islamic financial institutions refers to the probable reductions in their value due to changes in the business environment. in other word, risk refers to probable loss of income and asset value. only unexpected losses are included and expected losses are not included in the definition of risk. hence, islamic reporter of risk contained in the terms maysir and gharar. as islam prohibits compliance needs in falsehood; usury, maysir, and gharar is a source of the most important of the sleaze. justice aspect is emphasized islam does not require the falsehood because it would undermine the achievement of the overall objectives of islam (falah or welfare). the prohibition of riba and gharar (including maysir) become a central issue in the discussion of the islamic finance. riba more intersect with interest (interest), gharar while related with the problem of risk (risk). these restrictions have important implications for the nature of the financial assets, trade, and risk mitigation, as well as the management islamic financial assets in general (thariq, 2004). hassan (2009) identifies three types of risks from the islamic perspective. first, is the essential risk that is inherent in all business transactions. this business risk is necessary and must be undertaken to reap the associated reward or profit. two legal maxim associating returns to essential risks form the basis of islamic economic transaction. the first maxim state “the detriment is as a return for the benefit (majallah, 2011). this maxim attaches “the entitlement of gain” to the “responsibility of loss”. this maxim is usually used to propose the preference for profit-and-losssharing (pls) financing instruments. the second maxim is derived from the prophetic saying stating that “the benefit of a thing is a return for the liability for loss from that thing” (majallah, 2011). the maxim asserts that the party enjoying the full benefits of an asset or object should be bearing the risk of ownership. second is the prohibited risk in the form of excessive gharar. gharar means uncertainty and risk. gharar is not precisely defined as riba where it is absolutely prohibited. according to arsalan tariq (2004) gharar is any transaction whose consequences are hidden. a minor part of gharar may refer to consumer protection in modern securities law. gharar is present when an essential element of a transaction is missing such as the exact price or the ability to deliver the product. gharar is considered to be the second major prohibition in islamic financial institutions and finance. generally, gharar relates to the ambiguity and or ignorance of either the terms of the contract or in the object of the contract. thus, a sale can be void due to gharar, due to risks of existence and taking position of the object of sale on one hand and uncertainty of the quantity, quality, price and time of payment on the other. ibn taymiyyah (1998) provides another perspective of forbidden gharar by equating it to activities leading to evils and unjustified devouring of people's wealth as in the case of gambling. thus, transactions having gambling-like features are forbidden due to excessive gharar this prohibition aims to protect both small and large investors from future risks arising from uncertainty and speculation. an example of gharar is trading what you do not actually own. a contemporary example would be buying a house where the price or the specifications will be determined in the future. the final form of risk identified by hassan is the permissible risk that does not fall in the above two categories. examples of these risks can be operational risks, liquidity risks, etc. these risks can be either be accepted or avoided. although all businesses face uncertainty (risk), financial institutions will feature a special feature of the risks resulting from their activities. risks faced financial institutions can be divided into financial and nonfinancial risks. financial risks consist of market risk and credit risk. non-financial risk is risks ejif – european journal of islamic finance no 4, march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 operational, complains risk and legal risk (khan and ahmed, 2011). credit risk is defined as the prospect that the counterparty fails to meet its obligations in accordance with agreed terms. this type of risk is considered to be the main risk associated with islamic as well as conventional financial institution. the lending in conventional financial institution is replaced by investment and partnership in the islamic financial institutions system. therefore, islamic financial institution a chance of experiencing credit risks because the value of the traded commodity is volatile and may change. islamic financial institutions have to bear market risk and commodity risk on the asset side of the balance sheet (tariqullah, 2007). historically, credit risk has been thought of as the most significant risk in financial institutions, as it was the main reason for major cause of serious financial institutions potential distress continues to be lax credit standards for borrowers and counterparties, poor portfolio risk management, or a lack of attention to changes in economic or other external circumstances that can adversely impact the credit standing of a financial institution counterparties. based on principle it is said that credit risk inherent islamic financial institutions is intermingled with other risks, such as market risk, which makes it more severe than that in conventional financial institutions. nevertheless, it should be clarified that in conventional financial institutions too market risk associate other types of risks, which is referred to as the grey area accompanying credit and market risks, identified by morrison (2004). the grey area appear when credit risk is caused by unfavorable market conditions, which implies credit risk in this case arises as a result of market risk. market risk. different from conventional banks, the market risk in islamic banks is concentrated in the banking book due to murabaha, ijarah, salam, musharaka and murabaha. according to ashhoob (2013) credit risk and market risk must be managed together. the market risk in islamic financial institutions refers to the potential impact of adverse price movements such as benchmark rates (mark up risk), price risk, foreign exchange (fx) risk, as well as price fluctuations in securities price risk. the market risk may also arise from a decrease in the returns of investment accounts (saving). to protect against this, islamic banks are creating special funds (irr and per) aimed to support the clients in the case of non-desirable outcomes. these funds are created from the contribution of some of the bank‟s profits, investors, and takaful companies (islamic insurance). another issue development in the area of islamic financial instruments is a new form of debt; islamic sukuk, in their diversity and capability to provide funds. these are islamic bonds that act like regular bonds but comply with the rules of shari’ah. islamic sukuk can be an ideal solution in developing an integrated market of financial instruments of various risk levels to meet the needs of the investors. islamic sukuk will enhance the ability of the markets to grow, because its growth will not depend on the size of the institution and its ability to borrow, but on its ability to issue sukuk resulting from securitizing assets. permitting institutions to issue sukuk will improve their financial returns, growth prospects, and spread the risks resulting from the institutions borrowing from a larger number of investors those that issue sukuk, and not to let it be borne by islamic financial institution. in other words, it will improve the credit rating of the institutions that issue the sukuk and the banks that finance it (box, 2005; al manea, 2006). liquidity risk is the potential loss due to the incapability to meet obligations or to fund increases in assets. the two major types of fund providers are the current account and the profit loss sharing accounts. because the current account generates zero profit, it is considered as a debt or a loan that will be paid instantly upon the client‟s request. therefore, islamic banks must provide enough funds to support potential withdrawals. according to yaqoobi (2008), liquidity risk in islamic financial institutions is reduced internally and externally. it is reduced internally because it goes through the shari’ah board principles that treat financial institution management, shareholders, and stakeholders as trusted business partners. it is reduced externally, because it is regulated and connected with the real sector underneath the shari’ah regulations. risks such as rate of return, withdrawal, and treasury risk will all lead to liquidity risk. liquidity management function is a challenging task affecting the performance of islamic financial institution, which is particularly vulnerable to liquidity risk given their limited opportunities to access funds to meet their obligations. such risk results from the mismatch between the maturities of the two sides of the balance sheet, creating either a surplus of cash that needs to be invested or a shortage of cash that needs to be funded (maroun, 2002). prohibition by shari’ah law from borrowing as well as the absence of an active inters financial institution money market has restricted islamic financial institution options to efficiently manage their liquidity position. the current use of secured commodity murabaha and short-term trade ejif – european journal of islamic finance no 4, march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 financing has enabled islamic financial institution to invest their short-term surplus cash. however, islamic financial institutions do not have an efficient mechanism for funding their shortage of cash in case of need (secured commodity murabaha involves the purchase of commodities, traded on the london metal exchange, with the full payment of the spot price. this is followed by their sale to a third party on the basis of murabahafor a deferred payment with a maturity of one week to six months with spot delivery. repayment of the principal and profit is usually guaranteed by an acceptable international bank. short-term trade financing is similar to secured commodity murabaha except for the fact that it is mainly used to finance the importation of basic commodities needed locally, such as crude oil). therefore, these factors have raised islamic financial institution exposure to liquidity risk, and adversely affected their profitability by limiting their ability to invest their capital in long-term, generally less liquid but more profitable assets in order to honour withdrawal requests from their depositors. according to maroun (2002), factors such as lack of shari’ah compatible instruments, the absence of qualified market makers and the limited dissemination of information and data hinder the development of well-functioning secondary markets where long-term instruments can be traded. for instance, long-term mudharabah investment certificates can provide liquidity for both the bank and the investor by enabling the latter to trade the certificates in the secondary market without the need to redeem them directly with the issuing financial institution (as a result of these constraints, most transactions take place in the primary market with limited trading in the secondary market. ijara sukuk, issued by the bahrain monetary authority (bma), present an exception for which a secondary market exists. they are traded on the bahrain stock exchange). . in this respect, the establishment of the international islamic financial market (iifm) and the liquidity management centre (lmc) should permit a more efficient management of islamic financial institutions liquidity needs. operational risk. according to bcbs (2001), operational risk is the risk of direct or indirect loss resulting from inadequate or failed internal processes, people, and technology or from external events. operational risks are more significant in islamic financial institutions than conventional ones due to their specific features such as shari’ah requirements and legal environment. the main operational risks associated with islamic financial institutions are people risk, technological and system risk, and legal risks (vicary abdullah, 2007). as the islamic financial institutions are newly formed industry, therefore the operational risk in terms of personal risk can be acute in these institutions. one of the challenges faced by islamic financial institutions is the lack of qualified professionals (capacity and capability) to conduct the islamic financial operations (khan and habib, 2007). particularly the different nature of business, the computer software available in the market for conventional financial institutions may not be appropriate for islamic financial institutions. this gives rise to system risks of developing and using informational technologies in islamic financial institutions. legal risk. given the different nature of financial contracts, islamic financial institutions face risk related to their documentation and enforcement. as there is no standard form of contracts for various financial instruments, islamic financial institutions prepare these according to their understanding of the regulation, the local laws, and their needs and concern. lack of standardized contracts along with the fact that there are no litigation systems to resolve problems associated with enforceability of contracts by the counterparty increases the legal risks associated with the islamic financial institutions contractual agreements. equally important for the operation of islamic as well as conventional financial institutions is the presence of a conductive institutional environment and an efficient regulatory framework. such poor supporting institutional infrastructure exposes islamic financial institutions to systemic risks related to institutional, legal and regulatory issues. at the forefront of these is institutional risk resulting from the lack of consensus among fiqh scholars on contractual rules governing financial transactions. for instance, while some fiqh scholars consider the terms of a murabaha or istisna contract to be binding to the buyer, others argue that the buyer has the option to rescind from the contract even after making an order and paying the commitment fee. this raises islamic financial institutions‟ exposure to counter-party risks arising from the unsettled nature of contracts, and may lead to potential litigation problems (mulyawan, 2008). a related issue is the general confusion created by the heterogeneous interpretations of the fundamental rules resulting in differences in financial reporting, auditing and accounting treatments by islamic financial institutions. moreover the lack of standardized contracts for islamic financial instruments as well as the absence of effective litigation and dispute resolution systems creates a business environment risk. poor ejif – european journal of islamic finance no 4, march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 enforceability of contractual agreements ultimately increases islamic financial institutions‟ exposure to counter-party risks of default and delinquency. while the imposition of penalty in the case of late payment is not accepted according to the law, some islamic financial institutions enforce the penalty as a deterrent mechanism and use the collected sums for charitable causes. compliance risk. shari’ah compliance of finance transactions in islamic countries fuelled by sovereign-sponsored efforts of capital market development with successful issues creating firsts for different collateral types of islamic finance that create further demand as asset supply widens and the investor base matures. as most depositors and investors use islamic financial institutions due to their islamic character, financial institutions must ensure that all their activities conform to the principles and values of islam. this would require contacts and all necessary supporting documentations including the legal papers, forms and processes to be compliance. to be shari’ah compliance, islamic financial transactions can‟t involve interest, gambling, speculation, or prohibited industries another issue of compliance risk involveproduct development. as pointed out, the general trend in islamic finance has been to come up with compliant alternatives to conventional products. while this approach can potentially make the industry susceptible to similar risks and crises, it also exposes the sector to compliance and reputation risks. instead of using the current product-based method of developing compliant alternatives to conventional products, a functional approach to develop based products can be used to mitigate these risks. the functional approach to product development would examine the needs that the financial sector satisfies and then come up with islamic alternatives that can satisfy these needs. for example, one function of the financial sector is to provide financing to enterprises. the most common way to meet this need of enterprises in conventional finance is to provide interest bearing loans. under the product approach taken by islamic financial institutions, this would result in using a product like tawarruq that mimics the conventional loan in substance. the functional approach, however, would assess the need of the entrepreneur. in the case of a loan, the need is not money itself but the necessity of the entrepreneur to buy certain input with it (nanto, 2009). the functional approach to financing would require understanding the need of the enterprise and then devising appropriate modes of financing (like istisna, murabaha and ijarah) that appropriately satisfy the need. similarly, another function of financial institutions is to minimize risks. in conventional finance, derivatives are widely used as hedging instruments. if the current compliant product approach is taken in islamic finance, then one would try to develop islamic forward, islamic swap, etc. as conventional derivatives do not comply with principles, this may involve using financial engineering to come up with stratagems/ ruses to circumvent the prohibitions. under the functional approach, however, the need of minimizing risks can be accomplished by using other means. for example, al-suwailem (2006) suggests using a cooperative technique of hedging currency risks that does not employ any derivatives. iv. innovation in operational risk management many islamic and traditional financial institutions are reviewing their risk management functions and models. executive directors, supervisory board members, and boards of directors, are more actively engaged in the operational risk management decision-making process than ever before. the regulatory coordination and harmonization of standards and fatwa is inevitable and market and practice synergy is an aspiration of all stakeholders. enable operational risk management model in developing point of views on islamic finance risk intelligence. needless to say, the overall issues islamic financial institutions and risk executives were structured around namely governance, process, people, and technology. governance: the governance capability focuses on the structure and organization of the risk management function (even if no risk manager position formally exists) in order to make riskintelligent decisions and execute those decisions in a timely and effective manner. a company needs to define roles and responsibilities of the board and its committees, management, internal audit and risk management functions with respect to risk management. risk management policies such as risk appetite, tolerance and delegation of authority need to be formally documented and communicated. process: the process capability focuses on the process in place to execute risk management. this includes core operational and infrastructure business processes necessary to run the risk ejif – european journal of islamic finance no 4, march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 management in an efficient manner to create and protect value. risk management steps and process in outer look, seems to be very simple and easy, but in reality it is the resultant of a high complex and intricate process. risk management is often associated with risk identification, measurement, monitoring and controlling, but all these four steps cannot be effectively exercised unless the corporate governance issues and internal control tasks are performed well. within the model risk management we can divide to the three layers. this threefold model firstly has explained the most outer layer, where institutional development was emphasized. in the second layer internal control is contributing valuable part in risk management process and in the last layer risk management process itself has been highlighted. the model suggests that all policies, procedures, corporate governance and internal control are working in a single direction to manage risks in islamic financial institution. the above mentioned layers are implemented on each step of risk management process. accordingly risk management process has been divided into 4 steps, which are risk identification, risk measurement, risk monitoring and controlling. thus the model of risk management and regulatory from satar (2010) work concludes the entire risk management is interdependent with each other. it has been explained that risk management process three layers. these all the elements are interdependent. one layer cannot be complete without proper supervision and control of other factors. people: the people capability focuses on having the right number of people with the appropriate training and awareness to execute the risk management process. this includes trained people at all levels and a companywide risk awareness culture.  qualified human resources according to an imf (international monetary fund) survey, the shortage of human capital with expertise in islamic financial institution is deemed as part of the cause of the decline in the profitability of islamic banks during the recent global economic crisis of 2007-2008. the need for more qualified staff is frequently highlighted as being one of the major reasons that islamic financial institution has not developed any further or any faster. as noted, there are now a large number of courses and qualifications available. it is increasingly possible for institutions to send employee to these courses and are also fund available to pay for students to study for higher degrees. while there will probably always be some who become better known and whose opinion in most often sought, there needs to be a deeper pool of names. however, the skill required can only be obtained after many years of study in law, islamic finance, law and finance. this can be daunting process. islamic financial institutions will continue to need people who can monitor compliance in practice and ensure that there is a working system of governance in the institutions such as shari’ah supervisory board. the shari’ah supervisory board is an independent body of specialised jurists in fiqh al-muamalat (islamic commercial jurisprudence). however, the board may include a member other than those specialised in fiqh al-muamalat, but who should be an expert in the field of islamic financial institutions and with the duty of directing, reviewing and supervising the activities of the islamic financial institutions. the rulings of the shari’ah supervisory board are binding on the islamic financial institutions. the principal objectives of the shari’ah supervisory board are to guide islamic financial institutions in the setting of policies and regulations according to shari’ah in approving their financial transactions from the legal side and in reviewing their contracts for future transactions according to islamic law. provisions governing the duties and objectives of the shari’ah supervisory board at the respective islamic financial institution can be found in the articles of association, statutory laws, or central financial institutions guidelines. furthermore to having the necessary professional competence, and understanding the applicable laws, rules and regulations of any government, regulatory authority, licensing agency or self-regulating professional organisation, islamic financial institutions must ensure that the persons entrusted to deal on behalf ejif – european journal of islamic finance no 4, march (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 of the islamic financial institutions are equipped with an appropriate level of knowledge of the shari`ah compliant characteristics of the financial products and services offered by the institution. having staff with the necessary capabilities is key to avoiding excessive levels of operational risk in banking, and as such is a matter that falls under the supervisory review process. to solve the problem of lack of human resources, it is recommended that the government could provide incentives for the establishment of formal and informal institutions which provide education in islamic financial institution; islamic scholar and academic actively write and publish text books on islamic economics, banking and finance. the lack of quality human resources in islamic financial institutions is being identified as one of the biggest hurdles in the advancement of islamic banking. in addition the misconceptions and confusions pertaining to the principles and practices of islamic banking will continue to persist. the public will see no difference between the conventional banks and islamic financial institution and assume that interest-based activities still persist in the islamic financial institution. as a result it would create confusion among the general public and affect the public trust. technology: the technology capability focuses on it systems used to analyze and communicate risk information throughout the organization as well as to enable risk-intelligent decision-making in a timely manner.  management information system specific technological ability is important for islamic financial institutions as much of the existing technology is the result of „tweaking‟ of conventional technology. genuine effort is needed with the combination of effort from shari’ah scholars, market practitioners and academics to ensure a genuine technological product. while this focus is important, islamic financial institutions also need to have in place a system for measuring quality of the various risks. the effectiveness of risk measurement in financial institutions depends on efficient management information system, computerization and networking of the branch activities. the data warehousing solution should effectively interface with the transaction systems like core financial institutions solution and risk systems to collate data. an objective and reliable data base has to be built up for which islamic financial institutions has to analyse its own past performance data relating to loan defaults, trading losses, operational losses and come out with bench marks so as to prepare themselves for the future risk management activities v. conclusion the effective risk management of a developing financial industry is critical to ensure its future survival and profitability. increasing innovation is becoming the norm for the islamic financial institutions. there is a need to innovate and practice new ideas based on islamic foundation and at the same time that are in harmony with the demands of modern markets. the need to further develop financial products and services in compliance with islamic is essential to the survival and growth of the islamic financial institution. to compete, islamic financial institutions must continually improve their performance by innovating products and processes, and improve quality. the analysis in this paper highlights several challenges faced by islamic financial institutions one thing is certain – the traditional operations and management of islamic finance will need to change. islamic financial institution around the globe will not only need to deal with market risk management but will also need effective operational risk management. operational risk management requires a skilled workforce in islamic finance to enable gain public trust. responding to these new realities may require effective risk governance. islamic financial institution boards, supervisory boards and executives have an important role to play in providing proactive oversight of risk management and risk strategy. references [1] a risk management standard. 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(2001). the majelle (1876): being an english translation of majallah al-ahkam al-adliyyahand a complete code on islamic civil law.translated by c.r.tyer, d.g. dementriades & ismail haqqi efendi. kuala lumpur [24]maroun,y. (2002). liquidity management and trade financing. london and bahrain: euromoney books. [25]muljawan, dadang. (2008). risk management in islamic finance issues, challenging and strategies to mitigate risk. cert. paper presented at the 6th international conference at islamic economics, banking and finance, organised by islamic research and training instituteislamic development bank, bank indonesia, and ministry of finance republic of indonesia. [26]morrison m. (2004). international risk management. [online] available from: http://www.grmn.com [27]nanto, dick k. (coordinator) (2009, july 2). the global financial crisis: analysis and policy implication. crs report for congress. congressional research service. [28]sattar, abdul. (2010). risk management in islamic banking. usa: lambert academic publishing [29]state bank of pakistan.( 2003). draft instruction and guidelines for shari’ah compliance in islamic banking institution. [30]saunders, a. and cornett, m. 2006. financial institutions management: a risk management approach, mcgrawhill, irwin. [31]the european financial review. (2014).www.europeanfinancialreview.com.14 april 2015. [32]yaqoobi, n. (2007/08). shari’ah finance questions and answers. euromoney year books, islamic finance review. http://www.fsround.org/ http://www.ifsb.org/ http://www.lmcbahrain.com/ http://www.grmn.com/ http://www.europeanfinancialreview.com/ ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 corporate social responsibility in islamic culture. comparison between western csr and islamic csr: focus on islamic reporting initiative and islamic financial institution. abstract— the aim of this paper is to explore the state of the art of corporate social responsibility (csr) in islamic culture. this topic is interesting not because corporate social responsibility is a new concept, but because some corporate sustainability reporting values developed in western countries, as aa1000 or gri standard, are not focused in islamic values and beliefs. in fact, sustainable development is not a new concept, but it is embedded in the fundamental codes of conduct in islamic societies and laws through shari’ah (aman, 2016). the objectives are: a) literature review of islamic corportae social responsibility and shari’ah connection with csr. in particular, descriptive analysis of islamic financial istitution (ifi), which offer alternatives to the commercial activities that shari'ah prohibits, to answer to the dichotomy between the need to trade with the west and to follow the commands of islam (taman, 2011); b) a qualitative comparative analysis between islamic csr (icsr) and conventional csr c) a documental analysis (bowen, 2009) of the islamic network that implements csr strategies, policies and practices in islamic societies (iriislamic reporting initiatives) supported by an ad-hoc interview held with an iri’s staff member. the conclusion of this research discusses the perspective of islamic view in sustainability reporting by incorporating the concept of tawhid which provides a holistic guidance based on islamic beliefs, values and concepts (aman, 2016) and, in specific, the main differences between western and islamic corporate sustainability reporting perspective. the finding of the paper is to be useful to integrate and develop sustainable strategies for islamic companies. keywords: corporate social responsibility, reporting, accountability, islamic csr, islamic reporting initiatives, islamic financial institution. i. introduction although the expression corporate social responsibility (csr) was coined in the west, csr is not as exclusively western notion. according to taman (2011), despite it is true that there is nothing in the islamic faith or law that dictates that corporations should be “socially responsible” in those terms, if csr means conducting your business while preserving the environment, treating your workers well, being fair to your competitors and honest in your dealings, caring about the society and its less fortunate members, and looking after stakeholders’ interests without undermining those of the shareholders, thus the notion of csr lies at the very heart of the islamic faith and law (taman, 2011). the aim of this research is to explore the state of the art of corporate social responsibility in islamic culture, particularly of the reporting activities rising from the islamic reporting initiative. this paper aims to: explore the existing literature concerning the islamic csr (section ii) and the differences between the latter and conventional csr (section iv) and focus on the role of islamic financial institution in arab trade market; provide an analysis of the case study focused on the islamic reporting initiative (section v), considering its goals, mission and vision, and the creation of reporting standards able to integrate cultural and religious aspects typical of the islamic culture, since there seems to be a gap by other widely adopted western standards, such as the global reporting initiative. ii. theoretical background according to elasrag (2015), csr could be defined as the voluntary integration of environmental, social and human rights considerations into business operations, over and above legal requirements and contractual obligations; csr is the irene litardi, gloria fiorani and denise harb ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 commitment of an organization to act in a manner that serves the interests of its stakeholders and is concerned with the ways that companies generate profits and their impact on the broader community; it is about “how” companies manage their business processes to produce an overall positive impact on society (elasrag, 2015). this responsibility is very much felt in the islamic religion. in terms of accountability, muslims believe that they will be accounted for whatever they do in this world in the hereafter. individuals (and businesses, as group of individuals) are expected to feel socially responsible for others in the community. in general, the aim of the islamic economic system is to allow people to earn their living in a fair and profitable way on the basis of shari’ah without exploitation of others, so that the whole society may get benefits. islam also emphasizes the welfare of the community over individual rights (shamim and karim, 2010). a. islamic corporate responsibility: shari’ah’s remarks about the csr themes. shari’ah, or islamic law, is intended to regulate all aspects of a muslim’s life. it is broadly divided into two sets of rules: one relates to the obligatory worship of god (ibadah) and the other relates to daily life outside the context of obligatory worship (muamalat), including commercial and financial dealings (elasrag, 2015). the islamic system is based on two essential concepts: human well-being (falah) and good life (hayat tayyibah), both of which stress universal brotherhood and socio-economic justice, as well as a balance between the material and spiritual requirements of all himand being that is necessary to preserve and enrich faith, posterity and wealth (mohammed, 2007). shari’ah refers to the sum of legal rules that god has legislated and sent to the people through prophet muhammad. it consists of three primary sources: quran, sunnah and ahadith (taman, 2011; elasrag, 2015). shari’ah’s secondary sources are qiyas, ijma and ijtihad. qiyas represents the process of reasoning whereby the principles found in the quran and sunnah are extended to new cases by analogy. ijma represents the consensus of the islamic community on a particular issue. ijtihad is the interpretation and the opinion of islamic jurists on a particular issue (elasrag, 2015). over time, muslim scholars have surveyed the quran and sunnah and concluded that there is a set of main purposes that god intended for shari’ah. these underlying purposes include providing for the well-being of humans, diminishing hatred and disputes, and setting limits to human freedom, which generally ends where the freedoms of others start (muhammad, 2007). the purposes of shari’ah also include eliminating hardship and protecting the earth’s population. last, but most important, is the purpose of promoting justice, as the main pillar of islamic law and only way to eternal peace (taman, 2011). in islam, the business activities fall under the jurisdiction of muamalat, which has to do with the man-to-man relationships. trade (al-tijarah) is strongly encouraged and businessmen are highly praised (muhamad, 2007). islamic law provides a set of key principles, duties and prohibitions related to social responsibility towards people and the environment, and to financial and commercial 1 “[…] allah has permitted trade […]” quran, 2:275 transactions. they concern both individuals and businesses (table 1). islam fully recognizes the legitimacy of economic and commercial activities1 and argues that there is nothing wrong with fair trade, provided it is in line with the islamic code of conduct. islamic law prescribes specific guidelines for the governance of business, based on legality (halal: legal and permissible) of transactions. halal economic activities consist mainly in trading with mutual consent, truthfulness, generosity and clemency; being trustworthy, honoring debts and fulfilling obligations (uqud); treating workers fairly. as to haram transactions (unlawful and forbidden), they relate to the practice of usury and charge interest (al riba), trading prohibited items, sell in the presence of uncertainty and risk (al gharar) or speculation (al maysir), fix prices arbitrarily, accumulate food (ihtikar), exploit others’ ignorance of market conditions, cheating and defrauding (al najsh). because of the prohibitions discussed above, the people of islam are facing the dichotomy between the need to trade with the west and to follow the commands of islam (taman, 2011): this is the reason that led to the emergence of islamic financial institutions (ifis), which offer alternatives to the commercial activities which shari’ah forbids, including: a) murabaha, an agreement between a bank and a client in which the first becomes a commercial intermediary for the second (lewis, 2008); b) musharaka, a contract that involves the creation of a company where partners contribute with capital and/or work, sharing risks, profits and losses; c) mudaraba, a form of partnership in which one of the partners (the rabb al-mal, literally “the money lord”) provides capital, while the other (muḍarib) manages it; d) takaful (which literally means “solidarity”), an alternative to conventional insurance based on the concept of social solidarity, co-operation and mutual compensation of losses an idea that comes from the so-called “aaquilah”, a fund existing at the time of the prophet, to which each member of a particular tribe gave a contribution, in order to indemnify those, also belonging to the tribe, who had had to deal with unexpected disasters (ayub, 2003); e) al quard al hassan, an interest-free loan whose only debtor’s obligation is to repay the amount of the loan. ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 table i. shari’ah’s remarks about the csr themes. zakah and sadaqah (philanthropy and charity) the references in the quran and ahadith highlight the importance of charity, gift, alms, generosity, and payment of tithing, specifying the need for such gestures to be sincere and not aimed at personal gain. caring for orphans and for the needy the quran explicitly states who should be the legitimate recipients of beneficial care and donations, identifying those figures in all the needy members of the community, with particular reference to the orphans. caring for the environment the environment issue in the quran is recalled with reference to the importance of agriculture. the ahadith, however, emphasize the importance of allah’s creation. in these, there is a strong tendency to protect and safeguard the environment, even in the most difficult circumstances (for example, during a conflict). caring for animals the theme of animal protection, as an integral part of the environment, is mainly dealt with in the ahadith, where numerous stories describe the need to treat animals with dignity and respect. fair trade, fulfilling covenants, and free competition the quran calls concepts related to fair trade, ordering not to behave improperly in trade agreements and to refrain from adopting deceptive behaviors under any circumstances (strong is the promotion of the concept of justice, even in this context). fair treatment of workers in the sacred scriptures, a worker is compared to a brother. the most important indications, therefore, support honest and fair behavior in relation to the amount of work to be imposed and to the wage scale. al riba (usury) perhaps one of the best-known concepts in modern times, al riba, which means “usury”, is one of the most explicit prohibitions the quran expresses. the ban is to prohibit the application of interests (favoring rather the total nonrepayment of the debt, which becomes a donation sadaqah) al gharar (speculative activites) the quran, in its verses, prohibits corruption and forbids trade based on the uncertainty of the well-traded good. al maysir (gambling) the verses relative to al maysir refer to the prohibition of gambling, because the wealth derived from it is the result of “luck” rather than the benevolence of allah (and as such represent a shame). prohibited products it is well known that, within the islamic religion, there are a number of products whose trade and consumption are forbidden. among them are alcoholics and narcotics, idols, animals dead in a non-halal way. arbitratily fixing the prices according to mohammed’s statement, the market trend is decided by allah, so those who set prices arbitrarily commit a sin. accumulation of food the practice of collecting products has common features with the prohibition of price fixing in an arbitrary manner: retaining goods until the price rises up is strongly prohibited according to numerous ahadith. exploitation of the ignorance of others the most famous hadith regarding the exploitation of information asymmetry leads the example of city traders who should not sell the products of a foreign merchant on their behalf (as they would benefit from their informed status at the expense of the foreign merchant). cheating and defrauding fraud and deceit are recalled in many verses, often referring to the correct calibration of the “balance”, which must tell the truth and not deceive the buyers. in general, those who deceive are condemned by the sacred scriptures. al quard al hassan a practice that has to do with both the alms and the prohibition of usury, al quard al hassan was born as a response to the verses of the quran that invite to be lenient in calling the loans back. this “financial” practice is an interest-free loan. source: author’s elaboration. b. islamic financial institution (ifi). respect to the prohibitions descending from shari'ah, the islamic financial system has established alternatives that are consistent with religious dictates, generating value and sharing for the people who adhere to it. institutions are good, but it is credible, responding to the needs of people of islamic religion, faced with the need to face the dichotomy through the need to trade with the west and to follow the commands of islam. in order to comply with all the requirements, islamic finance has developed its operational tools; they are the concepts of murabaha, musharaka, mudharabah, takaful and al quard al hassan (see paragraph a). therefore, when the bank becomes an intermediary in the purchase of a good for the customer, the customer will pay the bank the same price increased only by expenses (murabaha). when the bank is considered a company, it itself participates in company risk, dividing profits according to a percentage established in the contract and losses proportionally to the portion of capital invested. the bank can provide money and not participate in the management of a company, limiting the capital invested, a difference of the other person; the profit is divided on the basis of a contract taken at the beginning of the relationship, and is in a quota which is expected, but not the amount, is always predetermined. even in insurance (takaful which literally means "solidarity") profits and losses are shared between the participants and the company that issues this service, referring to the concept of mudaraba, with the division of the prizes into two parts, a constituent the compensation of the participants, while the other invested in any activity that is consistent with the shari'ah. and the loans (at the end of the hassan) are without interest (with which the limits of the needy have been taken into consideration) with capital taken from the zakaat and sadaquat, previously deposited by other wealthy muslims at the ifi. in the same way, islamic ones have been affirmed which are different from the traditional ones; the first bank was created in 1963 in egypt, an experiment that however found full realization in 1975 with the islamic bank of dubai. institutions create excellent value, rather than values and beliefs. the islamic financial institutions, born in the '70s, in the era of the oil boom, are operating in more than seventy-five countries. in 1975, the establishment in saudi arabia of the islamic development bank (idb) represents the first commitment of institutions and funds in the development of islamic finance. in the eighties many initiatives continued to flourish, such as iran, pakistan and sudan, the process of islamization of their financial system began. in the nineties, the interest in the companies that opened the branches within the subsidiary companies operating in the shari'a countries, in 1995 the first two stock market indices were launched relating to shari'ahcompliant financial instruments (the dow jones islamic index and the financial times islamic index). thus began to feel the need for greater importance of islamic financial institutions, as a first reading in 1991 created in bahrain the accounting and auditing organization for islamic institutions (aaoifi), with ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 the aim of accounting and governance rules, the rules with the economy and the last decade have been constituted numerous supranational institutions, with a leading role played by the islamic financial services board (ifsb), established in 2002 in malaysia, which is the main islamic management (which in most of the islamic countries considered, like self-regulatory codes, simple judgment of soft law, with the exception of malaysia and bahrain, these standards were explicitly referred to by law, thus becoming hard law), with functions similar to those of the basel committee for the conventional banking system. a further peculiar feature of the islamic economic-financial system is the necessary presence within the financial institutions of the shari'ah supervisory board (or, more simply, "shari'ah board" or, also, "shari'ah committee"), ie of a council of experts on islamic law that ensures that (from the religious point of view) the activity carried out by the institute itself and the contracts, products, services and operations stipulated, offered and structured, conforms to the shari'ah and to the indications provided by the mentioned international standard setters. however, to be considered as paradoxical that institutions that reject usury can integrate into a system based on interest, in the era of globalized finance that has helped to give them strength. despite the fact that islamic finance has grown considerably thanks to the globalization of finance2, its spread in the west is still held back by the general western perception which tends to identify every application of islam with its most extreme manifestations. iii. research methodology after a brief background on islamic csr and specific connection between islam culture and principle of social responsibility (see table 1) and the important role of islamic financial institution (ifi), in section iv, the authors, did a comparative qualitative analysis between islamic csr and “western” csr underline the vision of through the triple bottom line approach (social, environmental, economic) of these two models (see table 2). the research focused on a case study analysis on islamic reporting initiative, enriched by a qualitative research methodology such as documental analysis for reviewing and evaluating electronic documents (bowen g. a., 2009) from iri’s website. moreover, the authors conducted ad hoc interviews to an iri’s staff member about the organization and its activities. the interview was created with a view to understanding the story behind the organization, its goals and purposes. the interview is composed by 14 questions on: general information about the interviewed; general questions about islamic reporting initiative; specific questions about the relationship between islamic reporting initiative and 2 “whereas the traditional world of finance, dominated by commercial, interestbased banking, could raise potentially troublesome theological issues, the new world of finance, characterised by the blurring of distinctions between commercial banking and other areas of finance, the downgrading of interest income, and financial innovation, has been rife with opportunities for islamic financial institutions.” (warde, 2001). 3 takwa implies making a deliberate effort to achieve the shari’ah’s goals in the manner prescribed by the shari’ah itself; it guarantees the social fabric, western csr; on islamic csr standards; the last question aim to investigate the future implications of introducing integrated islamic standards for islamic corporates. in conclusion, a comparative analysis with the global reporting initiative (gri), the most important initiative and organization in western countries that promoting the culture of social and integrated reporting. iv. islamic corporate social responsibility and comparison with conventional csr. social responsibility refers to the obligation for companies to protect and make a contribution to the society they work in: in this sense, csr is considered to be crucial in islamic businesses. it encompasses a wider meaning that embraces the concept of taqwa3, which refers to god’s conscience, for which an enterprise, as a group of individuals, must assume the role of servant and vicar (of god), and the responsibilities arising from it, always. this concept should occur naturally in economic activities and relationships with all stakeholders (siwar and hossain, 2009). in the islamic context, therefore, csr is a religious and moral initiative based on the belief that a company should do “good” regardless of the financial consequences, whether positive or negative. from an islamic perspective, social responsibility exercised by a business organization is seen as a benefit, rather than as a cost, and is not only a matter related to legal obligations or material rights of stakeholders: it is a moral duty and a matter of survival for both the organization and society, because each depends on the other (khatun and alautiyat, 2012). with reference to the guidelines of the shari’ah, we can deduce that according to islamic law is certain that any benefits brought to the company will represent, over time, an even greater future benefit for the organization and for the individuals who compose it (parvez and ahmed, 2004). the ummah4 concept shows that society has a “right” and a kind of “participation” in anything a muslim possesses and, wishing to extend this principle, to any activity and operation undertaken by an islamic enterprise. organizations are considered a human institution, part of the islamic community (ummah islamiyyah, precisely). moderation and concern for the needs of others, as well as for their own, therefore, become an integral part of islamic corporate social responsibility. individuals and businesses are encouraged to sacrifice, give and spend their wealth for the poor and needy, in view of the afterlife recognition. this sense of duty, responsibility, and spirit of sacrifice, nourished by the islamic religion, serves to remove egocentrism and greed and to promote the compassion, care, cooperation and harmony of the community (dusuki and abdullah, 2007). the tawhid because people become voluntarily engaged in achieving the central goals of human well-being; it also plays a unifying role, linking the community together and constituting a source of equality, solidarity and freedom (kamali, 1989b). 4 the concept of ummah embodies the universality of islam and provides a framework for religious unity, which houses the cultural diversity of believers (hassan, 2006). ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 paradigm is to carry out actions in line with faith (aqidah), worship (ibadah), and ethics (akhlaq). it provides guidelines for business management in accordance with the principles of shari’ah and islamic ethics. hence, according to the islamic view, economic organizations should adopt a wider vision of csr, deriving from the tawhid paradigm, which indicates three relationships: the relationship with allah, the relationship with man, and the relationship with nature (spiee and ali, 2001). these three dimensions represent the framework governing corporate practices in islam and, hence, corporate social responsibility. the fulfilment of islamic requirements over these three business relationships guarantee, in the islamic view, healthy, just and sustainable social and economic development. the conventional csr adopts the so-called triple bottom line (elkington, 1997) approach (tbl), a reporting framework that incorporates three dimensions of corporate performance: the social, the environmental and the financial dimension. the dimensions of the tbl approach are also identified as the three “p”: people, planet and profit. andrew savitz (2012) adopts a general definition for the “triple bottom line” expression, according to which this approach captures the essence of sustainability by measuring the impact of an organization’s activities on the world, taking into account both its profitability and the value of its shareholders, and its social, human and environmental capital. the “3p” approach is inherent in islamic law and religion, presenting similarities and differences to conventional csr (table 2). the most contrasting aspect between conventional csr and islamic csr is the role of philanthropy. csr has been defined as “a concept whereby companies integrate social and environmental concerns in their business operations and in their interaction with their stakeholders on a voluntary basis” (european commission, 2001). this definition of the european commission intrinsically links csr practice to commercial operations, thus excluding mere philanthropy and linking csr to the core of business operations. in western csr, therefore, philanthropy is linked to a limited degree of social responsibility, in the absence of a well-structured and farsighted environmental and social action plan, and the fear is to fall into the trap of green washing or blue washing. in the islamic context, however, philanthropy acquires a completely different meaning (thibos et al., 2011). the quran and the sunnah promote with emphasis charity and philanthropy, and provide very specific acts to fulfil these duties, both individually and at the organizational level: zakah, a compulsory financial act that promotes charity for the needy; sadaqah, a voluntary action of various kinds not necessarily financial that encourages the help towards others; and the bayt al-mal, a practice that is not so widespread today, but which originally acted as a “state treasury” and welcomed the zakah and the sadaqah so that those in need would know who to turn to get help. thibos and gillespie (2011) investigate how islamic religion influences social reporting in the arab world. the authors note conflicting results due to the fact that, on the one hand, there seems to be a strong awareness of the managers of large arab companies regarding the importance of csr and social reporting, on the other hand, there is very little evidence of a real practical commitment in that sense. selvik (2013) explores the promotion and adoption of csr in the arab world, analyzing the case of syria and the case of dubai. the author notes that, although there are governmental organizations working to promote csr, the difficulties they face in entrenching the concept among local entrepreneurs are many. the latter, according to the author, tend to remain faithful to a typically islamic framework of social responsibility that appears to be in conflict with csr as promoted by the organizations. table ii. conventional csr vs islamic csr. conventional corporate social responsibility islamic corporate social responsibility people fair and beneficial business practices towards the workplace, the community and the region in which a company carries out its business; prohibition of the exploitation of child labour; fair treatment of workers; honesty towards suppliers and customers. people care for women, orphans, the elderly and the needy; fair treatment of workers; prohibition of the exploitation of people or their ignorance; honesty towards suppliers and customers; promotion of fair trade; respect for free competition. planet sustainable environmental practices; reduction of carbon footprint; careful management of energy consumption and non-renewable resources; reduction of the waste in production; reduction of waste toxicity before disposal. planet protection and safeguard of earth; illegality of dumping toxic waste in rivers and oceans, manufacturing of ozone depleting products, indiscriminate oil spills, hunting of endangered species, unnecessary or irresponsible interference with the ecosystem, etc. profits the real economic impact the organization has in its own environment; the benefit derived from the socially responsible activities of the enterprise/organization. profits economic and commercial activities alternatives to haram activities: al murabaha, al musharaka, al mudaraba, takaful e al quard al hassan. philanthropy very marginal role; superficial approach to social responsibility; green washing; blue washing. philanthropy central role; holistic approach; philanthropic activities: zakah, sadaqah, bayt al-mal. source: author’s elaboration. v. case study: islamic reporting initiative. the islamic reporting initiative (iri) is a non-profit organization that works to create a framework of guidelines that integrates csr reporting with islamic principles and values, working towards achieving international best practice standards. the framework will enable organizations to evaluate, verify and certify their corporate social responsibility and philanthropy programs in an inclusive manner, supporting the ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 united nations sustainable development goals. the organization seeks to achieve the above through a culturally relevant and “impact-oriented” methodology. this approach is based on those studies according to which companies around the world are not always comfortable with the current csr reporting tools, since they do not fully reflect the cultural context in which they operate. iri sees the values of peace, compassion, tolerance, justice, environmental management and human dignity as the foundations on which to implement enterprise sustainability and social responsibility on a universal scale. currently, iri is in the first of three stages of development, in which the organization is mainly involved in gathering support, by welcoming signatory members and partnerships that are capable of representing all sectors. iri already welcomes members from all over the middle east and north africa, central and south-east asia, and europe, representing different economic sectors, including the health, the financial, the education and the environment sectors. the islamic reporting initiative (iri) drives the creation of an independent reporting framework based on islamic values, for the measurement and evaluation of sustainability and corporate social responsibility. recognizing and embracing the features of islamic business practice, iri will enable organizations to report more effectively than their csr and philanthropy efforts, so as to speed up achievement of sustainable value and growth. iri’s mission is to enable organizations around the world to look at the values that drive their activities and to express their contribution to sustainability in society and the environment with clarity and simplicity. the vision is a sustainable global economy that contribute actively to society and the environment, integrating the values of peace, compassion, tolerance, justice, human dignity and environmental management within the corporate culture. iri conceives csr in a broader way, including four dimensions: economic, legal, ethical and philanthropic. there is consensus that the current main frameworks (including the gri framework) are largely based on western literature and practice, leaving many contextsensitive factors, such as philanthropy, out. these frameworks tend to affirm the first two or three dimensions (economic, legal, ethical) and recognize the role of philanthropy in csr less, despite their compatibility. existing reporting standards, such as those proposed by the global reporting initiative among others, are not always practical or relevant in a particular cultural and local context. iri and gri have common features, but also some significant differences (table 3). iri faces a reality where social reporting and csr are already well-known and internationally diffused notions and practices, and collides with a different problem: the absence of a reporting tool that integrates csr disclosure with the cultural and religious component that local contexts refer to in their activities. table iii. global reporting initiative vs islamic reporting initiative. global reporting initiative islamic reporting initiative  boston, 1997  western context, postindustrialization  secular approach to csr  mission: empowering decision-makers around the world through their sustainability standards and their multi-stakeholder network, with the goal of acting towards a more sustainable economy and world.  vision: creating a future where sustainability is an integral part of the decision making processes of each organization  presence of an organizational firewall between principlesetting activities and other organizational activities  multi-stakeholder approach and indispensable relevance of stakeholders  importance of strategic partnerships  great number of western partnerships  sceptical approach to charity and philanthropy  exclusion of activities that serve to publicize the image of the business and generate visibility only  creation and implementation of a standard framework, accompanied by related services, already in place  dubai, 2015  middle eastern/eastern context  local and religion-oriented approach to csr  mission: allowing organizations around the world to review the values that drive their activities  vision: a sustainable global economy that actively contributes to society and the environment, integrating values of peace, compassion, tolerance, justice, environmental management and human dignity within the corporate culture  absence of an organizational firewall between principlesetting activities and other organizational activities  multi-stakeholder approach and indispensable relevance of stakeholders  importance of strategic partnerships  modest number of partnerships (growing), both arab-islamic and western  positive and inclusive approach to charity and philanthropy  exclusion of activities that serve to publicize the image of the business and generate visibility only  creation and implementation of a standard framework, accompanied by related services, not yet in place source: author’s elaboration. vi. conclusion and discussion. the islamic approach to corporate social responsibility is holistic, and it provides an integrated spiritual vision, founded on religious teachings of the quran and sunnah, with the intention of providing a “better alternative framework” in the belief that moral principles and ethics deriving from divine revelations are more enduring, eternal and absolute, and as such, they are best placed to provide guidance to companies in the conduct of their business and their social responsibilities at the same time. although there is a match between triple bottom line approach and islamic law, the islamic csr considers another methodology: according to the islamic view, the economic organizations should adopt a broader conception of csr, resulting from the tawhid paradigm, indicating three relationships the relationship with god, with men and with nature (which in a way are also found in tbl, except for the ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 religious component). islamic principles serve to permeate individuals and organizations of responsibility for the care of society, and influence society through various practices and perspectives. there is a general recognition that companies operating in accordance with islamic principles tend to embrace an organizational culture based on assumptions and notions of trust, morality and responsibility. these are the cultural nuances that influence and shape the behaviour of an enterprise and therefore sculpt its csr strategy, which is no longer a mere economic initiative, but a moral one, since it is based on the understanding that an organization must aspire to be a “good citizen”. the islamic reporting initiative (iri) is the first integrated sustainability reporting standard that provides a framework built on islamic principles and aspires to embrace culture compatibility in achieving the goals of csr. among the intentions of iri are: • providing culturally relevant support in measuring and advancing organizational sustainability, csr and philanthropy; • respecting the environment and life in all its diversity; • creating an international business tool to support organizations in reporting consistent with the regions and cultures they serve; • promoting the use of the triple bottom line (people, planet and profit) approach; • providing metrics and methods to measure and report on projects that support health delivery and promotion, invest in society and young people, strengthen and empower labour, minimize waste and develop mobility of skills and knowledge; • strengthening cooperation between countries through csr business partnerships to develop a global economy, society and a green and sustainable environment. iri’s vision and mission reflect the desire to bring an inclusive set of values to corporate social reporting. iri wants organizations to not only spend their profits responsibly, but also create them responsibly. in this sense, iri recognizes the intrinsic relationship between philanthropy and csr and understands that philanthropy is a key pillar of csr. csr reporting, increasingly demanded at the legislative level, allows organizations to gain valuable information about their overall performance, giving management the power to optimize the business strategy for an inclusive economy. in conclusion, considering that islam is concerned above all with the welfare of society, every economic activity in this perspective must be pervaded by a feeling of innate altruism, unlike the capitalist economy, where the basic assumption is that by satisfying their own interests of benefits they also fall on others, a representation of an exasperation of christian ethics at a time when it relied above all on individual merits (warde, 2001), the path to reconciliation between homo islamicus and homo economicus can to be easily identified precisely in the addition in the traditional economic conception of a social purpose, which is not so important in the jewish approach, christian or secular thinkers, who have always proposed a third way compared to the classification in the two opposite poles of the free market and complete control of the government. references [1] m. ayub, an introduction to takaful–an alternative to insurance, islamic banking department, state bank of pakistan, 2003. [2] glenn a. bowen, document analysis as a qualitative research method, qualitative research journal, vol. 9, 2009, no. 2, 27-40. [3] a. w. dusuki and n. i. abdullah, maqasid al shari’ah, maslahah and corporate social responsibility, the american journal of islamic social sciences (ajiss), 24 (1), 2007, pp. 25-45. [4] h. elasrag, corporate social responsibility: an islamic perspective, personal repec archive, munich, 2015. [5] j.elkington, cannibal with forks: the triple bottom line of 21st century business, oxford, capstone, 1997. [6] european union, green paper: promoting a european framework for corporate social responsibility, luxembourg: european commission, 2001. [7] k. m. khatun and h. alautiyat, corporate social responsibility: an islamic perspective, int. i. bus. technopreneurship, 2 (3), 2012, pp.415423. [8] m. t. b. hossain and c. siwar, a comparative analysis between islamic concept on corporate social responsibility and malaysia mangers opinion. management of environmental quality: an international journal, 20(3), 2009, pp. 290-298. [9] m. k. lewis, in what ways does islamic banking differ from conventional finance, journal of islamic economics, banking and finance (jiebf), 4 (3), 2008, pp.9-24. [10] j. a. mohammed, corporate social responsibility in islam, phd thesis, auckland university of technology, 2007. [11] j. a. mohammed, an islamic perspective of corporate social responsibility. the global conference on business, economics and social sciences research (gbsr ), 2013. [12] k. selvik, business and social responsibility in the arab world: the zakat vs. csr models in syria and dubai, comparative sociology, 12 (1), 2013, pp. 95-123. [13] m. shamim and n. karim, corporate social responsibility: contemporary thought and islamic perspectives, thoughts on economics, 21 (1), 2010, pp. 45-66. [14] n., sopiee and r. m. ali, business ethics and politics, in kahlid, a., & abulhasan, m. s. (eds.), ethics in business and management: islamic and mainstream approaches, asean academic press, london, 2001, pp. 113-134. [15] s. taman, the concept of corporate social responsibility in islamic law, ind. int’l & comp. l. rev., 21 (3), 2011, pp. 481-508. [16] c. thibos and k. gillespie, islam and corporate social responsibility in the arab world: reporting and discourse, in sandıkçı, ö., & rice, g. (eds.), handbook of islamic marketing (london: elgar), 2011, pp. 300318. retrieved from http://www.academia.edu/4181013/islam_and_corporate_social_respons ibility_in_the_arab_world_reporting_and_discourse. [17] united nations general assembly, report of the united nations conference on sustainable development, 13 to 22 june 2012, rio de janeiro, brazil, 2012 un doc.: a/conf.216/16. [18] united nations general assembly, the future we want, 27 july 2012, 2012. un doc.: a/res/66/28. [19] united nations general assembly, transforming our world: 2030 agenda for sustainable development, 25 to 27 september 2015, new york, ny, 2015, un doc.: a/res/70/1. [20] united nations general assembly, the millennium development goals report, new york, ny, 2015. [21] warde i., islamic finance in the global economy, edinburgh university press, edinburgh, 2001. [22] yahia a. r., the art of islamic banking and finance: tools and techniques for community based banking, wiley, hoboken n.j., 2010. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 contingency planning in traditional and islamic banks during the crisis in syria crisis management perspective . abstract— the syrian crisis is one of the worst crisis in the world. it has dramatically affected many aspects of life and civilization. it imposed millions of emigration to many countries, and negatively affected the national economy including international companies operating in syria, and also local. it imposed on its economic sides the exit of many institutions and companies from the market, and also led to the adoption of different types of retrenchment strategies by companies that could not exit or those who wanted to stay challenged and motivated by the management of its operations and activities in an exceptional manner commensurate with the crisis continues to the present. before the syrian crisis, banking industry (traditional and islamic) in syria was growing rapidly and in a stable pace. the crisis situation has resulted an unexpected conditions that banks were have to deal with. this research highlights the negative effects of the crisis on islamic and traditional banks operated in syria, it also indicates some of the responses the banks has employed in order to mitigate or eliminate the crisis bad effects. the applied research has been modified to explore implementation of crisis management literature in syrian banks (traditional and islamic) and the role of that implementation in supporting contingency planning. the study found three main results. first, there is a positive and significant correlation between the crisis management and contingency planning. second, the syrian employees believe that syrian banks has adapted crisis management practices. finally, the study indicated that banks’ employee believe that their work conditions and job environment was negatively affected by the crisis situation. keywordscontingency planning, traditional banks, islamic banks, crisis management, syria. i. introduction prior to the start of the crisis, syria was undertaking a number of structural reforms to liberalize the economy to make it more market-oriented. these reforms included unifying multiple exchange rates, allowing the opening of private banks and the damascus stock exchange, eliminating controls on interest rate, and raising pricing in some subsidized items. nevertheless, in 2010 the economy was still tightly regulated both internally and externally and the process of reform was designed to be very gradual. the largely positive external pictures was reflected in the relative stability of the exchange rate. the syrian pound (syp) appreciated steadily against the us dollar at an average rate of 2 percent per year and at the end of 2010 reached syp 47 to the us dollar. the private (traditional and islamic) banks entered the syrian market to meet the needs of economic development and to expand the horizons for foreign and arabic investments in syria. it also contributed to both development of the banking sector and the local financial market and attraction of financial savings. it also participated in financing the development projects in order to support the national economy due to the increased demand for banking services. this step was very important to develop the banking sector in syria due to the importance of the bank’s services and the big technical progress that will happen. there were fourteen private banks entered the syrian market (traditional and islamic). islamic banking in syria has expanded rapidly, witnessing increasing demand since it was first introduced to the syrian banking sector. there are many evidences ensure that islamic banks operate amid special care from the government in light to their large customer base and principles of sharia (islamic law) that render them less vulnerable to financial crises. in fact, since the beginning of 2009, islamic banks' services and products have diversified and developed to meet various loan requirements, including housing and personal loans. following the uprising the economy started to deteriorate significantly, slowly, 2011 and much more rapidly in 2012. in ahmad taha kahwaji* *phd in strategic management (from brescia universityitaly). department of management and marketing, college of commerce and business administration, dhofar university, salalah, sultanate of oman, postal code: 211 – p.o. box: 2509. ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 2011, official estimates show a decline of real gdp by 2.3 percent. the full damage to the economy became evident in 2012. inflation in 2012 jumped ten-fold to over 50 percent and international reserves fell to $2 billion at the end of 2012. the current account deficit did decline to $6 billion, but that was because of the dramatic drop in foreign trade. exports fell by 60 percent to under $5 billion and import to $10 billion from $18 in the previous year. the combination of spiraling inflation and a rapidly shrinking economy showed up in the behavior of the exchange rate during 2012 and into the first half of 2013. in december 2012, the currency fell to syp 60 to the us dollar, a decline in value of some 50 percent from the previous year. in early 2013, however, it fell off the cliff, when the currency had fallen to syp 170 to the us dollar. in the last two year, the currency reached a low of syp 500 to the us dollar. it had now become a full-fledged run on the currency and the government did not have the foreign exchange reserve to counter it. a report published by the un in march 2015 estimated the total economic loss since the start of the conflict was $202bn and that four in every five syrians were now living in poverty 30% of them in abject poverty. syria's education, health and social welfare systems are also in a state of collapse. the direct economic effect comes from the decline in the size and skills of syria’s labor force due to loss of life and refugee outflows, infrastructure destruction, the trade embargo on syria, cost-of-doing-business increases, and a decline in productivity. the indirect effect captures the opportunity cost of foregone trade integration initiatives aimed at improving trade logistics and liberalizing trade in services in the region. the indirect effect is important to consider because the war disrupted the intra-levant trade, which grew seven-fold between the early and late parts of the 2000s. it put an end to plans for deepening intra-regional trade ties further following the signing of the “levant quartet” agreement in 2010. the benefits of deep trade integration reforms were expected to be sizable, reflecting significant economic complementarities, as shown in a recent world bank study (2014). ii. methodology a. research methodology this study employs the quantitative method to precisely predict the relationship between the selected variables. the sample involved employees of syrian banks at all administrative levels and departments. the primary research instrument is a questionnaire that was designed and formatted as an online survey form. it is designed and translated into arabic to meet the samples' understanding. a unique survey link was created and distributed to e-mail and facebook addresses. an approximate of five days’ time was spent to gather the 58 responses. the research asks the respondent about what they think about 14 statements and likert scale was used to collect the answers. b. research problem during the syrian crisis, traditional and islamic banks are seeking to avoid and mitigate the outcomes of the crisis on their performance and results. and those banks were always seeking to keep their financial profits in order to meet the stakeholder’s expectations. the financial statements of the traditional and islamic banks studied before conducting this research, showed an aggregate 28% decline in loans extended to the last two years to the end of 2012 and a 29% decline in costumers' deposits. the assets and liabilities have fallen dramatically since the end of 2012. as the crisis has deepened, traditional and islamic banks studied in this research, have been converting foreign currency loans into local currency loans in the hope of improving their borrowers' ability to repay. little have been written about how the crisis has affected the traditional and islamic banks in syria. this research is designed to inspect the relationship between the contingency planning and the crisis management implementation. the research asks a question about what the effect of crisis management is on planning in some traditional and islamic banks were still operating during the syrian crisis. the research aims to find out if syrian banks (traditional and islamic) implement the methodology of crisis management, and what is the level of that implementation. and to define the impact of the crisis situation on employee’s organizational behavior. c. research hypothesis crisis management has improved contingency planning efficiency. syrian banks have used crisis management to overcome the crisis situation. crisis situation has affected the employee’s organizational behavior. iii. background a. the banking sector during the crisis in syria the banks put its own strategy. then they manage limits and perform control on the concentrations of credit risk wherever ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 they are identified. in particular, whether this risks located at individual, counterparties, banks, industries, and countries. the bank structures the levels of credit risk it undertakes by placing limits on the amount of risk accepted in relation to one borrower, or groups of borrowers, and to geographical and industry segments. in this way the bank can control the credit risk. such risks are monitored on an ongoing basis and are subject to an annual or more frequent review and at any time it is considered necessary by the board of directors. limits on the level of credit risk by borrower/group, product, industry, sector, and by country are approved quarterly by the board of directors. credit limits for any borrower including banks are divided by sub-limits covering onand off balance sheet exposures. actual exposures against limits are monitored daily, this monitoring is important to make sure that the bank works within the plan. exposure to credit risk is also managed through regular analysis of the ability of borrowers and potential borrowers. that is what the banks do in a regular working environment. the banks put its strategy and the board of directors approve it. this strategy changes when the environment changes, that’s what happened in the financial institutions during the six years of the crisis in syria. all financial institutions that remained in syria have changed their strategies and policies and practices in order to be consistent with the business continuity plan. and of course some of these changes were in accordance with the instructions of the central bank of syria and the resolutions of the syrian currency and credit council. b. banking sector performance and risk responses we will bring a spot light on some working banks in the syrian market (three are traditional and two are islamic). we can consider those banks as a statistical sample. and we will compare their financial statements before the syrian crisis and after the six years of the crisis. the three traditional banks are (1) bank audi syria (2) bank bemo (3) bank of syria and overseas, and the islamic banks are (4) cham bank, and (5) al-baraka bank syria. we will compare 2016 with the base year 2010. we noticed that the five banks have applied a contingency planning to face the multisided aspects of the crisis. in addition, an important provision was taken by each one of the working banks to ensure the continuity of their business. they prepare for a plan b in case of unusual event scenarios. those plans include people, processes, and technology for its headquarters facilities so they can continue working under any unusual event. they survived this crisis because of the new strategies they have developed. we will take a quick financial review starting with the first bank: bank audi syria 2010 (m syp) 2016 (m syp) change % total assets 93,789 64,441 -31.3 due to customers 81,813 49,015 -40.1 loans to customers 39,444 17,822 -54.8 net operating income 2,251 4,629 105.6 profit of the year 681 2,962 334.9 net interest income 1,501 973 -35.2 foreign exchange gain 65 2,962 4,456.9 credit loss expense 155 438 182.6 non-working credits 3.35% 25.55% table 1. annual disclosures of bank audi syria, syrian commission of financial markets and securities, 2017. at the first look on these above numbers we immediately notice that even though the total assets decrease by 31.3%the net profit has doubled more than 3 times. this growth doesn’t due to an excellent operative business plan but it comes from the unrealized foreign exchange gains that grows 44 times in the last year due to the fall of the syrian pound vs.usd, which is reflected in the net profit as we saw in the upper table. the credits also decreased by 54% to reach 17.8 billion sp in 2016 in alignment with the central bank of syria instructions. this decline accompanied with a growth in the credit loss expenses by 182% in alignment with the bank’s strategy. what strategies and risks responses the bank of audi has implemented during the crisis: the bank purchased an insurance contract that covers the riots and the unusual events additional to the regular risks. in addition to the above mentioned new insurance contract the bank took the necessary arrangements to maintain its assets with enough provisions taken into account for any possible loss, so it will be able to confidently face any challenge that the insurance contract doesn’t cover. the bank closed its mazzeh branch and deleted this branch from the banks list. the bank also changed the location of a branch in homs to another location in order to avoid the high risk in that area. ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 the bank put aside extra provisions to cover the credit risk under credit loss expenses shown in the income statement audi bank took the cbs approval to close 4 branches during the current crisis, located in al midan, harasta, aleppo, and deir al zorr. the bank put aside a provision for the 4 closed branches to cover the stolen funds. we can see from the financial statements that the bank stopped crediting the government but it’s still accept the government’s deposit. due to the economic sanctions, the banks could not anymore operate with certain countries like usa that’s what was reflected in their financial statements. for bank audi we can see that he is investing with the mena banks that formed 93% of his total deposits. this number can be compared with 2010 when usa held the biggest part of the cake forming 82% of the deposits with banks. the structure of the customers’ deposits also changed during the crisis, they deposit less in foreign currencies, the usd formed 24% of the total due to customers in 2010, noting that the amount is written in syp in the financial statements and the usd/syp exchange rate grows 6 times more in 2016 than 2010. let’s move to analyze bank bemo-syria which is the bank that holds the biggest part of the deposits in the syrian market: bank bemosyria 2010 (m syp) 2016 (m syp) change % total assets 114,761 138,895 21.0 due to customers 103,560 118,170 14.1 loans to customers 36,854 27,439 -25.5 net operating income 2,880 5,826 102.3 profit of the year 668 2,332 249.1 net interest income 2,000 1600 -20.0 foreign exchange gain 33.8 2,367 6,903.0 credit loss expense 22.9 909 3,869.4 non-working credits 6.89% 36.70% table 2. annual disclosures of bank bemo-syria, syrian commission of financial markets and securities, 2017. we can say that during the syrian crisis bank bemo has changed his policy regarding the terms and structure of both deposits and credits and even while dealing with other banks. bemo invested with non-local banks before the crisis with 87.5% from the total account with banks. but later in 2016 we can see that the bank invest more with the local banks due to the imposed sanctions on syria. loans to customers decreased 25.5% to reach 27.4 billion sp in 2016 due to the instructions of the cbs, accompanied with rise in the deposits as all the customers went back to put their funds in the banks again, which leads the bank to maintain a high liquidity position. credit to deposits ratio was 35.6% as at end 2010 and fell down to 23% as at end 2016 which was reflected in the net interest income that decreased 20% in 2016 affecting the profit of the year. the structure of its credits to customers didn’t really change between 2010 and 2016, the biggest part of the credits goes to the enterprises with 83% of the credit portfolio the rest goes to the retail customers, but we can notice the absence of the government and the public sector that was 206 million sp as end-december 2010. geographically, the credit exposure in 2010 was 68% in the country, 5.5% with other mena countries and 23% with europe, as at end 2016 we can see that zero credit exposure with usa and the exposure with europe fell to 14% the bank went to deal more with other mena countries with 16% of the total credit exposure. sight deposits formed 33% of the deposits as at enddecember 2010 versus 66% for the time deposits. this ratio has changed as at end-december 2016 the sight account formed 75% of the total deposits. most of the bank’s credit exposure was inside the country as at end-december 2010 when it formed 86% of the total exposure followed by 7.4% with europe and 5% with other mena countries. the exposure with euro increase at enddecember 2016 to form 15%, this increase doesn’t reflect any extra investment in europe but it reflects the devaluation of the syrian pound against the euro. the growth in the net operating income by 102% to reach 5.8 billion sp comes from the huge growth with the unrealized foreign exchange gain that reach 2.3 billion sp. the risk responses that the bemo bank made during the crisis were: close 12 branches in syria, after taking the cbs approval, due to the high risk of the area. cut down the credits that lead to a high liquidity position change the nature of the mortgages, the bank no longer depends on the cars and the heavy machinery as a mortgages the bank went for lending the enterprises more than retail lending cut off the credit to the government and the public sector increase the dealing with the local and mena banks during the crisis. extra provision and expenses to cover the risk. ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 finally let’s move to the third bankin our study, let’s start analyze the bank of syria and overseas: bank of syria and overseas 2010 (m syp) 2016 (m syp) change % total assets 92,140 105,420 14.4 due to customers 83,483 70,179 -15.9 loans to customers 30,353 6,943 -77.1 net operating income 2,004 3,892 94.2 profit of the year 712 1,987 179.1 net interest income 1,814 997 -45.0 foreign exchange gain 43 1,949 4,432.6 credit loss expense 21 392 1,766.7 non-working credits 0.95% 46.6% table 3. annual disclosures of bank syria and overseas, syrian commission of financial markets and securities, 2017 we can see a decrease in the deposits of customers by 16% at 2016 along with the huge decrease in the loans to customers by 77% at the same year. the bank lend 36% from its deposits in 2010 that ratio slides to 8% in 2016 which is reflected in the net interest income that decrease by 45% to 997 million sp in 2016 after it reached 1.8 billion sp in 2010. even though the loans to customers has decreased by 77% at end 2016 but the credit loss expenses doubled 17 times because of the provision that the bank is taking to cover the non-working credit and the doubtful loans. the increase in the net operating income by 94% comes from the unrealized foreign exchange rate that doubled 44 times at end 2016 to reach 1.9 billion sp after it was 43 million sp as at enddecember 2010. this gain is unrealized; it comes from the syrian pounds collapse against the foreign currencies. this unrealized gain affects the profit of the year that increased by 179% at end 2016 to reach 1.9 billion sp. the risk responses that the bank made during the crisis: 6 branches stopped working after taking the cbs approval in homs, adra and aleppo, due to the high risk of the area more provision was taken to cover the cash held in one of the up mentioned branches because the insurance contract doesn’t cover the conflicts events, it only covers the robbery and the fire absence of usa in the deposits with banks absence of loans for the government and public sector the bank tends to invest more with mena banks comparing with 2010 when it formed 16% versus 50% as at end 2016 the bank stopped investing with other sovereign bonds increase in the provisions to cover the potential charges in addition to the special provisions to cover the damaged branches also provisions to cover the fluctuations in the exchange rates all of these provisions in line with the banks conservative approach to sustain the crisis strategy. moving to the two islamic banks studied in this research, we can find that their situation not differ very much from the traditional. we have to note that the islamic banks observed are not listed on the dse (damascus securities exchange), and this was one of the obstacles to get data relating to these banks. however, the most obvious threats of the crisis are related to the continuation of the services of these banks, majority of it are physical. the destruction of some of their branches, or security threats that prevent bank restocking their atms or prevent their staff from going to work. the challenges faced by the syrian islamic banks sector, include, the lack of skilled human resources trained and qualified to practice islamic banking through a modern scientific approach to islamic principles. another challenge is promoting and raising awareness of islamic investment forms and activities. al-baraka bank syria (islamic bank) share capital (m syp) 4,541 branches 9 table 4. data collected from central bank of syria, 2012 al-baraka bank syria is the first islamic bank in syria to obtain the certificate of promotion according to the latest version of the international standard for the management of quality systems iso 9001:2015. in addition, the bank has been awarded the best islamic bank of syria in 2015 as part of the global finance awards, a global banking and finance consortium for international banking and finance institutions. it is worth mentioning that the main achievements of the year 2016 in al baraka bank syria entitlement to the degree of credit rating of investment grade bbb, to be the first bank in syria gets this category awarded by the islamic international rating agency iira according to the standard dfra. ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 c. organizational performance in banks during the crisis based on our observations and interviews, as a result of the crisis the banks replaced the expansion plans with contingency plans based on caution to follow a policy of retrenchment (such as marketing campaigns and advertising). as long as that the human element is the most expensive recourse in banks many banks implemented strategies to reduce this cost, those strategies includes: keep only the current staff. employee termination (least efficient staff for example). cancellation privileges granted to employees (bonus – training courses ... etc.). reduce costs on foreign employees. this, in turn, contributed to a growing sense of anxiety and stress for employees as a result of the feeling of insecurity and the probability of redundancy e.g. like what happened with their colleagues. this policy has led to increasing work pressures on the existing staff and the huge work load and accordingly to more stress. at the level of senior management, managers also feel the effects and consequences of this crisis on their job. the top management has reduced those managers’ allowances, remuneration and benefits in attempt to reduce the operational costs. these policies have led to the creation of a work environment filled with pressures and interactions that affected the emotions of the individuals negatively (indignation, sadness, fear) and their degree of absenteeism and the desire to recycle. that led to reduce the job satisfaction for the employees in general and to increase the frustration, stress, and high work pressure. in the same time no incentives or rewards system was employed to mitigate negative effects the crisis. so, under the crisis that is facing that banks, the need for organizational behavior science at the core factor of the organizational performance. the science of organizational behavior and applications presents insights and solutions to different issues and problems that have become the main feature of contemporary organizations environment. the development and strengthening of feelings of belonging and to labor force behavior by banks of important strategies that careful management to pursue, if it sought to improve the relationship between the banks and the force in order to preserve, or sought to develop creative behavior and move the motives to make more effort. a press report has mentioned that many employees in banks have faced a new and negative work conditions in some cases they also faced bad management behaviors. those behaviors sometimes resulted that this employee to receive a formal warning for no reasonable reason. the report also mentioned that many employees and senior employees are suffering from bad management behaviors some of those employees said that management was negotiating to terminate his contract. iv. literature review a. crisis definition the word “crisis” means different thing to different people in different professions. the term crisis has also been defined and conceptualized by different scholars and authorities in the field of management. british standard 11200 (2014) defines a crisis as an inherently abnormal, unstable and complex situation that represents a threat to the strategic objectives, reputation or existence of an organization. (fink, 2002) sees crisis as an abnormal situation, or even perception, which is beyond the scope of everyday business and which threatens the operation, safety, and reputation of an organization. crisis is also defined as a specific, unexpected, and non‐routine event or series of events that create high levels of uncertainty and threaten or are perceived to threaten an organization’s high priority goals (boins and sundelius, 2007). a change, which may be sudden or which may take some time to evolve, that results in an urgent problem that must be addressed immediately. an event that threatens the strategic objectives, reputation or existence of an organization (pearson and sommer, 2011). in fact, (dell'ariccia , detragiache and raghuram, 2004) indicated that the differential effects across sectors are stronger in developing countries, in countries with less access to foreign finance, and where banking crises were more severe. robustness checks include controlling for recessions, currency crises, and alternative proxies for bank dependence. b. crisis management in all institutions, depending on their size and activities, the type of crisis management applied varies substantially, but in the end they all try to move forward despite the negative effects that are generated. crisis management is defined as: the provision of an organization’s pre‐planned, rapid response capability supported by a leadership, information management and communications capacity in an integrated fashion to enable fast decision making at a strategic level within a structured environment, and thereby allowing for effective recovery and protecting an organization’s survival or reputation (cockram, 2012). crisis management is the art of making decisions to head off or mitigate the effects of such an event, often while the event itself is unfolding. this often means making decisions about your institution’s future while you are under stress and while you lack key pieces of information. consistent with the overall philosophy of crisis management, the key to being able to manage a crisis is doing as much planning as practical before a crisis starts in order to best ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 position you and your institution to respond to and mitigate such a situation. also (lotte, stam ,takeuchi and takeuchi, 2015) studied a sample of 383 middle managers operating in 34 business units of a large multinational corporation indicated that risk propensity weakens the positive relationship between personal initiative tendency and job performance. this negative moderating effect was further amplified when middle managers receive high job autonomy but was attenuated in business units with a strong performance management context. c. contingency planning preparing contingency plans in advance, as part of a crisis management plan, is the first step to ensuring an organization is appropriately prepared for a crisis. crisis management teams rehearse a crisis plan by developing a simulated scenario to use as a drill. the first hours after a crisis breaks are the most crucial, so working with speed and efficiency is important, and the plan should indicate how quickly each function should be performed. when preparing to offer a statement externally as well as internally, information should be accurate. providing incorrect or manipulated information has a tendency to backfire and will greatly exacerbate the situation. the contingency plan should contain information and guidance that will help decision makers to consider not only the short-term consequences, but the long-term effects of every decision. study by (d'aveni and macmillan, 1990) focused on the attention of top managers in surviving and failing firms, they indicated that under normal circumstances managers of surviving firms pay equal attention to the internal and external environment and more attention to the output environment than to the input environment. when a crisis of demand decline occurs, they pay more attention to the critical aspects of their external environment. in contrast, managers of failing firms deny or ignore output factors during crisis and pay more attention to the input and internal environments. also in other point of view (fahlenbrach and stulz, 2011) indicated some evidence that banks with ceos whose incentives were better aligned with the interests of shareholders performed worse and no evidence that they performed better. banks with higher option compensation and a larger fraction of compensation in cash bonuses for their ceos did not perform worse during the crisis. (gberevbie, 2010) in his study of zenith bank in nigeria indicated that organizations are likely to experience frequent employee turnover for as long as they fail to put in place appropriate employee‐retention strategies, which is capable of preventing enhanced performance. d. business continuity planning when a crisis will undoubtedly cause a significant disruption to an organization, a business continuity plan can help minimize the disruption. first, one must identify the critical functions and processes that are necessary to keep the organization running. then each critical function and/or process must have its own contingency plan in the event that one of the functional processes ceases or fails. testing these contingency plans by rehearsing the required actions in a simulation will allow for all involved to become more sensitive and aware of the possibility of a crisis. as a result, in the event of an actual crisis, the team members will act more quickly and effectively. the related terms emergency management and business continuity management, focus respectively on the prompt but short-lived “first aid” type of response (e.g. putting the fire out) and the longer term recovery and restoration phases (e.g. moving operations to another location). crisis is also a facet of risk management. in fact, (gan, 2004) showed from the texas real estate crisis in the 1980s that it exploits predictions that when hit by an exogenous shock, the slope of risk with respect to franchise value becomes more negative because thrifts adopt “bangbang” strategies and choose minimal or maximal risk. v. data analysis and discussion 1) sample analysis: below in figure 1 is the sample analysis in graphical representation. figure 1. graphical representation of the sample. ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 2) data analysis: the variable contingency planning was represented in the questionnaire by the questions from 1 to 5. and the variable crisis management was represented by the statements from 6 to 9. the last variable is uncomfortable work environment and it was represented by the statements 12,13 and14. the results showed that the mean of crisis management (the calculated variable) is 3.2366 which is higher than the scale mean. a further analysis was conducted to test the statistical meaning of that result as following: table 5. one-sample test test value = 2.5 t df sig. (2tailed) mean difference 95% confidence interval of the difference lower upper crisis management 5.619 55 .000 .73661 .4739 .9993 the test returns a positive result regarding the meaning of the mean. in other words, employees tend to believe that their management employ crisis management practices. by analyzing the correlation between the crisis management and contingency planning, the analysis results indicate a strong correlation between the two variables. table 6. correlations contingency planning crisis management contingency planning pearson correlation 1 .529** sig. (2tailed) .000 n 56 56 crisis management pearson correlation .529** 1 sig. (2tailed) .000 n 56 56 table 6. correlations contingency planning crisis management contingency planning pearson correlation 1 .529** sig. (2tailed) .000 n 56 56 crisis management pearson correlation .529** 1 sig. (2tailed) .000 n 56 56 **. correlation is significant at the 0.01 level (2-tailed). the responses were positive about the hypothesis h2: syrian banks has used crisis management to overcome the crisis situation. the mean of the responses related to statement#7 was 3.28 which is higher than the mean of the scale. in order to test the trust in that mean we apply the one sample t-test analysis. table 7. one-sample test test value = 2.5 t df sig. (2taile d) mea n diff eren ce 95% confidence interval of the difference lowe r upper manageme nt designed procedure to prevent business crisis to happened. 22.2 32 56 .000 0.78 07 0.485 1 1.0763 the table shows the mean difference is statistically significant. also analyzing the answers for statement#8. ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 table 8. one-sample test test value = 0 t df sig. (2taile d) mea n diff eren ce 95% confidence interval of the difference lowe r upper manageme nt pre-plan to deal with expected crisis 21.1 61 56 .000 3.21 053 2.906 6 3.5145 the results also show that the responders are positive towards the fact that the bank management plans in advance for the expected crisis. let’s move to analyze the variable of uncomfortable work environment. the mean of this variable is: 4.2917 which is higher than the mean of the scale, this result represents that there is a positive trend among employees to think that their work environment is not comfortable. table below support that result. table 9. one-sample test test value = 2.5 t df sig. (2tailed) mean differ ence 95% confidence interval of the difference lower upper uncomfortabl e work environment 18.150 55 .000 1.7916 7 1.5938 1.9895 vi. conclusion and racommendations in general, we can say that despite the flight of many industrial companies outside syria, the companies that remained, including the financial institutions, especially the commercial and islamic banks, played a large role in preserving the manifestations of economic life and tried at the same time not to deteriorate the national currency and control currency exchange with foreign currencies and commensurate with the financial and monetary transactions in the country. the banks studied showed that the managers focused on crisis management plans by expanding the planning to involve more departments and more bank employees. although the financial results in banking industry is badly affected by the crisis, and the inflation and foreign exchange rate fluctuation leads misleading results when analyzing the financial results of the banks through the crisis period, but good preemptive policies are efficient in relieving the risks of crisis. the challenges faced by the syrian islamic banks sector, include, the lack of skilled human resources trained and qualified to practice islamic banking through a modern scientific approach to islamic principles. another challenge is promoting and raising awareness of islamic investment forms and activities. the research showed that there is a significant correlation between the crisis management and contingency planning, especially when the mangers attempt to put a well – articulated operational intervention mechanism to enable the processes of the effective decision making, and when the banks also went to the short term funding like the financing the working capital and stopped financing the investments projects as a precaution in the light o the crisis. from the employee’s perspective, although the crisis situation has badly affected the work environment, but they tend to believe that their management employ crisis management practices, and they did not neglect the human element which considered one of the most key factor in success and development of the syrian banks even in bad crisis. worth to mention, there are few recommendations to overcome the bad effects of the continuing crisis, the bank management should revise their strategy vision every time a new significant environmental variable appears, and create long, medium and short term crises management plans, and it should strengthen the role of supervisory departments (internal audit, risk management, control and compliance). in order to perform a correct financial analysis, financial statements should be adjusted in order to eliminate the inflation effect and foreign currency price changes. banks management should be minimizing the liquidity level to ensure the business continuity. islamic banks should comply with basel ii requirements in terms of risk management and capital adequacy. the basel accords are recommendations on banking laws and regulations that seek to align regulatory capital requirements more closely to the risks that face. banks should strengthen the customer trust, and they should create new products and services that fit customers during crisis conditions. islamic banks should be closer to the customers, and consider them one of the main stakeholders, achieving their needs, despite of the bad effects of the crisis. banks management should increase employee's awareness of crisis management plans and conduct training to identify the likeliest to happen crisis, it should focus on the employee's ejif – european journal of islamic finance no 9, april (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 loyalty and commitment to ensure that they won't leave the institutions during the crisis. they must have trained on alternative plan in case of emergency, also train the staff how to deal with the riot and the cases of theft and looting. however, there were a few limitations in this study, regarding the sample questioned which was small, and it was not easy at all to convince the managers to be cooperative. the data collection obtained from the syrian commission of financial markets and securities depending on the annual disclosures of the banks registered in dse, and there was lack of data regarding the islamic banks, because they are not registered in the dse, and was difficult to obtain the annual disclosure as the traditional banks. moreover, future research should concentrate on the post – crises analysis comparing the islamic and commercial banking industry, and the new reforms of the syrian central bank. references [1] arjen, b., & bengt, s., (2007). the politics of crisis management: public leadership under pressure, cambridge university press. [2] barry, c., (2009). planning to manage your next crisis decisively and effectively, ivey business journal, online. doi: 1975205931. [3] christine, m., p., & amy, s., s., (2011). infusing creativity into crisis management. an essential approach today, organizational dynamic, 40(1), 27-33. [4] david, b., (2015). syria’s economy: picking up pieces, chathamhous. [5] dominic, c., (2012). cornstones of crisis management-thought leadership paper, steelhenge consulting ltd. [6] elena, i., (2014). the economic impact of the syrian war and the spread of isis: who loses & how much? the world bank. [7] gberevbie, d., e., (2010). nigerian federal civilization: employee recruitment, retention and performance, journal of science and sustainable development, 3(1), 113-126. [8] giovanni, d., a., enrica, d. & ragian, r. (2004). the real effect of banking crisis, journal of financial intermediation, elsevier, 17(1), 89-112. [9] glaser, l., wonter, s., & riki, t., (2016). managing the risks of proactivity: a multilevel study of initiatives and performance in the middle management, academy of management, 59(4), 1339-1360. [10] jei, g., (2004). banking market structure and financial stability: evidence from the texas real estate crisis in the 1980s, journal of financial economics, 73(3), 567-601. [11] lucy, r., david, g., james, o. & patrick, a., (2015). syria the story of the conflict, bbc news report. [12] mercy corps, (2016). what you need to know about the syrian crisis. [13] relifeweb, (2015). alienation and violence: impact of syria crisis. [14] richard, a., d., & ian, c., m., (1990). crisis and the content of managerial communications: a study of the focus of attention of the top managers in surviving and failing firms, administrative science quarterly, 35(4), 634-657. [15] roberto, p. v., (2005). organizational behavior, thomson/southwestern. [16] rudiger, f., & rene, m., s., (2011). bank ceo incentives and credit crisis, journal of financial economics, 99(1), 11-26. [17] saka, r. o., (2014). crisis management strategy and its effects on organizational performance of multinational corporations in nigeria: empirical evidence from promassidor ltd., european journal of business and management, 6(23), 79-86. [18] seth, h., (2015), the price of civil war: syria’s economy after four years of conflict, global envision. [19] seyram, p. k., & yakubu, a. w., (2013). risk management practices among commercial banks in ghana, european journal of business and management, 5(20), 186-191. [20] steven, f., (2000). crisis management planning for the inevitable, new york, ny: amacom. [21] syrian commission of financial markets and securities, (2017). annual disclosures of bank audi syria. [22] syrian commission of financial markets and securities, (2017). annual disclosures of bank bemo-syria. [23] syrian commission of financial markets and securities, (2017). annual disclosures of bank of syria and overseas. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france microsoft word 1075-4698-1-ed.doc http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 islamic formula of future value of asset: a scientific derivation ¹center of islamic finance, comsats institute of information technology, lahore, pakistan abstract— increasing price of an asset being sold on credit is a common practice of islamic financial institutions (ifis) and certain retailers using formulas of compound interest (riba) and speculation (maysir). as islam prohibits both of these concepts, relevant literature was qualitatively probed to find shariah compliant mechanism for setting future value of an asset being sold on credit negating riba and maysir. the study thus extracted a formula from authentic shariah sources and presented it quantitatively as an alternate to abandon the conventional formulas of interest and speculation. it further contributed recommendations for credit sellers and buyers in the light of shariah principles and possible future research. keywords: credit sale; maysir; riba; future value; inflation i. introduction islam guides mankind in all affairs of life. one common affair is bai (sale/trade) of items mainly commodities, accessories and luxuries. spot sale (bai-e-muajal) is usually the preferred mode for consumable commodities and accessories. for reusable luxuries both bai-e-muajal and credit sale (bai-e-ghair muajal) modes are adopted. sometimes bai-e-ghair muajal is also adopted for commodities and accessories. islam encourages bai of all legitimate (halal) assets/items in any mode stressing on honesty and fairness [1] [2]. in bai islam strictly prohibits all kinds of the following: 1. riba (usury) – is any undue exploitation in sale/trade seeking excessive profit than the prevailing market rate, or imbalance in weighing commodities during their sale by cheating and another type is charging interest/markup/usury in loans [3][4][5][6] and [7]. 2. milawat/talawa foist [7], 3. ahtekar/asa’ar/zakheera andozi illicit hoarding, [7], 4. al-qumar/maysir/gharar – games of chance such as gambling, speculation, and hypothecation [8] 5. dhokay bazi/ghash/khada’a – cheating/deceiving in selling [7] 6. israf extravagancy [9], and 7. yameen/qasam – false swearing on allah [7], [10]. this study focused on credit sale of halal assets where their value is increased due to deferred payment in installments. it thus declares details of all the above listed prohibitions in islam out of its scope. consensus among islamic scholars of diversified schools is reported on permission for increasing value of an asset being sold under credit sales to an extent that buyer does not have to face an undue exploitation [11]. islam does not allow entertaining time value of money considering money only as a medium of exchange with no intrinsic value at all. however, for halal assets it acknowledges the variation in their price/value from time to time. substantiating such concept [11] yet remained silent in answering how should a muslim seller calculate the future value of the asset s/he is selling under credit? as literature remained helpless in understanding the formula/mechanism for estimating shariah compliant future value of an asset being sold on credit, this study developed interest in pursuing the analyses of existing practices and adopted formulas/mechanisms in credit sale of halal assets especially by islamic financial institutions (ifis) and various retailers in pakistan. the significance of this identified gap enhanced as this study observed that all ifis including islamic banks, takaful companies, mudarbas and islamic mutual funds in pakistan yet employ the conventional formula of future value of asset/money which incorporates all three haram measures that are riba (interest), compounding for riba and maysir (speculation). references [12], [13], [14], [15] and [16] explained that formula that this presents as f-1: fv = pv (1 + i) ⁿ (discussed ahead as f-1) where fv is the future value of asset, pv is the present value of asset, i stands for rate of usury/interest known as (karachi interbank offer rate) kibor in pakistan, and n represents the period of lease/credit sale a linear version for computing same concept that is future value of asset through same references is: dr. syed m. imran haider naqvi, associate professor/head¹, ms. zainab naveed, assistant professor¹, and adeel ahmed khan, research associate¹ http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 fv = pv (1 + i x n) (discussed ahead as f-2) all elements in f-2 mean the same as in f-1. nevertheless f-2 does not demand compounding for sake of usury, but yet it is not immune from usury and speculation. this study did find more complex versions of f-1 that ifis in pakistan also utilize in their calculators and software, but it limited its scope to analyzing only f-1 and f-2 from shariah perspective for the reason that further complex formulas of usury will certainly enhance usury, compounding for sake of usury and speculation. before analyzing these formulas in depth here it is significant to give an overview of the pakistan’s economy and inflation as these determine the choice of sellers in credit sales. increase in general price level of goods/services is inflation that may be result of different factors. literature explains two main types of inflation i.e. demand pull and cost push [17]. it has been noted that different factors of demand and supply lead to increase in inflation. on the supply side factors like increase in prices of wheat, crude oil and various raw materials may cause soaring in prices. on demand side upward pressure on prices can be due to increase in investment and hence high demand for goods and services. at the same time [18] reviewed quantity theory of money by fischer that asserted inflation to be caused by increase in money supply. reference [19] has reported a close link between inflation and output gap for pakistan indicating that overall inflation in this country happened cost push instead of demand pull. such facts explained that theory of fischer as reiterated by [18] was fully true for pakistan. findings by [20] reinforced this understanding for our country as he reported that important factors that led to inflation in pakistan during 2012-2013 were government and non-government borrowing, increase in money supply, exchange rate and indirect taxes. such cost push inflation and the massive increase in the loose credit that was accessible to the private sector played a considerable role in disturbing the price system. similarly the ease of use of finance at a negligible cost encouraged hoarders and speculators [20]. it made sellers expect higher prices in future that in turn led to massive increase in inflation particularly in house rents, prices of land and food in pakistan. here we find it important to share how islam views inflation. in an ideal situation the true islamic economy is based on real productivity, islamic taxes and charity for welfare of masses and development in the state. according to [21] any rise in prices in an islamic economic system will only be result of natural rise in cost of materials, increase in wages paid to labours getting experienced or more productive, supplier’s profit margins or increased volume of demand relatively to the volume of supply due to natural phenomena. islam does not allow inflation due to riba, maysir (speculation), hoarding and other forbidden factors listed above. contrariwise in the prevailing conventional economic system drivers of inflation are interest, conventional taxes, speculative earnings and market imperfections. these conventional factors give rise to inflation while islam does not declare it a divine’s bounty rather it certifies that inflation due to forbidden factors is a sign of divine’s unhappiness and punishment [7]. the divine’s book of islam states [22], “and whatever strikes you of disaster/problem it is for what your hands have earned; but he pardons much”. further al-quran [23] states, “corruption has appeared throughout the land and sea by [reason of] what the hands of people have earned so he may let them taste part of [the consequence of] what they have done that perhaps they will return [to righteousness]”. these verses of the holy quran guide that inflation in prices due to misdeeds and corruption of human will put economy on astray. a real islamic economic system is thus challenging to be achieved in pakistan as it has high corruption index and thus inflation remains unleashed and in practice even in the credit sales of items. a common practice in pakistan during credit sale contract is thus to charge increased price whether it is for commodity or any expensive item. nevertheless such orientation to inflationary practices is true yet this study discovered that excluding commercial ifis and very few retailers, majority of the smes serving as manufacturers, wholesaler or retailers in pakistan selling commodities, accessories and luxuries items offer credit sale for the convenience of lower and middle income class without charging any markup of interest for short term period. these avoid demanding markup or interest in credit sale of items sold on short term contract considering it riba and maysir. for example certain retailers do not charge an increase in the future value of consumable commodities such as grocery items given on credit to well recognized and trusted customers living in their neighborhood despite cost push inflation in pakistan. it was very encouraging to observe and learn that such businessmen running small retail stores did not believe in enhancing value of commodities considering it usury. only ifis and certain retailers charge markup or increased price employing the same formulas f-1 and f-2 for estimating future values of assets being sold on credit. as ifis in pakistan believe in increasing the future value of reusable luxury and accessory items computing it incorporating interest rate plus profit margin, such diversified practices and believes motivated us to probe certain research questions in the light of quran and sunnah as mentioned next. ii. research questions the study set the following questions of interest relevant to future value of asset and islam: 1. in islam is it incumbent upon seller to increase future value of an asset being sold on credit? 2. is islamic order on computing future value same for commodities, accessories and luxuries in credit sale? 3. what does islam order for a market where deflation is likely to surpass inflation during the period of credit sale? 4. what if the rate of inflation remains unaltered or consistent after a year in a country? http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 5. does islam permit computing future value of an asset being sold on credit utilizing the formula f-1 or f -2 any of their more complex/simpler versions? 6. actual prices of luxuries and accessories sold on credit at higher price than their present value usually get depreciated while they are in use with the buyer. what is the order of islam for buyers for purchasing depreciating item on expensive cost through credit sale? 7. what is the limit for increase in future value to avoid undue exploitation of buyer and speculation? 8. what could be the shariah compliant formula for computing future value of any halal asset? iii. problem statement literature reporting islamic permission for increasing the future value of any halal asset being sold on credit without imposing undue exploitation on the buyer does not provide any formula/mechanism that traders/sellers should adopt for estimating shariah compliant future value of an asset ensuring negation of usury and speculation. further comprehensive answers to the research questions of this study can enrich the relevant literature. iv. methodology this is a theoretical, analytical, and qualitative study that standardized quran and hadtih as yardstick to whet the quantitative formulas of economics and finance employed by various retailers and ifis for computing future price or value of an asset they offer under credit sale in their calculators and software. it entertained and discussed relevant hadith from all diversified schools of thoughts in islam without any bias but considered the hadith substantiated by imams from ahl-e-bait (as) of prophet muhammad (saaw) more dependable. for interpreting the verses of the quran relevant to usury, same principle was preferred. the study conformed to the philosophical belief that all permissible (halal) and prohibitions (haram) from allah in quran and hadith relevant to financial matter of sale are universally final and beneficial for the mankind. the study utilized various books, journals and sources of economics and finance explaining the formulas of future value of money and asset and relevant theories. however, it limited its scope to analyzing the contents and effects of applying the formulas of future value of assets only. in addition to literature review, observation of the practices of various ifis and retailers offering credit sale was utilized as a parallel source of learning. the study employed logic and deduction for analyses, discussion, reaching conclusion, and contributing recommendations. it utilized simple mathematical and quantitative notations to formulate its understanding from hadtih on future value of asset into quantitative terms. v. literature and analysis to begin with this study reviews the rationales for credit sale contributed by [11] founding it on the two verses numbering 275 and 282 of al-baqra the second chapter of holy quran. first this study quotes their translations as presented by [11]: “allah has permitted trade and forbidden riba” (al-quran 2:275) “o you who believe! when you deal with each other in transactions involving future obligations in a fixed period of time, record them in writing.” (al-quran 2:282) the translation of a portion of verse 275 was found right both denotatively and connotatively when rechecked from the holy quran. while this verse attests the sanctity of trade and prohibition of usury/interest, denotatively it does not address the concept of credit sale directly. this study assumed that [11] perceived this verse connotatively declaring all types of trade of halal items permissible. it is thus perceived that [11] considered verse 275 as an indirect permission of credit sale. next we counter checked the translation of the verse 282 of al-baqra and learnt that [11] had relied only on its first portion again seeking connotation of their choice. denotatively the verse 282 of al-baqra explains order of islam on the matter of debt (dain) and not any general transaction involving future/credit sale with fixed time. can the arabic word dain connote as future sale transaction with fixed time? to the best knowledge and findings of this study dain only refers to debt that must be returned. envisaging implication of dain as trade and especially credit sale is not a norm among islamic scholars. this study thus identified that the second rationale of credit sale as perceived by [11] remained questionable. now we take into consideration the third evidence presented by [11] that was a hadith from sahih bukhari and sahih muslim which they narrated as: “a’ishah reported that the prophet (pbuh) bought some foodstuff on credit from a jewish trader and mortgaged his armor to him” [24] [25]. meaning wise this hadith seems an appropriate rationale for considering credit sale of needful (foodstuff) and mortgaging as the sunnah of our prophet muhammad (saaw). however reliance on only a hadith was not rational and therefore this study probe for the alternates. reference [26] reported a hadith in his book on islamic banking referring sahih bukhari that we quote as under: the prophet muhammad (saaw) advised to have hand on hand (spot) sale that is bai muajal for the following commodities: 1. wheat 2. barley 3. salt 4. dates 5. gold 6. silver as their credit sale will involve riba. where the first hadith states credit sale of foodstuff halal, the second referred by [27] renders credit sale of the mentioned http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 foodstuff and gold and silver haram. such diversity in findings encouraged this study to consult reference [7] for probing the order of islam on credit sale especially for foodstuff and valuables through hadith substantiated by the progeny (ahl-ebait) of the holy prophet muhammad (saaw). analyzing the chapters contributed by reference [7] relevant to sale and usury, this study identified the following authentic hadith # 4006 that it presents next to further interpretation and discussion on credit sale: abaan reported referring muhammad bin ali halbi and hamad bin usman also reported referring ubaidullah ibne ali halbi that imam jaffer sadiq (as) said that there was no prohibition in the hand to hand/on spot sale/barter (bai mua’jal) of the available heterogeneous grains/foodstuff (ghala), assets (maal) and items (cheezain) which happened better than one another by exchanging one (superior such as grain/asset/items) with two (similar such as currency or items of less quality or price) and delay in their sale is not right [7]. this authentic hadith clarifies that islam primarily encourages on spot sale of all grains/foodstuff, assets and items with exchangeable currency or less quality/price heterogeneous items. the platform of ahl-e-bait declares delay in their sale not right which to the best finding and understanding of this study connotes less preferred, however not haram. this study thus learnt that islamic order on credit sale is not to prefer it as a primary choice. for sale of any commodity, luxury and accessory the first choice of a muslim whether seller or buyer should thus be hand to hand or on-spot sale. having clarified islamic order on credit sale, this study now focuses when to adopt credit sale. islam allows credit sale in all scenarios demanding bai salam, bai istisna, and where buyer is running short of payment for the available items/grains /assets but yet agreeing on fixed time period for complete payment [7]. this study is primarily concerned with the scenario where buyer is not having adequate funds to opt on spot sale of any available halal item and seller thus demands an increased price due to credit sale within specified time period. reference [11] reported a scholarly consensus (ijma`) of the ummah on the permissibility of selling on credit if the due date is known. they further provided the rulings by traditional jurists for increasing the price of a commodity in credit sale that we quote: 1. al-kasani 1327 ah (hanafi) in bada’i`i al-sana’i`i: “the price may be increased based on deferment.” 2. ibn rushd 1379 ah (maliki) in bidayat al-mujtahid: “he has given time a share in the price.” 3. al-nawawi n.d. (shafi`i) in al-majmu`: “deferment earns a portion of the price.” 4. ‘ibn taymiyah 1398 ah (hanbali) in his fatawa: “deferment takes a share of the price.” reference [3] further reported that the islamic fiqh academy of the organization of the islamic conferences (oic) has substantiated price increase in the credit sales. this study respects and appreciates the consensus among four major sunni fiqas of islam and intends to review the ruling of fiqa-ejaferia on the same. while all the sunni jurists have sanctioned increase in credit sale, the literature did not explain mechanism or formula that a trader should adopt for increasing the price remaining shariah compliant. in other words the limit or capping on price increase is not elaborated in the light of shariah in the above mentioned rulings by jurists and not quran and hadith. to this study the style of these inputs of alkasani 1327 ah, al-nawawi n.d. and ibn taymiyah 1398 ah seem to be mere reports on the practices in trade these jurists would have observed in their respective times that were indeed far after prophet muhammad (saaw). only the words of ibn rushd 1379 ah refers the word he which seems referring to allah. if yes, ibn rushd’s 1379 ah ruling must have incorporated certain verse of the holy quran but this study could not find any relevant verse despite investigation. this study thus reserves its perception that ijma of scholars or jurists is the secondary source of shariah knowledge and must be founded based on quran and hadtih. the above stated rulings by jurists presented as core rationale for legitimacy of increasing price of an asset or item in credit sale by [3] yet needs verification from quran and sunnah/hadith. such gap in the literature further signifies the need to investigate relevant order of islam on this issue. first this study investigated in the holy quran and to the best of its findings out of 6,666 verses it did not find any verse directly sanctioning the increase in price of an asset/item/commodity in credit sale. next primary source of shariah ruling was hadith. it discovered that reference [7] reported a relevant hadith # 4022 directly explaining the islamic order on this issue that we present next: “muhammad bin qais reported that imam muhammad baqir (as) described that in a hadith my ancestor father hazrat imam ali bin abu talib (as) explained if any trader sells an item offering some price for hand to hand (on spot) sale but different price for credit sale, in such scenario although the buyer is given the right to purchase it at any price as per his free will but the right (islamic) criterion in such purchase for the buyer is to accept only the cheaper/economical/lesser price out of the two even if he has to avail loan for paying the lower price (on spot).” now from this authentic hadith this research learnt the following lessons: a. seller has the right to charge different prices in hand to hand (bai-mua’jal) and credit (bai-eghair mua’jal) sale modes, b. although islam respects free will of the buyer for accepting an item on any price, but yet it guides him/her to accept the cheaper/economical/less price only, c. accepting lower price and paying at once is given so much preference for the buyer that s/he is encouraged to avail loan from alternate source and avoid accepting and paying higher price, and d. islam thus encourages free trade among seller and buyer without any force on either one (seller and buyer) and yet sets criterion for buyer for shielding against undue exploitation. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 while this hadith indirectly substantiates the consensus (ijma) of above mentioned sunni jurists, it further explains the preferred criterion for the buyer. such finding of this study supplements the contribution of [3] addressing the gaps identified in their explanation. the same hadtih is a key to resolve the primary research question of this study how a trader offering credit sale may compute the increased price of an item/asset negating interest/usury and speculation. before extracting its solution, the study considers it important to demonstrate the effect of usury and speculation in the formula f-1 and f-2. indeed usury/interest is haram and thus in whatever calculation it is, a part will certainly lead to illegitimate estimations. it is just like a container of alcohol (khamr) will be najis (dirty/impure) from inside as khamr is najis. such logical premise is helpful in deducting that use of f-1, f-2 or any of its extending versions by ifis or other retailers does not negate usury and speculation. the severity of using f-1 for computing future value of any item exponentially skyrockets as it is designed to calculate compounding for usury such as greater the time period of credit sale, greater will be the compounding effect for the sake of riba. such built in attribute of f-1 formula guarantees speculation. this study thus interpreted that use of formula f-1 and f-2 lead to usury and speculation and these formulas must be replaced with alternate shariah compliant formulas for computing future value of asset/items being sold on credit. to further strengthen such deductive reasoning this study first provides quantitative examples explaining the effects of using f-1 and f-2 formulas. the study approached an islamic bank for seeking car ijara with a purpose of learning how ifi applies the f-1 for processing future value of asset. the car we asked was honda civic i-vtec prosmatic transmission whose cost was then pkr 2,156,000/-. the time period of ijara was requested to be 3 years committing a 30% down payment. the islamic bank offered this at kibor + 4 that was, 13% or 0.13 as interest rate (riba)/kibor was then 9%. it demanded 30% of the present value as down payment that was pkr 646,800 plus pkr 5,000 as processing fee. so the net down payment was pkr 651,800/-. for the remaining cost pkr 1,504,200/the calculator programmed on formula f-1 calculated the future value of the mentioned car as under: fv = pv (1 + i) ⁿ (f-1) fv = 1,504,200 x (1 + 0.13)³ fv = 1,504,200 x (1.13)³ fv = 1,504,200 x 1.442897 fv = 2,170,405/ the islamic bank then divided this future value on 36 to compute equal installment for a three years that was pkr 60,290/(approx). this installment was given a pretext as ijara/karaya. now the net future value of this honda civic remained pkr 2,822,205/-. this gives it an increase of over 30.9% in three years of its present value. this study learnt that the formula f-1 is programmed to increase the percentage of increase as the time period is increased. the greater the time period the more the price based on usury/interest and speculation, nevertheless the actual market price of the car will gradually depreciate and further there exists no guarantee or confirmation that in three years the accumulative inflation be in actual 30.9% for this particular car’s price, proving it a kind of speculation (maysir). similarly for examining the formula f-2’s effect on price increase without compounding although this study did not find any ifi in pakistan using this formula for the islamic products offered by them. as per application of f-2, with same 30% down payment model, the future value of honda civic i-vtec prosmatic transmission after above mentioned down payment would have been: fv = 1,504,200 x (1 + 0.13 x 3) fv = 1,504,200 x (1 + 0.39) fv = 1,504,200 x (1.39) fv = 2,090,838/ so it’s net fv with down payment = 2,090,838 + 651,800 = 2,742,638/-. this shows that f-2 leads to lesser future value for not compounding for sake of usury, but it yet caters both kibor (riba) and speculation. it is worth noticing that for the recent year the inflation rate in pakistan was reported to be 7% [19]. with an assumption that this inflation value will likely remain stable for sake of comparison we next calculate the future price of the same car using inflation rate instead of kibor. it is just to examine whose effect is greater. for this the study applied the following steps: 1. pv in current year = pkr 2,156,000/ 2. pv in 2nd year (@ inflation rate of 7%) = 2,156,000 + 0.07 x 2,156,000 = 2,306,920/ 3. pv in 3rd year (@ inflation rate of 7%) = 2,306,920 + 0.07 x 2,306,920 = 2,468,404/ such formula for future value computation based on inflation takes the following shape depicted as f-3: fv = ∑ t=0 to n (pv + rate-of-inflation% x pv), where n is time period of ijara/lease (f-3) application of f-3 although led to only 14% increase in price in three years in comparison with f-1 and f-2 that led double than this. f-3 thus seems more realistic. such calculation was based on assumption that there had been consistent annual increase in the value of the car based on stable inflation rate of 7%. one may argue that the inflation rate might have increased gradually in 3 years and considering it constant is not pragmatic. although this argument is rational but still on what ground one could confirm what will be the inflation rate after second year. the simple answer is speculation/hypothecation (maysir). economic indicators do provide realistic estimates of probable future inflation rate these days, but yet speculation cannot be ruled out of it. the study thus interpreted the following lessons: a. the use of formulas f-1 and f-2 lead ifis and other retailers to calculate future value of an asset incorporating both interest and speculation. such future values of assets lead them charge excessive http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 profit in comparison with what is expected based on inflation rate. as excessive profit is a kind of riba therefore use of f-1 and f-2 in credit sale of asset must be avoided. b. the formula f-3 that only caters inflation’s effect without interest may likely be shariah compliant. however in this formula the future rate of inflation will itself be result of speculation as keeping inflation rate fixed for entire period of ijara/lease will not be realistic. so use of f-3 though leads credit sellers to compute economic value of an asset, but yet negation of speculation is a challenge. however in certain circumstances where economic indicators provide figure of future inflation without speculation, f-3 might lead to shariah compliant computation of future value of asset. having demonstrated the examples of all three formulas f1, f-2 and f-3, this study discovered that yet an alternate formula needs to be engineered purely in line with quran and sunnah that completely negates both usury and speculation. the hadith # 4022 as reported by reference [7] from imam ali bin abu talib (as) provided this study the three parameters for deriving the solution that are; 1. free will of seller for setting future price (without riba and speculation), 2. free choice of buyer to accept offered prices, and 3. an atmosphere of win-win bargain among both parties to rationalize the future price of asset. the study derived the following f-4 as a solution to its primary question: fv of asset = free will of seller ↔free choice of buyer ↔ win-win bargain (discussed further as f – 4) for determining the operational details of the contents of f4 another empirical study will be needed. this equation should be adopted while ensuring the free wills of the seller and buyer. using kibor or any other form of riba is thus avoided. through a win-win bargain exercise market practices in credit sale of charging higher price are expected to be rationalized. one may argue that quantizing the contents of f-4 is nontrivial due to mentioned subjectivity. this study interpreted that islam encourages such subjectivity for leading market to a free and open state so that it remains immune from monopoly and exploitation. future researchers are expected to pay attention to f-4 for quantitative testing of its real application taking cases from real market where it is being exercised. vi. discussion the conventional supply and demand curves hold mostly for a short time period for normal goods especially for consumers who have access to full information [27]. such latest economic reality reinforces the islamic ideology of emphasis on spot sale in trivial circumstances as explained above. reference [27] further stated that traditional economic theory works on the basis of supply and demand curves, which are set on a number of grounds that take into account behavioral pattern of sellers and buyers. the formula f-4 of future value of asset derived from hadtih # 4022 by this study in its contents conforms to the behavioral pattern theory of [28] of both seller and buyer. on the other hand the conventional formulas f-1, f-2 and f-3 lack such ideal merit aspired by not only modern theorists but also islam. the key concept in economy is equilibrium and it is attained when each player (buyer or seller) has a vested interest in entering into a just and fair relationship with one another, whereby each one gets no less than what he gives on the basis of shared value system [27]. this study is confident that formula f-4 will help both seller and buyer reach such desired equilibrium which remains unavailable in current practices of credit sale by ifis and certain retailers who mostly employ formula f-1 and set future prices of asset of seller’s choice only. formula f-4 hence seems promising conforming to modern good theories of economics and may be tested in future research. equity is one of the most significant factors that can offer a sense of equilibrium between the seller and buyer. according to [28] desecration of moral principle is one of the factors that can damage equity and hence equilibrium. while adopting formula f-1 as ifis desecrate the mentioned moral principle for setting future prices of own choice only, an equilibrium enjoying economic activity just remains a dream. employing and testing f-4 in credit sale is thus call of the day for further empirical learning and optimization after necessary framework for credit sale by regulators with such shariah compliant mechanism. reference [29] gave the theory of invisible hand in 18th century where he stated that individuals following their own interest normally support the overall good of the society. people when act in their own self-interest demand for goods and services is created that induces increase in supply of goods and services in a manner that both the parties are benefitted without any exploitation. this leads to efficient allocation of resources. so the markets automatically clear and achieve equilibrium. today’s economists also largely use this theory to explain the free markets system and their working. in credit sale by ifi in pakistan yet the concept of free choice from either side is not even in theory, far is indeed such aspired practice. further ifis in terms of their existence are not traders or trading companies, rather they do it enjoying public money deposited with them. islam allowed conditionally in credit sale an increase for traders really investing their own money, while ifis have started enjoying this relaxation based on investing public money. further islam never aspires traders to adopt habit of such credit sale expect for needful cases or exceptional circumstances, while ifis have made it a habit. these facts and findings though invite further future research but here we focus on our specified agenda only. use of pro usury and pro speculation formulas indeed restricts the aforementioned ideal equilibrium that is strongly advocated by islam as well as modern economic theories and thus because of such practices exploitation is yet not negated from the use of formulas f-1 and f-2. f-4 is indeed a hope for future researchers, ifis and retailers intending true shariah compliance in their business of credit sale. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 this article is thus an attempt to propose a formula for future value of asset free of interest as interest is based on exploitation where one actor gains at the expense of the other. islam strictly prohibits a market condition where exploitation prevails in any manner be it the consumer or producer. high interest rate is the evidence of exploitation of weaker actor in the economy. reference [30] affirmed that the abolition of riba is one element of a comprehensive islamic reform to establish an exploitation-free economic system in pakistan. reference [31] stated the advocates of islamic banking and finance consistently presents moral statements about islam's disallowance of riba based on the dispute, exploitation and unfairness but all become irrelevant and off the point when it comes to practical application especially use of kibor and its formulas. our study has contributed f-4 and recommendation to probe its practical implications and effects on ifis, economy and stakeholders in future research. based on observation of small retail businesses that neither count on f-1 or f-2 nor even charge any premium in credit sale with their worthy customers, the study is confident that use of f-4 will likely lead to a win – win economy that respects choice of both the seller and buyers expecting equilibrium in gain on both sides. further the formulas f-1 and its complex versions used by ifis is a form of exploitation of public as higher future prices of goods are charged on the basis of interest rate plus prevailing profit rate in banking sector. such fact has limited ifis as imitators of conventional banking system while these are expected to replace this pro-riba system. the proposed formula (f-4) is expected to lead to equity and efficient allocation of resources that in turn will breed social development as it is programmed to lead seller and buyer both to a win-win situation ensuring inputs of all. further it is free of interest rate that is unjust and exploits the general public by making goods and services virtually inaccessible to them. pakistan has already unending inflation and unemployment that are enough to deteriorate the standard of living. formula f-4 as the mathematical projection of hadith # 4022 by [7] will likely be a novel contribution to literature in line with the aspired free market system of economics. in conventional books this formula has not been reported yet and it will therefore be new for conventional finance professionals. however, this study has not focused on centrally planned system where regulators are required to bring the market in equilibrium. therefore another call for future research is to investigate and devise a regulatory framework and directives encouraging ifis to adopt f-4 and abandoning f-1 and f-2. vii. conclusion & recommendations based on the aforementioned analyses of relevant literature, hadith, verses of quran, and discussion on formulas f-1, f-2, f-3 and f-4, this study infers that for sale of commodities, accessories and even luxuries islam primarily encourages on spot sale allowing hand to hand exchange of heterogeneous exchangeable between sellers and buyers. buyers may however accept credit offering provided they remain economical. it is not incumbent on seller to necessarily increase future value of an asset being sold on credit value. it is his/her discretion to increase future value under scenario/condition when the time period of a credit sale contract extends so much that the effect of phenomenal inflation gets applicable on the prices of items being sold. as inflation value is usually calculated after a year in most economies, seller should not increase price of items being sold on credit for a period less than a year or in which inflation does not hit prices. in case period of credit sale exceeds a year or period the phenomenal effect of inflation hits the prices, seller reserves the right to reschedule the prices as per the real inflation’s effect. however advance increase in future value of assets using any formula employing interest rate such as kibor or libor and/or speculation (maysir) is forbidden in islam. thus use of formulas f-1, f-2 and even f-3 for computing future value of asset is not shariah compliant. in case deflation overrides in an economy, seller better not reschedule the prices of items sold on credit. the assets that actually face depreciation in their actual market price but yet offered for an increased future value under credit sale must not be accepted by buyers for an expensive value surpassing expected values of inflation. such measure from buyers will automatically rationalize the offerings by credit sellers in the market. current practices in ifis of computing future value of asset in pakistan and even abroad only cater the will of seller (ifi) following kibor (riba) and speculations (maysir) as pro interest conventional banks do. hence ifis are yet not free sellers as they are bound by traditions and regulations to cater riba and maysir while calculating the future values of assets they offer on credit. by now most buyers dealing with ifis in pakistan are not at all free to choose prices in credit offerings. yet especially the retail clients do not get the option of bargain as ifis let only certain corporate clients negotiate. this scenario needs to be turned conducive for applying f-4. the study strongly recommends abandoning the practice of formula f-1 and any of its extended versions for all ifis and other credit seller across the world. it further recommends f-4 as the shariah compliant formula for calculating future values of assets being offered on credit assuring that buyers can bargain with choice and seller does not set future price entertaining usury and speculation. regulators are encouraged to think out of the black box for defining and implementing regulations that encourage ifis to use shariah compliant benchmarks and standards for future value calculations divorcing the convention creed. future studies are encouraged to be carried out for empirically testing the formula f-4 and its effects on the ifis, buyers and society. a limitation of our study is yet to provide empirical evidence of adopting f-4 and its effects in avoiding maysir and riba while assessing future price of items given on credit. a possible solution of incorporating real inflation instead of speculation is to include a stipulation in credit sale contract demanding the revision/review of estimated future value of the item sold as per f-4 after every year till its tenure gets accomplished. future researchers are encouraged to figure out how effectively f-4 enables the incorporation of inflation, avoidance of speculation, and any undue exploitation in real practices of credit sales being offered by traders other than ifis. it is also recommended to undertake conceptual investigations on what shariah risks will be avoided in investing public money using f-4 by ifis. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 references [1] al quran, al baqra chapter 2, verse 275 [2] al quran, an nisa chapter 4, verse 29 [3] al quran, al baqra chapter 2, verses 275-278 [4] al quran, al imran chapter 3, verse 130 [5] al quran, an nisa chapter 4, verse 161 [6] al quran, ar rum chapter 30, verse 39 [7] s. sadooq, “mun la yahzar faqih” urdu tans. syed hassan imdad, pakistan, al kisa publisher karachi, 1996. [8] al-quran, al ma’idah chapter 5, verses 91-92 [9] al quran, al a’raf chapter 7, verse 31 [10] al-quran, al ma’idah chapter 5, verse 89 [11] a. u. ahmad, and m. k. hassan, “the time value of money concept in islamic finance”, the american journal of islamic social sciences, vol. 23, no. 1, pp. 66-89, 2004. [12] m. y. khan, and p. k. jain, “financial management: text and problems”, tata mcgrawhill, ch 2, p 151, 2007. [13] j. d. andrew, and t. j. gallaghar, “ financial management; principles and practice”, freeload press, ch. 1, p. 50, 1968. [14] l. j. gitman, “principles of managerial finance”, pearson education asia, ch. 2, p. 98, 2007. [15] d. v. wijst, and n. v.wijst, “finance: a quantitative introduction”, cambridge university press, ch. 2, p. 101, 2000. [16] m. v. butcher, and c. j. nesbitt, “mathematics of compound interest”, ann arbor, mich publisher, ch. 1, p. 45, 1971. [17] mcconnell, and brue, “macroeconomics”, mcgraw hill, usa, ch. 11, p 215, 2002. [18] j. m. keynes, “the purchasing power of money: its determination and relation to credit, interest, and crisis”, the economic journal vol. 21, no. 83, pp. 393-398, 2011. [19] spdc “growing macroeconomic imbalances, state of the economy, social policy and development centre”, annual review, research report no.64, july 2006. [20] q. m. ahmad, s. muhammad, m. noman, and g. h. lakhan, “determinants of recent inflation in pakistan: revisit”. pakistan journal of commerce and social sciences, vol 8 (1), p 170 – 180, 2014. [21] m. kababji, “inflation management in islamic economics”. islamic economics project. retrieved august 19, 2015, from https://islamiceconomicsproject.wordpress.com/2012/04/08/inflationmanagement-in-an-islamic-economy/ [22] al-quran, al shoora chapter 42, verse 30 [23] al-quran, ar rum chapter 30, verse 41 [24] bukhari, “sahih al-bukhari”, islamic press, cairo, vol. 3, no. 101, n.d. [25] muslim, “sahih muslim”, islamic press, cairo, vol. 4, no. 123, 1375 ah. [26] dr. m. i. a. usmani, “meezan bank’s guide to islamic banking”, darul ishaat, karachi, pakistan, ch. 6, p. 50, 2012. [27] m. n. gregory, “ principles of economics”, dryden press, fort worth, tx, 1998. [28] f. v. wangenheim, and t. bayón, “behavioral consequences of overbooking service capacity”. journal of marketing, vol. 71, pp. 3647, 2007. [29] a. smith, “an enquiry into the nature and causes of wealth of nations”, random house inc. uk. ch 2, p 55, 1776. [30] s. n. h. naqvi, “islamic banking: an evaluation”, iium journal of economics and management, vol. 8, no. 1, 2000. [31] m. o. farooq, “the riba-interest equation and islam: reexamination of the traditional arguments”, november 2005, unpublished. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 how close islamic banks are to global fraud: learnings from dubai islamic bank in the time of sub-prime crisis khairul mukminin institute of islamic banking and finance, international islamic university malaysia abstract— this this paper attempts to reconstruct and achieve learning from the mega financial crime that occurred at dubai islamic bank (dib) during the global crisis and juxtapose it with fraudulent practices from a global perspective with the aim to acquire a broader knowledge on fraud, especially in shariahbased organizations. thus, this paper could conceivably contribute to the rarely covered topic concerning financial crimes within islamic organizations. additionally, descriptive, comparative, and analytical research are exerted in this study. as for the findings, the scandal divulged that the significant power of the government exercised through mandating faith-based banking and acquiring major shareholding does not seem to prevent white-collar frauds much to the outrage of civilized lawmakers. this implies that just like its conventional counterpart, islamic banking is not immune to fraud. in addition, the paper highlights that the most offensive misconducts found in the case are: i) the fraudulent activities were concealed or kept in secrecy; ii) there was a lack of ‘shoulder to shoulder’ knowledgeable people to oversee the risk and warning signs; and finally iii) the modus operandi employed was collaborating. accordingly, the study refreshes and stresses to the influential characters involved, namely, respective regulators and top-level officials of the organization on the importance of robust, prudent, and sustainable practical conduct for they are the accredited people whose enforcement and incompany culture will distinguish the right from the wrong. keywordsethic; financial crime; fraud; governance; global crisis i. introduction several academic studies have discussed financial crimes and frauds, juxtaposing with issues on ethics in the aftermath of the sub-prime mortgage crisis. it is acknowledged that at the time of the crisis, a majority of the financial institutions around the world, especially those in the banking sector, bore the major brunt of the effect caused by the ‘ordinarily unqualified’ mortgage portfolio which was turned into securitized instruments and offered as bluff investments. islamic banking contracts, especially in high leveraged countries like the united arab emirates (uae), place a high reliance on asset-backed transactions, viz. real estates and properties as collaterals. although islamic banks were not affected directly from the crisis, due to the prolonged duration of the crisis, it is undeniable that credit risk and financial gain suffered a decline due to the erosion in the value of collaterals in which a large share of financing was channeled to the real estate market. dubai as the real estate hub in the gulf cooperation council (gcc) countries took the largest hit from the property crash in 2008 [1]. notwithstanding some triumphs made in terms of improvement in credit and asset growth during the mortgage crisis, islamic banks (ibs) in the uae had flaws in risk handling which later on led to a deterioration in the profitability of ibs in 2009 [2]. a study revealed that among the countries in the gcc, only the uae had the experience whereby the ibs performed worse than the conventional banks (cbs) during the financial crisis period in terms of productivity and profitability [3]. kroll [4], ernst & young (ey) [5], and kpmg [6] delivered their findings that massive frauds had been unmasked in the gcc by way of massive infrastructure investments involving sovereign wealth funds, governmentowned entities, and private sector businesses as the primary sources of capital. the scandal in the public eye during 2007–2010, financial malfeasance in dubai-based companies during the crisis-stage involved over usd1 billion, of which usd501 million was incurred at dubai islamic bank (dib) within one year [7]. this is one of the largest cases exposed to the public in 2008 and revealed the involvement of several white-collar individuals from different positions as well as nationalities. the case is not the first scandal to take place at dib. in fact, between 1995 and 1998, the bank suffered financial losses due to embezzlement involving unauthorized transactions worth usd300 million [8]. the case unmasked three company employees who committed a breach of trust and illegally authorized transactions as well as twelve external individuals from different nationalities who together with the employees had defrauded dib [9]. this embezzlement, which is called a “significant fraud”, had prompted the government of dubai to ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 increase its shareholding in dib from 6% to a high level of 30% [10]. the uae, in which dubai is the central real estate in the gcc, has its idiosyncratic magnetism in investing activities, particularly from islamic financial industries. accordingly, this sumptuous attractiveness creates a huge supply-driven growth in human capital from the locals to the citizens of various countries who bring with them different cultures and faiths, not forgetting the large amount of funds to be invested and overturned. as might be expected, these investors, customers, and workforce have vast differences among them. most people believe that the implementation of technology is an excellent mean to prevent the diverse characters of human beings from committing a multitude of frauds within an organization. nevertheless, the banking institution is susceptible to potentially a variety of frauds [11] regardless of the major jurisdictional actions implemented. it is an irrefutable and inherent nature of a bank since this financial institution handles a huge amount of highly liquid capital, particularly in the form of cash. in addition, despite the fraudsters’ attempts to improve their modus operandi over time, they often tend to leave loopholes not exclusively for the institution but also for the relevant regulators to uncover the fraud. on this account, the paper endeavors to trace the chain of events to achieve an understanding of the mega financial crime that occurred at dib and juxtapose it with other global frauds during the crisis as well as draw attention to the potential reasons, key responsible figures and others possible learnings from the scandal. ii. theoretical framework a. unethical practices and crisis: silent or invisible? history has shown that financial misconducts are complex while fraudulent activities are unnoticeable. for instance, a study highlighted that the likelihood of fraud to be concealed would be increased in a corporate culture that exercises secrecy, centralized control and excessive control, while the lack of transparency keeps hanging in the air [12]. it means that fraudsters who occupy a top-level position would be more likely to be able to conceal their unethical action for many years even from supervisory agencies, victims, and bystanders as compared to the common worker [13]. in another scenario surrounding the issue, secrecy is committed by witnesses who possess information of something unlawful, illegal, and unethical occurring within the bounds of the organization, yet take no initiative to tell the truth [13]. the fraudulent activities go from bad to worse and will reach a point when fraudulent practices are claimed as a ‘custom’ or acceptable practice and needless to say, it is derived from forced self-justification of certain groups or individuals to rationalize their multifarious frauds. kpmg reported that “there was an increase in the proportion of cases involving collusion
in the ema (europe, middle east, africa) and asia-pacific regions” and additionally fraudulent action by dint of collaboration grow at the level of 32%, 61%, and 70% for the period of 2007, 2011, and 2013 respectively [14]. surprisingly, the report also highlighted that incidences of collusion were higher in states in which business dealings are frequently motivated by social and family relationships. b. white-collar fraud 1) quintessential white-collar crime as published by kpmg in its global survey of 69 countries and 78 countries in 2011 and 2013, respectively [6, 14], major typical fraudsters possess similar characteristics: male, at the age of 36 to 45, commits against own employer, work in finance or finance-related task, assumes a senior management role, has been employed by the company for more than one decade, and co-commits with another fraudster (conspiracy). the 2011 survey also brought to public attention the case where senior management together with a board member remained as major players in fraudulent business dealings in the period between the surveys of 2007 and 2011. table i. level of fraud perpetrator within organization level of fraud perpetrator within organization 2007 2011 senior management and board member 60% 53% management 26% 29% staff 14% 18% source: kpmg (2011) 2) potential rationale for fraud looking back at the period in which the world suffered from a financial crisis, an ey survey [5] revealed that the motivations for fraud in the middle east were mostly due to the selfish desire for wealth (greediness), followed by an opportunity to maneuver and perhaps surprisingly, personal debt plays a part as well. similarly, kpmg in its gcc fraud survey [15] revealed the reasoning behind the fraudulent dealings in which the fraudsters were substantially driven by greed and hunger for a lifestyle of grandeur beside being presented by an opportune moment (opportunity). as a comparison, the following charts show the results of the survey by ey and kpmg explaining the rationale for committing multifarious financial white-collar crimes during the period of the financial crisis (the results are shown in percentage): figure 1. rationales for committing frauds – ey survey ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 source: ey (2011), with rearrangement from the author figure 2. rationales for committing frauds – kpmg survey source: kpmg (2011) kpmg [15] and ey [5] explained that from their financial forensic result, poor ethical culture and inappropriate ethics policy within corporations are proven to go well with the contributing motivations for committing fraud. in other words, developing and implementing robust ethical practices as well as professionalism within the bounds of the business institution are essentially needed to save the would-be fraudster or the challenger of infringement from an attempt on the unlawful act. on the practical manner of fraud motivations, salin, manan, and kamaluddin [16] highlighted that the possible reasons for recurring frauds, corruptions and unethical practices in the firm's ecosystem could be due to the following (refer table 2): table ii. possible reasons for fraud, corruption, and unethical practices origin concerns directors with poor ethics unethical and fraudulent activities such as fraud, bribery, and misappropriations practiced by directors are a contradiction to proficiency status, namely education or expertness. deficient board model an absence of supervising function upon the potential unethical decision by the board. weak enforcement unfair judgment between unethical actions that bring losses and financial penalty by court judgment. political governance there are both ineffectual and inefficient lawmaking (legislation) and law-proceedings (litigation) whereby intervention of politicians into industries are more powerful than the enactment of rules and regulation. failure of thirdparty assurance provider the propensity of secondary service providers such as the auditor, corporate secretary (internalexternal), lawyer, and other professional advisors to transform into ‘gain keeper’ and contribute to corporate scandal. helpless secondary lifeline ignorance and passiveness of management over warning signs or critical questions delivered by analysts and researchers. source: salin, manan and kamaluddin (2017) 3) insider vs. outsider a number of studies mapped out that the fraudsters’ background in the environment of islamic banking could be from either internal or external parties [17, 18]. outsider fraudsters could be customers, suppliers, contractors, asset appraisers and lawyers. according to kpmg survey 2013, the fraudsters often conduct their fraudulent activities in collaboration with others instead of going solo [14]. in detail, the comparison between the two are 70% for the perpetrator being accompanied and the unaccompanied take the remnant of 30%. iii. methodology the development of the conceptual framework leads to the utilization of the descriptive analysis for the study. next, the paper would narrow down its analysis on dubai islamic bank public joint stock company’s (pjsc) scandal during the period of the financial crisis between 2007 and 2011. in terms of data collection, the author gathered data from varied sources. the most important data of the study is the secondary data, as access to primary data for this study is limited, which is unsurprising because dib and most commercial institutions, regardless of locality, would abstain from officially publishing information related to financial crimes perpetrated within the institution. on that account, in respect of fraud in a general scope, the author mainly took reference from independent financial forensic reports issued by globally established financial service providers, namely ey, kpmg, and kroll, besides academic journals. guided by the objective of the paper, viz. the scandal, data were obtained from news reports, articles and legal articles that have interest in the case. using the information obtained from the various sources, the author attempted to reconstruct the dib case so that the paper could deduce the major issues pertinent to factors of fraudulent activities, inter alia, potential reasons, key responsible figures, modus operandi and the possible aftereffect of the fraud including legal proceedings. iv. finding and discussion a. the scandal unveiled in the islamic bank 1) typical fraudster the dib financial scandal that is one of the largest frauds and had taken place in dubai was first heard in the dubai court of first instance in 2008 [19]. the case revealed six whitecollar perpetrators of the crime: two pakistani men who held senior executive positions in dib (a 39-year-old finance manager together with his 50-year-old deputy), two british businessmen (a 48-year-old and a 50-year-old), a 36-year-old turk businessman and an american businessman (the financial manager’s sibling) [20]. briefly, in 2011, the perpetrators came to light for defrauding, conspiring, and collaborating in the scandal when the highest court of dubai sentenced the six defendants for ten years and imposed a fine of usd501 million (it is the collective fine for the two former dib officials, two britons, and one turk) and usd 2 million (it is the collective fine for ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 the kith and kin: the american citizen and the former financial manager) as compensation for the loss suffered by dib [20]. the following subsection will discuss the substantial point of the case. 2) time journey of the scandal it is undeniable that the oil sector was a luxury investment. even dib declared that the rise in oil price and demand was in line with the remarkable financial achievement of dib during the financial year 2004. in the same year, dib, in which the government of dubai was the major shareholder, entered into an investment agreement with a company owned by three of the outsider defendants (a turkish private bank called cch) for project financing in the oil sector involving the acquisition of a canadian oil refinery and then shipping it to pakistan. as a consequence of this project, cch was in debt to dib for an amount of usd170 million [20]. as alleged by the ceo of dib in the courtroom, cch had breached the contract whereby cch had embezzled usd18 million into another project without dib’s consent [21]. thus, in 2007, a restructuring agreement was prepared since cch had defaulted on the facility. however, when they issued the ‘excellence recommendation’, the two former executives of dib had neglected the bank’s credit limit policy, and they subsequently granted more financing up to usd501 million to cch after receiving illicit payment and bogus documents provided by the outsider fraudsters [20]. on the surface, as a consequence of the agreement, the bank required a security to be provided so that more financing could be extended to cch, but for the usd18 million embezzlement, the bank gave the fraudsters 15 days to remedy the situation. the security in the case is a holding company, plantation holdings. it is a company owned by a friend of the outsiders, who was charged in the court with aiding and abetting on the restructuring process by providing plantation as security [22]. moreover, the reason that the security was included in the restructuring was mostly that it directly benefited from the money [23]. the security itself is a holding company called plantation holdings valued at usd3.5 billion [24]. due to the high security value, dib had abstained from taking legal action at that time [25]. apart from the three fraudsters mentioned above, the remaining offender, i.e. the american, had defrauded the bank of usd2 million by collaborating with the former financial manager. the american was a close associate of the three fraudsters, and the modus operandi employed was by supplying and approving forged documents. in summary, the conspiracy and collaboration among the fraudsters that had essentially brought them into conflicts with the law involved the following: i) granting and accepting bribery (kickbacks); ii) providing and approving bogus financing documents (forgery); iii) unlawful profiteering; iv) ignoring regulation on credit limit allowance; v) conspiring to embezzle public funds; vi) deliberately causing losses for dubai islamic bank, the government and its entities. the last point is the most significant accusation by the persecutors in the court. dib that is one of the most longstanding islamic banks in the world was established more than three decades ago and as of december 2009 was controlled by dubai government through 30% shareholding ownership. moreover, dib held 4% stake in the federal government pension fund. as mentioned earlier, dubai is a property hub in the gcc countries. unquestionable, dib, which supported assets-backed financing (direct equity), took the lead in dubai’s real estate market. as of 10 december 2009 however, the financial position of dib was reduced to a low level and was claimed as degenerating as an implication of the financial crime within the bank, which subsequently led to material default and negative climate in the property market as well as economic volatility in the gulf. moody’s analytics stated that “among uae-based islamic financial institutions, dib is in addition one of the most heavily exposed banks to both nakheel and dubai world” [26]. 3) collaborators insiders and outsiders probing the case further, it becomes clear that the fraudulent actions were conducted by more than one perpetrator. in other words, it involved deliberate collaboration or financial conspiracy involving both insiders and outsiders. the actions of the group of collaborators could be segregated in three directions: insider-to-insider, outsider-to-outsider, and insider-to-outsider. b. the other side of the coin 1) weak enforcement of corporate governance disclosure the case has substantiated that islamic banking institutions are no longer immune to financial crimes which come with a labyrinthine modus operandi. many studies have shown to the public especially during the global crisis that one of the major contributing factors to crimes is poor quality of governance [27] whereby there is limited access to information with regard to whether there is excessive control in the organization and how the organization’s internal control is functioning. in the case of dib, it is apparent that high-level officials of dib such as the board of directors turned a blind eye to the above issues and chose to avoid from further public scrutiny. ironically, this phenomenon exhibited that each of dib’s stakeholder had confidence in dib such that no question was raised even though dib had published its official governance reports only for 2011 and 2012. it is to be noted that the enactment of the code of corporate governance in the uae by the uae’s securities and commodities authority (sca) took place in early 2007. subsequently, in october 2009, the code was amended by the uae ministry of economy and takes effect starting 30 april 2010 to make corporate government disclosure an obligation for listed companies [28]. ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 2) poor judgment of risk management “the recent banking crisis created by the decisions of major international banks to abandon risk management in favor of huge but illusory gains” [29]. thus, the risk management function is vital for all companies all over the world. as a matter of fact, the risk management structure of dib evidently provides clear-cut roles and responsibilities of the various elements where one of the elements is the internal audit function [30]. yet these components failed to take charge ‘shoulder to shoulder’ of the internal affairs namely detecting, identifying, controlling, and approving the operations regarding the restructuring of the financing facilities worth usd501 million to the outsider firm. the risk management department and the internal audit department which superintended schemes of credit approval had failed to catch the breaches. surprisingly, however, the departments were unassailable even when giving information in the courtroom [31, 20]. table iii. risk management structure of dib in 2007 risk management structure of dib responsible for: bod overall risk management approach. approving the risk strategies and principles. risk management committee developing risk strategy, implementing principles, frameworks, policies, and limits. responsible for the fundamental risk issues and manages and monitors relevant risk decisions. risk management and control implementing and maintaining risk-related procedures for credit approval, credit administration, portfolio management, market risk and overall risk control. treasury managing the group’s assets and liabilities and the overall financial structure. managing funding and liquidity risks of the group. internal audit auditing risk management processes periodically (examines both the adequacy of and compliance with the procedures). discussing the results of all assessments with management and reporting findings and recommendations to the audit committee. source: dib annual report 2007 3) overdependence on the security pledged it should be borne in mind that islamic financial institutions (ifis) should have an awareness of the root of the sub-prime mortgage crisis whereby it initially originated from ‘poor credit background’ borrowers. the chief reasoning the lenders arranged the loans for the borrowers was primarily motivated by the securities provided by the borrowers. it is undeniable fact that the potential risk of financing/loan non-performance either in ifis or the conventional counterpart could be mitigated by obtaining security from the customers. as indicated in the previous section, the substantial fund of usd501 million as a result of the restructuring should not have been transferred to the outsider fraudster [32]. while the internal fraudsters had succeeded in approving the bogus document, which means the fraudsters had a centralized authority, another aspect that contributed to the scandal was overdependence upon the security pledged. c. legal action 1) suing the security for breach of contract in the jurisdiction of the english court in july 2008, legal action was initiated by dib against plantation holdings (plantation) after plantation dismissed dib’s notice demanding the company to rectify certain breaches of contract and non-compliance against dubai law within a month [33]. consequently, dib commenced foreclosure against the company through litigation mechanism. the contract between dib and plantation stipulated the choice of venue for both parties in the event of unsettled issues, namely the english high court. in 2013, the bank embarked on legal enforcement against plantation before the court, in which case, the bank obtained a court judgment of usd432 million against the defendant. this was followed by the appeal procedure. it was different from the earlier case, whereby in 2016–2017, dib became the defendant since plantation had made a claim against the bank. in brief, in april 2017, baker & mckenzie, a london-based law firm that acted on behalf of dubai islamic bank public joint stock company gained a successful outcome after winning against plantation’s legal representative, david wyld & co in an eight-week trial in the english commercial court [22]. despite plantation’s attempt to defend itself in the case involving usd2 billion, the plaintiff failed to prove that dib had breached the restructuring agreement in 2007 and as a consequence, lost its claim [22]. it was an unexpected finding that the judge of the court prevailed that “plantation's principal director had "made up" evidence and that another of plantation's witnesses had "manufactured" documents” [22]. lastly, other significance verdicts of the court are that plantation was ordered to pay 70% of the bank's costs on an indemnity basis and most importantly, plantation was refused further appeal, which means the case was closed [22]. 2) issue on choice of law one of the british defendants who was based in bahrain and had already lived in the middle east for more than two decades, in his defence, claimed that his actions adhered to the islamic principle [34]. regardless of the justification or the system of the law enforced by the dubai government, which is not the main purpose of the study, it is obvious that both the bank as the financier and the defendant as the customer had an unsettled contract and might have misinformation regarding the venue and the law that would be enforced when disputes materialize. with regard to the issue of the choice of law as well as the choice of forum in terms of cross-border transactions, it is vital to avoid uncertainty on the jurisdiction of hearing the case that is whether or not it falls under the purview of the shari’ah law [35]. v. conclusion and recommendation a. conclusion the the scandal divulged that islamic banking, with its significant growth in both credit and asset, could attract people to create unusual fraudulent transactions. unsurprisingly, the ejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 power of the government as evidenced through its majority shareholding and mandating faith-based banking does not seem to deter the executive-level collaborators, causing outrage among many civilized lawmakers. it shows that similar to its conventional counterpart, islamic banking is not immune to white-collar crimes. the achievement of astonishing growth in islamic banking assets does not seem to be matched by the capability to manage those assets. provided that islamic banks are prepared to move forward as a dynamic institution, there is a big chance that the industry will succeed in the long run. by an analogy, the islamic bank is similar to a vehicle whereby the bigger the vehicle, the harder it would be to steer. notwithstanding the road taken in the day-to-day activities is almost interchangeable, the individuals are changeable. as has been demonstrated, the damage is not ‘a scratch’ that endangers the bank directly and could be recovered in an instant, but it evidently results in a stressful situation not only for the bank as the ultimate victim but could also bring legal consequences, financial expense as well as bad impression to other parties either directly or indirectly through their links to the bank. therefore, islamic banks and other financial institutions elsewhere are challenged to not only have a wellbuilt structure as well as sound judgment at every stage to ensure that both major stakeholders and other wide-ranging stakeholders are protected against the perpetrators, but should also have virtuous higher-level human-resource personnel as role models. thus, sustainable, robust and prudent islamic code of ethics are essential instruments in islamic financial institutions, and this paper aims to restore the awareness of the need to comply with what is right or wrong from shari’ah perspective as well as the jurisdiction in which the industry is obligated to comply with certain policies and civilized laws. as the nature of fraud is ever changing and evolving, further studies should be done to achieve a dynamic, effective, refined and sustainable islamic banking sector in particular and islamic finance industry in general. b. recommendation  promoting as well as manifesting the commitment to disclosure rules and regulation concerning kyc (know your customer) have been a longstanding feature in the banking ecosystem. even so, there is one counterpart element that typically escapes notice, i.e. the absence of ‘know your agent’. it should be borne in mind that the ‘agent’, which this paper aims to highlight, is the first to enforce early prevention, detection, and scrutiny over frauds within an organization. second, there must be a certain degree of openness on the part of the agent concerning roles and responsibilities in running the business. it means breaking the silence to bring fairness, transparency and accountability to the organization. demand for accessible information such as corporate governance disclosure together with a feasible whistleblowing system that give protection and incentive are pivotal in boosting good agency relationship and responsibility of toplevel stakeholders, namely shareholders, chairman, board members and its committees (audit and remuneration), shari’ah supervisory board, senior management and chief executive upon other stakeholders such as customers, regulators, employees and the public. broadly speaking, oration without clear, pragmatic direction is blandishment of work thus the government as the supreme regulator in the state should manifest conclusively its commitment note solely to ensure robust disclosure, but also to declare consistently that bribe and such is illegal and must not be claimed as the “cost of business”.  flourishing beyond shari’ah as a resilient identity as an inherent nature of the financial institution, the islamic bank ought to accentuate the pro-active instead of the reactive approach. notwithstanding the bank places emphasis on recovery of the financing facility, the scandal has put the bank in the limelight such that the damages might give rise to new risks such as distrust of both customers and the public upon the bank particularly, and the islamic finance industry in general. while the ‘form and substance’ of a contract of products or services have been accomplished, the objectives of the islamic law, i.e. maqasid al-shari’ah should be attuned to. maqasid alahkam al-shari’ah or commonly linked to public welfare (maslahah) within the muslim societies emphasizes that the shari’ah ruling must protect five dimensions: faith, life, intellect, prosperity, and property. as an illustration, conducting partnership in lawful aqad and demanding collateral as a solution are permissible and convenient, however, conspiring by accepting illicit payment, committing forgery, breaching employer’s trust, neglecting well-judged coperformance, and channeling fund at the expense of the nation including money-laundering, terrorism, and other devious acts as well as being untrustworthy would be inconsistent to the intention of the lawgiver. a muslim need not wait for the judgment day to know what is right and wrong, as the results could be instant. for instance, the contracts could be lawfully nullified, bring legal consequences, cause a bad impression to the public, and in more serious situations it might be discovered as in the case of the sub-prime meltdown.  investing in islamic teaching as an ethical culture several social ills nowadays namely unlawful deeds including bribery, corruption and fraud occur because the public at large bestow dominantly on physical joyful rather than promoting human development such as spiritual necessities (versus hedonism) [36]. therefore, it is crucial that islamic teaching should be dedicated at the entire activities of human beings so that it could instill ethical and good practices starting from home to the workplace and embed in the heart until it is put into actual practice. as a consequence, islamic ethics in the person would grow as a powerful shield that is continuously adaptable to technology, the rapid growth of the economy and humans’ endless desires. in this respect, human resource and development is the department that should take this constructive duty to create a pool of high standard workforce because it is responsible for providing an end-to-end mechanism (screening, recruiting, maintaining, training, upgrading, firing) of the company’s human resource. moreover, it is advisable that the company keeps itself up-toejif – european journal of islamic finance no11, december (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 date with global issues and upgrades the expertise of the workforce by means of bridging relationships with external institutions such as professional accountants to promote a high standard of ethics coupled with a professional workforce. in addition, a set of feasible and pragmatic ethics policy plus regulation are indispensable as an ‘early warning system’ and to pre-empt loss of money, bankruptcy, sanction by the regulator, public scrutiny, and an abominable event such as a crisis.  certainty of legal resolution and demand for globalized standard from a legal perspective, it is clear that the government should contribute by assisting stakeholders in terms of legislation and litigation. while conducting cross-border business activities, however, it is important for any islamic organization to be in compliance with all related laws: local, international, as well as shari’ah. there might be added complexities when a country implements a dual financial system, but on the other side, the perpetrator lives in a jurisdiction that adopts a single system. for that reason, it is important for the parties to make it explicit in the clause in the contract regarding the forum and the law that will be used when they wish to settle a dispute. also, the study suggests that there is an urgency for islamic banking and finance institutions globally to have a globalized shariah standard either for litigation or non-litigation matters that is in line with the spirit of islam to enhance public as well as customer confidence in the industry.  bursting interdependence of interfaith communities by means of commercial transactions (muamalat), shari’ah as evidenced by the qur’an, sunnah, and other sources of islamic law gives lawful permission to make contracts with any eligible party. precisely, it nurtures long-term socio-economic goals, not exclusive to the muslim society but includes the non-muslim community as well. abrahamic faiths, i.e. islam, christian, and judaism have commonality in their holy scriptures concerning business ethics namely rejection of bribery, cheating, fraud, discrimination, and unfair compensation [37]. in depth, the aforesaid study came with a foregone conclusion that majority of religion and faith in the world have commonality in ethics issue. it refers to two declarations towards interfaith commitment of global ethic. an interfaith declaration: a code of ethics on international business for christians, muslims and jews (1993) and declaration toward a global ethic (parliament of the world’s religions 1993) signed by hinduism, buddhism, sikhism, baha’i, jainism, shintoism, and others at the parliament of the world’s religions in 1993 [37]. this is to say that practical discussions upon business ethics between the broader interfaith communities is practicable and acceptable. therefore, open interfaith discussions are essential to instil responsiveness over ethical standards among all muslims, christians, and jews all over the world. references [1] d. o’neill, united arab emirates: dubai islamic bank puts the past behind it. euro money, 2013, retrieved from https://www.euromoney.com/article/b12kjvffjf5j75/united-arabemirates-dubai-islamic-bank-puts-the-past-behind-it?copyrightinfo=true [2] m. hasan and j. dridi, the effects of the global crisis on islamic and conventional banks: a comparative study, imf working paper 2010. 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[33] i-law, plantation holdings (fz) llc v dubai islamic bank pjsc, 2017, retrieved from https://www.i-law.com/ilaw/doc/view.htm?id=375790 [34] shariah finance watch, british businessman fights dubai bank fraud claim, 2010, retrieved from http://www.shariahfinancewatch.org/blog/2010/04/08/britishbusinessman-fights-dubai-bank-fraud-claim/ [35] a. hasan and m. h. ahmed, the application of choice of law and choice of forum clauses to islamic banking and financial cross border transaction, australian journal of basic and applied science, 6(11):370380, 2012. [36] h. hamzah, human development and hedonism culture challenges: a review from islamic perspective, 2016. [37] m. quddus, h. bailey, and l. r. white, business ethics: perspectives from judaic, christian, and islamic scriptures, 2009. http://media.corporate-ir.net/media_files/irol/19/199381/moodysdibanalysis-feb2010.pdf http://media.corporate-ir.net/media_files/irol/19/199381/moodysdibanalysis-feb2010.pdf https://www.i-law.com/ilaw/doc/view.htm?id=375790 http://www.shariahfinancewatch.org/blog/2010/04/08/british-businessman-fights-dubai-bank-fraud-claim/ http://www.shariahfinancewatch.org/blog/2010/04/08/british-businessman-fights-dubai-bank-fraud-claim/ ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 profit maximization in islamic banking: an assemblage of maqasid shariah conception khairul mukminin institute of islamic banking and finance, international islamic university malaysia abstract— this paper aims to achieve enlightenment from maqasid shariah in terms of profit maximization within islamic banking. therein the study conducting library-based approach for every single data obtained by virtues of books, articles, and other scholastic literatures and additionally different supporting approaches, namely islamic jurisprudence, regulatory framework, accounting, and risk are engaged in this paper to exhibit more substantial apologia as regard of the topic. in respect of finding, making the best use of resources to achieve profit maximization within the bounds of the maqasid should be believed as maximization of other fundamental independentrights, inter alia, right of allah (zakah) and right of state (taxation). moreover, the profit generated ought to bring refinement not solely to strengthen the standing of nifs mal (preservation of wealth), but also to nurture whosoever muslim person who successfully transforms its distress, time, and assets into financial gain. it is obvious that in shariah perspective specifically in the case of profit, nonetheless the right of allah is the supreme, the right of human-being coming first after all worldly-obligations are adequately accomplished. differently expressing, maqasid al-shariah is a conception of precedence on how putting the best interest into the right time and the right place without inflicting suffering on the other interests with purpose that every single of interest could be on stage in the long run. for all practical purposes, this study call attention to the muslim public particularly by not losing sight of the fact apropos to the most fundamental of the maqasid principally in the circle of wealth namely, protection and establishment sequentially whereby ib should not be dictated to move with insistent haste by taking exhortations of greater distant of maqasid provided by numerous contemporary islamic scholars due to inherent nature of the bank per se. through careful interpretation, this study encapsulates on how to derive and benefit from the maqasid by stages (protection, establishment, nurture) rather than in an instant manner. keywordsprofit maximization; maqasid; shariah maxim; risk i. introduction an honoured islamic scholar, dr mohd daud bakar, alluded that there is clear ‘dichotomy’ about both terminology of shariah compliant and shariah based products in contrast with the past practices [1]. the chief point should bear in mind on this disputation is it is evidently presenting that the concept as well as the implementation of shariah compliant product in the islamic financial institution particularly is a merely resembling its conventional products counterpart. for instance, debt-based contracts instead of mudarabah. little is known by muslim nonetheless that the various aqad introduced by shariah such as mudarabah, ijarah, salam, and istisna to name a few, originally produced in the pre-islamic history [1]. it is noteworthy to note however, notwithstanding some scholars approach the bank on predominantly accomplishing mudarabah and musharakah, debt-based transactions in contrast with the scholars’ suggestion, is already given as a commercial instance by the prophet muhammad saw. as mentioned in on hadith from anas (r.a): “the holy prophet (pbuh) pawned a shield with a jew in madinah and he took from him some barley for his family” [2] what is more from the aforesaid hadith, firstly it evidently displays that the prophet transacted in deferred payment whereby the prophet acted as the purchaser. secondly, regardless who officially required or offered the pledged asset, the prophet substantiates the affirmation of providing security facility (rahn). logically speaking, it evidently shows that notwithstanding the prophet muhammad (pbuh) is eminently named al-amin, the trust should be manageable in feasible arrangement with objective that the value of both agreed parties shielded. thus, a question might arise, how about an ordinary muslim while their prophet (pbuh) himself gives an economic example through debt-based together with its collateral? likewise, while conducting commercial transaction, a trust might be built in tangible form. put it simply, the existing of collateral secures and manages uncertainty events such as default risk, breach of contracts, and possibility of inability to pay either deliberately or unintentionally in the future after the financing facility given to the customers. hence, the stance of both parties shielded by the rahn per se. up to this moment, islamic banking in general habitually remains averse to risk-taking. in terms of provisioning a financing facility, debt-based facility apparently exercises control over profit and loss sharing practice. it is an undeniable fact that plenty of shariah scholars advocate ib put pls into effect in the banking daily transactions. for instance, with ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 purpose of implementing as well as manifesting justice within the bounds of maqasid shariah in commercial proceedings, islamic banking is advisable to carry mudarabah as well as musharakah, instead of the debt-based. as augmented by antonio, sanrego, and taufiq [3] below: “so that whatever the outcome of the business (profit or loss), profit sharing system ensures no parties mutually agreed to do business, to feel aggrieved. those who do business (syarikat) will get results in accordance with the respective portions.” at first glance, it is truthful that the thought of pls could prevent involved parties from resentful aptitude since the forethought is born with its origin in the business performance. however, should islamic banking rely heavily on pls? irrespective to the bank positively or negatively performs, in fact, the bank substantively possesses diverse liabilities which is unable to be negotiated. moreover, whether a contract adhere to shariah, as matter of fact, the bank is not immune to uncountable riskiness due to its inherent nature that comprise tremendous cycle of liquid assets, inter alia, the likelihood of embezzlement, bribery, and mismanagement which could come in the scene in the form of collaboration (involving insider and outsider). thus, this study employs doctrinal methodology research by dint of deliberating several pieces of information from financial cost required by the bank to manoeuvre in banking ecosystem as well as financial forensic reports from varied financial service-based providers with main purpose that the paper could postulate and corroborate the implementation of holistic tenets of maqasid shariah that fully consider possible likelihoods in islamic banking without reservation. since preservation and protection become the paramount aspect of each and every element of the maqasid, it should then become fundamental understructure to gauge the regulatory framework in which the bank normally operates under dual-banking system so that stakeholder be it internal or external could be on stage in the long run. ii. overview of islamic banking in both islamic jurisprudence and system of state law a. the stance islamic banking in the sphere of shariah: islamic banking as fictitious person first, whilst most of society together with numerous writings and critics as regard of maqasid al-shariah make every effort to impose islamic banking on several holistic actions such as paying zakat, implementing real shariah-based contract such as musharakah & mudarabah (instead of a mere shariah compliant), contributing on minimizing poverty rate, and fairly distributing income to name a few, does not it mean ib have religious obligations? while it does so, would ib perform or be imposed on other religious practises such as fivetime prayers, fasting, and even making pilgrimage to makkah? this line of thinking may create self-contradiction and unreliability since what would be found is ‘deficient legal capacity’. moreover, it would bring a greater ambiguousness upon how the execution of penalties could be promulgated. on grounds of that issues, most of classical muslim jurists turn their back on the fictitious personality [4]. it should be taken into consideration that in the context of this study, the islamic bank is undeniably the fictitious person what the study leads to. upon deep contemplation, classical islamic scholars notice that concept of legal person towards fictitious personality is hardly accommodated within islamic law. the reason behind this is for in many cases it causes thoughtful disputation i.e. the key issue concerning legal capacity of the fictitious persons. other than that, it is a spurn of ‘inflexible doctrine of islamic law’ that is philosophically challenging since no matter how hard the scholar try to derive a hukm for the extent of islamic banking along with its complex attribute, they would be found on no occasion in the text [4] [5]. the aforesaid elaborateness seemingly conveys a bit cloudless deliberations. first, it is faithful and flawless that what majority of muslim contend over fictitious person is unmistakably unaccommodated within islamic law. it is not solely because of neither deficient legal capacity nor imperfect legal capacity, nevertheless, it also could scarcely be traced under both course of natural or acquired causes of defective legal capacity whereby the original intention and endeavour to bring this issue is trying to treat it as mahkum ‘alayh (the subject of the law). undeniably, circumstances of defective legal capacity namely minority (sighar), insanity (junun), idiocy (‘atah), sleep and fits of fainting (nawm, ighma’), forgetfulness, (nisyan), death-illness (marad al-mawt), intoxication (sukr), jest (hazl), indiscretion (safah), coercion and duress (ikrah), and mistake and ignorance (khata’, shubhah, and jahl) would hardly be traceable in the context of fictitious person like bayt al-mal, corporations, and other forms of faith-based organization [4]. second issue is another possibility, the existence of islamic banking as one significant part of financial institution as a whole by nature appears to be a ‘vehicle’ rather than the subject of hukm per se. briefly mentioning, this ‘vehicle’ is a comprehensive medium which has unique identity and comprises individual as well as collective individuals as ‘temporal passengers’ (in the biosphere of ib, simply put, consisting of internal stakeholders specifically shareholders, shariah board, board of director, senior management, employee, and so forth) so that they could arrange their mutualistic duties effectively. above and over, the hustle and bustle of the banking is not a five-finger exercise and utterly done by single person like a traditional commerce. in truth, the previous genus with plenty daily duties mentioned above are not only interacting among the internal person with different interest, but also should get in touch with other significant stakeholders such as customers, legislator (lawmaker), regulators, central bank, and other financial authority. therefore, third concern that should be taken into consideration is the presence of ib is the area of state whereby it is extremely dependent on the power of the authority. over and again, the muslim jurist would not take the long view on this kind of concern for in given place and given time, the ib ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 and all its attributes therein could be interchangeable among jurisdictions. b. legal standing of islamic banking in the compass of state law: islamic banking as legal person in some manners, the discussion of fictitious person from islamic law is more challenging than state law. however, since in many muslim countries, islamic banks exist in dual banking system whereby banking industries either shariah-based or conventional are controlled, influenced, and regulated by local or national government, thus it is important to examine the commonly-employed term in islamic law with other jurisdictions in which ib is governed and acted toward legal person. more significantly, with purpose of appreciating and minimizing the farther argumentation, malaysia jurisdiction comes down in favour of the purpose of the study as the designated muslim scholars within the bound of shariah advisory council of bank negara malaysia (sac of bnm) acknowledged as legitimate entity. pursuant to central bank of malaysia act 2009, the sac ascertains shariah compliance [6], circulate shariah rulings [6], and bind legally in judicial proceeding namely court and arbitrator [6] as regard of ib’s business, activities, and operations. hence, the study would approach example and evidence from malaysian jurisdiction in the orbit of legal framework of islamic banking business in which it is islamic financial service act 2013 (ifsa) that governs local and international islamic bank under prescription from minister of finance [7]. fortunately, the term of ‘legal person’ is easily attainable. in part 1 of section two concerning interpretation, it propounds some issues this study would like to spotlight as juxtaposition of islamic jurisprudence substantially. they are three paramount concerns of islamic law namely the source (lawmaker), the act, and the subject of the law that could be identified on following table: table i. islamic bank as legal person in malaysian jurisdiction subject to interpretation source of act is malaysian legislator the act: islamic financial service act 2013 objective “an act to provide for the regulation and supervision of islamic financial institutions, payment systems and other relevant entities and the oversight of the islamic money market and islamic foreign exchange market to promote financial stability and compliance with shariah and for related, consequential or incidental matters” subject of the act person “includes an individual, any corporation, statutory body, local authority, society, trade union, co-operative society, partnership and any other body, organization, association or group of persons, whether corporate or unincorporated” licensed person “means a person licensed under section 10 to carry on licensed business” licensed “means a person licensed under section 10 to islamic bank carry on islamic banking business and includes a licensed international islamic bank” provision of finance entering into or making an arrangement for another person to enter into, the businesses or activities which are in accordance with shariah including musyarakah, musyarakah mutanaqisah and mudarabah, murabahah, salam, istisna, ijarah, to name a few. right and obligation right: commercially conducting islamic banking business prescribed by the act obligation: conducting shariah compliance as well as other compliance by this act such as business granted, governance and other relevant act namely central bank act 2009, companies act, anti-money laundering and antiterrorism financing act 2001, whistle-blower protection act 2010. punishment/ penalty imposed for breaking act, contract, compliancy failure to compliance with shariah regarding aims and operations, business, affairs and activities. “any person who contravenes subsection (1) or (3) commits an offence and shall, on conviction, be liable to imprisonment for a term not exceeding eight years or to a fine not exceeding twenty-five million ringgit or to both.” relaxation “where an institution becomes aware that it is carrying on any of its business, affair or activity in a manner which is not in compliance with shariah or the advice of its shariah committee or the advice or ruling of the shariah advisory council, the institution shall— (a) immediately notify the bank and its shariah committee of the fact; (b) immediately cease from carrying on such business, affair or activity and from taking on any other similar business, affair or activity; and 
 (c) within thirty days of becoming aware of such noncompliance or such further period as may be specified by the bank, submit to the bank a plan on the rectification of the noncompliance”. source: ifsa of malaysia as has been spotlighted above, the state of malaysia enacts a comprehensive act that govern islamic banking for malaysian community so that it is obvious and possible to achieve. for instance upon this impression, it could be traced on the financial statements of the bank in a way that yield fiscal gain. in other word, what specified by the act is not impossible to be implemented. on top of that, it should be appreciated and eulogized, not solely because the state successfully display or deliver its right over ib, yet, greater than that it substantiates, endorses, and ensure numerous elements of the islamic law within the range of the act. iii. readdress assumption of the maqasid a. is the interest of temporal interest an ultimate objective? the above question connotes “what is the objective of allah swt over human-being along with its temporal attributes?”. hence, this chapter begins with the two very fundamental objectives of law which are instituted by alejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 ghazali. they are both purpose of the hereafter (dini) and purposes having relevant to worldly interest (dunyawi). alghazali has proved them beyond doubt that it makes no difference while there are so many elements or dimensions of maqasid attributed by islamic scholars, their proposition would backtrack on the aforesaid principles of al-ghazali’s. the further issue is however whether the purposes of worldly things are directed at spiritual aspect or at mere temporal benefit. for instances in several academic writings of maqasid shariah which proposes and urge major stakeholders of islamic banks, they have fancy for ibs to implement social plus environmental responsibility, equality in terms of distribution of income, and alleviation of poverty to name a few. broadly speaking, while the principle of dunyawi are divisible into four general dimensions namely nafs, nasl, ‘aql, and mal as a matter of fact, it is mindful as well that these four dimensions come into the scene of maqasid with aim that they ought to be profitable for the sole dini i.e. the afterlife purposes. imran ahsan khan nyazee [4] attracts attentive discussion by alluding other values that might be preserved and protected in different jurisdictions among muslim jurist and western law. he enhances that it is highly possible that the purposes by recent community and society either in the name of maqasid shariah or justice (with references to the western) would come together and intersect in the same dot such as issue of equality, security, civilization, and independence. regardless of how they differentiate each other, it should be borne in mind that the engagement of those might be placed as a possible field. meaning that, they may be changeable from time to time, from one person to person, from one regime to the other, or from one circumstance to the other. for all intense and purpose, it is worth mentioning that the islamic world view teach muslim not merely maximizing profit. hence, a question might arise to criticize the said statement ‘what is the value of shariah-basis banking compared to its conventional counterpart in reality that even dominating the market-share, generating much more profit, and at some time even allocating abundance philanthropy to society over the globe?’ logically what this subsection is trying to bring forward in these respect is that shariah scholar particularly and muslim in general should radically endorse as well as promote not solely to countless temporal advantages and virtuous conducts but also to the ultimate objective which is unquestionably presented at the opening of this section as against the secular point of view. chapra [8] call attention to muslim as regard of capitalist which transform into socio-economic and equitable distribution due to a mere social or political pressure. it is therefore utilitarianism, capitalist, socialist and other doctrines that only aggrandize the worldly whim the muslim scholars should be heedful of. to advocate and convey impactful postulation to, nyazee [4] points out significant issue regarding relationship between the temporal gain and the improvement of the next world from two big contemporary shariah scholars namely al-ghazali and al-shatibi whereby neither of them deny that the presence of other purposes on the compass of maqasid must affirm the foremost firmness of maqasid al-shariah viz., the protection coupled with preservation of din. all in all, islamic banking is expected to set the world alight by manners of multifarious innovative approach of earthly maqasid without compromising the intention of the hereafter prescribed by the lawgiver over human-being. figure 1. relationship interest of the din and dunyawi matters in the structure of maqasid al-shariah source: nyazee, (2009) dusuki and abdullah [9] advocate subtle idea to put some point of references into action in business paradigm to disregarding profit maximization and practicing taqwa-based to strive forward of happiness in the both worlds whereby islamic bank needs to provide sufficient shari’ah training to protect the interest of the employee’s faith. for that reason, therefore it is not morally wrong by reckoning with other religious mandatories into the bargain such as providing pleasant space and tolerable time for prayer during work-hour and such since in the perspective of maqasid al-shariah, the establishment of prayer takes precedence over promoting the growth of the intellect. b. issue on dual-side of the maqasid as for the implementation of the maqasid al-shariah, it has dual-side of coin to take into consideration viz. to convey the protection together with the establishment of the devout objective of the lawgiver (maqasid) that had been derived from islamic law (shariah). looking at these both general principles, as regard of wealth (mal), protection of wealth could be defined as assurance that the fund is legally protected whereas agreement that the fund would lawfully grow in number could be simplified as establishment of wealth. bearing in mind, it does not mean that it fully guarantees the fund or capital to be increased in number, it depends on the mutual consent and nature of the contract rendered. in the state of affairs, the organization might be under obligation to face with ethical-dilemmas circumstances. for instance, in one-side of coin the opportunity offers various potential benefit of profit and might be considered lawful from shari’ah point of view, however at the same time, in other contrast situations they apparently bring harmful to another party. thus, a question might come to light, which one come first? protection or establishment of financial gain? on that ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 account, an example of qawaid fiqqiyah (shariah maxim) “repelling evil supersedes securing benefit” [10] prevails to rule. it means while facing the tricky situations, preventing harm is preferable than taking gain. in islamic banking practise as was anticipated, orchestrating both establishment as well as protection are bound to happen. in the event of malaysian jurisdiction, the paper has exhibited that government of malaysia (gom) accommodates and encourages islamic banking products and services through its system of law whereby the presence of penalty and imprisonment strengthen the stance of the maqasid. accordingly, the bank bearing consequences as specified by the act. expressing differently, the protection what the maxim attempt to encourage has been there and the rest are the responsibility or choice of the bank to innovate profitably and prudently. thus, it is mindful that as the consequences of receiving fund from both depositors as well as shareholders, the bank would have exposures to risks, not solely risks pertaining to compliance with shariah and rules or regulations, but also risks that deliberately caused or accidentally misstated by either insider or outsiders such as fraudulent and unethical activities (fraud). c. precedence over the interest of the maqasid one of the pure worship and it is exclusively rightful prerogative of allah is zakat. the reader may be questioning whether it is right of allah alone or right of muslim since the zakat itself distributed to the beneficiaries. the response is slightly possible affirmative. it should be noted however that zakat is the third pillar of worship and thus predominantly belongs to allah swt, irrespective to whether or not there is mixture between them, in the case of zakat, the muslim has only single side i.e. obligation without presuming like ‘symbiosis-mutualism’. it is widely-known that zakat (legal alms) is obliged upon muslims whose certain amount of zakatable object (nishab). meaning that, some of them ought to do so, whereas one might not be obliged to do further conduct (amal) such as in the event of zakat. in other words, while the talk of profit or wealth comes in certain level, the obligation of zakat would subsequently prevail. it is obviously stated there would be 2 (two) key scenarios in the arena of the maqasid. firstly, the higher one would prevail: e.g. zakat (as part of the din) would come out on the top over the wealth (mal), only if the “certain requirement of the preservation of mal” being fulfilled. secondly, the lower one would be having precedence over the higher one, only if the “certain requirement” being failed. recall that, to achieve the din of zakat, muslim should have zakatable assets or otherwise the obligation would be demolished. it is believed that this principle would be consistent with other elements such aql whereby the din of shalat would be mandatory for muslim person who naturally or intentionally could protect his/ her intellect from intoxication or forgetfulness, and so on and so forth. it is nonetheless so unjust on supposition that islamic teaching present them with similar treatment. other than paying of zakat, in the ecosystem of ib governed as licensed person by rules and regulation of regulatory authority, ibs is not free of taxation cost into the bargain. a bit similar in case of legal alms, the tax itself requires no give-and-take arrangement. thus, in the next deliberation, this paper would relocate several essential sources and allocations of profit which transpire in the ib in order to identify its beneficiaries and also this paper could scrutinize concerning which interest is stronger or will prevail and which interest should be prime concern. iv. attentiveness to states of bank’s health a. health benefit of generating profit: an analysis of multifarious rights within islamic bank from a financial statement in the commencement of this study in respect of the postulation of profit, it already responded that from islamic perspective there is no significant issue on profit maximization. the matter of further discussion however is on ‘how to earn’ together with ‘how to spend’ the profit itself. recall that the original intention of the paper is to seeks the maqasid alshariah perspective on profit maximization. thus, firstly, presume that as long as every single part of the activities, transactions, and business are adherence to shariah and respected laws in which the bank operates under, by all means the matter of ‘how to earn’ is dispersed. moving forward on the eminent aim of ‘how to spend’. expressly questioning, the former term commensurate with ‘which party shall take benefit from the estate of generating profit?’ initially, either islamic bank or mainstream bank, the streaming of profit could be traced and be exhibited in income statement of annual report of the organization. however, the clear-cut distinction between them is the column of zakat. according to da jia qian and sivakumar velayutham [11] profit distribution in islamic banking could generally be separated into fivefold of entitlement: i) allowance for impairment of financing; ii) income attributable to depositor; iii) expenses/ costs; iv) zakat, taxation; v) profit to shareholders. below are accounts from income statement in which the bank structurally distributes its generated income and additionally in order to display more substantial apologia, one financial statement of an islamic bank would be employed anonymously. table ii. distribution of revenue/ income in islamic banking: tracing a financial statement source of income/ profit/ other potential obligation accomplished distribution of income/ profit potential right accomplished ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 income derived from investment of depositors’ fund income derived from investment account funds income derived from investment of shareholders’ fund reversal of impairment on other assets customers (in the courses of fund application in which a ton of repayment over financing facility successfully be arranged) allowance for impairment on financing and advances allowance for impairment on investments direct expenses customers (in the courses of fund application in which multiplex financing facility needs to be rearranged, let say rescheduling, restructuring) total distributable income wakalah performance incentive fees from restricted investment accounts customers (in the courses of fund sources) shareholders income attributable to depositor income attributable to investment account holders customers (in the courses of fund sources) total net income internal stakeholders: employees directorships ssc members external stakeholders: auditor utility provider personnel expenses other overheads and expenditures finance cost on subordinated sukuk murabahah internal stakeholders: employees directorships ssc members external stakeholders: auditor utility provider profit before zakat and taxation zakat allah swt profit after zakat tax expense government of malaysia profit for the financial year shareholders earnings per share (profit to shareholders) shareholders source: statement of profit or loss and other comprehensive income of an anonymous islamic bank for fy 2016 with arrangements from the authors in early days, accountants used to record financial accounts as single person, not as one entity or legal person in the perspective of normal law [12]. it is undeniable fact that such concept mostly impossible to be implemented in accessible annual report nowadays. however, the accounting which behave itself as an art as well as understood a science keep advancing its position over time. as the table above presents, it evidently displays on how this art works displaying heterogeneous interests in the form of unique accounts along with balancing between liability and income. in holistic virtue, this outlook brings to minds one shariah maxim which seemed corresponding to above matter i.e. “entitlement to profit depends upon liability for loss” [10]. prof dr muhammad tahir mansoori alluded that “the maxim means that the one who incurs risk and liability of a thing, is entitled to its benefits against the liability” [10]. addition to be noted. it may be realizable and applicable that imposition of taxation by a government is sensible therein since it is unmistakably due to the vital role of the government ensuring and providing good climate of economic and business during the crisis or even in the sound condition. 1) between profit and bank’s liabilities as simply elucidated in the prior subsection, it evidently exhibits that the maqasid al-shariah has level of precedence in terms of execution whereby at certain level one would not be enforced to administer higher-ranking conduct while the antecedent priority disregarded or otherwise the higher-level maqasid would be enforceable. in a word, the conception of the maqasid din the best interest into the right time and the right place without inflicting suffering on the other interests. a) allowances of impairment as per the above table (table 2), it shows to the public clear-cut accounts that before income distributed to the depositor the paramount priority firstly come into the scene of rectification of financing plus investment. turning the spotlight on the account of ‘allowance of impairment’. it is an ultra-fine example of redressal hardship especially on the execution of a maxim i.e. “harm has to be redressed” whereby the maxims could be applied when an actual loss has occurred [10]. the maxim also advises that the party whose difficulty issues should be given assistance to remedy. in ib perspective, it is primarily obvious that ib should give its customer assistance to meet the arrears of a financing facility such as by provisioning of restructuring and rescheduling. even so, the moral imperative come into customers’ consciousness as well since islamic law also protect and safeguard the right of every single of entity in the bank so that the bank could mitigate various related-risk to reduce non-performing financing. therefore, each party should seize initiative and come up with warmhearted ‘round-table’ to settle facultative-mutualism. b) distributable income: expenses, expenditures, zakah, and taxation in different respects, multifarious expenses and expenditures such as staff’s salary, wages, commission, directors and shariah supervisory council (ssc members’) remuneration, advertisement, it expenses, office rental, and so on and so forth thereupon are disbursed from the net-income. it must be realizable that in the sphere of expenses or expenditures, the company in general as well as islamic banks particularly, they have ‘fixed-cost’ accounts which cost the bank large amount of revenue produced time after time and could not be compromise by the bank’s performance namely, staffs’ salary, maintenance expense, utility charges, to name a few. the pay-out of zakat as well as tax are apportioned respectively afterwards. lastly, the owners of shares in the company shall takes their portion after every single one of interest mentioned earlier settled. ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 one thing is significant to bear in mind, the imposed taxation initially is not advocated under islamic legal system, it becomes approved counteraction since therein the right of state to secure the public interest prevails. moreover, it is widely-known that it comes as one of biggest part of an organization’s contribution to society for it commonly costs the bank tremendous expenses and even much higher than zakat literally. 2) achievement of maqasid al-shariah with paradigm of the profit maximization in vigilant senses, this figure display how the implementation of maqasid in the circle of wealth in particular and other dimensions of maqasid namely, hifdzul din, hifdzul nafs, hifdzul 'aql, and hifdzul nasl in general. figure 2. achievement of maqasid al-shariah source: adapted from imran ahsan nyazee’s book in deliberation of maqasid the named illustration gives a logical apologia that the preeminence maqasid which as far as one could judge having precedence over the lower-ranking maqasid, nonetheless gives the inferior maqasid the nod after all ‘non-religious’ obligation appropriately accomplished. maqasid al-shariah demonstrates a logically-accepted and holistic conception of precedence without inflicting hardship on the other interests. in clear-cut manner, the above figure which is supported by table (2) exhibit that successfulness of protection as well as certain level of establishment (nurturing) within the bounds of wealth would bring a new positive result, inter alia, let say zakah, otherwise the higher-right viz. the right of allah, the lawmaker, would not abide. in the field, even in order to provide a set of programme of shariah training, the certainty of profit is inevitable. additionally, it is believed, this understanding would bring consistency to other maqasid namely hifdzul nafs, hifdzul 'aql, and hifdzul nasl. for instance, in the sphere of intellectual (‘aql), a muslim person who fail to protect his (‘aql) either deliberately (intoxication) or accidentally (idiocy, minority) would not be mandated for conducting religious activities such as prayer. in contrast, while it could be prevented or achieved, nevertheless the establishment of ‘aql such as being knowledgeable (informed, educated, trained) come into the picture. b. bad scenario of health hazard: warning signs this part might be harsh somewhat. however, the authors see the parts which are about to be specified should become visible. simply put, profit and loss is like dual-side of coin accordingly. above and over, major issue is notwithstanding on the surface ibs have shariah compliance and other adherence to other laws, it does not mean that the bank is immune to or not exposed to risks or other unexpected events such as misstatement, loss, and fraud. moreover, it is expected to convey prudent awareness on the matter of maximizing as well as building shariah-basis workforce, instead of a mere profit maximization. therefore, it is important for whosoever stakeholders to take these matter into account. 1) bad scenario 1: failure of reaching for the star to begin with, opening case would glance at one islamic bank scandal in dubai i.e. dubai islamic bank. it is one of the largest fraud which took place in dubai and heard its first instance in 2008 [13]. additionally, it revealed six white-collar crime in which the biggest portion of loss derived from imprudent provisioning of restructuring: two-men pakistani that held senior executive positions of dib (a-39-years-old finance manager together with his 50-years-old deputy), twomen britons businessman (a-48-years-old and a50-years-old), a-36-years-old turk businessman, and a single american businessman (the financial manager’s sibling) [14]. briefly in 2011, the perpetrators came to light for grantingaccepting bribery (kick-back); providing-approving bogus financing documents (forgery); unlawful profiteering; ignorance on regulation of credit limit allowances; conspiring on embezzlement of public fund; deliberately causing loss over dib, and government and its entities [15] in the scandal when the highest court of dubai sentenced the seven defendants for ten-year and issued the verdict of fine payment of dh to usd 501million [15] and usd 2million [15] as the compensation of loss against dib. these are other learnings from others islamic banking: table iii. losses event in the islamic banking year ibs loss due to lack of governance 1997 ibsa (islamic bank of south africa) the ibsa was closed in november 1997 with debts of between r50-70 million due to lack of supervision from regulator, bad management, weak risk management, and large number of loans given to insiders. the ibsa was unable to compensate all of depositors who were mostly muslims who specifically had saved their money to perform their hajj. 2005 bimb (bank islam malaysia berhad) the bimb declared losses of rm457 million in 2005 mainly due to the provisioning of rm774 million as consequences of bad financing and investment. the issue regarding unappropriated number of board plus no board whose familiarity with banking sector as well as no sound and proper credit and debt collection. cumulatively, bank islam has a gross non-performing loan (npl) portfolio of rm2.2 billion. ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 (mushtak parker, 2005). 2008 dib (dubai islamic bank) fraud case of usd 501million revealing different high-level position and nationalities of perpetrators. some issue arisen: overdependence on the security pledged, weak enforcement of corporate governance disclosure, poor judgement of risk management. 20112012 bank syariah mandiri of indonesia barring providing-approving bogus document of financing facility for fictive customers worth more than idr50 billion, the fraudster did mark-up around 50% on the financing given. source: isra (2013): islamic financial system: operation & principles [16] and mukminin (2018) [17] and other sources 2) bad scenario ii: profit maximization or greedy? looking back at the period in which the global suffering pecuniary crisis, both global-popular-auditing-companies ey and kpmg put the rationale of ‘white-collar’ committing multifarious financial crime during period of financial crisis on the display. ey survey [17] figured out that fraud motivations in the middle east mostly due to selfish desire for wealth (greediness), followed by opportunity to manoeuvre and perhaps surprisingly, personal debt play a part in as well. it is undistinguishable, kpmg on its gcc fraud survey [18] put on the display of the reasoning behind the fraudulent dealing in which the fraudsters are substantially driven by greed as well and the hunger for grandeur habit and opportune moment (opportunity). v. reinvestigating the attributes of maqasid shariah: do ib need more elements of the maqasid? or should ib screen the best maqasid on its own? recall that in the beginning of this subsection, the paper highlighted already that the first and foremost objective of maqasid al-shariah over the mal is the protection of fund whereby certainty of capital as well as legal protection are the primary concern, following by the establishment on how to grow the fund in beneficial manners. however, it is so astonishing while the profit is maximized. ‘does not it mean the gain for others namely, depositors, zakat, and tax to name a few also increase at maximum level?’ nevertheless, while there is high demand to extend the money in some more profitable investments, the protection would take precedence over the establishment. above and over, the bank should not move with insistent haste by taking all exhortations. the study has approved that the bank is not immune to uncountable riskiness, hence it is unjust giving thought to the bank by putting it into greater extent of riskiness. the biggest worry and concern is banking institution is frangible to potentials of the varied fraud [19] regardless of the fact major jurisdictional actions and it system have been implemented. it is irrefutable and inherent nature of a bank since compared to other service-based or physical-product corporations this financial institution comprehends large cycle of very liquid capital, money-that is to say. meaning that, more considerate, moderate and prudent deeds must be in step with islamic principles as well as local law. it appears from above analysis of the maqasid, ib is not advisable to get involved in normal profit or even maximizing its sources of fund into financial gain. it also apparently that the notion of social movements advocated by islamic scholars and muslim community is not fully acknowledged here. again, for all intense and purposes, this study call attention to the muslim public particularly by not losing sight of the fact apropos to the most fundamental of maqasid al-shariah in the circle of wealth and not urging the ib excessively beyond the capability of the bank for instance in riskier contracts. in this respect, one maxim could again be applicable “repelling evil supersedes securing benefit” [10]. it is alluded that “when a person exercises a right which bring benefit to him but at the same time causes harm to someone else, he will be prevented from exercising that right” [10]. it is needless to say that whilst the ib is lawfully and fully recognized as legal person in certain jurisdiction and thereafter in national compass in the both level of macro and micro economic frequently keep increasing in terms of assets and profitability which means it successfully managing risks and minimizing non-performing loan, therefore there is no reason for the bank to not nurturing the interest of customers in the line of sources of fund. moreover, the bank is advisable to harmonize its profit to support not solely fortify the position of wealth itself namely investing in well-built it system, but also to consolidate other higher-rankings dimensions of the maqasid such as in terms of din (providing appropriate prayer room), nafs (coming up with healthy and safe workplace), family (protecting the employees with takaful programme), and aql (conducting in-house shariah training for the workforce). thus, by balancing the aforesaid principles whereby the protection takes precedence over the establishment and the establishment takes precedence over nurturement, ib could preserve the value of wealth and the other higher-values in the long run and presents an ideal bottom-up or inward tenets of the maqasid al-shariah. these conceptions conform and ameliorate the general principles of the three alluded by imran ahsan khan nyazee that the needs (hajat) and norms (hajat) comes into the scene of the maqasid to be considered as the servants of the necessities (darruriyat). it means the presence of the former two would embellish the standing of the latter [4]. following figure shows three elements of the maqasid the bank ought to take into accounts: ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 figure 3. figure 5 maqasid triangle source: adapted from imran ahsan nyazee (2009) vi. conclusion and recommendation a. conclusion maximizing of profit in the sphere of ib is always correlated and render disputation over social mandatory by most of islamic scholars. in islamic view, there is no material issue as regard of maximization of profit, even the shariah also provide that one is allowable to reduce its ratio of profit lower than its capital contribution or even selling one product under its real cost. additionally, making the best use of resource to achieve profit maximization should be believed as maximization of other fundamental independent-rights, to be specific, right of allah (zakat) and right of state (taxation). on top of that, the profit generated ought to bring improvement on security, good health, and well-being for whosoever muslim person who successfully transforms its distress, time, and assets into financial gain. it is obvious that in shariah perspective specifically in the case of profit, nonetheless the right of allah, the exalted, is the supreme, the right of humanbeing coming first after all worldly-obligation successfully achieved. differently expressing, maqasid al-shariah is a conception of precedence on how putting the best interest into the right time and the right place without inflicting suffering on the other interests. through careful interpretation, this study encapsulates on how to derive and benefit from the maqasid by stages (protection, establishment, nurture) rather than in an instant manner. this is believed as the essence of epistemological maqasid in which the term of protection means preservation and continuation without burdening other elements/ dimensions with perils for all intents and purposes, this study call attention to the muslim public particularly by not losing sight of the fact apropos to the most fundamental of maqasid al-shariah in the circle of wealth in general and in the ecosystem of banking industries particularly viz., protection and establishment sequentially whereby islamic bank should not be extorted with insistent haste by taking all exhortations of maqasid al-shariah suggested by most of contemporary islamic scholars. it should be borne in mind however that it is not solely for the inherent nature of the bank as a defective legal person but also as an intermediary which must safeguard the fund of customers. the study also exhibits how islamic bank evidently streams its ‘raw-profit’ into multifariousness interest from a financial statement. b. recommendation through the analysis and discussion above, there are some significant considerations to be recommended whereby integrating the increasing profit with aim to be in favour of other higher-level maqasid, as follows: board of director:  investing islamic teaching as ethical culture.  building a bridge between shareholders and senior management to dedicate and make commitment for voluntary sustainability of development programme, besides the mandatory one such as sadaqah and waqf [21] shariah member:  it is advisable that shariah members being knowledgeable about risk management to mediate perception of stringent shariah-matter, or at least one member whose such expertise.  strengthening the positioning of wealth in the circle of the maqasid by virtues of balancing between nurture, establishment, and protection together with endorsing the upper-level maqasid. senior management:  installing the maqasid in the circle of wealth and other higher-ranking maqasid (if possible) into the products and services.  it is undeniable fact that during generating profit, the preservation of wealth may intersect at higher-ranking maqasid that should be prioritized. for example, in the time of mandatory prayer which take precedence over other maqasid being seated in the first dimension.  promoting as well as manifesting in commitment to disclosure, especially on significant accounts pertaining to preservation of maqasid.  flourishing ‘beyond shari’ah’ as resilient identity which means extracting both the outward appearance of shariah as well as its essence.  providing venue for building bridge between other stakeholders.  since there is no issue on pm, human capital is vital organisational person. regulatory authority:  in the perspective of islamic jurisprudence over banking, the study already highlighted that the presence of ‘fictitious person’ is very dependable on the local government to accommodate social-will towards islamic banking industries which comes into the scene as ‘legal person’. therefore, the standing position of the government is very significance to ensure that the bank is not in the position ‘between the devil and the deep blue sea’ whereby in one side possess obligation to assure the fund fully protected as well as increased as financial gain and the other side imposed immoderate and excessive contribution to well-being of the society.  the right of state in terms of taxation which naturally cost the bank tremendous expenses and even much higher than zakat and historically interpreted as right of community therein with purposes of public interest such as hospital and road should be disclosed and ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 widely-known as one of biggest part of bank’s contribution to society. future research  it is noteworthy to concern the greed in islamic point of view with aim it could bring practical sense and be align in several findings of global surveys conducted by famed organizations. reference: [1] m. d. bakar, shariah minds in islamic finance, 2016, kuala lumpur: amanie media.
 [2] m. j. lee, islamic banking in malaysia: shariah theories, the laws, current structures and practices, and legal documentation, 2017, kuala lumpur: lexisnexis. [3] m. s. antonio, y. d. sanrego, and m. taufiq, an analysis of islamic banking performance: maqashid index implementation in indonesia and jordania, 2012, journal of islamic finance, vol. 1 no. 1 (2012) 012 – 029. iium institute of islamic banking and finance issn 2289-2117 (o) / 2289-2109 (p).
 [4] i. a. k. nyazee, islamic jurisprudence, 1945, 4th reprint of 2009 by islamic research institute islamabad.
 [5] i. a. k. nyazee, theories of islamic law, 1945, 4th reprint of 2014 by islamic research institute islamabad. [6] act 701 of central bank of malaysia act 2009.
 [7] act 759 of malaysian islamic financial service act 2013.
 [8] m. u. chapra, towards a just monetary system: a discussion of money, banking, and monetary policy in the light of islamic teachings, 1985, kingdom of saudi arabia, riyadh: international islamic publishing house (iiph). [9] a.w dusuki and n. i. abdullah, maqasid al-shari`ah, maslahah, and corporate social, 2007. responsibility. the american journal of islamic social sciences 24:1. retrieved from http://irep.iium.edu.my/2209/1/dusuki-abdullah-maqasid%5b1%5d.pdf [10] m. t. mansoori, shariah maxims: modern application in islamic finance, 2012, islamabad: international islamic university. [11] d. j. qian and s. velayutham, conventional banking and islamic banking: do the different philosophies lead to different financial outcomes?, 2017. [12] i. a. k. nyazee, islamic law of business organization: partnership, 1997, the international institute of islamic thought. pakistan: islamabad.
 [13] a. shaaban, dubai islamic bank fraud case adjourned, khaleej times, 2009, retrieved from https://www.khaleejtimes.com/article/20090428/article/304289911/ 1002 [14] a. mustafa, dubai islamic bank fraud repayment ordered back to appeals court, the national, 2011, retrieved from https://www.thenational.ae/uae/courts/dubai-islamic-bank-fraud repayment-ordered-back-to-appeals-court-1.375115 [15] a. hassoune, moody’s dib analysis february 2010, moody’s investors service. 2010, retrieved from http://media.corporate ir.net/media_files/irol/19/199381/moodysdibanalysis-feb2010.pdf [16] isra, islamic financial system: principle & operations, 2013, 2nd print, international shariah research academy for islamic finance (isra). [17] k. mukminin, 2018, how close islamic banks are
to global fraud: learnings from dubai islamic bank in the time of sub-prime crisis, european journal of islamic finance. [18] ey, bribery, corruption, and fraud in the middle east: first middle east bribery, corruption and fraud survey, 2011. [19] kpmg, gcc fraud survey for gulf cooperation council (gcc) countries, 2008, retrieved from http://www.middleeasttransparent.com/img/pdf/2008_gcc_fraud_sur vey_english_1_.pdf [20] z. m. sanusi, m. n. f. rameli, and y. m. isa, fraud schemes in the banking institutions: prevention measures to avoid severe financial loss. 7th international conference on financial criminology 2015 13-14 april 2015, wadham college, oxford, united kingdom. [21] p. p. biancone and m. radwan, social finance and financing social enterprises: an islamic finance prospective, 2019, european journal of islamic finance, special issue islamic and social finance . ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france waqf unit trust as an alternate model to realize waqf sustainability aazman hashim international business school (ahibs), universiti teknologi malaysia, ahmadkhaliq@iium.edu.my akulliyyah of economics and management sciences, international islamic university malaysia, ahmadkhaliq@iium.edu.my bazman hashim international business school (ahibs), universiti teknologi malaysia, nazimah.kl@utm.my cahmad ibrahim kulliyyah of law, international islamic university malaysia, tahiriiumedum@iium.edu.my abstract with poverty and unemployment is still the paramount concern across the globe, a study on waqf and capital market integrations is certainly a timely call for sustainable socio-economic development. the aim of this paper is to revisit the literature on the issue of illiquidity of waqf assets and eradicate the dependency on government provision. to ensure the sustainability of waqf institutions, financing apparatus primarily designed for waqf assets are explored. the study proposes a viable integration of waqf and capital market apparatus of unit trust investments based on the shariah-compliant standards ratified by the security commission of malaysia (scm) guidelines. the study opts for thematic analysis method of the existing literature on waqf financing. the finding indicates that there is a need for a novel apparatus such waqf unit trust instrument through cash waqf and share waqf to realizes greater waqf funds accumulation, investment, and distribution. it is highly advocated that the income of investment be optimally utilized for socio-economic projects. this study realizes as one of the pioneer endeavors to pool waqf fund via unit trust model as its sources and exhibit management undertakings of the model. keywords cash waqf; socio-economic; unit trust; waqf management; malaysia i. introduction malaysia as the leading international centre for islamic fund and wealth management has recently launched its islamic fund and wealth management blueprint earlier this year. this blueprint outlined the plan and recommendations to counter impediments to growth and innovation for financial development [2]. one of the noteworthy perspectives is seen to be the emphasis on the development of waqf, an islamic philanthropy-based vehicle, a public good, and a tool for redistribution of wealth focusing on social development. the securities commission of malaysia (scm) has viewed the effort to increase the level of sustainable waqf assets through fund management or capital raising a priority among its 11 recommendations and innovative plans. indirectly, this initiatives are aligned to the call to mobilize impact finance development towards the sustainable development goals (sdgs) [11]. in this view, this paper attempts to discuss a waqf related financing vehicle for raising capital and its management. over the years, waqf institutions have reached their peak and stagnation [32]. waqf sector has demonstrated a prodigious growth and significant role throughout islamic history. it has supported economic development, which covers aspects including social, political and others that are today financed by the state/government [35]. over the last fourteen hundred years, waqf has progressively become a significant institution in the islamic socioeconomic system and has played varied and astonishing roles throughout islamic civilization ([27]; [17]; [23]; [18]; [34]). waqf has attended to the needs of societies. it has provided education, healthcare, national security, commercial activities, agricultural activities, and even industry sector without depending on any government budget or grants [31]. reference [40] has articulated that at a time, a “person could be born in a house belonging to a waqf, sleep in the cradle of that waqf and fill up on its food, receive instruction through waqf-owned books, become a teacher in a waqf school, draw a salary financed by waqf, and be placed in a waqf provided coffin for burial at his death in a waqf cemetery”. all these were possible through generous donations by those who had wealth to those they did not. it is this why waqf institution is admired ahmad khaliqa, nazimah hussinb, and mohammad tahir sabit haji mohammadc http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 mailto:ahmadkhaliq@iium.edu.my mailto:ahmadkhaliq@iium.edu.my mailto:nazimah.kl@utm.my mailto:tahiriiumedum@iium.edu.my ejif – european journal of islamic finance no13, august (2019) for its redistribution features [15]. to sustain waqf institutions in such a productive state, efforts are needed to be made to keep its existing assets productive, attract new ones, and find innovative ways for getting funds for distribution. nonetheless, the recent literature demonstrates that there exist several reasons for the stagnation of current waqf assets. they include inconsistency among state laws governing waqf assets [20], lack of prime location of waqf assets [35], poor management, poor record keeping, and financial constraints ([36]; [37]). even though some of the issues have been gradually addressed, the inadequate capital reserves of waqf funds under each state islamic religious council (sirc) remains an issue that has to be tackled now and in future. ample works of literature on waqf have emerged recently in tandem with the success of waqf sector as a source of socio-economic financing ([6]; [36]), especially in the last 10 years. these works relate to cash waqf, waqf property, waqf concepts related to poverty alleviation [12], and remedies to the socio-economic ills of the society [8]. all these deal with the funding of waqf projects, which do not include the investment aspect of cash waqf or its equivalents. in an attempt to enrich the literature on waqf financing and investment, this study is an extension to the efforts of other eminent authors, focusing mainly on a waqf financing and investment model which is capable of financing waqf institutions for the benefit of the general community. the study has divided the need for waqf assets, the challenges of waqf institutions in having liquid assets for socioeconomic projects, the effort to develop waqf financing models, and the proposal for the investment of cash waqf funds in unit trusts and how such investment can be made. ii. waqf and its socioeconomic utility waqf is a socio-economic development tool for society. waqf is taken from the arabic verb of waqafa to stop (al-habs), to hold, to detain (al-man’) or to prevent its disposition. it implies the permanent and irrevocable devotion of the whole or a portion of wealth for the purpose of expanding its usufructs to legitimate socio-economic causes or charitable and righteous end with the prime objectives to become closer to allah هلالج لج. the understating of the four pillars of waqf, comprising the donor (al-waqif), property (al-mawquf), the recipient (al-mawquf alaih), and offer & acceptance (sighah), indicate the extraordinary dedication of waqf to the socioeconomic development of a society. they imply the perpetuity, irrevocability, and inalienability [37] of the waqf asset for the welfare of humankind. often when a waqf asset is endowed for its beneficiaries, it remains waqf forever. the permanency of waqf is protected by law by making waqf assets irrevocable, perpetual, non-transferrable, and non-inheritable. the irrevocability character of waqf deeds maintains the asset to remain irrevocable after the declaration has been made [14]. at the same time, the inalienability feature of waqf assets shows that the assets are not subject to any sale, disposition, mortgage, gift, inheritance, attachment or any alienation [14]. hence it implies that the waqf property should not decrease, cannot be revoked after validly declared, ownership is not transferable, and perpetual in nature. nevertheless, legal protection by itself does not guarantee the permanency of waqf assets. additional steps are needed to preserve waqf assets. therefore, the waqf institutions are given the capability to sustain themselves by growing their funds both by way of recruiting new or recurrent donors or having income generating properties. the income can be created through the use of waqf property in any of shariah compliable transactions, available in the market. the transaction would be profit maximizing, however, its objective would be not to enrich the donors rather it would be used to support the projects that improvise the welfare of society. in fact, waqf endeavors are one of the factors serves to ensure the sustainability and stability of human life (human sustainability) to achieve just and equal socioeconomics [28]. due to that, the waqf assets deserve the recognition in comparison to other assets obtainable in the market and should not be treated as an inferior class asset in a legal and market perspective so it may generate continuous revenue and self-reliant. in attaining the sustainability of waqf institution, the appointment of mutawalli (trustee) is deemed essential. the mutawalli or nazir is the property manager or administrator of awqaf. he or she shall take responsibility for the asset under his or her care to entail the sustainability of asset and continuously aid its beneficiaries. traditionally, waqf properties are endowed in the form of a mosque, land for muslim cemeteries, business premises, religious school and etc. contemporarily, majority of muslim scholars accept the waqf endeavors carried out in the form of cash waqf, share waqf, waqf of shares, takaful waqf, and waqf reits which are more liquefy and align to the current demand. the income generating waqf asset need not be bound by its class. an asset, dedicated to social http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ejif – european journal of islamic finance no13, august (2019) services as well as for the economic empowerment of a person or a group, maybe income generating. however, the main intention of the donors in this type of waqf would be to use the income of the asset for a defined objective. these assets are having a financing capability. the asset may be cash or a fixed, or movable property. to be income generating it all depend on the intention and objective of the donor, the manner asset utilized as specified by the donor, and the good management of the waqf property by its manager (nazir/mutawalli). for a non-profit oriented organization such as waqf, [13] asserts that four fundamental concepts are deemed essential for a nonprofit organization, which also known as 4ms; mission, money, marketing and management. on the other hand, for a cooperative, the fifth element would be the membership. certainly, [13] claims that the most essential would be the money¸otherwise no mission and aim of the organization could be realized and uphold in the market. thus, the nazir or mutawalli of waqf asset upholds a vital sense of duty to maximize the benefit or income from the endowed assets. this can be done either by proper maintenance of it or generating high income therefrom. in either case, the beneficiaries of waqf assets will acquire greater utility. the nazir will have to choose, from a variety of investment products, one that has greater utility. the limited the number of investment products, the limited would be the choice of nazir. hence, the development of many investment products, observing the nature and principle of waqf, is needed; only then, the nazir and mutawalli could choose one that is efficient and more profitable. iii. waqf financing apparatus literally, any waqf financing endeavors aims to offer wealth distribution to its recipients. reference [32] opined that it’s important to have a clear understanding on the method applied to manage the cash waqf contribution from the donors so it can optimally reach its beneficiaries which can be in three forms; public waqf (waqf khairi), waqf khas/family and waqf mushtarak (combined waqf family and public). reference [21] enlightened that the direct cash waqf is an endowment created by founder in cash to be channeled directly for developing any waqf property, on the other hand, indirect cash waqf is an endowment in form of cash, but to be invested first, and only the revenue generated to be channeled to the beneficiaries. figure 1 below depicts a direct cash waqf modus operandi; figure 1. direct cash waqf method source: [32] on the other hand, the indirect cash waqf works in a manner whereby the waqif/founder create the cash waqf in order to be invested and the revenue generated to be channeled to the beneficiaries through the management of mutawalli/trustee. figure 2 below illustrates the method applied: figure 2. indirect cash waqf method source: [32] referring to the above cash waqf structure, waqf financing endeavor in the capital market best comply for the indirect cash waqf method. this is to ensure that the appropriate allocation of accumulated cash waqf is invested in the shariah investment to generate continuous revenue before reaching the beneficiaries. evidently, the selection of investment apparatus suitable for waqf should consider the following parameters in ensuring the prudent investment of the waqf assets; i. shariah-compliant; any unethical elements (e.g.: speculation, high uncertainty and gambling activities) or prohibited dealings (such riba consumption, alcohol, tobacco and pornography industries) in the light of shariah principle must be discouraged and eliminated. ii. risk preference; investment portfolio entails waqf assets must not be exposed to high risk which could consequent to decline or loss in the given principle http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 ejif – european journal of islamic finance no13, august (2019) asset value. an investment portfolio should be diversified to mitigate the risk. iii. tenure; tenure of the investment should be fitting to the usability of the fund to maintain its liquidity. iv. debt funds; creation of conventional debt securities portfolio are not advisable and should not be an available option for an islamic fund manager. v. equity funds/shares; exclude firms and portfolios that do not adhere to shariah screening exercise methods such as sector screening, image screening, and financial ratios screening. vi. hedge funds; most of the derivatives instruments are exposed to high volatility risk. in line with the rapid and steady growth of the islamic finance industry in malaysia, this opportunity should be utilized by waqf institution to apply creative development strategies and innovative investment that meet the current needs and demands. iv. challenges to the growth of waqf assets in malaysia waqf endevours are common with unsettling events. a number of reasons contribute to the stagnation of waqf assets such as waqf in malaysia is solely governed by state islamic religious councils (sircs) with jabatan agama wakaf, zakat dan haji (jawhar) as a coordinator. the practice of waqf is not new to malaysian history as it can be traced to the 14th century after the embracement of islam by the malacca sultanate [9]. a number of waqf lands existed since then which were managed by a group of people like imams, community leaders (penghulu, or ketua kampung) and gradually they were transferred to sircs at each state under the jurisdiction of sultan [22]. currently, the supervision of waqf properties according to [26] has been improved to three-tier waqf management that consists of nazir (i.e. sric), mutawalli (i.e. perbadanan), and qayyim (i.e.: university). each of the tiers respectively has its powers and duties as assigned to them under and subsidiary state legislation. in addition, a number of waqf assets especially the waqf lands are found located at the nonstrategic location [35]. this somehow weakened the potential of the land to be utilized in generating revenue and further assist the needed beneficiaries. moreover, to construct any development project on these lands would incur additional cost and budget. furthermore, [19] assert that poor physical condition of the waqf assets and unprofessional record-keeping of the endowed assets leads to prevailing constraints constituted to challenges in the growth and development of waqf assets. waqf institutions thus far have played a significant role as an apparatus to secure the socioeconomic equality of wealth distribution comparable to the role of zakat institution. hence, the welfare of the needy community is safeguarded by the reliable function of these institutions. this approach is in line with the islamic teachings of brotherhood and equality in socio-economic welfare. however, their efforts are limited to the funds available to them. to be more effective, they need to attract new funds either by recruiting new and existing donors or generate more income through existing and new investment products. v. limited liquidity of waqf assets despite significant efforts of malaysian waqf institutions, waqf assets and their liquidity are limited. reference [38] claimed that during the postcolonization period the trustees (managers) of waqf lost some waqf properties. these properties were not considered as waqf due to loss of documents that could be used as evidence of proof of them being waqf assets. reference [37] and [7] have highlighted the phenomena of illiquidity and inadequacy of waqf assets and therefore suggests a search for alternative methods to resolve the issues of idle and undeveloped waqf assets. in addition, [3] and [25] opined that malaysia is struggling to utilize the existing waqf lands due to little income. this is consistent with [36] who opined that financial limitation is the factor that hinders the waqf development in malaysia. in studying the financial agencies reaction, [25] found that financial agencies are hesitant due to their belief that they will not “receive an adequate profit margin compared to the market value rate….” [25]. further, [16] in relation to muslims ' economic development, highlighted the limited financial resources that in turn limit the growth of waqf in malaysia. apparently, the malaysian government is the main source of funding to each sirc. the federal government through the rmk9-10 has allocated a large sum of money for the development of waqf sector. in 2012, bernama reported that under rmk-9 rm256.89 million was allocated for the development of 16 projects and rm72.76 million in rmk-10 for 10 selected projects [10]. nevertheless, [5] reports that millions of ringgit worth waqf land are still idle as the sirc has no adequate funding and expertise to develop it. reference [22] opined that at least rm 80 billion is needed to develop the entire available waqf http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 ejif – european journal of islamic finance no13, august (2019) land in malaysia. on contrary, this situation is far different from most of minority muslim countries such singapore for instance whose muis (islamic religious council of singapore), as mutawalli, proactively plan various approaches to develop waqf property assets to be in line with the current economic development trend in singapore. in fact, this scenario pushes muis to apply various development mechanism combines the traditional such istibdal, and hukr (long term rent) with contemporary financial instruments such as sukuk musharakah for the development of waqf properties. this combined initiative further enables them to upgrade and unlock the real value of waqf assets in singapore which used to be poorly assessed. ultimately, higher and consistent investment return was able to be generated for the betterment of the waqf beneficiaries. the limited liquidity of waqf sector hinders its asset development agenda ([25]; [29]; [38]. consequently, other alternatives are seen as essential to explore in order to achieve the growth of waqf assets. thus, this study explores the potential of a capital market instrument as a long-term investment vehicle, in order to preserve the sustainability of waqf as is requisite of waqf deeds. vi. contemporary waqf asset fruition after cash waqf was introduced as an alternate medium for waqf deeds, [4] and [30] claim that cash waqf had a great impact on the economic development of ottoman empire especially, the loan facility, which catered to the needs of poor households. in fact, [15] and [30] affirm that there was no exact date as a starting point when did cash waqf been practiced, as there were no records found in the islamic history at least since the 8th century to 15th. at present, there is a transformation from the cash waqf to waqf shares and then to cash waqf that has been deliberated by a number of scholars [30]. this is an evolution of waqf subject that is widely practised in the majority states of malaysia. mahamood et al. (2009) opined that the implementation of waqf share and cash waqf were certainly significant mainly in making a large pool of funds that can be used for the advancement of waqf assets. in exploring the ability of cash waqf as alternate to riba-based financing, [24] asserts that cash waqf has the potential and capable of promoting entrepreneurship with interest-free loans from the cash waqf institutions, making the poor self-reliant and dignified. this paper argues for further evolution by using cash waqf or waqf proceeds in a malaysian capital market product. the capital market offers a medium and longterm investment platform with a variety of financial instruments that allow the economic agents to group, value and exchange risk. it encourages saving in financial forms through attractive yields, liquidity and risk characteristics. particularly, it is essential at the time when an institution or a government agency is in need of long-term funds [33]. hence, the utilization of capital market instruments has the potential to indirectly contribute to the further development of waqf sector. this work, therefore, proposes the investment of waqf assets in unit trusts. vii. unit trust as a waqf assets since its formative years in 1959 to 1979 in malaysia, the unit trusts investment is ordinarily known as a form of collective investment which allows investors with similar investment objectives to pool their fund to be invested in a portfolio of securities or other assets. a professional fund manager then elected to invest the pooled funds in a portfolio for assets classes such equity, bond (debt securities), balanced (equity & securities), money market funds (money market instruments) and islamic unit trusts (shariah-compliant funds). ownership of the fund is divided into units of entitlement. it increases or decreases in accordance with the fund value or net asset value (nav). currently, the unit trust industry has attained sustainable growth from the 2000s to current. securities commission of malaysia act as the regulating body governs 36 unit trust management companies with the 649 total number of approved funds out of which 211 are islamic based. the unit trust industry is expected to value at rm 413.303 billion [39]. with the matured and concrete nav, it has the ability and potential for the waqf sector to utilize the platform confidently. each unit trusts shares can be regarded as an ownership entitlement in the investment portfolio and in the form of gained profit from the assets invested in the portfolio. these ownership entitlement and its utilities are categorized as an asset by majority islamic scholars as long as it entails value from a financial point of view and simultaneously delivers utility or usufruct. thus, each unit trust shares can be considered as legal assets that can be own and the ownership are transferable. this is in-line to the concept of share ownership in any corporate organization be it the ownership of its real estate, benefits, ownership, cash and debt [1]. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 ejif – european journal of islamic finance no13, august (2019) viii. proposed waqf unit trust model (wut) a number of scholars have deliberated in detail on the issue of the endowment through the financial instrument such as waqf share and sukuk in numerous research papers conferred in the majma alfiqh al-islami in 2009. the final fatwa did acknowledge the permissibility unit trusts among others. the scholars have approved the endowment of financial instruments such as waqf of company shares, sukuk, intellectual property and certificate of unit trusts, as they are legally recognised properties. the above fatwa contains two forms of unit trusts that can be used by waqf institutions: the donation of normal unit trusts as waqf and the investment of liquid waqf assets in the purchase of unit trusts. with the recent increase in the cost of living, lesser people are able to afford to endow physical or immovable properties for waqf. with the proposed establishment of waqf unit trust, this could enable more people to endow in the form of cash either periodically or even once in a lifetime. with the formation of the waqf unit trust (wut) model, figure 3 below illustrates the proposed wut model that can be utilized by society at large inclusive founders, individuals, organizations, institutions, and even companies to exponentially cultivate the waqf fund: figure 3. the waqf unit trust model source: author’s own referring to the figure 3 above, below is the modus operandi of the model: 1. waqf assets from donors (waqif) consist of individual and corporate donors are channeled to waqf fund. 2. waqf assets from the waqf fund consist of cash and waqf share (saham waqf) are then allocated to a consolidated fund. 3. these waqf assets then are channelled to an investment apparatus of a unit trust. 4. upon maturity of the investment, the proceeds from the investment would be realized. 5. this stage would require the disbursement of waqf assets in three ways: 5a. appropriate agreed upon amount of income is allocated back to waqf fund and then reutilized. 5b. an amount is dedicated to the management and sinking fees of the scheme. 5c. another portion of proceeds is channelled to sirc which also acts as a governance committee. 6. the disbursement of income realized from the scheme is distributed for the socioeconomic development projects. ix. conclusion and policy recommendation the aim of this paper is to revisit the literature on finance focusing primarily on philanthropic endeavors. the study proposes a model that integrates waqf and capital market apparatus of unit trust model based on standards approved by the security commission of malaysia (scm) while at the same time adhering to shariah requisite. the paper outlines and presents discernment on the prevailing literature of waqf especially the works related to financing and investment model and instruments in a manner that sheds light on the concept and sets the stage for future research and policy recommendation. through the integration of islamic capital market, wut model is proposed to realize greater waqf fund pooling. moreover, this model is expected to act at the optimal utilization of waqf fund for greater economic health and simultaneously as a remedy to eradicate socio-economic issues facing the global economy. the wut model in this study is subjected to further academic debate and is anticipated to benefit policymakers, particularly, sircs of each state and government as the governing body/organizations involved as well as organizations such as securities commissions of malaysia and federation of investment managers malaysia. references http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 ejif – european journal of islamic finance no13, august (2019) 1. aaiofi. 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(2016). the constraints of malaysian mutawalli in developing idle waqf lands. in fuadah & asma (eds.). the muktamar waqf iqlimi iii 2016 (iqlimi 2016) (pp. 1-9). ban nua mosque, songkla, thailand: pusat pembangunan pembiayaan wakaf (pppw), universiti sains islam malaysia (usim). 37. sabit, m. t., mar iman, a. h., & omar, i. (2005). an ideal financial mechanism for the development of the waqf properties in malaysia. johor: reseach management centre, universiti teknologi malaysia. 38. salleh, s. m., & muhammad, s. (2008). waqaf development in malaysia: issues and challenges. jurnal pengurusan jawhar 2, no. 1, 21. 39. securities commission of malaysia. (2016). summary of statistics – unit trust funds in malaysia. kuala lumpur: securities commission of malaysia (smc). 40. yediyildiz, b. (1990). institution du vaqfau xviiie siècle en turquie: etude sociohistorique (institution of waqf 18th century in turkey: socio-historical study). ankara, turkey: 35-39. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france abstract with poverty and unemployment is still the paramount concern across the globe, a study on waqf and capital market integrations is certainly a timely call for sustainable socio-economic development. the aim of this paper is to revisit the li... i. introduction ii. waqf and its socioeconomic utility iii. waqf financing apparatus iv. challenges to the growth of waqf assets in malaysia v. limited liquidity of waqf assets vi. contemporary waqf asset fruition vii. unit trust as a waqf assets viii. proposed waqf unit trust model (wut) ix. conclusion and policy recommendation references paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 the compatibility of cryptocurrencies and islamic finance fait muedini, ph.d.* *department of international studies, butler university (usa) abstract— in this article, i examine the compatibility of bitcoin and other cryptocurrencies within the context of islamic law. i begin with an introduction of bitcoin and other cryptocurrencies. i then discuss the notion of money in islamic history, with an emphasis on the importance of ethical financial dealings. i then argue that bitcoin and other cryptocurrencies are highly compatible within islamic finance, and in many cases, actually provide solutions to problems of government institution controlled currencies, arguing that bitcoin and other cryptocurrencies are a better solution for several problems that early islamic finance scholars were concerned with. unlike traditional fiat, the supply of bitcoin and many other digital currencies are fixed, thereby eliminating potential for gharar (deception), and also inflation. in addition, unlike fiat and precious metal coins, digital currencies such as bitcoin cannot be altered, forged, or manipulated. moreover, cryptocurrencies’ peer-to-peer transactions remove the need for any banking institution, thereby eliminating any risk with a third party controlling one’s money. i then conclude with a summary of the main points of the article, and examine future possibilities with regards to the role of cryptocurrencies. keywords--bitcoin; cryptocurrencies; islam; shariah, islamic finance; islamic banking i. introduction (bitcoin and other cryptocurrencies1) in 2008, an individual (or individuals) who went by the name of satoshi nakamoto (2008) published a paper entitled “bitcoin, a peer-to-peer electronic cash system,” that outlined the creation of this new digital currency, named bitcoin (btc or xbt). it is believed that this new currency was a reaction to the 2008 financial crisis, and subsequent government bailouts of banks. 2 as geiger (2017) explains, “bitcoin is an alternative to the current financial system. it removes authority from any single person or organization, and was created at least partially as a response to the 2008 financial crisis, where the poor [judgment] of a few led to layoffs, college graduates without job opportunities, and home 1 full disclosure: the author does own bitcoin, along with other cryptocurrencies. 2 as the new yorker (2013) notes, “when the experiment was launched and the first fifty [b]itcoins (the so-called genesis block) were mined, in january of 2009, he (or she, or they) included this line of text along with the data: “the times 03/jan/2009 chancellor on brink of second bailout for banks.”” foreclosures internationally.” through a blockchain (an online ledger), transactions are all recorded, and through a proof of work system (done by currency miners), these transactions are all confirmed. moreover, this blockchain also ensures that no double spending problem exists (thompson, 2017). a new, decentralized cryptocurrency was born. bitcoin began as a digital currency to counter traditional methods of finance, and, despite ups and downs in price over the years, the cryptocurrency is beginning to see more and more mainstream adoption. more people are now viewing bitcoin both as a means of exchange, and as a store of value. some are even calling bitcoin “digital gold” (popper, 2016), with digital currencies becoming the new form of money (antonopoulos, 2016). while some argue that digital and cryptocurrencies 3 are not real money, upon reflection, there is no intrinsic value to a lot of our existing money. as thompson (2017) explains: “a bar of gold. a disk of iron. a chain of beads. a card of plastic. a slip of cotton-linen paper. these things are worthless. one cannot eat them, or drink them, or use them as a blanket. but they are valuable, too. their value comes from the simplest thing. people believe they are money, and so they are.” to be money, the said currency should be a store of value, have a unit of account, be a medium of exchange, and also serve as a standard of deferred payment (bank of england, 2014, in adam, 2017). there are also a number of other characteristics that many believe money should have. for example, some look to aristotle’s definition of money, measuring bitcoin to these conditions. aristotle argued that money should be durable, able to be transported, divisible, as well as having intrinsic value. in addition, digital currencies like bitcoin also have a limited supply, which some believe lends further credibility to viewing them as money (jenkinson, 2017). again, as i shall argue, what we find is that not only do bitcoin and other cryptocurrencies fit these aspects of money, but also that these currencies may do so better than traditional forms of money like fiat and even gold. so, what we are seeing today with digital currencies is an increase in acceptance into the real world. more individuals are indeed treating these currencies, as just that, currencies, and they are doing so while also becoming less and less willing to embrace ‘traditional’ fiat as currency. 3 for a discussion on the differences between digital and cryptocurrencies, see tar (2017). ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 when looking at money, “throughout history, currency has taken one of two forms: physical assets, like gold or beads, and fiat currency, like government-backed paper and coins. bitcoin and its brethren introduce a third category: digital currencies that run on a combination of game theory, economics, and cryptography—thus, cryptocurrencies” (thompson, 2017). this innovation of bitcoin and other digital currencies then sparked a wide range of cryptocurrencies that followed bitcoin. while there are thousands of different digital currencies and tokens, some specific variations include coins with less fees and more scalability (such as litecoin), privacy coins such as monero, and projects like ethereum that have established smart contracts (which can ensure that a contract’s obligations are met before coins are exchanged). given the expanded functions of new digital and crypto currencies, any conversation about digital currencies can no longer just be limited to bitcoin. many of these cryptocurrencies are classified as commodities. a commodity is a form of money that is also seen as having some form of intrinsic worth. so, in the past this has included shells or animals (adam, 2017). cryptocurrencies such as tokens can fit in this category since they not only can be traded, but they can also be used to build programs or apps onto a blockchain.4 yet, because of the very new nature of digital currencies, there exists little conversation about the compatibility between such currencies and islamic law, let alone detailed discussions about specific classifications of digital currencies. therefore, what we seek to do in this article is to briefly discuss the history of money in early islam, examine issues with traditional fiat currency from islamic perspectives, and then argue that these new digital currencies solve many of these fiat issues, making them preferred to “traditional” money when it comes to themes in islamic finance and islamic law in general. ii. islamic finance one of the primary questions that islamic scholars, financial analysts and bankers have asked within the conversation of bitcoin and islamic finance is whether bitcoin 4 ethereum is one such example. ethereum is a smart contract focused blockchain platform that allows for different applications to be built upon it, which provides actual intrinsic value to the currency. as rosic (2016) points out, “ethereum’s smart contracts use blockchain stored applications for contract negotiation and facilitation. the benefit of these contracts is that the blockchain provides a decentralized way to verify and enforce them. the decentralized aspect makes it incredibly difficult for fraud or censorship. ethereum’s smart contracts aim to provide greater security than traditional contracts and bring down the associated costs. the smart contract applications are powered by ether, ethereum’s blockchain based cryptocurrency. ether, as well as other crypto-assets, are held in the ethereum wallet, which allows you to create and use smart contracts.” (and, given their new arrival, to a lesser extent, other cryptocurrencies) are compatible within the regulations of islamic finance. in order to better answer this question, in terms of methodology, we must first look at what various islamic scholars have said about the issue of money (and more specifically, paper money), as well as precious metals as a form of currency, and their compatibility with the quran and also the life and sayings of muhammad (the hadith) (choudhury, 2014). when discussing islamic law (and islamic finance), it is important to remember that all of islamic law has a long history, with various interpretations of different elements within this category of shariah (islamic law). this can be seen when discussing law in general, the role of islam in government, human rights (shah, 2006), etc… however, there is often a misconception that there exists a unified, agreed upon understanding of islamic law; the reality is far from this. throughout the centuries, islamic scholars debated matters such as money, interest, loans, charity contributions, etc… even to this day, a variety of opinions exist on such issues. without a religious hierarchy throughout much of the faith, along with the allowance for ijtihad (personal interpretation), several schools of thought have emerged out of the islamic tradition, each with their own interpretations of law and islamic finance. in order to examine the relevance and compatibility of digital currencies and islam, it would be useful to begin by looking at the role of money in early islamic history, as well as how paper money has been viewed by islamic scholars. by outlining positives and also critiques of “traditional” forms of money, we can then use this bar to compare it with digital currencies. again, today, paper money is often viewed as a “given” in terms of finance. while fiat is currently the most widely used form of money, we have to remember that this was not always the case; the advent of paper as a form of currency is a relatively newer phenomenon in the history of money. prior to that, things such as gold, silver, or goods served as mediums of exchange between people. examining the early islamic holy text of the quran, there are no specific guidelines on what money must look like (adam, 2017). during the time of muhammad in mecca (in the late 500s and early 600s), common forms of money included raw materials, as well as coins from the byzantine era. during the early islamic empires—beginning during the 18 hejira, the government issued its own dirhams (silver), whereas it was later, during muawiya’s rule that gold coins began to be minted and used. it was until the time of ‘abd almalik ibn marwan that byzantine coins were still used. during these periods, “coins were treated like raw metal: people continued to weigh rather than count them. another reason that weighing remained the most important way of measuring the value of money was that wear and tear afflicted coins so that they would lose weight over time…in general, coins were still objects of trade with respect to their silver or gold content rather than simply an exchange medium, and were weighed rather than counted” (siegfried, 2001). it was during malik ibn marwan’s rule that “a regulatory control http://blockgeeks.com/guides/smart-contracts/ ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 over the circulation of money came into existence through the establishment of a network of mint houses to issue coins which replaced the foreign currency” (ahmed, 1989: 39). this notion of currency continued to be structured on the gold and silver content of a coin (ahmed, 1989), and in fact, the exchange rate between gold and silver was something that scholars of islam have argued within the fiqh tradition (siegfried, 2001). things like copper (without the valued metal content of gold or silver) were often viewed in the category of al-istilah (token money), whereas gold and silver coins were seen as thaman khilqatan (real money).” the different schools of islamic thought have wrestled with the questions about how to treat gold and silver currencies (siegfried, 2001). yet, as siegfried (2001) writes, “…the introduction of paper money changes the situation fundamentally. as soon as paper money assumes the prominent role in economic transactions, a new legal concept has to be developed, which incorporates this new form of money.” and because “no currency is based on the gold standard…other concepts from classical islamic legal thought have to be employed to embed paper money in the theories of fiqh” (327). the idea of gold and silver as money has not been heavily contested in general (or specifically in islamic) history. in fact, some, such as al ghazali, viewed these precious metals as money god specifically created to be used (adam, 2017). however, in the 20th century, we began to see a great shift away from silver and gold (and the gold standard) and more towards paper money. because of this change, islamic scholars—to this day--continue to debate as to whether paper money is an acceptable form of exchange. while a number of scholars have suggested an acceptability of paper money within islamic law5, others have argued that fiat money, in its current state are “haram” or prohibited in the faith. for example, anwar & haque (1993) write: “fiat money is an innovation whereby governments extract resources from the people. issuance of fiat money itself is contrary to the principles of islamic justice as it entitles the issuing authority to “steal” commodities belonging to the people. the qur’an has clearly prohibited such transactions declaring them unjust [al-baqarah: 188]. besides, the qur’anic principle of mutual consent [al-nisaa: 29] in transactions is also violated as the people are coerced to relinquish part of their properties against fiat money which has no intrinsic value. therefore, fiat money cannot be considered at par with commodity money or paper money fully backed by commodities in discussing the question of riba” (962). other islamic scholars have been even more critical of paper money. one of the most direct critiques of paper money from an islamic perspective in recent years comes from three asatizah (scholars) of al-munawwar (2013). muhammad 5 for the different ways that islamic scholars have argued for the justification of paper money within islamic jurisprudence, see siegfried (2001). noor bin muhammad deros, amiruddin bin muhammad zain, and muhammad faisal bin muhammad ayub wrote a text entitled “the dazzling proof for the return of our pure money: the judgment on fiat currency.” in this text, among other things, they argue that fiat is unacceptable since it is not a store of value6, it itself has no value, and it is inflationary. they are also critical of fractional reserve banking7, and say that “since banking took control of the money supply of a country and as a result, the price of goods and services are deliberately forced to be raised and as an inevitable result, the value of the money in our possession (purchasing power) keeps falling.” what is also interesting to note is that in preislam (and early islamic society in arabia), “[t]here was no government control over the circulation of money, except that the second caliph minted some dirhams on the existing design at a very limited scale and these coins were in use along with the foreign coins.” while there are a few articles on islamic finance and bitcoin, the literature on the topic is still in its infancy. moreover, few societies in general (whether islamic or not) have fully embraced digital currencies; at the time of this writing, these currencies are still in the early stages of adoption. however, we are seeing much more attention to digital currencies, even within the islamic context. to give just one example of the developing intersection, in may 2017 marked the beginning of an islamic digital currency called onegram (das, 2017; maierbrugger, 2017). with regards to the currency, “onegram sees each coin backed by one gram at launch at its launch, with onegram’s developers pointing to the resiliency of gold over fiat money. every onegram transaction generates a small fee, which is reinvested to buy more gold to increase the gold reserves backing the token. the developers plan is to add more gold if or when transaction volumes increase with profits to be shared among all 6 this concept of wealth (māl) as being stored has been an important point of conversation in islamic circles pertaining to classifications of money (adam, 2017). bitcoin and crypto currencies seem to succeed much better than gold or fiat in terms of storing the currencies (since they can be done digitally, and accessed anywhere in the world with the private keys). 7 a number of scholars have suggested that in approved islamic finance, operational banks should have sufficient currency to back all accounts held at said bank. this way, the bank customer knows that their money is not only always safe, but that they can also access this money whenever they please. but while banks rarely have full runs on accounts, this of course has happened in the past (i.e. 1929 us stock market crash, or more recently, in cyprus7 and also greece7)). this itself is a problem. in islamic finance, there is a belief among many scholars that assets must actually be owned. however, with fractional-reserve banking, “only a fraction of bank deposits are backed by actual cash on hand and are available for withdrawal. this is done to expand the economy by freeing up capital that can be loaned out to other parties” (investopedia, 2017). however, martin (in dhaliwal, 2017) argues that “as a payment network, bitcoin is halal. in fact, bitcoin goes beyond what more conventional closed banking networks offer. unlike conventional bank networks which use private ledgers where there's no guarantee that the originator actually owns the underlying assets, bitcoin guarantees with mathematical certainty that the originator of the transfer owns the underlying assets. conventional banks operate using the principle of fractional reserve, which is prohibited in islam.” ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 onegram investors” (das, 2017). the board of onegram includes scholars of islamic law and finance, who serve to ensure that the coin complies with islamic finance (aitken, 2017). while the future of this currency is unknown, it is evident that there is at least some interest in finding ways to incorporate blockchain technology and digital currencies within ideas of islamic finance. iii. forgery another issue that early islamic leaders had to deal with pertaining to money was the forgery of coins. for islamic scholars, ideally currency would be unable to be forged, since counterfeit currency is of course deceptive, and puts an individual at risk for acquiring said currency. looking at historical conversations pertaining to counterfeit currencies, as siegfried (2001) explains: “…since not only counterfeiters but also rulers frequently melted the coins to change their alloy, the share of precious metal in a coin reduced over time. money with a low content of gold or silver, maghshush money, was continually used, forcing the legal scholars to deal with the question whether these coins were acceptable.” (321). thus, even currency made of gold was not without its problems. today, there are still serious risks pertaining to gold fraud. as redman (2017) writes: “over the years, many have claimed that gold is scarce and is hard to counterfeit. however, there have been cases that have proven gold is not as scarce as we think and the soft metal is often substituted with phony imitations.” for example, in 2017 “in edmonton canada, local law enforcement officials issued a warning to the public about a potential fake gold bar scam. various merchants in edmonton purchased fake bars last year, that investigators reported to be “professionally packaged and authentic.” “we tested the product for authenticity and quickly determined these gold bars were nothing more than copper bars plated in gold,” explained eps criminal investigation officer robert wellon”” (redman, 2017). also in 2017, “investigators in china revealed an ongoing investigation in which they discovered a fake gold operation stemming from the boyuan mining company. the knockoff gold bricks allegedly scammed investors and financial institutions out of 11 billion cny. moreover, the gold was used to secure mortgages and pledge loans from the people’s bank of china and shanxi province rural credit cooperatives. using gold as collateral for loans and real estate deals is common in china. suspects used 62 percent tungsten in the forged bars, but the outer shells were solid gold” (redman, 2017). then, there is another related matter, which is the issue of counterfeit money. for example, in 2012, “…as much as $220 million in counterfeit cash [was] circulating in the u.s. …” (zeveloff, 2012). in the 2015 fiscal year, the u.s. secret service “seized about $146 million in fake bills” (wilber, 2016). part of the problem is the amount of profit that can be made by counterfeiting coins. as worstall (2016) explains “printing a banknote is a vastly profitable enterprise. the us federal reserve tells us that it costs 20 us cents to produce a $100 bill. something they then sell for $100 of course. [this] [could well be the most profitable enterprise on the planet…” bitcoin offers a solution to such a problem. again, not only is there a set supply of bitcoin, but also, the bitcoin itself cannot be altered or manipulated. in every transaction, everyone knows that exact amount of bitcoin that they are either sending or receiving. there are no questions about the authenticity of the bitcoin (or cryptocurrency). since everything is done mathematically, it is not possible to create “fake” bitcoins since “[t]he network will not accept a forged bitcoin and will reject anyone trying to double-spend any unit in this capped supply” (redman, 2017). so, when looking at the creation of bitcoin compared to fiat, there are a number of advantages bitcoin offers. as evans (2015) argues, contrast the creation of [bitcoin] with the creation of fiat:  [bitcoin] is free of riba, whereas fiat is lent into existence in exchange for riba.  the face value of the goodwill backing [bitcoin] is, by definition, exactly equal to the value of the xbt in circulation, whereas the face value of loans backing fiat is, by definition, greater than the value of the fiat in circulation, due to present value discounting; the excess value represents the issuing bank's equity, thereby granting it a perpetual advantage over fiat holders.  new units of [bitcoin] come into circulation in exchange for the expending of real resources to maintain the integrity of the bitcoin system, whereas new units of fiat come into circulation at the will of individuals who borrow them into existence, whenever they deem it desirable to do so.  the quantity of [bitcoin] in circulation increases at a predictable and decelerating rate until it reaches its ultimate cap of 21 million units in circulation—each divisible to the 1/100  [bitcoin] is backed by the expectation that it will enable transactions for real goods and services that hitherto have been prohibitively expensive or even impossible, whereas fiat is backed by debt denominated in itself with a face value greater than the total amount of fiat in circulation. iv. risk (gharar) and inflation in islamic finance, the term gharar means “risk,” or “excessive uncertainty” (redman, 2015). islamic scholars have argued that any forms of payment used must be free from gharar. so, any types of transactions that bring about risk should to be avoided. some islamic scholars have viewed paper money—due to inflation--as fitting within this category ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 of possible exploitation, whereas bitcoin (and cryptocurrency) passes this condition. with paper money, there is always a risk that the money is counterfeit. with bitcoin, there is no risk as it pertains to counterfeit coins; the digitalization on the blockchain keeps an accurate bookkeeping for the amount sent in a transaction. with governments continuing to print money without end (or without pegging the currency to a precious metal such as gold), this leads to a decrease in the overall value of the currency. if a government gets too out of hand with overprinting money, this could lead to high inflation, which could result in little to no trust (or value) for the said currency. in islamic finance, inflation is thus seen as a problem, and thus, maintaining value is of the utmost importance. as chapra (1996) writes, “stability in the value of money should be accorded high priority in the islamic frame of reference because of the unequivocal stress of islam on honesty and fairness in all human dealings and because of the negative impact of inflation on socio-economic justice and general welfare.” thus, to chapra, “inflation is in conflict with islamic values” (31). in fact, one of the major problems that bitcoin and other cryptocurrency enthusiasts point out with government controlled fiat (paper money) is that this paper money can continue to be printed, at little cost, by a state. this in turn however will lead to inflation, given the continued addition of more and more paper money into the monetary system, thereby weakening the value of said currency. we can see why this is so problematic when looking at the case of a loan. say for example that there are two individuals, person a and person b. person a wants to borrow 5000 dollars from person b, and will pay the person back after one year. for the sake of simplicity, we shall say that there is no interest placed on the loan. now, given inflation of say two percent, when the person pays back the loan, those 5,000 dollars is actually worth 4900 dollars. now, a counterargument that some might be tempted to make is as follows: given the volatile nature of bitcoin and other cryptocurrency prices, couldn’t usury exist in the same fashion? if you believe the cryptocurrency will go down, then, could you borrow the digital currency, and then pay back the amount when it could be worth less than what one borrowed it for? in theory, this is correct, but the difference is that price fluctuations for the digital currency are not due to government inflation, but rather, trading in the currency by investors. with fiat, you have the trading of the currency for investment, but also the potential for government inflation of the currency. it is for this reason that some islamic scholars have advocated gold reserves for fiat to prevent inflation and also excessive risk (siegfried, 2001). however, the issue of inflation is not a problem for max-supply digital currencies. max supply digital currencies are deflationary currencies; the total amount of coins/tokens is predetermined, and thus, no additional coins (outside of the specified maximum supply) can be created. moreover, digital currencies are mined, and there is an expensive mining cost for digital currencies. fiat’s flaws are quite apparent, and open up greater possibilities of riba or usury. as ahmed (1989) writes, “…[t]here is a likelihood of an inverse emergence of riba, if the loss of depreciation is not fully compensated” (43). so, unless there was some form of compensation, islamic scholars were worried about someone being taken advantage of by loaning out money that would decrease in value because of inflation. cryptocurrencies, in theory, do not have this problem. since the supply is fixed for many digital currencies, once price stabilization on cryptocurrencies is in place, then there is no fear that supply will continue to rise. this same cannot be said for fiat, or even gold (since we do not know just how much gold actually exists in the world), and this absolutely cannot be said for paper money, which continues to get printed with very little regard to concerns about inflation. as matthew joseph martin, founder of blossom financial (in dhaliwal, 2017) argues, “bitcoin is more halal than any currency in wide circulation today but probably still falls short of the strict and narrow definition of money in islam. modern sovereign currencies are based on debt with usury this is strictly prohibited in islam. therefore, all modern money is not halal. bitcoin, on the other hand, is not based on debt it's based on a proof of work and this is at least not haram (impermissible).” again, digital currencies solve this problem. with a recognized form of digital currency, say bitcoin, there is never any uncertainty as to the overall supply of the coin. coins could be lost (and it is said that millions have been lost or thrown away), but no more than the capped amount (in the case of bitcoin, at the very most, only 21 million) will ever exist. no individual or government can ever do anything to change this. this poses a very attractive solution to that of governments inflating currencies, and a solution that i believe is much more just and fair, and thus, more aligned with islamic principles of finance. some, such as chapra (1996), suggest that the islamic central bank, for example, can serve a positive role here by ensuring no sort of monetary inflation. he argues that this bank “should estimate the demand for money at full employment within the framework of stable prices and other socioeconomic goals of islam and try to regulate the supply of money accordingly. hence the variable in terms of which monetary policy should be formulated should be the desired stock of money and not the rate of interest. the objective should be to ensure that inflation does not arise, and the citizens’ interests are always the only priority. while this idea is great in theory, sadly, there still exists a leap of faith that the bank will actually follow these prescriptions, namely, do what is best for the people, ensuring that inflation does not arise. but we cannot assume that banks and governments implement political and financial policies that best serve the interests of the people. time and time again we see governments continuing to print money, and pushing economic and financial policies that benefit them, or particular groups of constituents, and often at the expense of what may be good for society as a whole. digital currencies solve this problem. by removing the need for a central bank, or the government as the ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 controller of money, peer-to-peer transactions based on a constantly fixed supply will ensure that no policy mistakes (or corruption activities) will be able to inflate the currency. by removing self-interested politicians and bankers, we are left with a decentralized currency that is solely in the hands of the people. in fact, those, like chapra (1996) (writing many years before the birth of digital currencies) recognized the need (and also difficulties) of states to do what is right. he wrote that “while the above strategy does recognize the importance of regulating the stock of money in the successful management of the economy, it does not necessarily imply a simple monetarist approach or any commitment to its ideological overtones. there is no presumption that market forces left to themselves will be able to generate sustained non-inflationary growth, remove unemployment, reduce external imbalances and help realize the other desired goals if the growth of money supply is appropriately regulated. it should, in fact, be emphasized that for a full realization of the islamic goals, it will not only be indispensable to reform the economy and the society along islamic lines but it will also be necessary for the state to play a positive role. all state policies, including fiscal, monetary and income policies, would have to converge in the same direction…” (36). so, he offers ways in which we can ensure that the problems of inflation do not arise. he speaks against fiscal deficits, as well as credit from commercial banks, and also balance of payments surplus (chapra, 1996). however, there is an expectation that the state and the central bank use the resources for the benefit of the islamic community. again, this is a problematic assumption; many digital currency enthusiasts argue that it is exactly because banks and governments do not make decisions best suited for the people that a decentralized digital currency is necessary. v. islam and anti-authoritarian principles one of the other attractive features of digital currencies such as bitcoin is its decentralization, and also independence from any central government and/or bank. given the history of government and bank exploitation of money, there is a great demand for currencies that are outside of the control of these entities. thus, “[t]he weakness in existing currencies stems from lack of faith in institutions— particularly central banks, which are often in league with commercial and investment banks. when a government bails out a failed bank or insurance company—in essence, by printing money—the net effect is that the currency as a whole is debased, in favor of a few and at the literal expense of everyone else, which amounts to a fair description of today’s global financial system. hence the sudden appeal of [b]itcoins, which appear, for the moment, at least, to be immune to the machinations of inept or crooked bankers and politicians” (new yorker, 2013). time and time again, irresponsible government and bank decisions have led to serious problems for citizens of a country as it relates to their money. again, oversupply leads to inflation, which devalues the wealth one has. moreover, in cases where there are concerns about the solvency of the state, it is rather easy for the government to place restrictions on citizen behavior pertaining to accessing their money. with cryptocurrency, the power of control is fully in the hands of the individual. with “larger” amounts of money, storing them with gold begins to be a very difficult task (having gold bars at home is not only difficult to hide, but gold is also challenging to transport). with paper money, similar things can be said. furthermore, storing money in a bank always leaves one to secede some power and trust into the banking system; you expect that your money will be there, and you also hope that you can get access to your money when you please. but with cryptocurrencies, any such concerns are avoided. since the currency is digital, storing large amounts no longer becomes an issue. moreover, since you have your own private keys, nobody else on the planet can access your money. this cannot be said for bank storage. as martin points out, “[o]ne nice aspect of [b]itcoin is that it ensures ownership of underlying assets with 100% mathematical certainty” (redman, 2015). the issue of bankers’ control over money was a serious concern to nakamoto (2009), who wrote: “[bitcoin is] completely decentralized, with no central server or trusted parties, because everything is based on crypto proof instead of trust. the root problem with conventional currency is all the trust that’s required to make it work. the central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. we have to trust them with our privacy, trust them not to let identity thieves drain our accounts… with e-currency based on cryptographic proof, without the need to trust a third party middleman, money can be secure and transactions effortless” (in new yorker, 2013). so, despite critiques from a number of voices in the banking industry about bitcoin and other digital currencies, when one looks at the behavior of the banking industry, one comes to a realization that it is not bitcoin that should be on the defensive about its use, but rather, some current banking practices. vi. conclusion in this paper, i discussed the problems with paper currency as it pertains to islamic finance. inflation, unlimited supply, government abuse, as well as forgery make fiat currency less than an ideal currency for islamic finance and banking. counter to this, bitcoin and other digital currencies seem to be much more aligned with principles of justice and social fairness, characteristics valued in islamic jurisprudence. ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 bitcoin’s capped supply (its inability to be inflated), the ease of transport, and decentralized nature are all positive aspects to the currency, in essence giving power to the people, and not governments or banks. moreover, bitcoins and other digital currencies cannot be double-spent. moreover, bitcoin cannot be forged, something that continues to plague coins and paper money. as mentioned in the footnote above regarding ethereum, there are still other ways that currencies and crypto tokens will provide benefits to society in a way that “traditional” currencies cannot do. one such way is the use cases for crypto currencies. for example, more and more cryptocurrencies are being used for smart contracts. whereas paper money does not provide any specific value in and of itself, these digital currencies like ethereum that allow for smart contracts allows more trust in everyday transactions, which provides additional value for the crypto currency. as we can then see, this is yet another advantage of digital currencies to paper money, something that would thus be in line with conditions specified within elements of islamic finance. another place for the use of cryptocurrencies and blockchain technology is with regards to social development based projects. as martin (in dhaliwal, 2017) writes, “i think the immediate opportunities lie in micro microfinance and micro-takeful, for example. i also see huge potential in the use of smart contracts for cross-border crowdfunding and also islamic modes of financing, such as mudaraba/musharakah (profit sharing) and muraba. i think there's also an interesting angle for micro-takeful (sharia-compliant insurance) to use crypto”. groups such as blossom financial have been relying on bitcoin and other blockchain technology for micro-lending and profit sharing structures (blossom financial, 2017). you are beginning to see “[m]ajor aid agencies, nonprofits and startup companies…working to extend blockchain systems across the developing world to help poor people around the world get easier access to banks for loans or to protect their savings” (kshetri, 2017). this itself is a large problem with current banks and financial institutions. as andreas antonopoulos (2017b) argues, the current system “…does enormous harm…part of the reason that billions of people have no participation in the world economy, are financially excluded, is directly related to the fact that a closed financial system, where authority is given to few, to decide who is good, and who is evil, to decide who should have access to money and who should not, and which starts with a fundamental idea of identity being a requirement for every endpoint of every transaction is a system that will always exclude billions. in the age of the internet, we have come no further in terms of financial inclusion, and in fact, we are now backtracking. entire countries, entire continents are disconnected from the world economy in order to satisfy the moralistic, bourgeois idea that we are safer if we allow bureaucrats to decide who has access to money, and who doesn’t” (antonopoulos, 2017b). since so many poorer individuals have no access to banks, cryptocurrencies and blockchain technology are providing them the ability to have power and protection over their own wealth, without relying on banks or the state. this is therefore a new, empowering system of finance that is highly compatible with islamic finance and islam’s message of justice for all people. i imagine that islamic finance scholars will continue to discuss points around digital currencies, especially as digital currencies (which are still in their infancy) grow in popularity and usage, as well as the investment aspect of cryptocurrencies. with the opening of futures trading on bitcoin in december of 2017, there will also most certainly be questions on whether futures contracts are compatible with islamic law, since, as aitken (2017) notes, “in most cases trading gold futures contracts is forbidden by islamic law as gold futures contracts are not backed by physical gold and one can end up paying or receiving interest on your trading account. the upshot is that most people who wanted to buy gold as an investment have purchased gold in its physical form through for example coins or [jewelry].” now, it must be important to note that futures trading is done through existing financial institutions, and has no direct relation on the underlying element of digital currencies; it is a way for institutions to become investors. so while the conversation about this practice should be had, critiques of futures trading should have no bearing on one’s opinion of digital currencies, because they are not one and the same. the same can be said for crypto trading. for example, on january 1st, 2018, shawki allam, who is the grand mufti of egypt, issued a fatwa (islamic ruling) said that because of the risk in trading, participating in crypto currency investing is prohibited. allam also criticized bitcoin’s potential use for activities such as money laundering (zhao, 2018). something else that might lead scholars to challenge digital currencies such as bitcoin is not related to the underlying digital currency use, but rather, the harmful effects of mining. one of the concerns is that bitcoin has “a high ecofootprint,” having a negative effect on the environment (bergstra, 2015: 13) in the case of bitcoin, the digital currency (and many other digital currencies) run on a “proof of work” system to verify transactions, “as [b]itcoin grows, the math problems computers must solve to make more [b]itcoin (a process called "mining") get more and more difficult— a wrinkle designed to control the currency's supply. today, each [b]itcoin transaction requires the same amount of energy used to power nine homes in the u.s. for one day. and miners are constantly installing more and faster computers. already, the aggregate computing power of the [b]itcoin network is nearly 100,000 times larger than the world's 500 fastest supercomputers combined” (holthaus, 2017). moreover, “the total energy use of this web of hardware is huge — an estimated 31 terawatt-hours per year. more than 150 individual countries in the world consume less energy annually. and that power-hungry network is currently increasing its energy use every day by about 450 gigawatthours, roughly the same amount of electricity the entire country of haiti uses in a year” (holthaus, 2017). ejif – european journal of islamic finance no10, august (2018) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 however, there are arguments that also challenge this idea that bitcoin mining is troubling for the environment the way critics suggest. for example, antonopoulos (2017a) argues, “the energy consumption in mining…is misrepresented very often in two ways. one is that mining itself is one of the few industries that is completely geographically independent, meaning that it doesn't matter where you are if you are mining as long as you have inexpensive electricity. so what that allows you to do is choose the location of your mining system based entirely on the local cost of electricity, which means that mining is doing arbitrage.” thus, they are simply going where energy is least expensive. he goes on to say that cheap energy often exists in an area because “it does not match the demand at that location” so, by building power plants for the near and long term future, they are often built thinking about future needs. but, for the short term, this leads to a disparity between demand and supply. because it is often difficult to shut off this energy (in the case of wind, for example), antonopoulos (2017a) argues that through mining, you can “turn that energy into an alternate store of value” and reduce the time to pay off your investment. second of all, he also argues that bitcoin is targeted because it is more “obvious,” but that many other sources of finance also have energy issues that often get overlooked. for example, behind credit cards are data centers that use mass amounts of energy. as antonopoulos (2017) argues when we every use of a credit card, we don’t think about the energy data centers use, or offices, banks, cars transporting money, trucks, etc… nevertheless, this doesn’t means that we still cannot think about ways of making cryptocurrencies compatible with ensuring a clean environment. newer cryptocurrencies can consider the advantages of operating on a “proof of stake” system (where people stake their coins as a form of confirming transactions) and its potential effect as a more environmentally friendly option. or, there could be reform within the proof of work system. 8 or, with mining rewards reduced over time, this itself could lead to declines in energy usage (antonopoulos, 2017a). but despite these concerns, bitcoin and other cryptocurrencies continue to revolutionize the way we think about currencies and money. moreover, from an islamic perspective, cryptocurrencies offer characteristics that far supersede traditional currencies, attributes that are fully in line with islamic value of social justice, values that counter corrupt governments and predatory financial institutions. as such currencies become more and more popular throughout the world, we can expect increased attention and conversation on the role that they play in islamic banking and finance. references 8 for a discussion on solutions to mining as it relates to bitcoin, see bergstra (2015). adam, 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nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 social finance and financing social enterprises: an islamic finance prospective department of management, university of turin, italy, paolo.biancone@unito.it department of management, university of turin, italy, maha.radwan@unito.it abstract— enterprises that have a dual objective of generating positive social impact and financial economic benefit turned to be vital with the increased level of poverty and other major social problems accompanied with limited public spending. the growth and development of social impact enterprises is fundamental for all economies and financing them is a challenging issue where they struggle to accessing finance. traditional financial instruments are difficult to access especially after the recent financial crisis due to that social enterprises face high risk regarding generating profit, problems of governance model, and lacks of performance measurement valuations especially when it comes to measuring social value. on the other hand, islamic finance has experienced progressive growth in the last years and could play significant role not only limited to muslims but also for non-muslim countries. advances in islamic finance and social finance demonstrate an increasing global attention for finding alternative ways of financing and creating value in the society since both of them have similar ethical dictates. sharia that regulates all islamic financial instruments and investments and its screening methodology prohibits unethical businesses and practices that are similar to the negative screening methodology adopted by the socially responsible investment which make both of them connected to social finance. this paper is exploratory in nature and argues that islamic finance could be a viable potential alternative with its diversified instruments for financing social impact enterprises. the paper provides insights for researchers, decision makers, and practitioners of how islamic finance provide valid financing tools for social finance through mobilizing private funds allocated from investors who seeks investments that generate both social and economic value. keywordssocial finance; islamic finance; impact finance; social enterprises; sharia compliant i. introduction the increment of poverty and unemployment, the emergence of several social problems, the limitations of public spending, and the environmental changes problems have all called for an innovative approach for overcoming such social problems through blending a social objective with businesses. social entrepreneurship emerged in the private, public and nonprofit sectors to reduce social problems, alleviate poverty and to strengthen the relationship between entrepreneurs and society from perspectives such as charity and philanthropy as well as social services [1], [2] social entrepreneurship is an emerging area of research which examines business that is significantly influenced by social impact instead of being purely economically driven [3].social entrepreneurship turned to be a phenomenon that impacts the society by employing innovative approaches to solve social problems [4]. social entrepreneurship is not limited to creating employment opportunities and improving economic growth; but it contributes to the well-being of the community [5]–[9] . the social enterprises is considered a catalyst for the development of civil society and the need for their advancement through new strategies that are innovative in terms of models, tools, and instruments is necessary. focusing on social impact enterprises that have a dual objective of generating positive social impact and financial economic benefit is fundamental for all economies however on the other hand financing them is a challenging issue where they struggle to have access to finance. social enterprises face many challenges in accessing finance due to the high risk regarding generating profit, problems of governance model, and lacks of performance measurement valuations especially when it comes to measuring social value. social enterprises seek finance from banks, venture capitals, grants, public funding, and others but traditional financial instruments are difficult to access for such enterprises especially after the recent financial crisis. the public sector and governments are urged for finding innovative and alternative sources of financing like for example tapping the islamic financial instruments as an alternative. islamic finance has many principles that makes it very close to social finance like risk sharing and calls for social justice and welfare. the dynamically increasing importance of the culture and religion in developing impact finance can be seen especially when religion has a positive approach towards it [10]–[12]. there are solid evidences in islamic history for financing the social sector using islamic financial tools like zakat (obligatory charity) sadaqa (voluntary charity) and waqf (perpetual endowment). these financial tools participated heavily in the development of public facilities and services in the past; where it has meant reduced burden on the part of the government to raise for public spending; it is considered a clear notable beneficial effect that a well-designed waqf system can have on a country’s ethical, social, and economical status [13]. paolo pietro biancone1 and maha radwan 2 mailto:paolo.biancone@unito.it mailto:maha.radwan@unito.it ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 therefore, islamic finance could play a big role to enhance the development of the social enterprises expanding its universe of sharia compliant products to develop more innovative instruments that provide solutions to social problems and promote social welfare. islamic financial instruments like zakat, waqf, microfinance and sukuk (islamic bonds) could be a potential solution and fitting as tools for poverty alleviation, enhancing financial inclusion and maintaining sustainable growth. islamic finance industry has been growing remarkably in the previous years whether for islamic or western countries [14] where muslims counts for around 24% of global population and islam is the world’s second-largest religion with the fastest growth rate [15]. according to the banker [16] islamic finance assets have a compound annual growth rate of 12.7%. while western countries like uk and switzerland were listed in the top 20 largest countries in total sharia-compliant assets. conventional financial institutions have extended their operations to provide islamic financial products targeting islamic investors. moreover, entrepreneurs financed by banks have been gradually increasing in most of the countries where islamic banks operate and this is because of more awareness and greater supply for entrepreneurs who have started demanding islamic products. despite of the expansion and growth of islamic finance in the previous decades, but the full potential is not yet realized specially in the social arena [17]. expanding to new innovative financial tools is required that could be reached by developing tools that can take into consideration the aspects of both risksharing and social impact [13], [18]. there is a criticism to islamic finance industry concerning the lack for innovative solutions for social objectives like for example mobilization of zakat and sadaqa endowment funds to create financing for sustainable social projects for making a difference on welfare of societies. in addition, institutions that regulate and manage zakat funds were often been described as incompetent and inefficient [19]. a plenty of researches have been conducted on social finance from different prospective, there has been few studies that takes into consideration the connection between islamic finance and social finance [20]. the motivation of this paper comes from the global progressive attention towards supporting social impact e and empowering social enterprises, where a research on the linkage between islamic finance and social finance is highly important and necessary as well as developing new models to expand the universe of sharia compliant financial instruments which can provide financing for projects with social returns. this paper is exploratory and conceptual in nature that provides insights for researchers, decision-makers, and practitioners of how could be islamic finance used as a valid financing tool for social finance. this paper is organized as follows: section two starts with background of islamic finance in a way that explores its principles and its relation with social finance. in section three we provide the screening methodology of businesses to be considered sharia compliant. section four discusses the instruments of islamic financing and exploring how it could be valid for supporting social finance. finally section five concludes. ii. islamic finance: background islamic religion calls for a comprehensive development of an economy and puts emphasis on social welfare and urges for maintaining social justice, equity, and poverty alleviation [21], [22]. its teachings stresses on the duties of muslims towards humanitarian and social welfare [23] the concept of the maqasid al sharia (purpose of sharia) upholds the principle of serving the public interest of maximizing benefit and reducing harm of the community. thus eradication of poverty, socio-economic justice are among the primary goals of islam [24] that is based on adl (social justice) and ihsan (benevolence) [25], [26] which makes islamic finance attractive to the western countries is that this financial system operates in an ethical way similar to the socially responsible investments [27]. in addition, islamic finance with it various financial products is not limited to muslims but on the contrary available to everyone [28], [29] and this is confirmed by its diffusion and ability in attracting the attention of the investors, financial institutions and regulators as a valid alternative to conventional one [30]. islamic financial instruments should all follow the sharia dictates. sharia are the set of rules derived from the main resources quran and sunna and other sources like ijma and qyias (consensus and analogy) covering all aspects of a muslim’s life [31], [32]. sharia prohibits; 1) riba (usury/interest), 2) gharar (speculation/uncertainty), 3) maysir (gambling), 4) investing in haram (unpermitted) activities and business like alcohol, tobacco, pork-related products, adult entertainment (pornography), and weapons [27], [33]. moreover some other concepts should be maintained like; 1) investments should be asset-backed or identified to an underlying tangible assets, 2) application of the profit and loss concept (pls) [34] , 3) fulfilling the obligation of zakat (charity) towards the poor and needy. the islamic finance have a various array of products from islamic micro lending and microfinance to the issuance of “sukuk” (islamic bonds) [35], [36]. given the main problem is lack of financial access; alleviating poverty will be creating wealth through development of social enterprises; islamic tools could support social enterprises as a way to empower the poor and graduate from poverty through micro financing, zakat which is obligatory , and waqf as an voluntary charity. iii. sharia compliance screening due to the requirements of the sharia screening criteria for qualitative and quantitative criteria since investments should be always a sharia compliant. the qualitative criteria are mainly related to the business activity of the company and it permissibility according to sharia and the quantitative criteria are a set of financial ratios and levels that had to be examined. islamic finance could be seen as part of social finance which ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 can be defined as an approach to mobilizing private capital that delivers a social dividend and an economic return to achieve social and environmental goals. both islamic finance and social finance have many similarities in terms of ethics and social goals. for example both exclude companies with business activities (qualitative criteria) which are considered unethical like: alcohol, tobacco, weapons and pornography. passing this initial qualitative screening phase means moving towards a quantitative financial screening. in addition, financial structure (quantitative criteria) should be free of interest (usury), speculation, gambling, and uncertainty [37]. thus a financial screening for the level of interest, the level of liquidity, and the level of leverage in any enterprise that muslims should invest in should not exceed certain threshold. the strong correlation between business and sharia principles has strong consequences on the business activities where investments or earnings should be sharia compliant [38]–[40]. the ownership of any share of a company or investing in a business or being a partner in a business within the sharia concept should be done in a full adherence to the sharia principles. sharia compliant usually done through negative screening where it ensures investors that the money they invested is not used to support investment that is prohibited by islam, these investors are not given the opportunity to affirm their belief in a more positive manner, that is to pro-actively direct investment to areas which have important impacts from the maqasid sharia point of view. iv. islamic finance tools for social finance finding innovative ways of financing especially for social impact enterprises could be found in tools like waqf, zakat, sukuk waqf, sharia compliant crowd funding, and microfinance. one of the new innovative financial resources is the impact investments, where funds are allocated from investors who are seeking investments that generate both social and economic value. a social business is a social objective oriented entrepreneurship that applies commercial strategies to maximize improvements in human well-being rather than maximize profits [41]. social business is expected to bridge the gap of the public and private sectors to achieve their socioeconomic goals. this type of social business similar to islamic finance for having a main primary scope of community benefits, rather than individual benefits. the islamic development bank (idb) and the undp issued a report “i for impact: blending islamic finance and impact investing for the global goals” that is considered a key step forward in conceptualizing islamic finance-based impact investing, and building an ecosystem in support of this idea. the idea of social impact enterprise is increasingly gaining attention due to it stability for income generation while offering societal contributions. the social enterprise is known in the western countries with a concept of that surpluses earned would mainly reinvested in the business or in the community oriented, rather than being driven for maximizing shareholders’ wealth-oriented [42], [43]. thus having a dual objective of financial sustainability and social purposes [44]. islamic finance has various array of social instruments demonstrated in waqf, microfinance, sukuk and social impact sukuk and many others that are able to offer a possibility bridging opportunities for economic growth and social welfare. social impact bond (sib) is an innovative way for public, private and not for profit organizations to cooperate to achieve social outcomes. the funds are raised from investors who are seeking investment with social impact for better social outcomes. the sib is a series of pay-for success contracts where private investors provide capital and the government agrees to repay them for successful achievements of social outcomes. if the project leads to a positive social outcome then the investors will receive their capital along with an additional return [45]. however, if the sib project is not successful, the investors may lose their entire investments [46]. the sib model is a multi-stakeholder partnership approach involving public, private, and the social sector according to the model structured in the figure i by so & jagelewski (2013) where it functions as follows: at first the government assign a sib and negotiates with other stakeholders the agreement regarding the outcomes and payments terms and conditions. then the sib delivery organization issues bonds to be sold to investors to raise funds that will provide capital for the project. the third step is that the social service provider receives the funds and it will be used to finance the delivery of services to the target population. afterwards, an independent evaluator control and evaluate the outcomes and then report it to the government. the final step is mainly based on the report issued by the independent evaluator where in case of the agreed outcomes are achieved, the government makes the necessary payments to the investors. figure i: structure of sib source: so & jagelewski (2013) the first social bond launched in 2010 was the peterborough social impact bond in the uk, followed by others like the new york city social impact bond in 2012 raising usd$9.6m capital and the newpin social benefit bond in new ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 south wales in 2013 raising aud$7m capital. these social bonds are innovative tool as solution in the social problems. the social enterprises often lack funding and with governments in many countries having huge debt problems, such social impact bond could be used as tool to help raise finance to provide solutions to social problems. islamic finance has the social impact sukuk developed to provide financing solutions for some of the social issues in the community. as an example for the social impact sukuk is the vaccine sukuk which was launched in 2014 by the international finance facility for immunization (iffim) with the world bank issued the debut vaccine sukuk worth usd500 million. the success of the inaugural transaction led iffim and the world bank to issue the second vaccine sukuk in 2015, worth another usd200 million [46]. though the strong potential of the social impact sukuk but it is still a new tool that needs to be expanded and wellstructured in the future to get its full power. thus other tools are considered to be also significant to be explored to their full capacity like for example zakat which is an annual obligation of charity of giving can have a key important role in reducing and preventing poverty by redistributing wealth to all parts of society. the worldwide value of zakat alone is potentially us$200 billion to us$1 trillion annually. however, this extraordinary potential has yet to be fully realized, even in the world's largest muslim-majority country, because informal giving of zakat remains much larger than contributions made through formal islamic organizations. zakat can combine with other sources of islamic finance to support social enterprises and expand financial inclusion through the following sharia compliant instruments and mechanisms: (1) redistribution of wealth, through zakat, sadaqa, waqf and qard hasan, and (2) usage of risk-sharing based financing via microfinance of small and medium enterprise [37]. microfinance aims to combat the exclusion of the most deprived from the conventional banking system through the creation and development of microfinance institutions. indeed, it is an alternative for low income households to create income generating activities, to raise assets and to improve their socioeconomic status. the islamic financial system is based on principles of social solidarity and equity that coincides with the objectives of microfinance. [47]. islamic finance, hence, offers a moral approach through a profit and loss-sharing approach in the form of musharakah and mudarabah modes of financing [48]. islamic microfinance offers interest-free contracts that are sharia compliant and can support the poor by contributing to productive activities, increasing revenues and savings, and allowing the generation of capital. there are three sources of finance: 1) donations based on tabarru (a voluntary charitable action) can include zakat, sadaqa, waqf (an endowment made by a muslim to a religious or charitable cause) and hibah (gift); 2) deposits including wadiah (safekeeping/custody/trust), qard hasan (benevolent loan); and 3) equity including mudarabah (a partnership where one party provides capital and the other party provides expertise and musharakah (a partnership where each party contributes to the capital). funds can be collected by the islamic responsible institution from members of the community in the form of zakat and sadaqa, and to redistribute the funds to those entitled to receive them, or to loan to members who need them due to financial distress, through qard hassan financing products (benevolent loan or zero-percent interest). islamic finance can provide also crowd-funding which could be described by obtaining small portion of money from high number of people through an online platform in a sharia compliant manner. islamic crowd funding is seen as a cost effective way for sharia-compliant equity financing [49]. equity-based crowd funding provides access to capital to wide range of finance to entrepreneurs providing a financing mobilization of resources. the role of waqf that is a charitable form that involves donating a land, building or any asset for religious or charitable purposes, with no intention of reclaiming this asset. waqf have several benefits like; the development of a social capital market and increase social investment, raising awareness of rich people on their responsibility for social development, and enhancing the integration between social security and social welfare [23]. establishing waqf-based financing institutions serving the poor is highly beneficial [50], [51] sukuk can leverage private finance for investment in infrastructure in areas where social impact enterprises development is taking place thereby providing a local economic environment where they are more likely to thrive. it could be implemented under the scheme in which waqf lands are used for underlying sukuk issuance [52] in addition, the return of the sukuk could also be utilized for financing micro enterprises through islamic microfinance. as sukuk grant partial ownership in the underlying assets proportional to its value. the issuance of sukuk is usually intended for general funding purposes or for financing infrastructure projects, such as power plants, ports, airports, hospitals and toll roads [35]. v. conclusion social impact enterprises that have a dual objective of generating positive social impact and financial economic benefit is fundamental for all economies however on the other hand financing them is a challenging issue. the social enterprises is considered a catalyst for the development of civil society and the need for their advancement through new strategies that are innovative in terms of models, tools, and instruments is necessary. the public sector and governments are urged for finding innovative and alternative sources of financing like for example tapping the islamic financial instruments as an alternative. islamic finance has many principles that makes it very close to social finance like risk sharing and calls for social justice and welfare. there are solid evidences in islamic history for financing the social sector using islamic financial tools like zakat (obligatory charity) sadaqa (voluntary charity) and waqf (perpetual endowment). these financial tools participated heavily in the development of public facilities and services in the past. in light of what explored, the islamic financial instruments can be considered in line with the same objectives and requirements social impact investments that generate social and economic benefits. ejif – european journal of islamic finance special issue islamic and social finance (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 however, despite of the expansion and growth of islamic finance in the previous decades, but the full potential is not yet realized specially in the social arena [17]. islamic financial instruments face several challenges requires both strengthened accounting standards and more expertise and qualified people , and many efforts are needed to raise the awareness of such instruments [35], [52]–[55]. the paper had explored the various arrays of financial instruments that can be used in social impact investing. we argue that the islamic finance with its ethical principles represents a possible potentiality for offering innovative financial instruments for achieving social goals where social impact investing and islamic finance are highly complementary as both of them uphold rigorous moral and social criteria for investments and emphasize on inclusiveness. the paper had shed the light on the wide range of islamic financial charitable instruments like (zakat, waqf, sadaqa, and qard hassan), more over micro credit loans, microfinance, crowd funding. accessing such financing instruments requires that business core activities and financial transactions and business model all fully sharia compliant. the screening methodology is usually done through negative screening where it ensures investors that the money they invested is not used to support investment that is prohibited by islam, while we recommends it to be done by giving opportunity to the investors to affirm their belief in a more positive manner, that is to pro-actively direct investment to areas which have important impacts from the maqasid sharia point of view. the paper highlights these tools and look at their potential, especially in promoting ethical and social impact investments. social impact bond (sib) which is an innovative way for public, private and not for profit organizations to cooperate to achieve social outcomes. the funds are raised from investors who are seeking investment with social impact for better social outcomes. islamic finance offers the social impact sukuk that are still nascent, for example for the vaccine sukuk which was launched in 2014 by the international finance facility for immunization (iffim) with the world bank issued the debut vaccine sukuk worth usd500 million and the success of the inaugural transaction led to issue the second vaccine sukuk in 2015, worth another usd200 million. therefore, the issuances of social impact sukuk can potentially tap into the needed expansion and reinforcement of the islamic finance industry to achieve maqsad al sharia that upholds the principle of serving the public interest of 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[56] r. a. a. karim, “international accounting harmonization, banking regulation, and islamic banks,” int. j. account., vol. 36, no. 2, pp. 169– 193, may 2001. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france one of the more important features of the cycle of the political of started territorial development in italy in first years ninety is constituted from the progressive affirmation of the experience, rich and diversified, of the agencies of local developme http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 the equity crowdfunding italy: a model sharia compliant paolo pietro biancone*, silvana secinaro* *university of turin, italy. abstract the islamic financial instruments is an opportunity to arise the equity crowdfunding in italy? the study try to answer, throuth the analisys of the equity crowdfunding business model and the sharia compliance. a certification by a recognized islamic body of the italian equity crowdfunding company would make a great "business card" for observant muslims who would like to invest in italy and that can be a good opportunity also to develop islamic finance in europe key-words: equity crowdfunding, islamic finance i introduction the crowdfunding is the process by which most people ("crowd" or crowd) give sums of money (funding), even modest, to finance a business project or initiatives of various kinds using internet sites ("platforms" or "portals ") and sometimes getting a reward. there is talk of "equity-based crowdfunding" when, by investing online, you buy a real title of ownership in a company, in which case, the "reward" for financing is represented by the complex economic rights and administrative resulting from participation in the enterprise. italy is the first country in europe to have with specific legislation and organic on the only equity crowdfunding (consob regulation no. 18592 of 2013) is seen as a tool that can facilitate the development of innovative start-ups through rules and financing methods that can exploit the potential of the internet. consob has been entrusted with the task of regulating some specific aspects of the phenomenon with the aim of creating an "environment" reliable able, that is, of creating investor: there is, therefore, a register of operators of portals consob, which are reliable and secure platforms for investors. the results achieved so far by the platforms, the date of 10 october 2014, according to data consob, are: 9 projects published, including 3 closed successfully and four still in progress. the data show a modest interest from investors traditional lenders are still missing and the declared and apparent openness to foreign investors a certification by a recognized islamic body of the italian equity crowdfunding company would make a great "business card" for observant muslims who would like to invest in italy the screening to see if a company is sharia compliant was based on qualitative and quantitative criteria. the qualitative criteria relate to the type of industry in which companies can not operate: this sector includes all activities not permitted haram, namely : alcohol and pork products , pornography, tobacco , gambling , interest-bearing financial assets, weapons and defense , biology and animal genetics ( cloning ). in quantitative screening , however, the financial reports of companies are tested for amounts not exceeding certain thresholds and thresholds are different in the percentages and formulas between different global indices . ii the object of the research the research aims to analyze if the platforms are sharia compliant in terms of the companies financed, and thus open up to islamic investors. iii the sample currently, the platforms entered in the register are 9. the sample is representative of all the company's equity crowdfunding italian . the figure 1 shows the geographical distribution. figure 1: the data geografic distribution ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 iv design of the research the research methodology follows a path of inductivedeductive analysis, by the assessment of the compliance with the sharia. the evaluation process and compliance is based on criteria, divided into two categories: the first category consists of the quality criteria and the second those quantities. the qualitative criteria are mainly related to the business activities of the company and its eligibility according to the sharia. regarding the quantitative criteria, are a series of reports and financial levels that need to be examined, and their results should not exceed the specified threshold. thus, by controlling the qualitative and quantitative criteria, companies are verified on the basis of their resources "activities" and their financial structures. both categories must be met in order to be classified as shariah-compliant. according to what we had discussed on the main concepts and principles of sharia law, companies must conduct their activities within the lawful activities, which are called halal, and avoid all activities that are not permitted, calls haram activities.. the activities must obviously include all the production and sale of their products. the activities not permitted are the following: alcohol, products related to pork, pornography, tobacco. gambling, financial services of interest-bearing (ie conventional banks and insurance companies), weapons and defense, genetic engineering biological human and animal (eg. cloning). media and advertising companies, with the exception of news channels, newspapers, and sports. the control of those assets within companies is considered a crucial step and a crucial phase. this step is the classification of the core business of each company. switch this early stage of quality control is to move towards a quantitative financial control. as for the quantitative control, the three main aspects that need to be tested are the level of leverage (the ratio of debt ratios), ratio of interest, the liquidity ratio (cash and credit), and finally the portion of revenue that is generated by non-compliant. these aspects must be respected above all for corporate equity crowdfunding (platforms), which will guarantee a set of evaluation procedures by finance companies of comparable strength. level of debt: any debt based on interest is not allowed according to the principles of sharia. for this reason there is a threshold about the same among all the global indices, however there are some differences in the calculation formula. if the interest based on the debt does not exceed this threshold then it can be accepted. the level of debt is to measure the ratio of total debt and total assets. according to islamic index , the level of debt ratio is: (total debt / total assets) < 33 % ratio of interest that head in practice the investment in fixed income instruments and ensures that the income generated is not considered riba. among the indices is equal to the threshold but again the formula is different. according to islamic index , the interest ratio is: (cash + interest bearing securities) / total assets < 33 % liquidity ratio: focuses primarily on tests of liquidity in the company (cash and receivables). in this report, all indices are different and do not have common thresholds. as well as the formula for the calculation is different. some require a certain minimum level of assets. according to islamic index , the liquidity ratio is: cash + receivables / total assets < 33.33 % income ineligible: a criterion of the final financial report to be verified is based on what is the level of income ratio is not permitted; ie, the income must be generated in order to be admissible accepted, according to the sharia.. according to islamic index, the income ineligible ratio is income not allowed / income < 5 % v theoretical background for several years, the financial industry have developed new investment forms under the purpose of diversification. amongst them, some have particular features which could sound a bit innovative. they are the so called social impact investments (or impact investments). impact investors want to allocate their wealth and savings in investments which could generate positive social or environmental development (o'donohoe, leijonhufvud, & saltuk, 2010) [32]. impact investments are considered as innovative investment forms since they have gone beyond the common capital allocation framework: investments are usually intended to optimize risk-adjusted financial return while donations are designed to increase social impact. impact investments are those investments whose aim is to create positive social or environmental impact rather than financial return. usually, they take the form of private debt or equity instruments, but other options take into consideration guarantees or deposits, too. there are public listed impact investment instruments, too, but the market is still in a start-up stage even though there are many positive indicators that it will expand soon because of a growing demand from investors and the higher supply of social businesses recipients of impact investing. the biggest portion of listed impact investments are social responsible investments which focus mainly on minimizing negative impact rather than fostering positive impact. the intended impact refers mainly to the so-called base of the pyramid (bop) population ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 which need more resources to improve their living conditions or to environmental issues, too. moreover, the most significant feature is the combination between financial return and social/environmental impact which will encourage businesses to grow in a financially sustainable way. the social impact investing could be considered as an important complementary source of funding together with governmental and phylantropy actions to serve the poorest products and services needs(chamberlain, 2013) [13]. lehner (2013) [25] has proposed a scheme of operation of crowdfunding in the context of social entrepreneurship that characterizes it. this diagram describes what actors are involved and what factors are involved in the encounter between demand and supply of funds in crowdfunding. in particular, businesses are the borrowers as the crowd as a whole is identified as a lender of funds. the essential element in this context is the recognition of the opportunity by not only entrepreneurs but also crowdfunders. this happens through the communication channels offered by web 2.0 and content for users on the platforms of crowdfunding. the meeting between the crowd and enterprises occurs when members (crowdfunders) decide to take this opportunity on the basis of the legitimacy of their perceived idea about business. unlike the case with traditional sources of funding where the entrepreneur has to convince a small group of investors, typically through a business plan and forecasts, in crowdfunding creators must be able to communicate the opportunity to a large heterogeneous mass of people, therefore adopting different strategies and the multiple communication tools offered by web 2.0 and platforms. the platforms act as intermediaries, each with its own communication strategy and its business model; social networks that are created within the crowd leverage on these. aspects related to the economy of information (information asymmetry) and the equivalent risk for the individual constitute the so-called block motivational. the outcome of the project is moderated by the rewards (reward), the levels of control and participation offered and also depends greatly on the characteristics brokerage platform. the laws and regulations in turn form a further block that serves as a mediator between the crowd, the crowdfunding platform and desire for participation in the project business (mollik 2013) [31]. the literature on the "herd behavior" (rational herding) states that individuals to reduce their risk of the face of uncertainty, in this case associated with a new business idea, interpret the number of people who have invested as a quality signal of the project. the authors argue that the herd effect probably also the case of crowdfunding but the main difference is that the crowdfunders not interpret the investment decisions of others as a sign of quality. the propensity to invest in the latter fact, undergoes an increase in the final stages of the project as the supporters expect that their contribution will have a greater impact when the project is closer to its target collection and therefore has a higher probability of success. the study conducted on the investments made through the platform sellaband between 2006 and 2009 shows three interesting results: • the propensity to invest increases the funds raised; • local investors and those "remote" are characterized by different behaviors in investment decisions. in particular, it is shown that for investors "remote" the propensity to invest increases with the accumulation of capital raised while local investors do not. this result, as mentioned earlier, is in contrast to the existing literature that emphasizes instead the importance of geographical proximity in the financing of a business venture; there are no further differences between local investors and "remote" if not in the size of the network of social contacts that, of course, is far superior to the local level. to demonstrate this, the authors found the percentage of investments from friends and family, and emphasize the importance of the latter in its own provide a signal to potential investors of the efforts made by the entrepreneur. these signals can also be used by the entrepreneur himself to increase the likelihood of success of the collection through access to sources of capital "at a distance" and any other friends and relatives. equity crowdfunding the ―crowdfunding‖ encompasses various types of fundraising that can range from collecting donations to selling equity stakes via the internet. but a clear definition of the term has yet to be proposed. one definition comes from hemer (2011), who defines crowdfunding as an ―open call, essentially through the internet, for the provision of financial resources either in form of donations (without rewards) or in exchangefor some form of reward and/or voting rights in order to support initiatives for specific purposes‖. belleflamme, lambert and schwienbacher (2012) [33] offer a similar definition.the focus of crowdfunding can vary greatly, both in goals, such as political campaigns(barack obama raised over $100 million in small contributions during the 2008 presidential election), charities, or art projects, and in magnitude. donations can range from $1 to several millions of dollars in entrepreneurial seed financing.politicians in the u.s., seeking new routes to stimulate the economy, have favored smallbusiness and new venture creations (see the 2011 jobs act, as well as the entrepreneur access to capital act). however, such efforts often require external financing, which can be difficult to obtain at the initial stage via bank loans or equity capital. thus, companies may find themselves either unfunded, or funded with a less than preferable source of capital (see,for example, cosh, cumming and hughes, 2009; robb and robinson, 2012; and cole and ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 sokolyk, 2012). to bridge this gap, politicians are suggesting new, more modern means of capital formation. equity crowdfunding is a form of financing in which entrepreneurs make an open call for funding on the internet, hoping to attract a large group of investors. the open call and the investments take place on an online platform (such as, e.g., crowdcube) that provides the means for the transactions (the legal groundwork, pre-selection, the ability to process financial transactions, etc.). in recent years, the equity branch of crowdfunding has become an increasingly important financing alternative for start-ups, and volume has doubled every year since 2009. in 2011, start-ups worldwide raised u.s. $88 million through equitycrowdfunding platforms (crowdfunding industry report, 2012). the funding process on most crowdfunding platforms is similar, regardless of the type of crowdfunding used. it begins with a fundraiser initiating a request for funding, typically by indicating what the money is needed for, and what, if anything, is offered in exchange. potential investors can browse the offers, and, if interested, invest a small amount (generally a few dollars) toward the target amount. the crowdfunding website provides the technical platform for the exchange of funds, voting rights, etc. the categorization of the four main types of crowdfunding (donation-based, reward-based, lending, and equity) is based on what, if anything, investors receive for their contributions. the legal complexity and the degree of information asymmetry between fundraiser and investor differ significantly depending on the type of crowdfunding alfiero, casalegno, indelicato, rainero, secinaro, tradori, venuti, 2014) [3]. for example, in donation-based crowdfunding, funders donate to causes they want to support, with no expectation of monetary compensation. this can also be considered a philanthropic or sponsorship-based incentive. this form of funding is not complex from a legal standpoint. furthermore, the degree of uncertainty is less important than it would be for other types of crowdfunding, because donors presumably already have a positive opinion of the organization. an example of a donations crowdfunding platform is fundly, which allows individuals and organizations to create an online fundraiser solely for the purpose of collecting donations. in contrast, reward-based crowdfunding offers funders a non-financial benefit in exchange for their investment. a prominent example of this type of platform is kickstarter. kickstarter allows fundraisers to raise money by offering non-monetary rewards in return for financial support. for example, a team of product developers raised over u.s. $10 million. kickstarter by pre-selling an e-paper watch at a discounted price. lending crowdfunding is another model, where funders receive fixed periodic income and expect repayment of principal. lending crowdfunding platforms, such as prosper, generally facilitate peer-to-peer loans. in other words, individuals receive loans directly from other individuals.the last model is equity crowdfunding, in which investors receive some form of equity or equitylike arrangements (e.g., profit-sharing) in the venture they support. assob is one of the most prominent equity crowdfunding platforms. it enables entrepreneurs to sell equity shares to small investors. for example, an australian high-tech start-up sold approximately 10% of its equity on assob for aud 630,000 (approximately u.s. $645,000) to twenty-three small investors in 2009. we believe that equity crowdfunding is the most relevant empirically for studying entrepreneurial signaling to small investors. this is in contrast to donations crowdfunding, where factors other than potential monetary returns are important for funders, which makes a meaningful comparison among crowdfunding types difficult. therefore, information asymmetries surrounding the entrepreneur’s or startup’s ability to generate future cash flows are less important in this context. richard harrison (2013) [24] analyzed the economic context in which the equity crowdfunding is developing. in his work explains how the market for raising capital for companies nell'early internship has changed a lot in recent years. following the financial crisis of 2008, in fact, there was a sharp decline in the availability of bank loans for small and medium businesses a reduction of liquidity on the other traditional financing channels. before 2008 the funding in phases at high risk start-ups was chiefly through the so-called "love money" that was based on the 5f: founders, family, friends, fans and fools and through state subsidies. in some cases, particularly for companies 'social', part of the loan could be paid from sources philanthropic and altruistic, idealistic and individuals defined as "followers" of the project objectives. these sources also fall within the definition of "love money" issued by hermer et al. (2011). the equity crowdfunding is the disintermediation of the financial market, a tool that allows direct contact traimprenditori and lenders. this source of funding, however, is still evolving, the different characteristics of the instruments traded (financial instruments in effect) than other forms of crowfunding require that the management of funds meets the standards that regulate the financial markets, which is why the models that led to the success of the other forms of crowdfunding can not be applied directly to equity crowdfunding. for these reasons, harrison (2013) [24] states that the scenario in which the equity crowdfunding is developing not possible to determine with certainty what the future of this new form of financing, if you configure a transformation of the market for financing for start ups or vice versa as a tool less. schwienbacher & larralde (2010) [33] have identified some factors that influence the use of crowdfunding as a model of raising funds for small businesses. the authors argue that the use of this form of financing is possible if there are certain needs from the proponent and certain characteristics of the company or project financing. the need, on the part of the undertaking or proposing, to collect a reasonably low amount of capital, which gives ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 rise to a small number of investors. this is because there are some limiting aspects both from legal point of view (the kinds of participatory forms) both from the point of view of management of a large number of shareholders who, in some cases, can be very onerous. however there are some platforms that offer tools to circumvent these problems, such as the introduction of nominee structure and elected representatives from the crowd. the second requirement is that the business idea or project must be based on something innovative that can capture the interest of the people and encourage them to invest. this aspect is crucial because often crowdfunders are likely to participate actively in decision-making for which the minimum requirement should be the interest in the particular product or service. crowdfunding is also a valuable tool for the proponent when he needs to extend their skill set or at least welcome opinions and views of others. the authors also highlight the importance of knowledgesharing, to be facilitated by the platform thanks to the web 2.0, satisfying the desire for participation and communication that characterizes crowdfunders. gerrit k.c. ahlers et al. (2012) [2] conducted an empirical analysis to determine what type of signals are used for start-ups to induce individuals to invest their financial resources through equity crowdfunding. the study is based on data collected on a sample of 104 projects published in the australian assob platform between 2006 and 2011. in particular, have been taken into account: • the basic information for potential investors, which includes an overview on the details of the company and the board; • information on the process of financing the enterprise, including perspectives on exit (ipo, trade sale, lbo, buyback and other modes), the time horizon and the planned objective of the collection; information concerning the composition of management (total number, number of executive and non-executive etc.) and their qualifications (those who possess an mba etc.); • presence or absence of financial projections (used as indicators of the risk associated with investing) • historic investments; • number of rounds and their duration. the results show the importance of only a few signs in determining the success of the collection. these are mainly related to the presence of information on the exit, on the level of risk (percentage of capital offered and financial forecasts), on 'experience of the board and the education level of their members. in contrast not found to have a significant impact the external certifications such as patents, prizes, awards, scholarships or grants. as regards the characteristics of the board, the statistically significant is that a greater percentage of members with a mba increases the number of investors. likewise, a greater number of the board has a positive and statistically significant impact on the success of financing in terms of number of investors of capital raised. another interesting fact is the negative correlation between the percentage of capital offered to the crowd and the number of investors. in particular, the higher the percentage range and the lower the number of investors. an important strand of literature on equity crowdfunding is the study of the needs regolamentative and regulations implemented internationally. cumming and johan, (2013) [19] studied the development of regulation in canada in terms of the actors involved in the market. the study was conducted through inteviste carried out at the beginning of 2013 when it had not yet been issued a real regulation. the authors' aim was to verify the veracity of three hypotheses: 1portals, entrepreneurs and investors require regulation bland in order to maximize the collection of capital; 2portals, entrepreneurs and investors are basically neutral to the degree of market regulation; in this case the objective is the minimization of the cost of regulation (through a replication of regulations already in force in other countries); 3portals, entrepreneurs and investors require a very strict regulation in order to minimize the risks. the study found the desire by businesses to a low level of regulation in order to encourage investment; one of the main constraints to the listing of a company are the high costs that it incurs (legal fees, accounting, publication of prospectuses, etc.), without considering the limitations that may be imposed on the maximum number of investors and amount of capital raised. these elements lead to an increase in costs above those benefits to the point that nonendere cheaper fundraising market. the equity crowdfunding can reduce these costs provided they are legislated some exemptions to the many constraints that the undertakings (consider, for example, the number of investors that the offer is addressed through crowdfunding that far exceeds the maximum allowed) without exceeding the deregulation. it has emerged as companies want to minors constraints on the amount of capital that can collect each year, portals less disclosure and less constraints on the time of collection, as investors seek markets heavily regulated especially when the reasons for the investment are of a financial. why investors seek markets where the amount that can be collected by employers is limited, the level of education of these is high and where it is guaranteed that the tender submitted is subject to due diligence. comparing these results with the three assumptions, the authors argue that the situation most desired by most of those involved is aimed at achieving a highly regulated environment that protects investors from one side and the other creates the preconditions for the formation of a market that will attract business initiatives of quality and, consequently, a greater number of lenders. islamic finance & equity crowdfunding the islamic finance, ideally, is an alternative way of financing based on ethical and socially responsible standards, which ensures fair distribution of benefits and obligations between all the parties in any financial transaction (abdullah s. 1999) [1]. the crowdfunding ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 carries these characteristics and provides the ground for new developments in the field, as it can use islamic finance as an ethical and socially responsible tool to promote financing and development. islamic finance and crowdfunding both conceptualize costumers as investors and can potentially provide investment opportunities with higher returns investors take an equity stake in the project and gain returns based on the principle, which ensures a fair distribution between shareholders and entrepreneurs. the sharīʾa-compliant crowdfunding invests in halal socially responsible projects/products, shares the risks of the investment, and its characterized by the absence of an interest rate. tthe company takes equity stakes in the project, the model of product-based crowdfunding eliminates the issue of interest altogether (ahlers, 2012) [2]. regarding the certification of the shariʾa-compliance of these platforms, the most widely used approach to ensuring the islamicity of islamic banking at the private sector level is that of the religious supervisory boards. yomken is a product-based crowdfunding platform that opened in egypt in october 2012. it is the first example of product-based crowdfunding and it defines itself as sharīʾa-friendly. by the idea of crowdfunding, wanted to develop a crowdfunding model suitable for egypt and the arab world. wishing to have a social impact and promote solidarity in the context of egypt after the revolution, yomken combines three different business models: crowdfunding, open innovation, and islamic finance. as new products are generally not financed by banks because their market demand is unknown, yomken removes this risk by offering the new product through its platform on the pre-commercialization phase. yomken follows a two-fold process. firstly, it links people who want technical solutions with people who have them, such as university students, researchers, specialists, or even companies, in order to make new products or improve the existing ones. yomken partners with ngos involved with entrepreneurs, micro and smes, in order to locate small businesses facing technical challenges which require creativity and expertise, and link them with the wisdom of the crowd. problem solvers are rewarded depending upon the case: they get a share of the benefits, a lump sum benefit, or an award from yomken. on the site, users can post ―challenges‖ and ideas for new innovations for free. the website creates a competitive environment amongst contributors in order to come up with the best solution. secondly, once the prototype is developed, a target number of buyers it set up according to its production costs, and the product is offered through yomken´s web-page on crowdfunding basis. if the target number of buyers is reached, the prototype is fundraised, produced, and delivered to them, showing that the market needs the product. in the event that the target funding amount is not collected, contributors retrieve their initial funding amount. that way yomken removes the risk of innovations and assist new product ideas to become reality. to ensure that a product is delivered, yomken finances the challenge temporarily until the crowdfunding phase is completed, "placing faith in these businesses before users do". this is a risk that the company is willing to take, as solutions might not reach the funding goal. the originality of productbased crowdfunding lies in the fact that in return, the investor does not receive interest, but the product itself, which promotes the creation of new products and furthers innovation. investors that pay for a product they wish to have, can track the production process and see how their money is spent through weekly updates on the progress of the projects. transparency is a very important part of the project, and a direct link between the customer and the workshop owner is established from the beginning (biancone, 2012) [8]. in order to understand their compatibility with sharia, it is based on qualitative and quantitative criteria: the qualitative criteria relate to the type of industry in which companies can not operate : this sector includes all activities not permitted haram , namely : alcohol and pork products , pornography , tobacco , gambling , interest-bearing financial assets , weapons and defense , biology and animal genetics ( cloning ). about the second one, the quantitative screening. the financial reports of companies are tested for amounts not exceeding certain thresholds and thresholds are different in the percentages and formulas between different global indices . v discussion can something be "islamic" without an islamic reference and discourse? is a "true islamic" product defined by its quality, by its name, or both? these questions include essential issues relating to authority and legitimacy. who defines what is "islamic", "halal", or "sharīʾa-compliant"? currently, the principles of islamic banking are largely unknown to the majority of muslims. provided that education in this respect improves, the future might see more actors questioning and assessing the "islamicity" of their finances. thus, sharīʾa-compliant crowdfunding opens up new debates within the industry and challenges current definitions of "islamic", empowering a much larger customer base to access sharīʾa-compliant finance.islamic finance is not a target, but an ethical and socially responsible tool to promote financing and development. the purpose of the equity crowdfuinding italian style is to relate ideas, people and financial resources by proposing start-up projects with exciting and innovative that transmit messages, also a social the qualitative analysis control of those assets within companies sample is considered a key step and a crucial phase. this step is the classification of the core business of each company and reveals no contrast to the sharia. the modus ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 operandi of the platforms has led to the identification of a pattern of operation of the collective funding. above diagram identifies the main phases of a recurring and crowdfunding campaign, the creation of a business idea to obtain the funds needed to conduct the same (figure2): 1) preparatory activities 2) crowdfunding 3) implementation (possible) the prerequisite for the launch of a campaign of crowdfunding is represented by the value proposition that the author intends to launch: despite the practice of funding from the bottom is commonly believed, a highly accessible, disintermediated and transparent, with which to carry out artistic and cultural projects , develop business ideas and to involve the community in a project economically social or public utility, is still an economic act. the main implication of this assumption is clearly the need to structure its proposal the business logic and business creation. the proposer shall not be limited to the launch of a simple idea, he will have to play a series of preliminary activities aimed at identifying the contents of the project and the assessment of its feasibility. a crowdfunding campaign is the initiative of a new entrepreneur in a market, both real and virtual, in most cases the existing competitive and characterized by specific logic. the applicant must therefore plan their campaign along a gradual path that starts from the clarification of the idea and the target, will wind along the analysis of market and competition, through the evaluation of the financial and economic underpinning and ending with the clear definition of the primary and secondary objectives that the campaign is intended to reach. along this path feasibility review the proponent will develop more critical thinking and communication skills, will be defined in detail and clarity with every aspect of its proposal, amplifying the ability of communication to the public and not thus incurring the risk of frustrating their engineering effort. most active platforms have structured access to their services in a very simple and direct, after the registration phase, the user can access the section dedicated to the publication of the projects and will be guided by a structured form tended to homogenize the submission of projects and highlight the key variables of the project. the role of the platforms of crowdfunding is to focus on an online portal viable projects that will attract the interest of the crowd, the platform's ability to attract supporters will also depend on the ability of the applicant to provide a description of their attractive and adequately detailed idea by using different multimedia tools. the main stages of the structuring of the campaign can vary depending on the business model of the platform, it will in any case the proponent define: project description, author and title: through images and text, the user can enter the title of the campaign, any authors also non-material and a range of content through the evidence suggests precisely the goal of the project. storytelling: numerous platforms proposers to produce video aimed to tell the project through evocative images of sensations and feelings that will ensure the emotional involvement of the crowd, and that provide a clear demonstration of the product or service promoted. budget: it will be up to the proposer fix the budget goal of the campaign in relation to the resources that realistically considers necessary for the realization of its vision and taking account of all the charges you pay compared to the campaign and the system of rewards (if provided). rewards: if crowdfunding campaign is proposed in the segment reward, the proposer will enhance the donations received by him with rewards choices, the value of which varies depending on the size of the donation. promotion: the campaign will be completed by the activation of all the social channels of which the proposer has (twitter, facebook, blogs etc.) to create a constant flow between the platform and the communication and sharing habitually employed by the offeror. figure 2: phases equtiy-crowdfunding campaign the quantitative analysis switch this early stage of quality control is to move towards a quantitative financial control. the precise quantitative analysis of the platforms you can not bring it because the platforms are all luck for a year, so they have no balance sheet data useful for the assessment on sharia compliance. the sample is still "young", all companies have started operations at the beginning of 2014: there are, therefore, available indicators that can give certain answers, objective and reliable compatibility to sharia. it was decided, however, to ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 identify the data and the relevant elements to attract islamic investors, also in comparison with the experiences of equity crowdfunding in islamic countries, such as egypt, already cited in the theoretical analysis the data subject to evaluation were: target: investments and their maximum and minimum amounts required. the offers: • can not exceed the sum of 5 million euro; • can be handled only by portals managed by persons registered or recorded in the register kept by consob; • may concern only financial instruments representative of equity (shares or "shares"); • are successful only if 5% of their amount is underwritten by a professional investor; • they must recognize the right of revocation to investors in cases where significant is changed in the situation of the start-up or the conditions of the offer. finally, that the offering is permitted on the portal, the status of the start-up should include: • in case once you closed the offer on the portal the controlling shareholders to transfer control to third parties, the possibility for other shareholders to withdraw from the company (right of withdrawal, after which you are entitled to liquidation of their holdings) or the right to the other shareholders to sell their holdings even the person who purchases the "controlling interest" under the same conditions applied to controlling shareholders (called right of "co-sale" or "tag-along "), • communication to the start up and the publication (on the site of the same) of shareholders' agreements. focus: type of companies to be funded (start-up, specific sectors, new projects) board: verified the existence of a board of qualified address in particular, a sharia supervisory board or sharia committee is set up by a financial institution (usually an islamic bank or an islamic insurance company) to advise and certify certain financial products1.originally, the sharia board was not compulsory in islamic finance but it became so over time because of the sophistication of financial products. the benefits are twofold: 1 the sharia board is delineated by aaoifi accounting and auditing organization for islamic fianancial institution there is now formal confirmation on whether or not these products are fully islamic and, having a sharia board, adds credibility to islamic financial institutions. investor education: verified the existence of rules of conduct backed firms and investors. managers of the portals on the register of the consob applies a discipline "lighter" than the one dictated by the traditional intermediaries with whom habitually savers make their investments. in return managers enrolled may not hold sums of money attributable to the investors or directly execute orders for the subscription of the securities offered on their portals, having to that purpose transmit exclusively to banks or sim. the managers can not then play in any way financial advice to the investors. the fundamental role of the portal is to ensure that investors can understand the characteristics and risks of the proposed investments, taking vision of the related information in the portal and in this section of investor education. special protection is directed towards retail investors (ie those other than banks, investment firms, insurance companies, etc.) who must complete a real "path of conscious investment": to access the section of the portal where you can adhere to the offer must indeed have filled in a questionnaire on-line showing that they have read the information provided and who understand the features and risks of investing in innovative startups. if the retail investor does not exceed the path manager can not allow them to adhere to the offers on the portal. once the investor decides to invest in a startup, the operator of the portal is to convey the order of participation in a bank or investment firm who will refine the underwriting of securities (and to collect the sums involved in an account sidelined in favor of the issuer). under current regulations (also known as "mifid discipline" because of the derivation by the european standard), the banks and the sim will carry out the work in compliance with the regulations on investment services that provides a number of disclosure and behavior to the investors (including the so-called "customer profiling"). access: checked the type of access to the data of the companies that require financing through the platforms, focusing on openness to investors of islamic culture. in these analysis is most important that the platform use the international language. the synthetic results are in figure 3. ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 figure 3: italian equity-crowdfunding analysis shows that the equity crowdfunding, in italy still in its infancy, is closely oriented to start-ups and has not considered islamic investors, while adopting methods and procedures for the identification of investors and selection of business ideas, which are compatible with sharia. vi – the conclusion and advances the equity crowdfunding is an italian model shari'a compliance with the need to introduce aspects that better could turn to islamic finance. among these, in the first place, the existence of a shari'a board, who could monitor the investment in each phase. the sharia board provides specific shari'a screening and legal formalities. you also need to declare and report on the platforms open to foreign investors, second, of course, the rules consob and protection of the stakeholders that the platforms are subjected in italy. in particular, using a investor education, investor education that will be a central element in order to develop a healthy market. references [1] abdullah s., islamic banking and interest. a study of the prohibition of ribā and its contemporary interpretation, vol. v. 2, studies in islamic law and society (leiden: brill, 1999), 108. [2] ahlers, gerrit kc, et al. "signaling in equity crowdfunding." available at ssrn 2161587 (2012). [3] alfiero, s., casalegno, c., indelicato, a., rainero, c., secinaro, s., tradori, v., & venuti, f. communication as the basis for a sustainable crowdfunding: the italian case. international journal of humanities and social science vol. 4, no. 5(1); (2014) [4] backes-gellner, u., and werner, a. (2007): entrepreneurial signaling via education: a success factor in innovative start-ups, small business economics 29, 173-190. [5] belleflamme, p., lambert, t., and schwienbacher, a. (2010): crowdfunding: an industrial organization, working paper. [6] belleflamme, p., lambert, t., and schwienbacher, a. (2012): crowdfunding: tapping the right crowd, available at ssrn: http://ssrn.com/abstract=1578175. [7] biancone, p. p., "islamic finance: what is the outlook for italy?." world academy of science, engineering and technology international journal of social, education, economics and management engineering vol:8 no:2, 2014 [8] biancone, paolo pietro. "il bilancio della banca islamica e la rappresentazione dei principali contratti finanziari (2012), franco angeli, bologna. [9] black, b.s., and gilson, r.j. (1998): venture capital and the structure of capital markets: banks versus stock markets, journal of financial economics 47, 243-277. [10] bradford, s.c. (2012): crowdfunding and the federal securities laws, columbia business law review, 2001(1), 3-148. [11] burtch, g., ghose, a., and wattal, s. (2012): an empirical examination of the antecedents and consequences of investment patterns in crowdfunded markets, working paper. [12] busenitz, l.w., fiet, j.o., and moesel, d. (2005): signaling in venture capitalists—new venture team funding decisions: does it indicate long-term venture outcomes? entrepreneurship theory and practice 29, 1-12. [13] chamberlain, m. (2013, april 24). socially responsible investing: what you need to know. retrieved from forbes.com. [14] cole, r.a., and sokolyk, t. (2012): how do start-up firms finance their assets? evidence from the kauffman firm surveys, working paper, depaul university. [15] connelly, b.l., certo, s.t., ireland, r.d., and reutzel, c.r. (2011): signaling theory: a review and assessment, journal of management 37, 39-67. company target focus board sharia board investor education access 1 investment start up/new business ideas yes no yes userfriendly 2 na na na na na na 3 cleantech investment start up/innovative project/intangiblesyes no no reserved 4 na na na na na na 5 investment <1,800,000 euro for year (min 2 years)start up no no no reserved 6 investment <1,800,000 euro for year (min 2 years)start up yes no no userfriendly 7 investment <1,800,000 euro for year (min 2 years)start up yes no no userfriendly 8 investment start up yes no yes userfriendly 9 investment <5,000,000 euro for year (min 2 years)start up yes no no userfriendly ejif – european journal of islamic finance no 5, june (2016) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 [16] conti, a., thursby, m., and rothaermel, f.t. (2010): show me what you have: signaling, angel and vc investments in technology startups, journal of economics and management strategy, forthcoming. [17] cosh, a., cumming, d.j., and hughes, a. (2009): outside entrepreneurial capital, economic journal 119, 1494-1533. [18] cumming, d.j., johana, s.a. (2009): venture capital and private equity contracting: an international perspective, elsevier science academic press. [19] cumming d., johana, s.a., (2013). demanddriven securities regulation: evidence from crowdfunding. [20] davila, a., foster, g., and gupta, m. (2003): venture capital financing and the growth of startup firms, journal of business venturing, 18, 689-708. [21] el nazer, shaimaa. ―crowdfunding platform yomken makes launching products easy in egypt.‖ wamda, october 29, 2012. http://www.wamda.com/2012/10/crowdfundingplatform-yomken-makes-launching-products-easyin-egypt. [22] el-gamal, mahmoud a. islamic finance: law, economics, and practice. cambridge: cambridge university press, 2006. [23] gerrit, ahlers k. c., cumming d., g nther c., schweizer d., (2013). signaling in equity crowdfunding. [24] harrison r.,(2013). crowdfunding and the revitalisation of the early stage risk capital market: catalyst or chimera?, venture capital: an international journal of entrepreneurial finance, 15:4, 283-287. [25] lerner j., (2013). venture capital and private equity: a course overview. [26] lin, m., prabhala, n., and viswanathan, s. (2009): social networks as signaling mechanism: evidence from online peer-to-peer lending, working paper. [27] malmendier, u., and shanthikumar, d. (2007): are small investors naive about incentivesjournal of financial economics 85, 457-489. [28] megginson, w., and weiss, k. (1991): venture capital certification in initial public offerings, journal of finance 46, 879-903. [29] michael, s.c. (2009): entrepreneurial signaling to attract resources: the case of franchising, managerial and decision economics 30, 405-422. [30] milgrom, p.r. (1981): good news and bad news: representation theorems and applications, bell journal of economics 12, 380-391. [31] mollick e., (2013). the dynamics of crowdfunding: an exploratory study.of smaller compagnie. [32] o'donohoe, n., leijonhufvud, c., & saltuk, y. (2010). impact investments: an emerging asset class. j.p. morgan. [33] schwienbacher a., larralde b., (2010). crowdfunding of small entrepreunerial ventures, book chapter forthcoming in handbook of entrepreneurial finance (oxford university press). ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 smart sukuk structure from sharia perspective and financing benefits: proposed application of smart sukuk through blockchain technology in islamic banks within turkey abstract— smart sukuk structure is the new generation of sukuk issuances structures. it uses blockchain technology to allow more investors in both retail and corporate sectors to participate in sukuk issuances. through this technology, all financial institutions can issue their sukuk. all types of documents and information related to the issuance of sukuk are kept with the issuer's chains and the chains of the central registration institution. limited research was conducted on the transactions of smart sukuk structures, such as sukuk issuance model, traded sukuk transactions and committed transactions market, from the sharia compliance perspective and its financing benefits. this paper presents an in-depth study of the aaoifi standards, the decisions of islamic jurisprudence academies and sharia boards, that related the sukuk structures, applied in the islamic bank of the paper's study society and the transactions of smart contracts from sharia compliance perspective. on the other hand, this paper presents how to apply proposed smart sukuk structures models that use blockchain technology and smart contracts, within the largest islamic bank in turkey, in order to find out its financing benefits. the research findings indicate that from the sharia perspective there are some issues in some applicable sukuk models, such as the issue of capital guarantees. the use of blockchain technology in smart sukuk structures reflects several benefits on the financing markets, as it gives more capacity to access to more investors and markets, faster processing capability, transparency, invariance, and low transaction cost. keywordssmart sukuk; islamic banks; blockchain; shari’ah compliant; financing benefits. i. introduction one of the biggest challenges for finance and islamic finance in the next decade is using the tools of fin tech technology such as smart sukuk. in the digital world, traditional financial practice will be left behind. smart sukuk structures uses the blockchain technology and the smart contracts that have many advantages where contribute to enhancing transparency and eliminate fraud and speculations in sukuk transactions; it was also designed to avoid the involvement of intermediaries and reduce costs and make the transactions easier. therefore many governments and financial institutions working on the use of this technology in some areas, including the issuance of sukuk, which would contribute significantly to the creation of sources of financing and greater investment, expand the circle of participation, participation by individuals and sme ii. sukuk a. sukuk overview islamıc financing mechanisms have different alternative forms and transactions from the conventional financial institutions in which they do not deal with interest. there are two alternative mechanisms of financing, equity financing or debt financing startıng by the equity financing there are two famous financing structures that are considered shariacompliant financing (partnership) and musharaka (joint venture) where those contracts are based on the profit and loss sharing a principal. as for the debt financıng alternative that are all sale contracts mechanisms namely mudaraba are murabaha (cost plus markup), ijara (leasing), istisna (construction). (biancone & maha, 2018). sukuk linguistically” are identification“ صكوك document representing a financial right to its owner. while sukuk are certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity, however, this is true after receipt of the value of the sukuk, the closing of subscription and the employment of funds received for the purpose for which the sukuk were issued. (aaoifi, 2017, p. 468). osama hamza ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 the idea of sukuk is based on the profit and loss sharing between the parties; that is each certificate gives its owner a share of the profits or losses that made from assets, projects or trade activities managed based on one of islamic financial contracts depending on the nature of the contract. sukuk are traded on the basis of islamic sharia; that is, the issuance and dealing of sukuk are based on islamic principles and rules in accordance with the standards of islamic finance, it is worth mentioning that the first decision of the islamic fiqh (jurisprudence) academy of the organization of islamic cooperation (oic) legitimized the use of mudaraba thought seminar on the mukarada (mudaraba) sukuk which held in jeddah in august 1987. during last twenty years, islamic finance industry has witnessed great popularity in the world, due to sukuk industry that contributes to the process of financing, investment and development at the locally and globally levels. perhaps the feasibility of investing in sukuk, whether sovereign and quasi-sovereigns sukuk or corporate, in addition, fis sukuk issuance, contributed to confidence of the investors and made it the first financing instrument in the islamic finance industry. depending on the particular needs of an institution, there are a variety of sukuk structures based on various sharia compliant contracts: profit sharing (sukuk almudaraba), deferred-delivery purchase (sukuk al-salam), lease of an asset (sukuk al-ijara), joint venture (sukuk almusharaka), sukuk al-istisnah (project based), and cost-plus asset purchase (sukuk al-murabaha)…etc. (blossom, 2018). b. sukuk issuances 1) sukuk issuances (globally) total global sukuk issuance amounted to usd 123.15 billion in 2018. as illustrated in chart 1a, global sukuk issuance has shown a modest increase of +5% from usd 116.7 billion in 2017 to usd 123.15 billion in 2018.the steady issuance volume during 2018 was mainly due to sovereign sukuk issuances from asia, gcc, africa and certain other jurisdictions while malaysia continue to dominate the sukuk market though share of countries like indonesia, uae, saudi arabia and to some extent from turkey increased as well. (iifm, 2019). chart i: total global sukuk issuances (jan 2001 dec 2018) all tenors, all currencies, in usd millions total global sukuk issuance usd 1,101,502 millions source: iifm sukuk database among the jurisdictions malaysia is a market leader and a dominant player in terms of issuances as illustrated in chart 2a, with market share of 60.84% as of 2018.other jurisdictions in order of their approximate share in the global market are the uae (7.21%), saudi arabia (10.7%), indonesia (7.22%), bahrain (2.8%), qatar (2.6%) and turkey (2.49%).the number of jurisdictions who are directly or indirectly issuing sukuk are increasing year-over-year which in turn is keeping the sukuk market progressive. (iifm, 2019). chart 2a: sukuk issuances rate %, 2018 (global) source: iifm sukuk database. to analyze the sukuk issuance globally in the recent years, as it's known sukuk issuances are divided into several categories, which can divided to international sukuk issuances and domestic sukuk issuances which include long-term, mediumterm and short-term sukuk, also according the nature of sukuk issuers, as quasi-sovereign sukuk, corporate and financial institutions sukuk. in general, the figures indicate to a decreasing in the rate of issuance of the international sukuk that is amounted usd 37,648 billion in 2017 and usd 32,988 billion in 2018. on the other hand the rate of issuance of domestic sukuk has increased, that is amounted usd 79,069 billion in 2017 while amounted usd 90,162 billion in 2018. 2) sukuk issuances (turkey) the share of participation banks in turkey in the turkish banking market is still 5% since 2010, although in the last years the turkish government established three participation banks, zirrat participation bank, vakıf participation bank and recently emlak participation bank these banks started working with other participation banks al-baraka türk participation bank which established in 1985, kuveyt türk participation bank which established in 1989 and türkiye finans participation bank which established in 2005, that can contributing to take part in sukuk market, particularly the government is working to increase the participate banking sector to be 15% by 2025. sovereign ijara (leasing) sukuk that issued by turkish treasury (domestic currency) between 2012 and december ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 2018, amounted try 32,600 billion. while privet sukuk issuances between 2010 and december 2018, kuveyt türk participation bank amounted try 11,114 billion, türkiye finans participation bank try 7,930 billion, vakıf participation bank try 5,756 billion, zirrat participation bank try 4,904 billion, al baraka türk participation bank try 4,513 billion and corporate sector amounted try 3,259 billion… etc. as illustrated in chart 1b. chart 1b: total sukuk issuance volume in turkish lira (million try, 2010-2018) source: bloomberg sovereign sukuk that issued by turkish treasury (usd currency) between 2012 and december 2018, amounted approx. usd 6,000 billion. while privet issuances between 2010 and december 2018, kuveyt türk participation bank amounted usd 2,072 billion, türkiye finans participation bank usd 1,394 billion, al baraka türk participation bank usd 1,095 billion… etc. as illustrated in chart 2b. note: in 2017, turkish treasury started issuing sovereign sukuk based on euro currency, while in 2018 it issued sovereign sukuk based on gold. (tkbb, 2019). chart 2b: the total foreign currency denominated sukuk ussuances of the establishment in turkey (usa million, 2018) source: bloomberg in general, the figures indicate to an increase in the rate of issuance sukuk in turkey that is amounted try 37,189 billion in 2017 and try 68,457 billion in 2018, which means the increase by more than 64% in one year as illustrated in chart 3b. chart 3b: domestic turkish lira sukuk issued valume (million try 2010-2018) source: bloomberg iii. smart sukuk to understand the meaning of smart sukuk and its work mechanism we should know the concept of smart contract and blockchain technology. what is the concept of smart contract and blockchain? a. smart contract is “computer code that, upon the occurrence of a specified condition or conditions, is capable of running automatically according to pre-specified functions? the code can be stored and processed on a distributed ledger and would write any resulting change into the distributed ledger.” (commerce, 2018). nick szabo stated, “i call these new contracts “smart”, because they are far more functional than their inanimate paper-based ancestors. no use of artificial intelligence is implied. a smart contract is a set of promises, specified in digital form, including protocols within which the parties perform on these promises” (szabo, 1996). b. blockchain is a specific type of distributed ledger technology (dlt) transactions? “the transactions are ordered and grouped into blocks. it can be defined as a platform whereby peers can exchange values using transactions without the need for a central trusted arbitrator” (bashir, 2018). in another way, blockchain is a computer code or protocol that allows many participants of a same network to record information on a single shared ledger, where every participant can see the same data and information that inserted. blockchain technology system has several ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 advantages which are not found in the traditional transactions, where it characterized by transparent, distributed (decentralized), validated, incorruptible, unalterable and efficient database. this type of technology became as a real revolution in several financial areas, including the sukuk issuance transactions. so all types of documents and information related to the issuance of sukuk kept with the issuer's chains and the chains of the central registration institution. smart sukuk has different features from the conventional sukuk; it is obvious that sukuk markets are the most favorable in islamic finance. however, it is also clear which normally issued by powerful institutions and government agencies, therefore sukuk become very costly in terms of issuances. the smart sukuk structure has endeavored to use the blockchain technology and boost efficiency, transparency, reduce the cost and make it possible for small and medium enterprises smes, social impact projects, groups and associations to issue their own sukuk using the new technology. the world first innovation in smart sukuk introduced by blossom finance, the facility endeavored to change the conventional ways of sukuk issuance using the blockchain. the blossom’s smart sukuk uses ethereum blockchain smart contracts in other to strengthen the efficiency and make it a globally acceptable sukuk. the main significance of smart sukuk is standardizing and automating the accounting, legal and overhead payments of conventional sukuk offerings all these will fully backed by a licensed legal entity in the issuing country (sa’ad, 2018) the adoption and implementation of this new technology would help to simplify the sukuk issuance and trading processes and improve regulatory oversights. this is possible because ethereum smart contracts can help in standardizing and automating the legal, accounting and payment overhead of the sukuk structure ((i) identifying the asset and structure; (ii) negotiating (sharia, legal); and (iii) finalizing the documents. (damak, 2018). c. smart sukuk structures 1) sukuk issuance model structure, based on blockchain; the proposed smart sukuk issuance structure goes through several stages, as illustrated in figure (i) and as the following stages.  sukuk issuance announcement: spv company announces the issuance of smart sukuk for sale to all the investors via the platform.  demand transmission process: in order to overcome the cultural adaptation process, individual investors will be able to pass their demands to buy smart sukuk from the bank branches via bank mobile application or internet banking (the website of the bank). the demands of individual investors have been passed via blockchain in the background; on the other hand, corporate investors will also forward their demands directly to the authorized investment institution (the bank) via the platform.  finalization of distribution list: after the demand collection process is completed, distribution lists are finalized by the spv company and the bank. (due to the distribution process taking into consideration certain criteria, some clients can make part of the demand holder).  equivalent value of sukuk tokens: spv company equivalents sukuk tokens to turkish lira via platform at the clearing day; equivalent value of sukuk tokens are made available in turkish lira token account by the bank. the exchange of both transactions via smart contract will be automatically approved by the central registry institution (rci).  the approval and registration process: in order to complete the clearing transaction, the smart contract will be given automatic approval through the central register institution and the transactions will be registered in the nodes in both the central register institution and the bank.  transfer sukuk tokens to clients' wallets: following the automatic approval process through the central registry institution, the relevant sukuk tokens will transferred to the wallets of the clients. figure i. smart sukuk isuuance strucures 2) sukuk extinguishing (itfaa) model structure, based on blockchain. figure (ii) shows the proposed structural of smart sukuk extinguishing (itfaa) stage. ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 on the day of sukuk extinguishing (itfaa sukuk) transaction, paying periodic return and principal amount of sukuk.  the bank makes the turkish lira token available to cover the itfaa amount that is the periodic payment and principal amount.  on the value date, the system automatically makes the payment to the client accounts. in the same time, sukuk tokens are also deleted from the system. figure ii. smart sukuk extinguishing (itfaa transaction). 3) sukuk traded transaction, based on blockchain; figure (iii) shows the proposed smart sukuk traded transaction structure.  our bank transmits its request from the blockchain system to the network through the system to sell sukuk in its portfolio at a certain price and quantity.  a bank, which wants to buy the sukuk, passes the demand from the system and makes the tl token available in its account.  by smart contract, the clearing of transaction is performed automatically via settlement bank (takas bank) and the transaction is stored in the nodes in our bank and settlement bank (takas bank). figure iii. smart sukuk traded transaction structure 4) committed transactions market, based on blockchain; clearing date of the transaction. figure (iv) shows the first stage of trading smart sukuk in committed transaction market.  a bank transmits its demand from the blockchain system to the network through the system to sell sukuk in its portfolio over a certain date, price and quantity.  our bank, which wants to buy the sukuk, passes the demand from the system and makes the tl token available in its account.  by smart contract, the clearing of transaction performed automatically via settlement bank via settlement bank (takas bank). figure iv. clearing date of the transaction (first stage) a bank: investment institution which sales with buy back commitment. our bank: investment institution that buys with resale commitment. 5) clearing date of committed transaction. figure (5) shows the second stage of clearing date of committed transaction.  on the date of value, the tl (turkish lira) token in settlement bank (takas bank) has sent to our bank via smart contract; the relevant sukuk token is an automatically transferred to the settlement bank (takas bank).  a bank makes the tl token available in the account to purchase the sukuk in settlement bank (takas bank), and smart contract automatically executes the transaction. the transactions are registered to the nodes in settlement bank (takas bank) and our bank. ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 figure v. clearing date of committed transaction (second stage) iv. advantages & disadvantages through the proposed sukuk issuance structures and sukuk trading structures, there are many advantages and some expected disadvantages. a. advantages the advantages of using these sukuk structures can be summarized in the following points: access to more investors and markets, fast processing capability, transparency and invariance, low transaction cost, more effective audit and reconciliation system, minimize operational processes (documentation, signature, etc.), transactions open 24/7, will create an opportunity for the sukuk market to grow. b. disadvantages immature technology, high capital cost, cultural adaptation, lack of regulation, software errors. v. sharia perspective & issues in general smart sukuk works by smart contract of blockchain technology with its digital ledger, which are some protocols that are programmed by humans and it has many advantages such as more transparent, incorruptible, decentralized, robust, unalterable, efficient, reduces the cost of transactions... etc. all of these advantages could facilitate transactions in convenient way and hence would contribute to wellbeing. that achieves the maslaha, as well as the digital ledger in smart contracts designed to protect against fraud and this is one of the five pillars of the maqasid al-sharia (purposes of sharia), which is the protection of al-mal (property). the prophet (pbuh) said, "make things easy and do not make them difficult, cheer the people up by conveying glad tidings to them and do not repulse (them)" (al-bukhari). also regarding sharia compliance, auditing smart contracts characterized as more effective audit and reconciliation system. however, smart contracts of smart sukuk should guide by the broad principles of sharia by avoiding the prohibited elements in the transactions. sharia issues in smart sukuk could be a few noticed that can avoid when make the programming its protocols, “the certificates may be traded through any known means, that do not contravene the rules of the sharia, such as registration, electronic means or actual transmission by the bearer to the purchaser” (aaoifi, 2017). for example, will be no option of cancellation or amendment but in some contracts as mudaraba contract, where any of the mudaraba contracting parties has the right to terminate the contract individually (iqala). therefore, there should be an agreement stressing that once the smart contract is actualized and automated, there will be no termination, amendment or cancellation of the contract (sa’ad, 2018). in the conventional sukuk which based on debt such as sukuk of mudaraba or wakala contract if the profits are less than the anticipated return, the issuer/obligor stands ready with a liquidity facility to make up the shortfall, but “the certificate holders own the assets of mudaraba and the agreed upon share of the profits belongs to the owners of capital and they bear the loss, if any”. “the certificate holders own the assets represented by the certificates with its benefits and risks, and they are entitled to the profits, if any”. (aaoifi, 2017). in mudaraba sukuk contract, the profit value are sharing between the investor and issuer. if the investor could not make profit or may lose, in this case the issuer will not get its profit or incentive. smart sukuk can be the solution of these obstacles related to the conventional sukuk issuances in terms of its compliance to the sharia. vi. conclusion blockchain technology and smart contract considered as real revolution in the financial life. smart sukuk is becoming the future for sukuk issuances in the islamic finance industry. because of the advantages of this technology, it may contribute to the spread of sukuk more widely, which leads to the creation of more sources of islamic finance. in turkey, the government is working to increase the islamic (participation) banking sector to be 15% from the banking sector by 2025. the use of this technology in the issuance of sukuk will contribute to the growth of the islamic (participation) banking sector in turkey effectively. the proposed smart sukuk structures are designed to meet the sukuk issuance and its trading processes, as well as have taken in consideration the cultural aspect and investment environment of individuals and corporate sector. smart contracts of smart sukuk should guide by the broad principles of sharia by avoiding the prohibited elements in the transactions. the advantages of smart contracts could facilitate transactions in convenient way and hence would contribute to wellbeing and other positive things. sharia issues of smart sukuk could be a few noticed that can avoid when make the programming its protocols. perhaps the challenges that are facing smart instruments and smart contracts in general are to find legislation that will regulate their work, and adapt to the use of this technology in daily life. vii. references aaoifi. (2017). shari'ah standards. manama: dar almaiman for publishing & distributing. ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 al-bukhari, i. m. (n.d.). sahih al-bukhari. beirut: dar ibn kathir. bashir, i. (2018). mastering blockchain: distributed ledgers, decentralization and smart contracts explained. birmingham: packt. biancone, p. p., & radwan, m. (2018). social finance and unconventional financing alternatives: an overview. european journal of islamic finance, 2. bloomberg. (2019). bloomberg. retrieved from https://www.bloomberg.com. blossom. (2018, may 7). https://blossomfinance.com/press/islamic-financeupgraded-smarter-sukuk-using-blockchain. retrieved from blossomfinance.com. commerce, s. c. (2018). smart contracts: is the law ready? publication. damak, m. (2018). sukuk market update. dubai: s&p global. iifm. (2019). iifm sukuk report. manama: iifm. popper, n. (2015, 5 15). the new york times. retrieved from https://www.nytimes.com. sa’ad, a. a. (2018, feb). smart sukuk structure from shari’ah perspective: the application of mudarabah smart contract. e-proceedings of the global conference on islamic economics and finance 2018, 4. szabo, n. (1996). smart contracts: building blocks for digital markets. retrieved from http://www.fon.hum.uva.nl. tkbb. (2019). sukuk issuance 2010-2019. istanbul: turkish participation banks union. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 insaniah (humanistic) economics of waqf: from ir 4.0 to a human-centred tawhidic society 5.0 http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 abstract this paper provides an account of the commonalities of theoretical foundations of insaniah (humanistic) economics prevailing in waqf transactions (islamic endowment). the paper establishes the integration of the two theoretical foundations, the insaniah (humanistic) economics in the waqf transactions. keywords: waqf, insaniah, humanistic economics, societal benefits and shariah compliant 1. introduction considering thatwaqf is about preserving the usufruct (the right-of-use) of specified asset(s) by donor (waqif) so that it may benefit the society in the long run (aaoifi, 2018), and conceptually ownership of a waqf belongs to allah s.w.t.alone;the paper proposes a trajectory from an existing secular economics of societal transformation society 5.0 (a super smart society). the society 5.0 itself is a societal transformation plan from ir 4.0 and emphasizes on social implications, ethics, and social acceptance by all stakeholders. in view of the substantial role of waqf as one of islamic economic rites, a human-centred tawhidic society 5.0is the common purpose in all the transformational phases. 2. literature review the insaniah (humanistic)economics isa distinct economic proposition that places“persons-first”. fundamentally, it isabout achieving organisational purposesthrough care, flourishing and well-being of people.in a nutshell, it is about human participation inbusiness organizational pursuit that granados(2015) among others, puts forth a principle of limitation. by this,it is wrong to produce morethan what one can consume.central to the entire theoretical foundation of insaniah (humanistic) economics is a focus on broadening ownership of wealthin the society, co-creating and uplifting the well-being ofhumankind.in the same vein, the waqf transactions are intended to achieve equality of allhuman beings in relation to allah s.wt. in consistent with the principle of tawhid. the principle specifies the absolute right of ownership of all the world’s resources belongs solely to him. in addition, the resources must be used to generate wealth for a fair and just distribution of the wealth. as all human beings have equal rights on these resources as they are given only as a trust for custody or stewardship. further, the insaniah (humanistic) economics is an alternative framework to the one that issolely oriented towards profits motive. the latteris a secular economic that focuses on profit maximation. it places people as mere resources for business organizational pursuits.through this the rich are getting steadily richer. consequently, there is growing wealth inequality in the society. on the other hand, the insaniah (humanistic) economics is the human psychology side in the economics. it is a recently invigorated modelof economicsthat has been growing interests among scholars. a conception of insaniah (humanistic) management as a distinct perceptive with underlying dynamics to create a more balanced relationship between objects in the society has been suggested by kabadayi, alkire, broad, livnetarandach, wasieleski&puente (2019). it is an alternative to a skewed approach to the “mechanistic” management. though it does not deny or is against, the significant of efficient techniquesand skills in the “mechanistic” management to maximise outcomes such as achieving targeted productivity and reducing costs. and that business goes about to create more shareholder value or large size profitable organizations and money which also allows employees need to feel safe and acquire things that make their lives better. one core value of humanistic organization is inclusion (fish, dean, previte, robertson & rosenbaum (2018) argue that by acknowledging the human needs for fair opportunity, human (insaniah) progress become plausible. after all a detailed examination insaniah (humanistic) economics of waqf: from ir 4.0 to a human-centred tawhidic society 5.0 associate professor dr. mohd yaziz mohd isa a professor dr. zulkifflee mohamed b a universiti tun abdul razak, malaysia. mohd_yaziz@unirazak.edu.my b universiti tun abdul razak, malaysia. zulkifflee@unirazak.edu.my mailto:mohd_yaziz@unirazak.edu.my mailto:zulkifflee@unirazak.edu.my ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 of humanistic economics by burleson (2015) showed that human relationship with money is a critical foundation to make a difference in human lives; but the insaniah (humanistic) management adds the other side of human nature other than selfinterest, and the human interpersonal relationships in the workplace and society. the bonding and community that people required, and purpose to truly achieve success and happiness for mankind. meantime, waqf is an islamic endowment, established in expressed compliance with islamic law or shariah. the word “waqf” means “to stop”, “to pause”, “to detain”, “to withhold” or “to prevent” something from movement. it is making an asset invulnerable to any disposition that leads or causes to transfer of ownership. 3. discussions many recent studies have focused on waqf and on its dedicationto donate the usufruct (the right-ofuse) of specified asset(s) by donor (waqif) to beneficiaries, humans or ummah for uplifting their well-being. given this, it may be inferred that the theoretical foundations of insaniah (humanistic) for economic gains and societal benefits is also at the heart of our understanding of the (waqf) transactions. in a study by shulthoni and md. saad (2018); they examine varioustraditional and modern methods of waqf fundraising. the authors draw our attention to waqf transactions as dedicationsto transfer of wealth from the rich to the poor to effect social justice. in addition, the authors offerexplanations that insuchtransactions,prosperity is then circulated from the rich to the poor. it is inthe same vein with insaniah (humanistic) economics because it focuses also on principles of sharing andbroadening of ownership of wealth toummah. a scholar, cizakca (2016) opines that in islam accumulation of wealth and its redistribution are jointly related. biancone & radwan (2018) have further subscribed to the belief that waqf raises awareness among the affordably rich people on their responsibility for social impact development for the ummah and for economic gains. the scope of waqf asset(s) includes from traditionally real estate/property to other instruments such as cash, unit trusts and other types financial investments & instruments, andmoveable items such as livestock. biancore & secinaro (2016) propose equity crowdfunding for an italian market. as in any phase of human development, innovation functions as a driving force for economic activity and mechanisms through which the economic activity are transacted and diversified with a momentum that is overturning existing industrial structure as well. this includes the scope of waqf asset(s) as well. however, the core purpose for waqf remains to provide or generate income or service or usufruct to its beneficiaries. it is to fulfil a non-profit purpose. essentially, waqf is not established to generate profit for its contributors of capital. interestingly, capital in insaniah (humanistic) economics is also explained widely. in granados’s (2015) principle of economic justice, the author points outsince capital pays for itself that once allowed to concentrate in the hands of a few, it spirals out of control and leads to wealth inequality.both waqf and humanistic economics propose the principle of distribution and participation. in this regards, in granados’s (2015) context of humanistic (insaniah) economics, the author finds that it is morally wrong and illicit for a person to own a capital and produces income he or she has no intention or capacity to consume especiallywhen somewhere there is someone who is being denied his or her right to participatein economic activities.in the same vein, lambin (2014) in his concept of humanistic (insaniah) market economy as a concept that embraces humanism and market forces, is very critical of capitalism.muslims are ordained to redistribute the accumulated wealth therefore helping fellow ummah in the society (cizakca, 2016). the redistribution of the wealth allows for the provisions of myriad of essential services to muslims and non-muslims allowing for the substantial reduction in government expenditure. in turn, a reduction in the government spending goes on to reduce business sole preoccupation with achieving targeted productivity and profitable organizations, the two pillars of secular economics. the insaniah (humanistic)economic on the other hand, is self-correcting and enhances humankind through wide-spread participation in the society, lambin (2014) adds. the challenges to this approach are the complexity of human behaviour. economists should understand individuals and their motivations and should help individuals to achieve their goals at the same time while pursuing organisational goals. in this context, the economists have power and responsibilities, whose roles essentially are as motivator of or facilitator for others. humanistic (insaniah) economics entails guiding principles that are based on three dimensions, first that humans deserve our dignity to be respected, second that ethical considerations called upon in all aspects of economics decisions, ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 and third the initiating and maintaining an ongoing dialogue and consultations with all stakeholders in thoughtful ethical manners. a stakeholder is any person or group of people who will be affected by an economics decision. these three dimensions shall promote human well-being that is conducive and add-value to society at large. in a similar fashion, with the waqf transactions, budiman (2014) in refuting western scholarsclaims that waqf could no longer perform its role in the contemporary economy, demonstrate the(waqf)transactions could generate income to benefit the society. the transactions involve diverting funds and resources from current consumption for future consumption and accumulating of capital in the economy. omar (2018) suggeststhat waqf holds great potential for economic development and development of an inclusive economy. 3.1 from ir 4.0 to a human-centred tawhidic society 5.0 we are presently in a new era where innovations driven by enabling technologies such as iot, ai, and robotics are bringing profound changes to the economy and society. in this era of the enabling technologies, everyone can enter the ring to change society. the digital technological trends are evolving to further fuel the economy through complementarity between science & technology, and innovations. while technological innovations are expected to continue to play significant role to address challenges and greatly enhanced lifestyle convenience, theycould also increase social complexity. some negative aspects of the digital society are becoming apparent like displaced labour and reduced labour productivity.therefore, it is becoming increasingly difficult to ignore the need to equip the growth plans with the flexibility to respond to a world that is changing daily at tremendous speed.it is due to continuous development in science & technologyand economic growth. in this age of uncertainty, we cannot predict what the world will be like five or six years from now. therefore, as a prerequisite for innovations, it become increasingly necessary to dictate the direction for our society to be pursued. this is the case especiallybecause digital technological innovations can affect progress not only in positive ways but also in negative ways (2019, november 7). there have been negative aspects accompanying scientific and technological advancements such as increase in inequality among ummah. looking back at the society 1.0, it is defined as a hunting society consisting of groups of people hunting and gathering in harmonious co-existence with nature. the society 2.0 is a forming group based on agricultural cultivation, increasing organization and nation-building while the society 3.0 is a society that promotes industrialization through industrial revolution, making mass production possible. it follows with the society 4.0 as an information society that realizes increasing added value by connecting intangibles assets as information networks. raw materials & agricultural products invention of steam locomotives start of mass production invention of computers start of information distribution iot, ai super smart society information society industrial society development of irrigation techniques firm establishment of settlements agrarian society coexistence with nature hunting society natural products explicit technology added products explicit knowledge through networks innovative knowledge products/service the birth of human beings 13,000 bc end of the 18 th century later half of the 20 th century from the 21 st century figure 1: trajectory of human-centred tawhidic society 5.0 taw hidic ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 the society 5.0 is an information society built upon the society 4.0. the society 5.0 aims for a prosperous human-centred society. in the society 5.0, movements toward incorporating new elements from both secular and islamic economics into existing technologies and knowledge,thereafter, designing and creating previously unknown business services are gaining visibility. taking into accountsthe scope of waqf transactions has expanded concurrentlyon the verge of the human-centred society 5.0from traditional platforms due to the socio-economic demands, it becomes increasingly necessary the human-centred tawhidic-based principles is the foundation for economic activities for the ummah. innovation is increasingly important as a driving force for economy activities, without a doubt. underneath all this is “digitized information”, in the future, innovative information-based technologies such as internet of things (iot), artificial intelligence (ai), and robotics are expected to generate new added value. the blockchain technology which is a distributed ledger technology (bianance, 2019) is an example where waqf transactions take place in a distributed ledger technology. through the technological advancements, the waqf purposes realize maximum potentials for the benefits of ummah (obaidullah, mohammed, 2018). as in any phase of human development, innovations function as a driving force for economic activity but its mechanisms are diversifying with a momentum that is overturning existing industrial structure as well. for waqf (islamic endowment) the core purpose however remains to provide or generate income or service or usufruct to its beneficiaries, the ummah.its social impact benefits for economic growth and income generation to the ummah are for long term period (biancone & radwan, 2018) give insights. it is always a core of people, not technology in the concept of society 5.0. this is in the same spirit of tawhidic society 5.0 that is a human-centred society. because tawhidic paradigm provides the philosophy of purpose of doing things that is solely for allah s.w.t. to secure his pleasure (ismail &mdh. sarif, 2018). the authors in their study of the critical importance of the tawhidic paradigm link the spirit of tawhid with management functions. entrusted by allah s.w.t., humans have at their dispositions the physical and spiritual resources but with terms and conditions. the resources are not owned absolutely by humanity; they are only a trust from allah s.w.t. in the human-centred tawhidic society 5.0, all opportunities and possibilities belong equally to all human beings. in the human-centred tawhidic society 5.0, digitalization is a means, but human (ummah) submission to allah s.w.t. remains central. in the same vein, the waqf transactions, for they are carried out through donations by donors, whose actions despite various options, have chosen (novak, 1997) to leverage emerging digital technological advancements to donate into investment in the administration of an administrator (mutawalli) via legal instrument (wafiyyah). any returns (incomes) or usufruct (the right-of-use) of that asset benefits a stated beneficiaryor is used for a stated purpose in a sustained and fruitful ways for humankind in the society. in the human-centred tawhidic society 5.0waqf are transacted in a mergedof physical space (real world) and cyberspace by leveraging ict to its fullest. it is a society that aimsat human beings, the ummah, providing breadth as a shared concept to them.the physical resources available are transacted are not owned absolutely by any human, as they are only a trust from allah s.w.t. in the human-centred tawhidic society 5.0 various needs of the society are finely differentiated and met through various ict approaches by providing the necessary products and services in the required amounts to the ummah who need them when they need them, and in which all the ummah can receive high-quality services and live a comfortable. with our understanding of the insaniah (humanistic) economics that adds the other side of human nature, the human-centred tawhidic society 5.0 is set on the pre-determined duties of human (insaniah) as servant and vicegerent of allah s.w.t. hilmiyah, possumah & mohd shafiai (2016) investigated on the islamic economics system. the authors propose tawhidic-based system as the ideal form of a socio-economics order. because the system’s focus on cultivating the solidarity (charity), it fits the reality of human life that is to create benefits for all ummah, the authors conclude. the setting up of well-structured framework for governing is important for attracting islamic investors to invest in shariah compliant instruments, biancone & radwan (2016) find. returning to the insaniah (humanistic) economics, the approach recognises the uniqueness of each participant in the society. it places a great emphasis on interpersonal relationships, the singularity of each situation and the necessity of managing “like an artist” instead of managing using a set of learned guidelines. for this reason, humanistic economics is view as an art by david eli lilienthal in his book with a title management: a humanistic art. the author defines humanistic economicsas the art in getting things done with people (the human) coordinating theirefforts and allocating resources and knowledge in accordance with the ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 organizational mission to accomplish goals. and the goals are for the betterment of the humankind. the guiding beliefs of insaniah (humanistic)economics for business is that a business is a “community of persons” where they can flourish and cooperate for achieving common goals. it rejects the idea that business as a mere aggregate of individuals united exclusively by contracts. for the latter ignores human relationality and sociability and the rich framework of relationships existing in the business beyond contracts. that business is born in the society, is part of it and the receptor of its activity is the society.a key aspect of social business is that it is expected to bridge gap of the public and private sectors to meet their socio-economic goals due to its income generating while offering societal contributions (biancone & radwan, 2019). the authors provide insights on the wide selection of islamic financial charitable tools including waqf. in an earlier study on possibility of shariah compliant tools for italian smes, biancone & radwan (2014) revealed they create prosperity in the economy. similarly, in the waqf transactions, the donor (waqif) having dedicated the waqf asset, goes on to gain returns from the waqf assets that are dedicated or donated to a stated beneficiary/ies, and for stated purpose for societal benefits. the beneficiary is the person and the society who is entitled to the disbursement of waqf’s benefits in accordance with the provisions of the waqf deed. this is in line with the view of insaniah (humanistic)economics that is aimed at the creation of sustainable human welfare. martyn and suganya (2016) propose justified, and equitable distribution and share for all mankind the economy and resources to solve growing discontent in the society in the same ways that waqf assets are dedicated for the societal benefits. in the case of waqf transactions, the returns or incomes gain can be used only for waqf purpose/s or objectives. it can be only used to increase the future economic benefits of the waqf, just like in the insaniah (humanistic) economics that promotes human flourishing. the donor (waqif) and administrator (mutawalli) may be a non-natural such as a corporate entity. it’s moral legitimacy should come from contributing to the common good of the society by providing goods and services fairly and efficiently, maintaining and creating jobs that are consistent with human dignity and appropriate to fostering human flourishing and generating wealth. in contrast, non-humanistic is viewed as those business activities which are to the detriment of human dignity. when the term humanistic economics was introduced, it was introduced as alternative proposals to overcome the monotonous repetition of tasks established by scientific management to improve productivity above all other concerns. the reason was that the scientific management give little or no thoughtto worker motivation. going back to scientific approach in economy, it was frederik w. taylor in early 1900s who pioneered the principle during the world war ii to assist the military. it was so successful that it is apply and use by many companies in economic decision making and planning. it was also called job enrichment, humanistic management isa new way to cope with old problems with the scientific management; motivation or the lack of it, work satisfaction or the lack of it, morale or the absent of it, responsibility or the lack of it, variety in jobs or the lack of it; and productivity or the lack of it. it soon becoming as a means for achieving both, productivity and developing human capital potential. the philosophy promotes the development of economic system but with respect for human dignity and well-being. the dignity of human being lies in its ability to define the purpose of its existence.the view of human being is morefrom that of onlyhuman capital or resources for economic goals, so that human being can be transformed from the passive or obedient employee into an active-cooperative one in economic activities.for human being is capable to selfdetermine and self-interest is not the only motivation for human behaviour. in this regard, work for human beings is deemed to contribute to both production cost-benefits analysis and personal development by acquiring skills and moral virtues. chronic issues such as climate change, pollution, food injustice, and poverty have been further aggravated by organizations that peruse for-profit maximation. the author goes on to argue that the dominant economic paradigm that many businesses follow today is ineffective at it centres only on money, power, and self-interest, but has failed in creating wider benefits. as a result, people often feel unhappy and unsatisfied at work. the defence of human dignity in face of its vulnerability is because the human being in the process to define the purpose of its existencecooperate socially, involve in business and economic activities. this interactions and involvements can either foster or obstruct human life and wellbeing.in this perspective, individual is seen as someone with talents who can be motivated to cooperate and work with high or low morale and can develop feelings of resentment for the organization or pride at belonging at it. therefore, taking care of people’s (ummah) motivation and having a more complete view of human being, is seen as important aspects of management.it expands in recent times to centrality of people (ummah) within the organisation and the society, ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 and on considering human beings. it is humancentred for interaction and fulfilment that goes beyond traditional rigidity of structures and system. control techniques are important but fostering creativity, motivation and good feelings are also very relevant. some scholars go to the extend to suggest putting people first to achieve organisational success.theupholding of humanity is the ultimate end, the focal point and principle of all economic activities. the principle echoes that individuals (ummah)in society interact ruled by justice and benevolence and civic friendship without losing their personality and sense of responsibilities that calls for respect for human dignity which in turns respect for freedom. the economic entities or firms are viewed as a community of persons. in it, collective decision-making should be based on free and equal deliberation, participation, or representation of all affected parties. thedefinition of economic success in life-conducive market activities that is based on quantitative metrics should be complemented by qualitative evaluation criteria which human dignity of every man and every woman is universally respected. 4. conclusion the arguments for insaniah (humanistic) through waqf transactions long precede, and complement, more explicitly to the insaniah (humanistic) economic. it is about efforts to share (walsh, 2019) the prosperity among humankind. all the efforts of humanistic economics, as with waqf transactions are geared toward protecting and promoting of human dignity with an emerging focus on wellbeing (gohl, 2018). taking into considerations that waqf is about preserving the usufruct (the right-ofuse) of specified asset(s) and conceptually ownership of a waqf belongs to allah s.w.t. the paper establishes a human-centred tawhidic society 5.0 as the common purpose in the societal transformation. references 1) aaoifi (accounting and auditing organization for islamic financial institutions) (2018), waqf governance g3/2018 version 8.4 pp. 1-52 2) biancone paolo pietro & radwan maha (2014). shariah compliant “possibility for italian smes”. european journal of islamic finance, no. 1, december 3) biancone paolo 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(2019), who will it take for business to improve lives? the “man” in the mirror. humanist management journal, pp. 1-7 26) 2019, november 7. digital technological is key. dr. m: it will play a critical role in sdgs despite innovations. the star (2019, november 7), pp. 2 https://ssrn.com/abstract=2808475 https://www.firstthings.com/article/1997/10/004-economics-as-humanism https://www.firstthings.com/article/1997/10/004-economics-as-humanism https://sadaqa.in/2018/02/28/blockchain-for-waqf/ https://sadaqa.in/2018/02/28/blockchain-for-waqf/ https://www.bis.org/review/r180411b.htm ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 the role of sharia supervisory boards in meeting maqasid syariah – study on islamic banks in indonesia accounting department, economics faculty, universitas negeri semarang, indonesia email : hasanmukhibad@mail.unnes.ac.id abstract— islamic and conventional banks have real operational differences, so it would be better to measure the performance of these two kinds of banks with different tools. one alternative performance measure is maqasid syariah. the research has been conducted to prove whether the corporate governance, sharia supervisory boards (ssb), and corporate ethics have contributed to the achievement of maqasid syariah. the research sample is commercial islamic banks in indonesia with an observation period from 2009-2017. the data processing uses equation model structure. the result studies are maqasid syariah have not yet become a matter of concern for islamic banks in indonesia. this fact is proven by the lack of any role for the corporate governance and ssb in ensuring that maqasid shariah are met. corporate governance have a positive influence on profitability. islamic banking makes a positive contribution to corporate ethics, and has a positive effect on profitability and maqasid syariah. keywords-component; maqasid syariah, the role of sharia supervisory boards, corporate governance i. introduction the growth of islamic banks is an integral part of the growth of the global sharia economy. kustin (2015) mentioned that, in 1970, islamic financial institutions had assets of usd 500,000 and this had increased to more than usd 1 billion in 2009 with an average increase of 14% per year. ernst & young estimates that the total assets of sharia financial institutions reached usd 3.4 billion in 2018. indonesia has seen a rapid growth in islamic banking. statistics on this sector in indonesia show that the average growth in the assets of the nation’s islamic banks is 28.42% with an average increase in return on assets (roa) of 5.20%. the following table shows data on islamic banking from 2010 to september 2017. table 1. islamic banking statistics 2010 2017 indica tors 2010 2011 2012 2o13 2014 2015 2016 sep17 mean roa 1.67 % 1.79 % 2.14 % 2.00 % 0.79 % 0.84 % 0.95 % 1.41 % 1.50% operat ing expens e ratio (oer) 80.54 % 78.41 % 74.97 % 78.21 % 94.16 % 94.38 % 93.62 % 87.46 % 83.09 % ʃ asset (billio n idr) 97.51 9 145.4 67 195.0 18 242.2 76 272.3 43 296.2 62 356.5 04 395.0 93 395.09 3 roa increas ed 12.73 % 7.28 % 19.29 % 6.29 % 60.69 % 6.61 % 12.90 % 49.06 % 5.20% oer increas ed 4.56 % 2.64 % 4.39 % 4.32 % 20.39 % 0.24 % 0.81 % 6.58 % 1.08% asset increas ed 47.56 % 49.17 % 34.06 % 24.23 % 12.41 % 8.78 % 20.33 % 10.82 % 28.42 % source : bank indonesia, 2017 the performance of islamic banks in indonesia, as shown by the data from bank indonesia, has many weaknesses, namely weaknesses in determining performance indicators. the iindicators formulated by bank indonesia in its circular letter no.9/24/dpbs pertaining to "commercial bank soundness rating system based on sharia principles", indicate that islamic banks are measured based on six indicators, namely (1) capital; (2) asset quality; (3) earnings; (4) liquidity; (5) sensitivity to market risk; (6) management. these indicators are measured by financial ratios that are commonly referred to as camel ratios. syafii, sanrego, & taufiq (2012) consider camel ratios to be commonly used to assess the performance of conventional banks. this approach to measuring the performance of islamic banks, where the financial ratios used hasan mukhibad ejif – european journal of islamic finance no13, august (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 are also commonly used for conventional banks, is very inappropriate (hartono & sobari, 2017; syafii, sanrego & taufiq, 2012; kuppusamy, et al. 2010; mohammed & tarique, kazi; islam, 2015; hurayra, 2015). this is because the objectives of islamic banks and conventional banks are different in principle as well as in theory and practice (syafii et al., 2012). thus, with the use of financial ratios as a measure of the performance of islamic banks being not appropriate, other more comprehensive measures are needed (syafii et al., 2012). some researchers have developed alternative performance measures to replace financial ratios, namely maqasid syariah which essentially means islamic goals or purpose. the basis for the development of this measurement model is that the principles used by islamic banks are those of islamic law, so the performance measurement must also be in line with the goals of islam (maqasid syariah) [5], [6]. some researchers have used maqasid syariah in measuring the performance of islamic banks. asutay & harningtyas (2015), who examined 13 islamic banks in six countries, produced findings showing that the performance of maqasid syariah islamic banks was still low and there were no differences in the level of maqasid syariah between countries. hurayra (2015) also found that islamic banks in bangladesh have a low level of ms due to unavoidable debt from benefits received by banks due to macroeconomic conditions. research by hartono & sobari (2017) produced findings that showed bus and bprs in indonesia had small values in terms of maqasid syariah. as can be seen from the several studies cited above, most of the research that has been conducted has been into measuring achievement of maqasid syariah goals and conducting inter-bank comparisons. however, kolid & bachtiar (2014) identified factors that influence the level of maqasid syariah performance and found the size of boards of commissioners and audit committees had a positive relationship with ms performance. based on the description above, it can be seen that research related to the measurement of ms performance is still limited to the measurement of the number of ms values that there are, and to comparative tests between several banks; existing research that explores the factors that affect maqasid syariah performance is still limited. therefore, it is necessary to conduct research that can explore the factors that affect ms performance. this study has been conducted in order to complement the existing research [8] in exploring the factors that influence maqasid syariah performance in islamic banks. in this study, new propositions are developed that have the potential to have an impact on the level of ms performance. the variables that strongly influence maqasid syariah are corporate governance (cg), sharia supervisory board (ssb) profile, and corporate ethics disclosure (ced). ii. theoretical framework and hypotesis a. stakeholder theory islamic banks have principles, theories and practices that are different from conventional banks [2]. the main difference between islamic and conventional banks is the use of islamic law as the main basis for developing their business concepts, theories and practices. islamic banks are banks that use islamic law for their business practices, so there must be compliance with islamic principles. stakeholder theory explains that companies must be oriented towards meeting all stakeholders' interests. stakeholders are "groups and individuals who can influence or be affected" by actions related to the value creation and operations of the company [9]. the operation of a company is basically a team performance that cannot be separated from the participation of all stakeholders, so the fulfillment of all stakeholders' rights fairly is normal. freeman, harrison, wicks, parmar, & de colle (2010) assessed that the aim of stakeholders' theory is to create value for all stakeholders. in the concept of an entity based on having religious law as its operational basis, islamic entities have a wider range of stakeholders than conventional entities. islamic entities have an orientation towards holistic performance which includes performance in this world and in the hereafter (falah oriented). so, the stakeholders of islamic entities are concerned with god. the fulfillment of god's interests is carried out by the operationalization of islamic banks in accordance with islamic law. to guarantee the fulfillment of islamic law, islamic banks have a sharia supervisory board (ssb). this ssb has functions as a supervisor and as a consultant for the management regarding the running the bank so that its operation is in accordance with islamic law (mohammed & muhammed, 2017). thus, the effectiveness of the role of ssb in carrying out its functions determines, to a large degree, whether the bank achieves its objectives, that is to say, from the point of view of stakeholder theory, the fulfillment of all stakeholders' interests. in addition to ssb, banks also need other parties who guarantee that banks can meet the needs of stakeholders. from the point of view of agency conflict, there is an asymmetry of information between the owner and management. management, as the agent, and the owner, as the principal, have different information pertaining to the company's performance. management, as the party running a company, certainly has more information than the owner. corporate governance is needed to reduce agency conflict. thus, corporate governance is needed to guarantee the interests of all stakeholders. b. maqasid syariah in textual terms, maqasid syariah means the purposes or goals of islamic law. serving the public interest to maximize benefits and reduce losses for society is the main ejif – european journal of islamic finance no13, august (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 principle of the maqasid syariah [12]. islamic law is basically derived from several sources (qur'an, hadith, ijtihad) and has several objectives, namely to promote the welfare of society by protecting their religion (din), life (nafs), intellect ('aql), posterity (nash) , and prosperity (mal) [2], [5], [7], [13], [17] [18]. several previous studies have developed the extent to which ms can be applied by islamic banks. syafii et al. (2012); hartono & sobari (2017) and rusydiana (2016), in measuring the level of maqasid syariah performance in islamic banks in indonesia and jordan, measured its performance by using three targets, namely in terms of education (tahdhib al-fard), justice (al-adl), and welfare (almaslahah). educational goals are measured by the ratio of educational scholarships to total donations, the ratio of reseach costs to total costs, the ratio of training costs to total costs, the ratio of advertising costs to total costs. the purpose of justice is measured by using the indicator of ratio of profit to total income, the ratio of bad loans to total investment, the ratio of interest free income to total income. the purpose of public interest is measured by the ratio of net profit to total assets, the ratio of spending on zakah (religious donations) to total assets, and the ratio of investment deposit to total deposits. meanwhile, (syafii, et al., 2012; asutay and harningtyas, 2015; rusydiana, 2016; hartono and sobari, 2017) used the value of maqasid syariah disclosure to measure ms bank performance. ms performance is measured by several indicators, including justice, educating individuals, and public interest. c. development of hypotheses some research related to the measurement of maqasid syariah performance in islamic banks was conducted previously by asutay & harningtyas (2015); hurayra (2015); kolid & bachtiar (2014); mohammad & shahwan (2013); mohammed et al. (2015); muchlis, et al. (2016); rusydiana (2016); shinkafi et al. (2017); soleh (2016); syafii et al. (2012); tarique & ahmed (2017). however, most of the above studies measure the performance of islamic banks using the ms method and comparisons between the maqasid syariah performances of banks. these studies are still limited to research that connects several variables that allegedly influence the maqasid syariah performance of a bank. for this reason, this research will develop propositions derived from theory and logical analysis. in addition, propositions will be strengthened by several studies that are commensurate with the propositions developed. corporate governance is a system by which the company is directed and controlled including in terms of compliance, accountability and transparency (jamali, et al. 2008). this control is exerted in order to improve the company in achieving its goals. in addition, cg is needed to ensure that managers carry out their functions while adhering to existing rules, laws and codes of ethics (jamali, et al, 2008). some researchers have proven empirically that cg has a positive effect on achieving company goals. generally, company goals are measured by profitability [see sakawa & watanabel (2011); rehman, et al. (2010); mayur & saravanan (2017) shittu, et al. (2016), and a relationship between cg and profitability has been found. however, mayur & saravanan (2017) found that the number of board meetings had no significant influence on performance. in this study, the achievement of company goals is measured by ms performance. this is in line with the opinion of al ghozali which is that the goal of implementation of islamic law is maqasid syariah performance. cg is measured using the ratio of independent commissioners, the size of audit committees, and the size of boards of commissioners. h1: corporate governance (ratio of independent commissioners, size of audit committees, and size of board of commissioners) has a positive influence on maqasid syariah performance the characteristic of islamic financial institutions is that they use islamic law. in carrying out their operations, these entities will be supervised by a ssb. ssbs have a function of monitoring and guaranteeing that the banks have complied with islamic law in all their operations. the study of stakeholder theory discusses the role of all company managers in meeting the interests of all stakeholders. according to the islamic view, stakeholder theory provides an overview of the role of ssb in meeting the interests of all corporate stakeholders (mohammed & muhammed, 2017). the participation of ssbs in meeting stakeholders' interests is based on the view that all parties have a contribution to make to achieving company performance. that is to say, it is very possible to develop the role of the ssbs in achieving the performance of islamic banks. some researchers have developed ssb functions that go further than just bank compliance with islamic law, such as the functions of improving the quality of financial statements (rini, 2014), reducing earnings management (discretionary loan loss provisions) [27], increasing profitability (nomran, et al., 2017; shittu et al., 2016). it is found that ssbs have a role in improving bank performance because ssbs have been proven empirically to carry out monitoring and management consultancy for the running of the company (almutairi & quttainah, 2016; dan farook et al., 2011). however, asrori (2014) and matoussi & grassa (2012) found that ssb has no influence on financial performance. in this study, ssbs have been measured using size of the ssb, the number of meetings held, the cross membership of board members, and their education level and background. these five indicators are used to assess the effectiveness of ssbs in monitoring and supervising bank performance. in addition, these five indicators have also been used for several previous studies, such as ghayad, (2008), nomran et al. (2017), mohammed & muhammed (2017), matoussi & grassa (2012), mersni & othmanc (2016), almutairi & quttainah (2016); dan farook et al. (2011). ejif – european journal of islamic finance no13, august (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 h2: sharia supervisory boards (number of members, number of meetings, cross membership, members’ educational level and background) have a positive influence on maqasid syariah performance in the study of stakeholders' theory, values are part of the management of the company's business (freeman, et al., 2004). ethical values and economic activities cannot be separated (freeman, et al., 2004). ethics are needed to improve the company's economic morality which can further improve moral performance. hörisch et al., (2014) divide stakeholder theory into four types, namely descriptive/empirical stakeholders, instrumental stakeholders, normative stakeholders, and integrative stakeholders. the focus of descriptive/empirical stakeholder theory is describing how the company is regulated (identification of relevant stakeholders). instrumental stakeholder theory discusses the role of management stakeholders in achieving company goals. normative stakeholder theory has a focus on corporate goals and moral justification from stakeholder theory. the scope of integrative stakeholder theory considers descriptive, instrumental and normative aspects of stakeholder theory to become more closely related. in the formulation of company goals, there has been a major development. the purpose of the company is not only focused on fulfilling the interests of the owner, which are proxied by profitability, but also meets the interests of all stakeholders. one of the ways to increase the effectiveness of the company in realizing the company's goals is by using corporate ethics. [35] found that ethical disclosures improved the performance of company shares in the long run. persons (2013) found that there is a relationship between ethics and company performance. berrone, et al. (2005) revealed that ethics have information value and increase shareholder value, and that applied ethics have a positive impact through increasing stakeholder satisfaction. cuomo, et al. (2016) have identified the existence of inverse causality between positive financial performance and ethical orientation in banking companies in italy in the study of instrumental stakeholders theory, ethics formulation is carried out by company management. this is because management, in setting the "tone at the top", has the authority to manage the company. the director has an important role in developing ethical codes and reducing the occurrence of corporate inequality [39]. in line with felo (2011) with, carcello (2009) corporate governance can be an important defense against unethical corporate behaviour. h3: corporate governance (ratio of independent commissioners, size of audit committees, and size of board of commissioners) has a positive influence on islamic ethics in the management of islamic banks, there is one unique board, the sharia supervisory board. it has been proven empirically that ssbs are effective in supervising company management and providing management consultancy (almutairi & quttainah, 2016; and farook et al., 2011). in managing the company, there are many activities that can improve the achievement of company goals, including ethics. that is, ssbs are likely to have a role in developing corporate ethics, so the hypotheses that can be developed is follows: h4: the sharia supervisory board (number of members, number of meetings, cross membership, education level and background) has a positive influence on corporate ethics disclosure. ethics is one of the corporate tools used to manage a company. business ethics have had an important role because of the occurrence of financial scandals, due to the fact that unethical behaviour can lead to bankruptcy of companies such as seen in the enron and worldcom cases [36]. this is because behaviour that is not ethical will have an impact in terms of reduced profitability and stock prices [36]. this is evidenced by several studies, such as those conducted by (jo & kim, 2008; persons, 2013; berrone et al., 2005). jo & kim (2008) found that ethical disclosures improved the performance of company shares in the long run. persons (2013) found that there is a relationship between ethics and company performance. berrone, et al. (2005) revealed that ethics have information value and increase shareholder value, and that applied ethics have a positive impact through increasing stakeholder satisfaction. cuomo, et. al. (2016) have identified the existence of inverse causality between positive financial performance and ethical orientation in banking companies in italy. in this study, the measure of company goals are the levels of profitability and maqasid syariah. so, the hypothesis can be developed as follows: h5: corporate ethics disclosure has a positive influence on maqasid syariah performance iii. method the population of this research is 11 islamic banks in indonesia. the research sample was determined based on purposive sampling, where the sample was selected with the following criteria: the banks published their financial reports and complete good corporate governance reports between 2009 and 2017. the variables and measurement methods used in this study are as follows: a. corporate governance is measured by the ratio of independent commissioners, size of audit committees, and number of meetings between the board of commissioners and the management. b. sharia supervisory board (ssb) is measured by the number of ssb members, number of ssb meetings with management, ssb members with cross membership, and education level and background of ssb members. c. profitability is measured by return on assets (roa), return on equity (roe), and net profit margin. ejif – european journal of islamic finance no13, august (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 d. corporate ethic disclosure (ced) is measured by indicators that have been developed by haniffa & hudaib (2007) and have been implemented by zaki, sholihin, & barokah (2014). haniffa & hudaib (2007) who called this method the corporate ethics identity model. the indicators used include (1) vision and mission statements, (2) bod and top management, (3) products and services, (4) zakah, charity and benevolent loans, (5) commitment to employees, (6) commitment to society, and (7) ssb [41]. e. maqasid syariah (ms) performance is measured by three indicators that have been developed by [2], [3], [7], [16] which include justice, educating individuals, and public interest. the analytical method used is structure equation model analysis with the warppls approach. this approach was chosen because it can test all models at once. so, from each measurement, the decision to reject or accept the hypothesis can be evaluated. the levels of significance used are 10% and 5%. iv. results islamic banks in indonesia have a sharia supervisory board (ssb) with between 2-3 members who hold 14 meetings. this number of members and meetings is still very limited in terms of carrying out supervision duties for islamic banks that have thousands of branch offices. however, an ssb with two members meets the minimum standards set by bank indonesia. the ssb’s effectiveness in carrying out its tasks is strengthened when one board member performs the ssb tasks in three institutions. the factor that reinforces ssbs in carrying out their duties is the level of education of ssb members which, on average, is a master’s degree with 50% having a background in the field of islamic law, finance, and accounting. islamic banks in indonesia have an audit committee comprising 3-4 auditors. this number of members is enough for the committee to carry out its bank auditing duties. however, in the composition of the board of commissioners, there are still banks that do not have independent commissioners. the absence of independent commissioners has the potential to diminish the effectiveness of monitoring. this condition is strengthened by the number attending meetings that are still held once a year. however, on average, 66.50% of commissioners are independent. this ratio is categorized as large because more than half of the committee members are drawn from independent commissioners. the average value of profitability, measured both by roa and npm, shows a positive average value. however, if measured by roe, the resulting average value is negative. the low roe value is due to the large number of banks that have negative roa such as victoria, maybank and bank jabar banten. the average npm value is 45.13%. this score illustrates that the amount of profit sharing given to the owners of deposits and savings is 45% of income from the financing. table 2. descriptive analysis variables max min mean std. deviation size of ssb 3 2 2.37 0.4860 ssb meetings 30 5 14 4.093 cross membership of ssb members 5.5 1 3.21 1.0287 bacground education of ssb 3 1,5 2.29 0.4356 education level of ssb 3 1 2.41 0.4531 audit committee 9 1 3.53 1.0646 independent board 100 0 0.67 0.1879 meeting board 9 1 3.53 1.0646 roa 0.0732 -0.1687 0.0029 0.0289 roe 0.2979 -3.6046 -0.021 0.5310 npm 1.1225 0,0001 0.451 0.208 ced 0.7083 0.40422 0.536 0.118 maqasid shariah 0.705 0.179 0.570 0.103 islamic banks in indonesia have revealed a ced of 53.59% and a ms disclosure rate of 57.02%. both of these disclosure values are far from ideal. ms disclosures are detailed in the following table: table 3. maqasid syariah disclosures no indicators max mean std. deviation 1 faith 0,75 0,502659574 0.12959138 2 rights and stakeholding 0.8 0.744680851 0.135691793 3 self 1 0.212765957 0.411457949 4 intellect 0.67 0.443258865 0.164963543 5 posterity 1 0.957446809 0.20292981 6 social entity 1 0.787234043 0.411457949 7 wealth 0.4 0.365957447 0.091054977 8 ecology 0.5 0.010638298 0.072539326 9 average 0.71 0.570240235 0.102989308 table 3 shows that the disclosures that have been carried out by islamic banks are posterity, social entity, rights and stakeholder indicators. the least disclosure is in terms of the ecology indicator. islamic banks in indonesia still have little disclosure related to a bank’s concerns about the environment. ejif – european journal of islamic finance no13, august (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 the results of the hypothesis testing are presented in the table below: table 4. acceptance or rejection of hypotheses independent var. dependent var. beta sig. corporate governance mechanism maqasid syaria disclosure 0.05 0.31 profitability 0.17 0.04* corporate ethics disclosure 0.32 <0.01* sharia supervisory board maqasid syaria disclosure 0.01 0.44 profitability 0.10 0.15 corporate ethics disclosure 0.54 <0.01* corporate ethics disclosure maqasid syariah disclosure 0,29 <0.01* profitability 0.81 <0.01* * sig at 5% the research results shown in table 4 indicate that the corporate governance mechanism has impact on ms disclosure. islamic banks that use islamic law in their operationalization do not yet seem to have made all of their operations compliant with islamic principles. the purpose of implementing islamic law is maqasid syariah (ms) or to meet islamic performance goals. corporate governance is needed to provide assurance that the management of a company’s resources is conducted in order to realize company goals, including compliance with islamic principles. however, the results of this study indicate that bank managers have not used performance in terms of ms as the target. we surmise that compliance with islamic principles in islamic banks in indonesia emphasizes the use of contracts or transactions in accordance with the rulings of the national sharia council (dsn fatwa). this is in line with law no.21 of 2008 pertaining to islamic banking which states that islamic principles that must be complied with are the dsn fatwas. that is to say, compliance with islamic principles in islamic banks in indonesia does not yet cover all the objectives of sharia (maqasid syaria) which include protecting their religion (din), life (nafs), intellect ('aql), posterity (nash), and property (mal). in this study, the measurement of corporate governance mechanisms was conducted using the ratio of independent commissioners, audit committees, and number of commissioner meetings. table 4 shows that there is no effect of cg on ms performance. the size of the ratio of independent commissioners, the number of audit committees and the number of commissioner meetings has no effect on improving ms performance. these findings reinforce the previous statement that ms performance has not become a goal that must be directly achieved in managing bank resources. in contrast to maqasid syariah, if the measurement of bank performance uses profitability, it shows that corporate governance mechanisms have a positive impact on it. this finding corroborates the findings of sakawa & watanabel (2011); rehman, et al. (2010); mayur & saravanan (2017) shittu, et al. (2016), who found that there was a relationship between cg and profitability. if a comparison is made between the results of research that uses performance based on ms and performance based on profitability, it produces contradictory findings. these findings indicate that for islamic banks in indonesia, achieving profitability performance is more important than ms performance. in addition, these findings prove that corporate governance has more of a role in improving profitability performance than ms performance. we surmise that one of the reasons islamic banks in indonesia focus more on profitability performance than ms performance is because profitability is the bank's main measurement tool. moreover, bank indonesia, as the banking regulator in indonesia, also uses profitability indicators as a measure for evaluating the health of banks [43]–[45]. this indicator is the same as the indicator used to assess the health of conventional banks. bank indonesia circular letter no.9/24/dpbs, dated 30 october 2007, pertaining to the rating system for commercial banks based on islamic principles, explains that the assessment indicators of the health of islamic banks concern the aspects of capital, asset quality, earnings, liquidity, sensitivity to market risk, and management. meanwhile, bank indonesia circular letter no.6/23/dpnp, pertaining to the commercial bank health assessment system, explains that conventional bank health indicators are measured by capital, asset quality, earnings, liquidity, and sensitivity to market risk. from the two circular letters, we can conclude that profitability is the main performance measurement tool for both islamic and conventional banks. table 4 shows that corporate governance mechanisms have a positive influence on corporate ethics disclosure. ethics cannot be separated from business, because ethics will increase company effectiveness in achieving company goals (jo & kim, 2008; persons, 2013). developing and implementing ethics that have an important role in achieving company goals have become a priority for banks. more specifically, implementing corporate ethics developed from islam. the aim of islamic teachings is to establish ethics. [41] developed a model to reveal the ethics of islamic banks which they called ethical identity and which had, as indicators, the bank’s philosophy, governance, products, services, zakah and charity, the ssb, and their commitment to society, debtors and employees. the results of this study indicate that islamic bank management cares about the implementation of ced. the average ced for islamic banks in indonesia is 53.59%. islamic ethics applied to islamic banks are an important key for banks to carry out their operations. corporate ethics are a moral obligation that guides corporate behaviour (zaleha, et al., 2012). in fact, in their conclusion, [46] state that ethics are the heart of cg and are a requirement for cg implementation. ejif – european journal of islamic finance no13, august (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 in addition to playing the role of independent commissioners, the ssb also has a positive role in corporate ethics disclosure. the results show that the role of ssb, as measured by the number of meetings, the number of members, their cross membership, and their educational background and level, had a positive impact on corporate ethics disclosure. assuming that what is reported in the annual reports is the same as what is being implemented, the number of ssb members will increase bank effectiveness in implementing corporate ethics. this effectiveness is also strengthened by the number of meetings between ssb and bod, along with the education background and level of the board members. board members with a doctorate in islamic economics are more effective when carrying out their duties than those with other educational backgrounds. an education in islamic economics will provide a board member with more comprehensive understanding and skills with regard to islamic law, economics and finance. board members with skills in the fields of islamic law and finance will find them very supportive in carrying out their duties [47] as external auditors (farook, et al., 2011). the research findings also show that ssbs have no role in achieving bank performance as measured against islamic goals (ms). these findings corroborate other studies that show that the management of islamic banks in indonesia has not prioritized the achievement of performance in terms of ms goals. ms performance has not become a goal that must be achieved by indonesian islamic banks. we surmise that the priorities for the management of healthy bank operations are those that are in accordance with the rules issued by bank indonesia. apart from not having an impact on performance in terms of islamic goals (ms), the role of the ssb also does not affect the bank's profitability. the size of the ssb, the number and level of meetings that are held, and the education level and background of its members, do not have an impact on improving a bank’s profitability performance. ssbs in islamic banks in indonesia have the duty to ensure that dsn fatwa (national islamic rulings) are complied with by the banks in all transactions. ssbs in indonesia have no duty to improve the profitability performance of banks. this finding corroborates the results of research by asrori (2014), kolid & bachtiar (2014) and matoussi & grassa (2012) which shows that ssbs have no influence on financial performance. ssbs have the duty to provide consulting services and to conduct monitoring of management, but the services provided are related to bank compliance with the principles islamic law (farook, et al., 2011). managers consult ssbs regarding products that have been developed. this consultation is needed in order to assess whether the new products comply with the principles islamic law (farook, et al., 2011). the results of testing the influence of corporate ethics disclosure on profitability performance and islamic goals performance (ms) show a significance value below 5% and beta positive. the results of this study indicate that corporate ethical disclosure (ced) will make a bank more effective in achieving its objectives, namely increasing bank profit and its performance in terms of maqasid syaria. assuming that the ced policy implemented by banks is the same as that which is actually applied, the results of this study corroborate the findings of previous researchers, such as (jo & kim, 2008; persons, 2013; berrone et al., 2005) who found that ethics had a positive impact on financial performance. the application of ethical values is an important tool for banks to increase the effectiveness of their corporate operations as measured by profitability and ms performance. corporate ethics disclosure (ced) in this study is measured by ethical disclosures based on mission, vision, management, product, service, zakah (religious donations), charity, sharia supervisory boards (ssb), and commitment to employees, debtors, and society (haniffa & hudaib, 2007; farook et al., 2011). this means that the identification of the implementation of ethics in this study was carried out indirectly, namely through disclosures in the bank's annual report. the results of this study, which show that disclosure of islamic ethics has a positive impact on bank performance, are in line with the results of previous research [48]. ethical disclosure can provide benefits: (1) it increases the attractiveness of a company’s shares to investors who are ethical and socially responsible; (2) it provides clear signals through information about the attitudes and beliefs of the company which reduces uncertainty about risks and long-term actions; (3) it meets investors' needs for ethical and social information; (4) it is a valuable tool for creating reputation capital in the form of a good corporate image and increasing reputation, which gives the company a competitive advantage; (5) it establishes trust and commitment between shareholders and top management, thereby reducing opportunistic behaviour and transaction costs [48]. v. conclusions the results of this study indicate that cg and ssb mechanisms have a positive role in ced disclosures. it is very important for ced to be implemented because it has a positive influence on performance, both in terms of profitability and in terms of the maqasid syariah (islamic performance goals). the bank's profitability performance is influenced by the cg mechanism and is not influenced by the role of the ssb. maqasid syariah performance has not yet become a concern of banks because the mechanisms of gcg and ssb have no influence on fulfilling maqasid syariah performance goals. islamic banks in indonesia still make financial performance the measure of bank performance in the same way as conventional banks do. in this study, there are variables whose measurements are based on content analysis from annual reports, so the researchers' judgements were possibly less objective when assessing disclosures made by banks. in addition, the information presented by the banks was often very incomplete and this caused the sample that was used to be smaller. therefore, researchers in the future could develop a more ejif – european journal of islamic finance no13, august (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 objective measurement method and avoid the judgements made by the researchers when making measurements in this study. acknowledgment thank you to unniversitas negeri semarang (indonesia) for funding this research references [1] b. kustin, “islamic (micro) finance: culture, context, promise, challenges,” financial services for the poor, no. august, p. 50, 2015. 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[48] m. k. hassan, m. rashid, m. y. imran, and a. i. shahid, “ethical gaps and market value in the islamic banks of bangladesh,” rev. islam. econ., vol. 14, no. 1, pp. 49–75, 2010. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 a comparative study of csr practices of islami shariah based pcbs and conventional pcbs in bangladesh abstract— csr is an obligation of corporate entity towards society for social development. the term was coined during 1950s and mostly practiced by developed countries so far. for least developed countries like bangladesh, the practice of csr wasn’t so popular before 1980s, in the years of 2016, bangladesh ranked 31st largest economy, and in 2019 it ranked as 5th fastest growing economy around the world. with such exponential growth of bangladesh economy, the private sector is currently booming with enormous potentiality, especially the banking industry. following the drastic change of economy, bangladesh government has declared 10% tax rebate on csr activities to promote social development. the banking industry of bangladesh is mainly dominated by two types of private commercial banks (pcbs), conventional and islami shariah based banks. the objective of this study is to find out the trends and preferences for csr investment area of each bank type. the study was conducted by using secondary source of data, which was collected over the duration of 4 years (2015-2018). online version of annual reports, csr reports and journal were used in this study. quantitative analysis method was used to find out the heavily and narrowly invested csr areas. the study reveals that the both islami shariah based pcbs and conventional pcbs invest heavily on 3 common areas (disaster management, education and health) and narrowly invest on areas sports, arts-literature & culture and environment, this study also indicates that islami shariah based pcbs have significant higher csr expenditure than conventional pcbs on prescribed csr areas. keywordsislamic finance, corporate social responsibility, islami shariah based private commercial banks, conventional private commercial banks. i. introduction corporate social responsibility (csr) is a recently invented term that gained the popularity around the world during the last two decades. according to aguinis (2011) csr is “context-specific organizational actions and policies that take into account stakeholders’ expectations and the triple bottom line of economic, social, and environmental performance” [1].according to carrol, (1991) corporate social responsibility is “an organization’s commitment to operate in an economically and environmentally sustainable manner while recognizing the interests of all its stakeholders” [2]. there is no denying that corporate social responsibility has a serious impact over the social development, because it consists of such initiatives that concerns for moral and social upliftment, education, health and so on. but the degree if impact varies from state to state from society to society, obviously the difference between of csr practice between developed and developing country is enormous, and has a huge gap among them. bangladesh is a small country of south asia, in the year of 2008 bangladesh government initiated a project called ‘vision 2021’ to become a middle income country, and inaugurated many associate sub project to achieve the vision like digital bangladesh (islam.s. 2018)[3].a successful csr program can benefit the society in such way, which usually is often impossible for government. as bangladesh is currently striving towards the prosperity, it is high time to utilize the banking industry to its utmost potentiality, the central bank of bangladesh, bangladesh bank have already enhanced the prescribed csr areas for tax exemption, in the year of 2012, which was only a few the previous year (rahman,t. 2014)[4]. at present time csr has gained such momentum, that it has become one of the determinants of success of an organization prior to the philanthropic activity that earns reputation for that organization. the case of bangladesh is no different, but still there are some organizations which follow classical philosophical view of social responsibility and focus more on profit than collective social return. the study was conducted on two popular banks types of bangladesh financial system, which fall under the category of scheduled bank; these two are conventional private commercial bank (pcbs), and islami shariah based private commercial banks (pcbs). the conventional pcbs which are the mainstream banks of bangladesh, run on interest based function; on the other hand the islami shariah based pcbs run in accordance with islami shariah based principle which is profit-loss sharing (pls) mode. objectives of this study: the objective of this paper is to analyze two popular bank types to reveal their preferences on csr activities. the finding of this study shall help to find out, that the present csr policy of these two bank types is consistent or not, with the national policy of bangladesh along with the sustainable development goals (sdgs). md. tanvir alam, stamford university bangladesh ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ii. literature review corporate social responsibility (csr) is known by many names like corporate accountability, corporate responsibility, corporate citizenship, corporate ethics, etc, though there are different names, but they all point towards one common thing and that is the social obligation of corporate or business entity. like many names csr have many definitions too, which all are formed on basis of different economic, social and geographical need. according to michael hopkins;"corporate social responsibility is concerned with treating the stakeholders of the firm ethically or in a responsible manner. ‘ethically or responsible' means treating stakeholders in a manner deemed acceptable in civilized societies. social includes economic and environmental responsibility. stakeholders exist both within a firm and outside. the wider aim of social responsibility is to create higher and higher standard of living, while preserving the profitability of the corporation for people both within and outside the corporation.”(hopkins, m. 2007)[5]. another definition of definition of corporate social responsibility (csr) by author carrol (1991) is as follows; “csr is an organization’s commitment to operate in an economically and environmentally sustainable manner while recognizing the interests of all its stakeholders” [2].where the european commission defines csr as; “csr is the responsibility of enterprises for their impacts on society” (ec, 2011)[6]. despite being the presence of an universal definition of csr, all available definitions refers to the profit earning attitude of corporate body with having respect for legal, ethical and economic value of society.although the literature established the fact, that the modern csr was coined during 1950s, but the philanthropic actions of business and corporate entity was already present in the society long ago, but it wasn’t known by all under as an established label. chaffee (2017) suggested that the origin of present csr can be traced back to primeval roman laws, to establish his statement he drew examples like orphanage, old home, poor home, hospital and asylum of that time, he also suggested that this concept of social upliftment was carried further to the next civilization by literature and history [7]. later on the 18th and 19th centuries, a social development oriented religious philosophy of abraham religion christianity took place, mainly followed by the devastating poverty of western region. this religious philosophy later paved the way for shaping idea of social welfare of victorian era (harrison, b. 1966) [8]. furthermore, carrol (2008) suggested that the same philosophical approach was the cornerstone of modern csr, which we see today in europe and america continent [9].after the victorian era, during the early 1900s, a new type of philanthropic approach emerged among the businessman and corporation, the primary focus of which was employee oriented, and then it expanded its concern from economic value to civic and religious values (heald, 1970) [10]. as the modern notion of csr was established during 1950s, some scholar suggest that, it was driven by aftermath of world war ii, since the contemporary governments had failed to tackle the global disastrous situation on their own, but lee (2008) argues that, it was the theoretical and academic contribution that led to actual implication of modern csr [11].considering the viewpoint of csr, many of such practice like donation, philanthropic activity, engagement with social welfare, charitable work was already present in the society of bangladesh either driven by religious cause or humanitarian cause. as a major portion of business institutions of bangladesh were and still is owned by family, they have a strong involvement with the local community, they always been donor and patron of many social development without any formal framework involving the expenses or indirect motive of profit or reputation earning (nasrullah & rahim, 2014) [12]. the formal framework regarding csr policy formed by the central bank of bangladesh which is bangladesh bank, in the year of 2008, the purpose of that initiative was to formalize the csr practice in banking industry of bangladesh, later an autonomous institution was inaugurated called csr-centre of bangladesh to promote csr practice in bangladesh (rahman & juy, 2016)[13]. being a citizen of a muslim state like bangladesh, almost everyone is familiar with the islamic finance system, the proceeding of islamic banks solely depends on islamic finance, in other words sharia laws. sharia is considered as the principles of islamic laws, it is a set of rules, regulation and parameters, which derived from the holy scripture of al-quran and sunna of prophet mohammed (pbuh), the sunna are the hadith (narrations) of the prophet (chintaman. s.a, 2014) [14]. there are few principled of islamic finance, which is given below;  prohibition of usuary; interest,  prohibition for haram good in business ; impure goods like pork, alcohol,  uphold social value and need; provide interest free short term loans to those who needed,  profit loss sharing attitude among partners. besides the usual islamic financial activity, islam encourages to donate and perform charitable works to utmost extent, allah says in the holy quran;“the charity of those who expend their wealth in the way of allah may be likened to a grain of corn, which produces seven ears and each ear yields a hundred grains. likewise allah develops manifold the charity of anyone he pleases, for he is all-embracing, all-wise” (alquran) [15], in addition to that; it was narrated from abu hurayrah (may allah be pleased with him) that the messenger of allah (peace and blessings of allah be upon him) said: “allah said: ‘spend, o son of adam, and i shall spend on you” (al-bukhaari & muslim) [16]. a seminar was organized by the business students' society (bss) of independent university, bangladesh (iub), on 1st march, 2012 for youth & young entrepreneurs to shed light on csr and un global compact for sustainable business (iub, 2012) [17]. in another university named iubat held a seminar on topic of csr as the continuous learning process ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 and collective competence, expert and academics discussed educating workforce and improving the overall management by csr practice (survey report, 2014) [18].on 2017 a seminar on “propagating csr projects by corporate in bangladesh” organized by sr asia bangladesh and dhaka chamber of commerce and industry (dcci) was held on dcci auditorium in the capital, where many speaker including state minister for finance and planning said the trend of csr paradise in bangladesh is very popular and undoubtedly it has serious positive impact over the social development (theindependentbd, 2017) [19]. ferdous (2015) identified in her study that the state owned commercial banks (socb) of bangladesh have limited participation in prescribed csr areas, in addition to that she also revealed that the main contribution of socb are only in areas of disaster management, education health and art & culture [20]. dr. s. a. chintaman (2014) in his study finds out that the csr practices of islamic banks are more innovative and the conventional banks are at par with the islamic banks regarding csr practice. he also suggested the role of international organization like un, who, unesco can provide sophisticated guidelines for further advancement in this sector [14]. porag r.s (2014) in his study reveals that there is a significant gap between the government corporate as well as business organization for encouragement of csr activity at all level, he also reveals that major portion of stakeholder doesn’t have a clear idea of formal csr framework rather they have a socially oriented idea of csr[21]. a study by biancone & radwan (2018) full of insights on islamic finance and its diverse financial instruments argued that islamic finance as an unconventional alternative of finance can create positive impact on international economies and can possibly on social enterprise development [22]. shariah based islamic banks are just one of the integral instruments if islamic finance, and recently it is gaining much popularity throughout the world, as the islamic finance is serving muslim community as well as much of non-muslim community, by its unique safe and sound investment policy (biancone & radwan 2018) [23]. supporting biancone & radwan’s statement, another author named allali (2016) proposed that inception of financial products based on shariah compliant system on italy can open up a new window of opportunity in its economy[24]. iii. methodology this study intends to find out the trends and preferences for csr expenditure of both conventional private commercial banks and islami shariah based private commercial banks. the study was conducted based on secondary source of data, collected over the period of 4 years (2015-2018). the method was choose to collect sample was convenience sampling due to the unavailability of adequate csr report. the online version of annual reports of sample banks was used along with other csr report and journals because of unavailability of printed version. quantitative analysis was used to find out the heavily and narrowly invested csr sector and number of invested csr sector. bank type conventional pcbs & islami shariah based pcbs type of data source secondary type of version online method quantitative duration 4 years (2015-2018) document annual report, csr report and journals table 1: methodology iv. analysis and findings corporate social responsibility expenditure of islami shariah based private commercial banks (pcbs): csr expenditure of first security islami bank limited from year 2015-2018 (figure in million tk) year sector 2015 2016 2017 2018 total emergency disaster relief 79.8 109.7 141.5 201.9 461 education 15.2 33.4 51.5 60.0 160.1 health 4.1 1.00 2.8 25.5 33.4 sports 26.01 0.075 50.00 14.00 90.085 arts, literature & culture 11.7 0.9 9.7 30.00 52.3 environment 3.5 2.0 0.95 2.7 9.15 capacity building of emergency rescue service 1.3 5.4 8.2 6.00 20.9 total 141.8 151.7 264.6 340.2 898.3 table 2: preferred areas of csr on basis of expenditure (largest to smallest): emergency disaster relief, education, sport, artsliterature & culture, health, capacity building of emergency rescue service, environment. csr expenditure of islami bank bangladesh limited from year 2015-2018(figure in million tk) year sector 2015 2016 2017 2018 total humanitarian & disaster relief 323.90 425.95 568.46 647.72 1966.03 education 175.24 161 382.82 2118.56 2837.62 health 226.04 16.84 28.97 1.75 273.6 sports 26.60 0.00 21.00 8.20 55.8 arts, literature & culture 5.12 0.12 11.50 22.59 39.33 environment 21.42 26.39 26.40 1.05 75.26 others 22.11 40.47 18.62 13.20 94.4 ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 total 800.43 670.77 1057.77 2813.07 5342.04 table 3: preferred areas of csr on basis of expenditure (largest to smallest): education, humanitarian & disaster relief, health, others, environment, sports. csr expenditure of sahjalal islami bank limited from 20152018(figure in million tk) year sector 2015 2016 2017 2018 total disaster management 45.5 84.7 56.9 119.7 306.8 education 4.7 6.8 27.03 3.3 41.83 health 3.2 6.1 6.3 2.2 17.8 sports 0.05 4.5 0.05 20.3 24.9 arts & culture 0.075 0.8 1.04 0.012 1.97 environment 3.47 6.08 34.2 8.6 52.35 others ----- total 57.6 109.2 126.1 154.5 445.65 table 4: preferred areas of csr on basis of expenditure (largest to smallest): disaster management, environment, education, sports, health, arts & culture. csr expenditure of al-arafah islami bank limited from 2015-2018(figure in million tk) year sector 2015 2016 2017 2018 total disaster management 12.40 23.20 10.80 15.03 61.43 education 9.70 9.70 8.10 15.83 43.33 health 159.10 64.60 2.60 01.83 228.13 sports ----- arts & culture 6.70 2.00 0.90 6.36 15.96 environment 1.80 5.80 1.70 7.13 16.43 others 15.30 -133.30 75.39 223.99 total 205.00 105.30 157.40 121.57 589.27 table 5: preferred areas of csr on basis of expenditure (largest to smallest): health, others, disaster management, education, environment, arts, literature & culture preferred csr areas on basis of expenditure of sample banks (islami shariah based pcbs) banks csr areas fsibl aibl ibbl sibl 1st priority emergency disaster relief health education disaster management 2nd priority education others humanitarian & disaster relief environment 3rd priority sports disaster management health education 4th priority arts, literature & culture education others sports 5th priority health environment environment health 6th priority capacity building of emergency rescueservice arts, literature & culture sports arts & culture 7th priority environment - arts, literature & culture - table 6: priority based csr investment area of islami shariah based pcbs. corporate social responsibility expenditure of conventional private commercial banks (pcbs): csr expenditure of bank asia limited from 20152018(figure in million tk) year sector 2015 2016 2017 2018 total disaster management 9.77 19.34 82.60 27.13 138.84 education 17.36 61.28 45.70 39.23 163.57 health 18.25 3.88 13.18 1.28 36.59 sports 4.50 6.83 0.20 1.17 12.7 arts, literature & culture 2.11 1.96 0.50 7.23 11.8 environment 0.51 0.06 0.33 -0.9 others 13.85 15.70 41.32 51.33 122.2 total 65.91 109.06 183.83 126.91 486.6 table 7: preferred csr areas on basis of expenditure (largest to smallest): education, disaster management, others, health, sports, arts-literature& culture, environment. csr expenditure of mercantile bank limited from 20152018(figure in million tk) year sector 2015 2016 2017 2018 total disaster management 17.30 33.70 80.91 74.40 206.31 education 16.90 17.60 63.70 22.80 121.02 health 49.20 10.90 11.44 10.10 81.64 social development ----- arts, sports & culture 7.30 2.70 2.60 8.50 21.1 environment ----- others 2.60 2.00 27.60 6.50 38.7 total 93.30 66.90 186.25 122.30 468.75 table 8: preferred csr areas on basis of expenditure (largest to smallest): disaster management, education, health, others, arts-sports & culture. csr expenditure of mutual trust bank limited from 20152018(figure in million tk) year sector 2015 2016 2017 2018 total humanitarian & disaster relief 25.23 30.22 100.01 67.6 223.06 education 12.76 13.52 50.65 6.43 83.36 health 6.50 14.37 9.90 2.49 33.26 sports 1.00 2.8 0.05 -3.85 arts, literature & culture 4.50 4.3 0.2 5.46 14.46 environment 1.0 1.0 1.0 -3.00 others 5.30 2.9 14.23 2.26 24.69 total 56.29 69.20 176.18 84.29 385.96 ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 table 9: preferred csr areas on basis of expenditure (largest to smallest): humanitarian & disaster relief, education, health, others, arts-literature & culture, sports, environment. csr expenditure of premier bank from 2015-2018 (figure in million tk) year sector 2015 2016 2017 2018 total humanitarian & disaster relief 10.00 23.03 -131.2 164.23 education 3.2 0.78 33.5 50.8 88.28 health --2.00 0.1 2.1 infrastructure 1.55 0.6 --2.15 sports 3.6 ---3.6 social welfare 59.95 92.00 --151.95 others 14.6 1.99 0.3 0.5 17.39 total 92.97 118.45 35.8 182.6 429.82 table 10: preferred csr areas on basis of expenditure (largest to smallest): humanitarian & disaster relief, social welfare, education, others, sports, infrastructure, and health. preferred csr areas on basis of expenditure of sample banks (conventional pcbs) banks csr areas bal mbl mtbl pbl 1st priority education disaster management humanitarian & disaster relief humanitarian & disaster relief 2nd priority disaster management education education social welfare 3rd priority others health health education 4th priority health others others others 5th priority sports arts-sports & culture arts-literature & culture sports 6th priority arts, literature& culture - sports infrastructure 7th priority environment - environment health table 12: priority based csr investment area of conventional pcbs. the trends and preferences of islami shariah based pcbs: 0 500 1000 1500 2000 2500 3000 ibbl fsibl sibl aibl csr expenditure of islami shariah based pcbs disaster management health education sports others chart 1: csr expenditure of islami shariah based pcb (in million tk) the above graphical illustration indicates that islami shariah based pcbs prefers to spend on three particular areas of prescribed csr framework, which are disaster management, heath and education. the trends and preferences of conventional pcbs: 0 50 100 150 200 250 bal mbl mtb pbl csr expenditure of conventional pcbs disaster management education health sports others chart 2: csr expenditure of conventional pcbs (in million tk) the above graphical illustration indicates that the conventional pcbs too prefer to spend on three particular areas of prescribed csr framework, which are disaster management, heath and education. ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 disaster management education health 732.44 456.23 153.59 2816.23 3082.79 552.93 heavily invested csr areas conventional pcbs islami shariah based pcbs chart 3: the above graphical illustration indicates that islami shariah based pcbs spend significantly more on three particular areas of prescribed csr framework than conventional pcbs, which are disaster management, heath and education 0 50 100 150 200 narrowly invested csr areas conventional pcbs islami shariah based pcbs chart 4: the chart shows that islami shariah based pcbs spend significantly more even in narrowly invested csr areas of prescribed csr areas which are environment, sports and culture. ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 v. conclusion at present day society is changing fast, with this rapid transformation, several important aspects of society are evolving, emerging and booming. economy is one of the important aspects which are drastically growing. in bangladesh among the determinants of economic growth, banking industry is one of them, which is largely owned by private sector, and it is as usual to expect in this era of capitalism. the private commercial banking sector of bangladesh is enormous, and it has a long history of performing corporate social responsibility. this study finds out that in government prescribed csr framework, there are some areas in which the contribution or invest for csr purpose are significantly low from both types of private commercial banks. sectors like sports, environments, art & culture are narrowly invested, even the it sectors too. while sectors like education, disaster management and health gets priority for csr investment. the study suggest that the central bank of bangladesh should provide a framework for csr investment concerning towards the neglected sector such as it, as it is consistent with the project ‘digital bangladesh’ and in this era of digitalization. taking everything into consideration of described above, the findings of this study are as follows; 1. both that islami shariah based pcbs and conventional pcbs, main focus of csr investment are limited into three specific areas only. 2. both that islami shariah based pcbs and conventional pcbs, neglects to invest on areas like sports, cultural, arts, environment etc. 3. the islami shariah based pcbs have significanthigher expenditure rate than conventional pcbs. references [1] aguinis, h. 2011. organizational responsibility: doing good and doing well. in s. zedeck (ed.), apa handbook of industrial and organizational psychology (vol. 3): 855-879. washington, dc: american psychological association. 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[16] al-bukhaari, 5073; muslim, 993 [17] iub seminar on csr(2012), ‘sensitizing the youth & young entrepreneurs on csr and un global compact for sustainable business’, last retrieved from http://www.iub.edu.bd [18] survey report (2014), csr in bangladesh: current issues and future trends, dutch embassy benchmark survey, last retrieved from http://csrbangladesh.org [19] theindependentbd (2 august,2017), csr policy on the cards, last retrieved from http://www.theindependentbd.com [20] ferdous.j (2015), corporate social responsibility practices in bangladesh: an assessment of four stateowned commercial banks (socbs), international https://www.dhakatribune.com/ https://www.dhakatribune.com/ http://www.iub.edu.bd/ http://csrbangladesh.org/ http://www.theindependentbd.com/ ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 journal of business, economics and law. vol. 8, issue 2 (dec.) issn 2289-1552, p-40 [21] porag r.s(2014), corporate social responsibility in bangladesh: practice and perpetuity. safety and rights publishers, p-16. [22] biancone, p. p., & radwan, m. (2018). social finance and unconventional financing alternatives: an overview. european journal of islamic finance, (10). [23] biancone, p. p., & radwan, m. (2015). sharia compliant “possibility for italian smes”. european journal of islamic finance, (1). [24] allali, a. a, (2016). corporate governance and corporate social responsibility in islamic banking: the case of the moroccan banks in italy. european journal of islamic finance, (1). ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. buerhan saiti, istanbul sabahattin zaim university, turkey prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 impact of asymmetric information in islamic financial contract: an empirical analysis abstract— a primary source of asymmetric information arises from banks’ uncertainty about borrowers ‘creditworthiness. this can generate two types of barriers to efficient credit allocation in the loan market: ad-verse selection in the likelihood of repayment and moral hazard in the riskiness of firms’ business decisions, also affecting repayment. this study investigated the consequences of asymmetric information on islamic financial contracts in the pakistani market for small and medium enterprise (sme) business lines of credit. islamic bank’s main financial contracts were discuss the two of them which are istisna and murabaha .the methods of’ t test’ was conducted to ascertain the difference in means of both forms of financing, whereas multiple regression analysis using panel data to assess the relationship of critical variables with disbursed amount, profit rate, spread, tenor. data of three year i.e. from 2016 to2018 of 35 firms, with 105 numbers of observations having istisna and murabaha contract, were taken. the results suggested that both the means of murabaha and istisna financing are significantly different in major performance indicators, implicating companies that have taken these two financing have performed differently. secondly, in most of the ratio that mattered like efficiency and profitability, murabaha based financing have yielded results that are more efficient and better performed as compared to istisna) keywordsasymmetric information; islamic financial contracts; istisna; murabaha; islamic bank; pakistan; i. introduction 1.1. background to the study banking sector serves as the engine of growth for any economy. an economy cannot run without the existence of banking sector as it channelize the funds from those who have excess to those who have opportunities to deploy those funds in profit generating activities and share the benefits with the owners of the funds. islamic banking emerged as a practical reality and started functioning in 1970s. since then it has been growing continuously all over the world. the global market share of islamic banking in total islamic financial industry (ifi) is equivalent to usd 1,557.5 billion which represents 76% approx. the islamic financial industry (ifi), which is equivalent to usd 2,050.2 billion. the global ifi, which comprises of islamic banking, islamic capital market and islamic insurance (takaful) sector has growth at 8.30%. table 1: breakdown of global ifi by sector source: islamic financial services industry stability report (2018) as depicted in above table banking assets forms the largest part of ifi. the islamic finance industry has expanded rapidly over the past decade, growing at 10-12% annually. today, shariah-compliant financial assets are estimated at roughly us$2 trillion, covering bank and non-bank financial institutions, capital markets, money markets and insurance (“takaful”). in many majority muslim countries, islamic banking assets have been growing faster than conventional banking assets. there has also been a surge of interest in islamic finance from non-muslim countries such as the uk, luxembourg, south africa, and hong kong. islamic banking and finance has emerged as a potential replacement of interest based financial market. the growth is not limited to the muslim dominated countries but also shown its foot prints non-muslim countries. the global islamic banking industry, operating alongside conventional financial institutions, has also weathered several systemic challenges over the past several years. 1 major financial markets are discovering solid evidence that islamic finance has already been mainstreamed within the global financial system – and that it has the potential to help address the challenges of ending extreme poverty and boosting shared prosperity. 1 islamic financial services industry stability report (2018), page 87, 88 sajjad hussain zafar, research scholar, karachi university business school, university of karachi,pakistan.email:executive.scs@gmail.com dr.danish ahmed siddiqui, associate professor, karachi university business school, pakistan, email: daanish79@hotmail.com sectors of ifi banking assets sukuk islamic funds takaful total amount in usd billion 1,557.5 399.9 66.7 26.1 2,050.2 percentage share of each sector 75.98% 19.50% 3.25% 1.27% 100% ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 in pakistan, the banking industry is comprised of conventional banking sector and islamic banking sector with 87.1% and 12.9% share respectively state bank of pakistan (2018). being the second largest country of muslim population after indonesia, pakistan has great potential for growth of islamic banking and financial industry. islamic finance is equity-based, asset-backed, ethical, sustainable, environmentallyand socially-responsible finance. it promotes risk sharing, connects the financial sector with the real economy, and emphasizes financial inclusion and social welfare. the following key principles guide islamic finance: 1. prohibition of interest on transactions (riba); 2. financing must be linked to real assets (materiality); 3. engagement in immoral or ethically problematic businesses not allowed (e.g., arms manufacturing or alcohol production); 4. returns must be linked to risks. some of the obvious differences between islamic and conventional banks are the nature of contract on the basis of which financing is being extended to the customer and mandatory sharia board supervision of all islamic banking activities including islamic financing. islamic banks extend financing on the basis of sharia compliant mode of contract while conventional banks provide financing on the basis of loan and interest. the other major factor is the sharia governance by sharia board of every islamic bank and islamic banking windows. in islamic credit model, the customers specify goods to be purchased through contracts with the bank to acquire on customer’s accounts, the banks buy good and attains title of ownership from seller, clients take delivery of the product and pay on deferred basis and if the client defaults, the bank cannot reimburse the penalty charges. elgari (2003). here, structural difference with regards to financing between islamic and conventional banks is that sharia compliant financing contract should be linked to real assets whereas in conventional financing, loan is granted and interest is charged based on creditor’s riskiness. subsequently, those funds are utilized to acquire asset. this means, no asset is involved directly in contract but indirectly as a result of the contract. this would likely to lead to the problems of asymmetric information. the borrower has better information regarding potential returns and risk associated with investment projects for which financing are done, than the lenders. this information primarily includes borrower real intention of utilizing borrowed funds. lack of information creates problems in the financial system on two fronts, before the transaction is entered into and after. these problems are referred to adverse selection and moral hazards respectively stiglitz and weiss (1981). adverse selection occurs before making transaction, when those potential borrowers who are most likely to produce an undesirable outcome-bad credit risk-are the one who most actively seeks out a loan and thus most likely to be selected. whereas, moral hazards occurs after making transaction, whereby the borrower might engaged in activities that are undesirable (immoral) from lenders point of view because they make it less likely that loan will be paid. these activities includes making investment in highly risky business such as real estate and property markets while taking loans for less risky project. moral hazard produce adverse incentives on bank owners to act in way which are contrary to the interest of bank’s creditors mainly depositors, by undertaking risky investment strategies, which if unsuccessful would jeopardize the solvency of the bank. moral hazard on bank owner can become worse by number of factors which may force borrowers to choose investments with higher returns but with lower probabilities of success stiglitz and weiss (1981). similarly, adverse selection can also affect the financial soundness of a bank. higher lending rate and a greater volatility in expected rates of return to borrowers’ project can lead to decline in the average quality of the pool of the applicants who are willing to borrow from the bank. the high creditworthy borrowing customers are driven out of the market by higher lending rates. a prudent bank would ration credit in this situation stiglitz and weiss (1981) reliable collateral may help to mitigate the banks' asymmetric information concerns by ensuring repayment (bester, 1985; chan and thakor, 1987). to compensate for adverse selection risks, banks may refrain from funding risky firm. however, in highly competitive markets, banks grossly ignore these two conditions making their cash flows more instable and can potently lead to higher nonperforming loans (npl) on the contrary, as islamic financing contract includes real asset, the problem of asymmetric information (that includes borrower real intention of utilizing borrowed funds pre and post transaction) is resolved as funds can only be utilized in buying assets mentioned in contract. this makes their cash flows more stable and less susceptible to have a non-performing financing. 1.2 problem statement the presence and consequences of asymmetric information in islamic banks financing markets are of crucial importance for ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 credit allocation and financial development, which make the contracts some time, void. asymmetric information arises from banks’ uncertainty about borrowers’ creditworthiness. it can occur before or after execution of financial contract. asymmetric information can generate two types of barriers to efficient financing in the islamic financial /banks market: 1) ad-verse selection in the likelihood of repayment 2) and moral hazard in the riskiness of firms’ business decisions, first is the after effect of holding data that is obscure to somewhere around one gathering engaged with the agreement and makes the individual or association who hold the data have favourable position or get any type of advantages, which would have not been gotten if the data was known to all gatherings engaged with the agreement, this type of asymmetric information leads to adverse selection of products or services offered by the firms. islamic bank face this situation when asymmetric of information remains unmanaged. the second sort of asymmetric information is the consequence of exploiting holding explicit data after the agreement has been concurred or worked out. both type of issues create the inefficient allocation of financing and become the challenge for the validity of contract. the aim of this study is to examine at what extant gharar will create uncertainty in the istisna and mudarba contract. islamic banking assets are 12.9% of the whole pakistanibanking sector. however, by reviewing the historical data it is been revealed that the non-performing financing of islamic banks in pakistan is quite low (2.7%) as compared to overall banking sector non-performing loans (7.9%). state bank of pakistan (2018) following table depicts the comparative level of nonperforming financing of islamic banking and conventional banking of last nine quarters spanning from june 2016 to june 2018. moreover, islamic banking institutions and conventional banking institutions are working in the same domestic and worldwide macro-economic environment but the nonperforming financing portfolio of the two set of banks are different, therefore a need of study is arise to ascertain the factor, which are acting differently for different set of banks i.e. islamic and conventional banks. we need to ascertain what factors are causing nonperforming portfolios in islamic and conventional banks. moreover, what are the reasons of their disparity? furthermore does this disparity depict in performance of firms taking financing. table 2: islamic banking npf v/s overall banking industry non performing financings to financings (gross) islamic banking overall banking industry 18-jun 2.7 7.9 18-mar 2.8 8.3 17-dec 3 8.4 17-sep 3.5 9.2 17-jun 3.7 9.3 17-mar 3.9 9.9 16-dec 4.1 10.1 16-sep 4.8 11.3 16-jun 4.5 11.1 source: islamic banking bulletin of state bank of pakistan, various quarterly issues 1.3 gap analysis handel (2011), (handel, 2011) lustig (2011), (j, 2011) and starc (2012) (stare, 2012) found the effects of adverse selection and imperfect competition in us health insurance markets. however, they mainly focused on insurance markets and no similar work was done to measure the consequences of asymmetric information in lending. few papers provide crude evidence of the problem of information asymmetry. for example, bofondi and gobbi (2006) show that new banks entering local markets perform poorly relative to incumbents, as entrants experience higher default rates and concentration and default rates are positively correlated. gobbi and lotti (2004) claim that there is a positive correlation between branching and markets with low proprietary information services. few papers explored impact of asymmetric information in islamic banking. yousfi (2013) showed that mudarabah enables to mitigate the moral hazard problem and lead the entrepreneur to provide the first best levels of effort. on the contrary, musharakah does not solve the moral hazard problem. one explanation could be the fact that the two parties jointly fund the project and that both of them provide non-contractible efforts, which diminish their incentives. david kömling (2014) also studied the link between the profit and loss sharing base islamic financial contracts with respect to information asymmetry and shows that musharkah and mudarba base financial contract are mostly facing the moral hazard and adverse selection problem, but there is limited research on debt base islamic financial contracts like murabaha and istisna. shatha (2014) also concluded that the profit and loss-sharing contracts are supposed to be vulnerable to any kind of asymmetric information problems, as the financier faces stronger incentives to closely monitor his clients than he would face in a debt like contract. despite the fact that there is a dearth of islamic financial literature focusing on comparative performance of islamic and conventional banks (see among others aggrawal and ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 yousef, 2000, abdul-majid et al., 2010b, beck et al., 2010; and kablan and yousfi, 2012), there is a large gap that is not covered yet. for instance, academic literature does not provide rigorous analysis of the islamic financial product structure, and what are their role under asymmetric information, and how to deter opportunistic behaviour of borrowers there was one study, crawford etc. al. (2013) (crawford, 2013) that empirically measured the extent and consequences of asymmetric information in borrowing by regressing different efficiency factors on variables like loan size, tenor, and interest rate of loans. this riskiness influences banks’ pricing of loans as higher interest rates attract a riskier pool of borrowers, increasing aggregate default probabilities. data on default, loan size, demand, and pricing separately identify the distribution of private riskiness from heterogeneous firm disutility from paying interest. results suggest evidence of asymmetric information, separately identifying adverse selection and moral hazard. however, these studies were not done in the context of how financing contracts were designed, neither have they carried a comparative analysis for different mode of financing, and the information asymmetry in each. and above all they were not done in environment of a developing country having higher information asymmetries. moreover, there was a need to compare conventional and islamic mode of financing with regards to asymmetric information, as they are designed different and the problem of asymmetric information in islamic finance is supposed to be reduced by transferring physical position of financed asset. however, as there are many other factors that are different in islamic and conventional banks, that cannot be held constant, making their performance and profitability comparison un-reliable. these are size of business, their past loan history and their stage in business life cycle. businesses that are more stable and mature normally have long term credit history with conventional banks thereby reducing many of the problems of asymmetric information such as moral hazards and adverse selection. islamic banks are relatively new and are facing more information asymmetry. hence comparing those with conventional banks might not give credible results as we are purely focusing on the problems of asymmetric information that arrived from the way financing contracts were designed. a work around was to compare mode of financing within islamic bank that doesn’t involved new assets being purchased (istisna) with that in which new assets are purchased (murabaha). in istisna financing, the bank order to manufacture some goods to the and then by an agency agreement customer sell those goods to end buyer firms existent asset is purchased by bank and leased or sale back to firm on deferred payment, effectively giving money to firm that can theoretically utilized that in more risky businesses. and because that intention is not known, this information asymmetry would lead to the problems of moral hazard and adverse selection. whereas in murabaha, new assets is purchased directly by bank from the third party and after taking physical or constructive possession, it is sold or leased to that firm, affectively not getting money that could be invested somewhere else, but as asset. this will reduce the problem of information asymmetry. hence, in this way factors discussed above were affectively controlled for. moreover, to keep other bank specific factor constant (that are different within islamic banks), we select customers from a single bank. we selected meezan bank as it’s a largest full fledge islamic bank in pakistan. moreover, country pakistan is selected as islamic banking is relatively new but rapidly growing at the rate of 14%. and new banks seemed to have more information asymmetry of borrowers as compared to old established banks where borrowers have long credit history. 1.4 research objective and significance in this paper, we measure the consequences of asymmetric information in the pakistani market for small business lines of credit. this riskiness influences banks’ pricing of loans as higher interest rates attract a riskier pool of borrowers, increasing aggregate default probabilities. to measure the distribution of asymmetric firm riskiness, we estimate models of loan size, profit rate on financing, tenor of financing, and default spread. following stiglitz and weiss (1981), (weiss, 1981) we assume firms seek lines of credit to finance the on-going activities associated with a particular business project, the riskiness of which is private information to the firm. in fact those firms know the riskiness of their own project, but banks can only observe the average riskiness of their borrowers, conditional on observable firm characteristics. for a given interest rate, firms’ expected profits are increasing with risk due to the insurance effect of loans: banks share a portion of the costs of unsuccessful projects. as a result, higher-risk firms are more willing to demand higher-rate loans. this, in turn, influences the profitability and performance of the borrowing firms. as firms invest in risky business due to asymmetric payoffs, their profitability and performance is compromised. banks credit department filter out these risky firms through their credit rating, collateral and business risk. financing rates are charged depending on these characteristics. since they would grant financing for a particular business and in particular conditions, this would make the firm more disciplined, and efficiency thereby increasing their ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 performance. however, there is always a chance that firm invest that money somewhere else ex-post. since bank is not aware of firm’s intention, that information asymmetry would not only increase risk and lowering the profitability of the bank, but also for the firms themselves. for this reason, higher rates for any bank also worsen the risk composition of its accepted loans. this increases its aggregate default rates, lowering its profitability. in this study, we analyzed two islamic financial contracts istisna and murabaha to assess the impact of information asymmetry on borrowers’ performance. we employ independent t-test as well as regression and co-relation to assess the extent of information asymmetry affecting their performance. we also did a comparative analysis of these two modes of financing. four variables were proposed which can affect the islamic banks financing contracts especially in murabaha and istisna in the environment of asymmetry information. we investigated separately for both islamic financial contracts and their impact on asset and liabilities that can affect any firm or complete sector. this will help identify the main reasons for moral hazard and adverse selection so that the bank will select the techniques to reduce it. this would also help the bank to avoid the impact of asymmetric information while using these two products. 1.5 research question particularly, the discussion in this study to review the following questions: 1. how is the business concept of islam in the system of financing in islamic banking helps to tackle the problem of information asymmetry. 2. by tackling asymmetric information problem like moral hazards and adverse selection, how it affect the ex post performance of the borrowers ii. literature review this section of study examines the previous studies, concepts, methodologies from other researchers. most of the studies have done on conventional sector to analyses the relationship between the asymmetric information and companies financing and investment decisions. both in conventional and islamic financing and investment tools. (yousfi, 2013) (yousfi, asymmetric information and islamic financial contracts, 2018) showed that mudarabah enables to mitigate the moral hazard problem and lead the entrepreneur to provide the first best levels of effort. these efforts depend on the level of risk of the project. first, the profit share of the entrepreneur depends closely on the level of risk of the project. second, the threat to have no payment in case of failure increases the entrepreneur's incentives. on the contrary, musharakah does not solve the moral hazard problem. one explanation could be the fact that the two parties jointly fund the project and that both of them provide non-contractible efforts which diminish their incentives. shatha (2014) (shatha, 2014) concluded that, the majority of the islamic investments attributed to murabaha and ignores the other islamic investment "istisna". islamic banks working in jordan, the majority of the islamic investments attributed to murabaha and, istesna’a percentage are very low, less than 3%. although comparisons is being done between the both type of contracts which highlight that the profit and loss-sharing contracts are supposed to be vulnerable to any kind of asymmetric information problems, as the financier faces stronger incentives to closely monitor his clients than he would face in a debt like contract. aggarwal, r.k. and t. yousef (2000) (aggarwal, 2000) studied the set of instruments used by islamic banks to finance projects in muslim countries given that islamic law prohibits the charging of interest. the evidence indicates that the bulk of the financing operations of islamic banks do not conform to the principle of profitand-loss sharing (e.g., equity contracts). instead, most of the financing is based on the markup principle, and is very debt-like in nature. they also imply that economies characterized by adverse selection and mora hazard will be biased towards debt financing. abdul-majid, m.; saal, d.; battisti (2010) (abdulmajid, 2010) investigated the efficiency of islamic and conventional banks in 10 countries that operate islamic banking for the period 1996–2002. they found that islamic banking appears to be associated with higher input usage. they also found that islamic banks are found to have moderately higher returns to scale than conventional banks. beck et. al. (2010) (beck, 2010) showed that many of the conventional products can be redrafted as shariacompliant products, so that the differences are smaller than expected. while islamic banks seem more cost-effective than conventional banks in a broad cross-country sample, however, conventional banks that operate in countries with a higher market share of islamic banks are more costeffective but less stable. there is also consistent evidence of higher capitalization of islamic banks and this capital cushion plus higher liquidity reserves explained the ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 relatively better performance of islamic banks during the recent crisis. kablan and yousfi (2012) (o.yousfi, 2012) analyzed islamic banks efficiency over the period 2001-2008. they found that they were efficient at 78.9%. the level of efficiency could however vary according to regions. asia displays the highest score with 84.64%. country like malaysia and pakistan implemented reforms in order to allow islamic banks to better cope with the existing financial system. they also found that market power and profitability have negative impact on islamic banks efficiency. concentration leads to higher costs through slacks and inefficiency. again other results from robustness checks appear to stress the specificity of islamic banks, like their first aim for financing rural population 2.1 asymmetric information ugo albertazzi etc. al. (2014) (ugo albertazzi, 2014) analyzed asymmetric information in securitization deals is based on a unique dataset comprising a million mortgages. the main finding was that securitized mortgages have a lower default probability than non-securitized ones. crawford etc. al. 2018) also studied the effects of asymmetric information and imperfect competition in the market for small business lines of credit. they found evidence of adverse selection in the form of a positive correlation between the unobserved determinants of demand for credit and default. while increases in adverse selection increase prices and defaults on average, reducing credit supply, banks’ market power can mitigate these negative effects. lester et al. (2017) (lester, 2017) show that equilibrium contracts in insurance and credit markets are jointly determined by adverse selection and market power, and that increased competition and reduced informational asymmetries can be detrimental for welfare. karlan and zinman (2009) (karlan, 2009) estimated the presence and importance of hidden information and hidden action problems in a consumer credit market using a new field experiment methodology. they randomized 58,000 direct mail offers to former clients of a major south african lender along three dimensions: (i) an initial "offer interest rate" featured on a direct mail so licitation; (ii) a "contract interest rate" that was revealed only after a borrower agreed to the initial offer rate; and (ii) a dynamic repayment incentive that was also a surprise and extended preferential pricing on future loans to borrowers who remained in good standing. they found strong evidence of moral hazard and weaker evidence of hidden information problems. a rough estimate suggests that perhaps 13% to 21% of default is due to moral hazard. jalaluddin and metwally (1999), (jalaluddin, 1999) showed a positive relationship between the probability of financing through pls and the business risk. this means that an entrepreneur with a risky project is more willing to enter into a pls contract rather than an entrepreneur with a lesser risky project. they also found that if the costs of borrowing (through interest) are high, the probability of financing through pls is higher. in addition, they found negative relationships between the probability of pls funding and some independent variables. safieddine (2009) (safieddine, 2009) has done an investigation of the investment accounts of islamic banks. he applied agency theory to the banks and found that investment account holders expose their money to risks but lack influence on the management. as, investment accounts of islamic banks are created through a so called "two-tier mudarabah" the depositor is therefore exposed to risks associated with the investment decision of the bank, but the bank does not face any risk, because in the mudarabah contract the supplier of funds is solely liable for losses. if the investment accounts holders' lack influence and monitoring possibilities on the management due to difficulties gathering information, then there is room for agency problems. khan (1989) (khan, 1989) developed a model which is used to compare variable return schemes (vrs, like equity or pls) withfixed return schemes (frs, like debt or markup). he found that under the assumption of symmetric information the vrs dominates, because it spreads the risk much better than does frs. as soon as he relaxes the assumption of symmetric information, the frs becomes the dominant method of financing. according to khan (1989) the dominance of frs under asymmetric information has two reasons. first, lesser monitoring takes place because only a "reported return below the fixed return is suspicious". second, the frs allows for lower monitoring costs because it "minimizes information requirements". because of these two reasons, he concludes that the dominance of the debt contract stems from the asymmetric information problem observed in practice. david kmling (2014) (mling, 2014) compared the asymmetric information problem between a debt like contract and an equity like contract. it proved that profit and loss sharing contracts are more beneficial to make the project successful because it minimizes the risk of maximum losses. rifki ismail (2014) (isma, 2014) in another theoretical study, gave the assessment of moral hazard in murabaha financing which shows the impact of information asymmetric in moral hazard in relation with price risk (which is the volatility of commodity price). the study ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 also shows which steps can be taken when the honest default occurs and when dishonest default occurs. kaouther jouaber (2012) (kaouther jouaber, 2012) also showed the asymmetric information impact in the shape of moral hazard in murabah financing, the study aim was to analyze the price risk in the context of moral hazard, and price was dependent variable to select the customer by bank. alsayyed,(2010) (alsayyed, 2010) studied the uses of commodity murabaha, and found that murabaha is clearly the islamic treasurer’s funding product of choice, as it is flexible enough to facilitate many structures for financing, hedging, and currency exchanging paolo pietro biancone and maha radwan (2018) studied that the unconventional financing alternatives could positively (radwan, 2018) impact international economics and be a viable potential alternative for financing with its diversified instrument for social enterprise development. iii. methodology 3.1 theoretical framework of study: moral hazard in islamic based financial contracts can take different forms, which vary according to the type and nature of the contract between the bank and the client. the most common factors triggering moral hazard are: (i) the borrower using the funds for different purposes than agreed with the bank; (ii) the borrower not reporting the profit correctly and truthfully; and (iii) holding inside information used against the interest of the bank. to tackle the moral hazard problem the bank needs to regularly monitor the performance of the borrowers by obtaining and screening various types of financial information, such as statement of financial position, profit and loss account, cash flow statement, and statement of change in equity. banks also send inspectors to firms to monitor borrowers’ progress. investigating moral hazard leads to additional costs to the bank and the outcome of investigation can be either a success or fail. where: mc is the monitoring cost. if the moral hazard is detected the bank takes back the remaining value of the asset financed and needs to forgo the mark-up. if the moral hazard is not detected then the bank bears the monitoring costs and the borrower continuous to retain the asset. chart: costs for impact of asymmetric information use of incentive can overcome the problem of asymmetric information in islamic financial contracts.it will encourage the borrowers to provide the critical data of company that save the islamic financial institutions from moral hazard. in istisna the industry practice is that bank after purchasing the product from customer appoint him as agent of sale in the market on incentive basis, so this lead to work the customer as an agent smoothly that will safeguard the bank from moral hazard and on the other hand customer don’t complete his responsibility his incentive become zero so that bank can cover its share of loss of financing cost. the risk of adverse selection can be solving by taking security /collateral from the customer, this shows the customer creditworthiness. so bank can cover his repayment risk in murabaha by disposing off the security islamic bank also use the credit rationing techniques as the conventional do to resolve the issue of adverse selection, after some period of time bank can gathered a comprehensive data about the good and bad customer with which prevent him from loss. 3.2 process flow 3.2.1 murabaha the following process flow serves as the basic process flow for murabaha financing (excluding spot murabaha). any customer willing to avail murabaha financing must accept this process flow along with the customer specific details and provide acknowledgement on the format attached.). after the necessary credit and shariah approvals, bank and the customer will enter into mmfa and agency agreement for the purchase of goods. the bank representative will educate customer about the murabaha process and especially about the importance of placing order form to bank before/along with finalizing order with supplier and well before the dispatch of goods ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 from the supplier’s premises, signing of declaration and murabaha contract before consumption of goods and storing the purchased stock of goods separately from the stock already present in the warehouse for proper identification. as an agent, the customer will negotiate the price of the goods in the market for bank and finalize the details with the suppliers and deliver an order form to the bank before/along with finalizing order with supplier (before the dispatch of goods from the supplier’s premises). the disbursement must be done at the time when the customer has to make the payment to the supplier. this implies that in case of advance payment, the disbursement will be done at the time of the order form. in case of credit payments, the disbursement will be done later i.e. at the expiry of the supplier’s credit period (which is normally after the declaration and murabaha contract). the disbursement will be made to customer’s account with bank for onward payment to the supplier via any approved payment instrument in favour of suppliers. the customer will provide copy of this payment instrument payment evidence to bank for 100 % of the sub murabaha transactions. upon receipt of goods, the customer will declare the goods through declaration form in the days mentioned in the customer specific details along with providing the purchase evidences goods receipt evidence for 100 % of the sub murabaha transactions. simultaneously, customer will give an offer to bank to purchase the goods via murabaha contract. it must be ensured by the customer that the goods are not consumed before signing of declaration form & murabaha contract. in case of partial deliveries, separate partial declaration form and murabaha contract must be executed immediately for each delivery trench. to ensure that goods are not consumed before signing of declaration form & murabaha contract, the bank representative will also perform random physical inspections of purchased stock in the no. of sub murabaha transactions mentioned in the customer specific details & telephonic confirmation report (in case physical inspection is not conducted) will also be enclosed with the declaration form & murabaha contract. upon confirmation, bank will accept the offer by signing the murabaha contract and the ownership of assets will transfer to the customer. at this stage, the tenor of sub murabaha, contract price and payment schedule will be finalized through payment schedule. in order to ensure that acceptance of murabaha contract is communicated to the customer, the bank representative must communicate the acceptance of murabaha contract to the customer via email/telephone/fax etc immediately on the same day of acceptance of murabaha contract. for record and control purposes the bank's representative must also mention over the murabaha contract the date and mode of communication of acceptance along with name of the customer's representative to whom acceptance was communicated. in case of email of fax, a copy of the same maybe attached. the customer will settle sub murabaha on or before the maturity from its own sources 3.2.2 istisna the following process flow serves as the basic process flow for istisna financing. any customer willing to avail istisna financing must accept this process flow along with the customer specific details and provide acknowledgement on the format attached. after the necessary credit and shariah approvals, bank and the customer will enter into mifa and agency agreement for the sale of goods manufactured by customer the bank representative will educate customer about the istisna process and especially about the importance of placing written offer to bank before/along with finalizing order, signing of declaration and istisna contract before selling the goods in the market on behalf of bank agent. as a manufacturer, the customer will negotiate the price of the goods with the bank, finalize the details with the bank, and deliver a written offer to the bank before/along with finalizing order. the disbursement must be done at the time when the customer has to make the written offer to the bank. in cases there should be advance payment which generates the running for customer. upon receipt of goods, the customer will declare the goods through grn (goods receiving note) in the days mentioned in the customer specific details along with verified quality. ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 simultaneously, customer will give an offer from bank to sell the goods via sale contract. the customer act as agent with agency fees also customer has given an incentive also which is over and above the bank target selling price.in this price bank can receive it’s in istisna customer to settle the bank payment on maturity from original proceeds from end buyer, customer is not allowed to repay to from his own resource because it is not the loan transaction but it is sale base sharia mode of financing. 3.2.3 murabaha vs istisna with respect to moral hazard and adverse selection both the islamic financial contracts have risk of moral hazard and adverse selection but they have difference in stages where both the problems exists, e.g. in murabaha adverse selection risk exist when customer credit proposal is in approval process if the customer hide his some information form islamic bank which purely the customer have and bank has no direct excess on that information. for example after providing proper security to bank for approval of credit proposal and on its behalf customer receive the disbursement for bank and supplier is fake or he has make fake settlement with supplier which is his partner but is not disclose in any document. in this situation in case of disbursement to customer if bank identify this issue of adverse selection bank only can receive its principle amount without profit bank only black list the customer in future but in istisna also the issue but bank can mitigate this by two ways, one is that the bank can ask the customer to disburse the amount verification of manufactured good if the product received on time bank made payment otherwise bank can apologies to disburse but by this way the istisna product will not remain viable for industry because its nature is to cooperate with customer to fulfill his running finance needs.in second option bank can ask the customer to if the customer fails to deliver the product at delivery time he is bound to deliver the goods by purchasing from market and also bank can stop the customer factory produced to deliver to any other person and get it delivered to bank itself by force, finally bank has no need to receive the disbursed amount without profit but sometime this is risk in murabaha. iv. empirical analysis 4.1 data to attain the objective of this study, a primary annual data from 2016 to 2018 is selected. this data is selected from meezan bank of pakistan‘s small and medium enterprise (sme) and commercial customers. the number, of observations are 105 from murabaha customers and 50 observations are from istisna financing customers. the data is selected on basis of their disbursement, profit rate, tenure, along with balance sheet and income statement figures. data of above-mentioned financing customers were collected from directly from meezan bank record. in data the mean, standard deviation, and probability shows significance level, probability in all is less than 0.5 which consider very efficient in industry table 3: descriptive statistic (murabaha financing) table 4: descriptive statistic (istisna financing) see both in last of article when we make comparison in both modes of islamic financing we found that probability of both the financing is have level of significance e in murabaha the level is very high because all independent variables in relation with dependent variable have probability under the acceptable range but in istisna probability of dependent variable have negative relation with independent variable but it does not affect the real factor which shows that the istisna financing on roe, icr, fat does not have any impact. 4.2 variables this section explains the econometric models used for measuring impact of disbursed amount (da), spread, profit rate (pr) and tenor on various efficiency indicators like profit margin (pm), total assets turnover (tat), equity multiplier (em), fixed asset turnover (fat), return on assets (roa), and interest coverage ratio (icr). 4.2.1 dependent variables the process of data selection and collection and issues arising are discussed here. this is followed by an overview explaining the list of variables used in the econometric models. variables are explained as under. 1. disbursed amount: this measured the amount volume of loan sanctioned to the borrower. this amount is disbursed to a needy customer after approving its credit proposal from business unit, risk, cad, management office and from sharia dept. 2. spread: this depicts credit default spread, i.e. additional rate charged over and above the risk free rate to compensate for the probability of default, higher the probability of default, higher would be the spread. these percentages vary from customer to customer as well as on basis of amount financed and its tenor. 3. profit rate: the rate of profit charged by the bank on the financing amount. the profit rate is the percentage of principle amount being financed from a commercial bank to its customer usually it followed by a well-known benchmark like kibor, libor etc. ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 4. tenor: the maturity period of the financing, after this period, the principal become due. 4.2.2 independent variables our main variables consisted of profit margin (pm), total assets turnover (tat), and equity multiplier (em). these three financial ratios are decomposition of return of equity (roe) ratio, and known as dupont equation. the du-pont equation in profitability analysis explains the drivers of profitability in detail with three drivers which are asset turnover, financial leverage, and profit margin. succinctly, the dupont model enables the analyst to ascertain whether the overall profitability of a firm is (1) emanating from the firm’s income minus expenses (profit margin), (2) a result of effective and efficient use of organization’s asset (ato), (3) stemming from the mix equity and debt employed by the company (capital structure), or any combination of these factors (turner, broom, elliott & lee, 2015). (turner, 2015) each of the factors is briefly explained below 1. margins: net income/total revenue. high margins are often associated with organizations that are involved in rendering niche services / products, have stringent control over its cost structure (economies of scales or effective use of assets), and the ones enjoying monopolistic market conditions. 2. efficiency: asset turnover ratio is a metric most commonly used for measuring firm’s efficiency by dividing total sales with total assets. it allows the users of financial information to assess how effectively the firms is capitalizing its assets in generating profitability 3. financing policy: the third component of dupont model pertains to measurement of company’s financial leverage by means of equity multiplier. it is a financial ratio determined by dividing a company's total asset value by total net equity. other ratios that depicted performance were also analysed, these includes 4. fixed asset turnover: it is used by analysts to measure operating performance. this efficiency ratio compares net sales (income statement) to fixed assets (balance sheet) and measures a company's ability to generate net sales from its fixed-asset investments, namely property, plant, and equipment (pp&e). in general, a higher fixed asset turnover ratio indicates that a company has more effectively and efficiently utilized its fixed assets. 5. return on assets (roa): is an indicator of how profitable a company is relative to its total assets. roa gives a manager, investor, or analyst an idea as to how efficient a company's management is at using its assets to generate earnings 6. interest coverage ratio is a debt ratio and profitability ratio used to determine how easily a company can pay interest on its outstanding debt. the interest coverage ratio may be calculated by dividing a company's earnings before interest and taxes (ebit) during a given period by the company's interest payments due within the same period. the interest coverage ratio is also called “times interest earned.” lenders, investors, and creditors often use this formula to determine a company's riskiness relative to its current debt or for future borrowing. 4.3 methodology we attempted 3 pronged approach for analysing the problems of moral hazards and adverse selection. at first, we compare the mean and variance of different efficiency and performance measure and performed independent t test to ascertain whether the performance to the two modes of finance statically different. 4.3.1 performance comparison of the two modes of financing the first four dependent variables were financing details and subsequent six variables are performance details of three years after financing have being taken. we hypothesized that in murabaha financing, where problems of asymmetric information is less because of position transfer mechanism discussed above, this will more efficiently be utilized in the business, these funds would not be diverted in other risky sectors that would increase the risk and reduce the performance in long run. in short run, they might benefit from the windfall profit in risk businesses but due to stochastic nature of risky returns, these will cancel off in long run thereby decreasing the performance and efficiency. table 5: t-test: two-sample assuming unequal variances see in last of article table 4 showed that the input variables do not depict any significant difference apart from disbursed amount. especially the profit rate and spread that depict the riskiness of investment didn’t seemed to differ significantly (p value 0.99, and 0.23). this means that both modes of financing have more or less the same risk level of customers. despite the fact that on average murabaha financing has slightly more maturity that is significantly different. ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 11 on the other hand, the output variables depict a slightly different picture. two out of three dupont measures showed mildly significantly difference among them. with both profit margin and turnover that showed demand and supply side performance and efficiency respectively are on average higher for murabaha financing. where tijara and istisna is mainly benefiting from leverage however the difference showed insignificant. the other ratios like roa and interest coverage, also shown better performance for murabaha financing with higher mean and both significant at 10% and 5% respectively. this analysis showed two major findings 1. both the means of murabaha and istisna financing are significantly different in major performance indicators, implicating companies that have taken these two financing have performed differently. 2. in most of the ratio that mattered like efficiency and profitability, murabaha based financing have yielded results that are more efficient and better performed as compared to istisna. 4.4 correlation analysis table 6: correlations (murabaha financing) table 7: correlations (istisna financing) see in last of article the above two tables showed coefficient of correlation among the variables of istisna and murabaha financing. it is evident that a moderate correlation exists between disbursed amount and the profit rate. spread is also highly correlated with tenor for istisna financing. tenor is also moderately linked with the profit rate. this kind of relationship is not evident in case of murabaha financing. this showed that istisna more closely behaved with debt security then murabaha. roa and profit margins seems to have high correlation as expected, this suggested that main driver for return were demand led growth rather than supply led efficiencies. 4.5 regression analysis: we apply multi-regression analysis to analyse the impact of disbursed amount, spread, profit rate, and tenor. we made fourteen models, the first six models were regressed with the total asset, total liabilities, sale, and net profit. in this analysis, we consider total asset, total liabilities, sale, net profit as independent variables and disbursed amount, spread, profit rate as dependent variable. we employ the following regression equation y’ = α + β1 ta + β2tl + β3sale + β4np the rest of the models were regressed in different performance ratios. these included profit margin (pm), total assets turnover (tat), earning multiplier (em) as a proxy of leverage, fixed assets turnover (fat) to assess the quality of fixed assets, return on assets (roa), and interest coverage ratio (icr) we employ this in the following regression equation y’ = α + β1pm+ β2tat + β3 em + β4 fat + β5 roa + β6 icr table 8: regression equation result see in last of article in model 1, disbursed amount is significantly affected by total assets, where in model 2 (istisna) it remained insignificant. this showed that in murabaha financing, more assets leads to more loans as expected, but not for istisna. this could be because the istisna have no direct effect on customer assets as in istisna customer produce the goods and sell to the customer/ultimate buyer. similarly, total liabilities have a more significant effect on disbursed amount in case of istisna. this means more borrowing in case of more liability. it could be a sign that company is utilizing additional borrowing so where else. however, it is not the case in murabaha due injection of payment in real asset as bank try to utilizes the amount in real purchasing. total assets have more pronounced effect in spreads in model 3 (murabaha). more asset leads to lesser spread as accepted for murabaha, but for istisna, the relationship is inversed. this means that assets quality was not captured in istisna leading moral hazards. spread was also seemed to be influenced by total liabilities in istisna financing (model 4). this clearly showed, more liability, leads to more spread for murabaha, but not for istisna this mean information is not properly absorbed in spreads for the case of istisna. similar to spreads and total assets, the profit rate were also significantly influenced in assets in case of murabaha, this indicated increase in assets followed by more risky financing. similarly, liabilities also have a significant effect in profit rate as in spread. means risky investment were charged more in case on murabaha, lowering the problems in information asymmetry. the factors in istisna remained insignificant. ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 12 in model 7 (table 8), profit margin had a strong and significant impact on disbursed amount for murabaha financing as compared to istisna. this means, in case of murabaha, higher profits are better captured by banks, and disbursed amount are better utilized. the reason is that, in islamic financial contracts, banks focus on sale contract for customer financing. whereas, disbursed amount were not seemed to be effected from quality of fixed assets for both model 7 and 8. disbursed amount was also affected by financial leverage for model 7 (murabaha). this showed higher disbursement, leads to increase leverage effect, this would ultimately be increasing riskiness of roe, whereas that relationship is not significant in istisna. similarly, in model 7 and 8, quality of fixed assets didn’t seem to effect the disbursed amount in both the cases. table 9: regression equation result see in last of the article the effect of return on asset (roa) on dispersed amount was highly significant for murabaha, whereas insignificant for istisna. this showed borrowing are affectively utilized in murabaha as compared to istisna, the reason behind is that in murabaha customer purchases the goods from bank at the market rate. that variation in prices produced more effect on return on equity (roe). however, customer cannot capitalized on higher market rate as in istisna, because customer sell the goods to bank, and now bank can set the price that would not necessarily depicted in market. high significance of interest coverage ratio on disbursed amount in model 7 showed istisna business have more safely covered from default risk. in model 9 and 10, different performance variables were regressed on default spreads. profit margin have highly significant effect on default spread, for both cases, this showed risky projects were effectively captured by the bank in higher spreads. similarly, financial risk due to leverage was also captured adequately in default spreads in case of murabaha. higher spread also leads to lower total assets turnover in model 9, according to expectations, whereas the relationship is inverse and significant to istisna (model 10). this could mean, in istisna, fund were invested in those areas where risk was not captured by the bank, evidence of asymmetric information. similarly, spreads are also being influenced by financial leverage (em) for istisna but the effect remained insignificant at 5%, showing information asymmetries not fully captured by the bank in model 9 (murabah), fixed asset turnover, had a strong and significant effect on default spreads. this indicated that better fixed assets utilization increase their turnover at a higher spread. this means more risky business are utilizing funds efficiently, however it remained insignificant for istisna case. this relationship is also valid to return on assets, as both is significantly influencing the spreads. in model 11 and 12, financing rates were negatively affected by profit margin for both forms, indicating risky investments seems to have lower profitability, the effect is however insignificant for murabaha maybe because of better utilization of financing. the same effect is witnessed for total assets turnover. financial leverage also negatively affected that financing rate as in case with spreads. the effect is significant for istisna (model 12) return on assets was also positively related to financing rates for both forms however, the effect is significant for istisna (model 12). it showed that higher financing rate leads to higher returns afterwards, it could mean, in case of istisna, that banks were funding business that were more cyclical in nature, whereas in murabaha financing, funds were invested in core activities that didn’t significantly move with the rates. in model 13 and 14, profit margins had inverse effect on tenor, the effect is significant for istisna. this showed that long term projects yields more profit as compared to short term, however the effect was not significant for murabaha. similar result were found with fixed assets turnover and return on assets, as it positively and significantly affected the tenor for istisna (model 14), indicating more efficiencies in longer run, however it remained insignificant for murabaha. at last, interest coverage ratio largely remained in significant in all models.. v. conclusion asymmetric information topic has widely discussed in relation with conventional banks. some studies have been done on asymmetric information in relation with islamic financial contracts as it discussed in literature review but majority studies are on equity base islamic financial contracts like musharkah and mudarba with respect to both aspect adverse selection and moral hazard, the studies shows that both problem exist in musharkah and mudarbah and has been discussed their solution. there is another type of islamic financial contract which is consider on debt base i.e ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 13 murabaha, istisna few article are on one side of effect of asymmetric information as moral hazard in murabaha but no study found on istisna in connection with moral hazard and adverse selection. this study not only focused on murabaha but also compared it with istisna, it proved that murabaha also have the problems of adverse selection in a way that at time of selection of a customer a bank may make mistake in credit worthiness checking of client, however, it can be cover by taking security. in istisna it can be covered by not making disbursement till time of delivery of final product to the bank although as per sharia disbursement to customer is allowed before the delivery as well as at time of making istisna order, but practically if the islamic banks restrict the disbursement till delivery the product will not remain viable for market because the customer needs financing for purchasing the raw material, although it is risky which leads to moral hazard we selected three years annual data of 35 customers with the 105 number of observation of islamic bank, which are utilizing many sharia compliant financing facilities, but i select two: istisna and murabaha financing products in different commodities like cotton bales, fertilizer, pesticide, oil cake, rice, wheat seed, cotton seed, chipboard, fans, auto parts, canola seed and medicines. we found no payment delay in all customer which are from very different segments unlike in case of conventional financing, where this ratio relatively high. in islamic financing contract, the disbursement amount actually placed in asset which has its monetary value so in case of any loss due to availability of actual asset customer can recover major portion of his disbursed amount and will be able to pay the bank financing at the time of maturity, but in the conventional bank, the disbursed amount did not inject directly in physical asset so at time of repayment if customer has not got enough, liquidity he would default. this leads to the problem moral hazard ultimately. hence, the injection of disbursed amount in real asset is more beneficial for economy. recommendations the study suggested that sme and commercial sector to finance their projects under the islamic financial contracts. it is more secure and disciplined way for both the sectors. benefit of using these contracts is firstly to avoid interestbased transactions, also these contact does not create the bubble in economy, which can burst at any time acknowledgments: foremost, i would like to express my sincere gratitude to my advisor dr. danish ahmed siddiqui associate professor karachi university business school, university of karachi, pakistan for the continuous support of my m.phil. study and research, for his patience, motivation, enthusiasm, and immense knowledge. his guidance helped me in all the time of research and writing of this thesis. i could not have imagined having a better advisor and mentor for my ph.d. study i thank my entire fellow and class matches for the stimulating discussions, for the sleepless nights we were working together before deadlines, and for all the fun we have had in the last three years. last but not the least; i would like to thank my family: my parents, for supporting me spiritually throughout my life. references 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[24] paolo pietro biancone and maha radwan (2018) social finance and unconventional financing alternatives an overview. european journal of islamic finance ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 15 table 3: descriptive statistic (murabaha financing) da spred pr tenor pm tat em fat roa icr mean 4868653 0.022594 0.096346 148.2762 0.209546 5.271286 1.690048 83.51522 0.466732 0.838144 median 2000000 0.0225 0.0868 178 0.0699 3.50137 1.2189 15.76127 0.2241 0.2659 maximum 25000000 0.0565 0.951 270 7.51657 71.40822 7.80021 964.8595 10.1659 10.705 minimum 125000 0.01 0.0716 1 0.00271 0.08189 0.16777 0.1108 0.0162 0.0175 std. dev. 6570561 0.011326 0.084895 62.0977 0.749522 7.606361 1.384871 189.9784 1.091595 2.256208 skewness 2.020009 0.769974 9.853098 -0.12034 9.009218 6.442254 1.917884 3.324476 7.216809 4.027875 kurtosis 6.113479 3.37444 99.71429 2.15708 87.78951 55.70852 6.847657 13.60189 61.89783 17.7666 jarque-bera 113.8178 10.98845 42621.19 3.361932 32873.42 12880.87 129.1394 685.163 16088.12 1237.896 probability 0 0.00411 0 0.186194 0 0 0 0 0 0 observations 105 105 105 105 105 105 105 105 105 105 table 4: descriptive statistic (istisna financing) da spread pr tenor pm tat em fat roa icr mean 11337259 0.020625 0.096258 114.1667 0.094464 3.820821 2.981174 190.9057 0.265353 0.315242 median 11292534 0.0225 0.0938 90 0.0583 2.839515 0.991115 19.61888 0.1969 0.16465 maximum 29583360 0.03 0.1159 180 0.39321 13.11266 64.71127 1939.676 1.4742 2.5346 minimum 1160430 0.01 0.0721 60 0.0001 0.25657 0.15068 1.22244 0.0007 0.0175 std. dev. 7775263 0.007328 0.012527 47.29089 0.100509 2.861496 10.65358 447.9905 0.285906 0.453498 skewness 0.816737 -0.24978 -0.03201 0.317256 1.71419 1.250137 5.631386 2.87391 2.580821 3.585734 kurtosis 3.347564 1.881462 2.319252 1.509492 4.874004 4.402553 33.1287 10.38909 10.61087 17.36472 jarque-bera 4.183553 2.251022 0.701275 3.936327 22.89852 12.32779 1551.883 131.4541 126.8519 386.6626 probability 0.123468 0.324487 0.704239 0.139713 0.000011 0.002104 0 0 0 0 observations 36 36 36 36 36 36 36 36 36 36 table 5: t-test: two-sample assuming unequal variances mean variance t stat p value (two-tail) disbursed amount murabaha 4868652.95 4.317e+13 -4.473934 4.098e-05 tigara/istisna 11337259.25 6.045e+13 spread murabaha 0.022592143 0.0001283 1.1941622 0.2354193 tigara/istisna 0.020625 5.371e-05 profit rate % murabaha 0.096345714 0.0072072 0.0102272 0.9918576 tigara/istisna 0.096258333 0.0001569 tenor murabaha 148.2761905 3856.1249 3.4307706 0.0009599 tigara/istisna 114.1666667 2236.4286 profit margin murabaha 0.20954618 0.5617825 1.5336053 0.1278974 tigara/istisna 0.094465318 0.0101018 total assets turnover murabaha 5.27128662 57.856728 1.6439478 0.1024633 tigara/istisna 3.820820235 8.1881596 equity multiplier murabaha 1.690048252 1.9178672 -0.725054 0.473239 tigara/istisna 2.98117466 113.49866 fixed asset turnover murabaha 83.51521608 36091.792 -1.395906 0.1706391 tigara/istisna 190.9057377 200695.48 return on assets murabaha 0.466730561 1.1915714 1.7256025 0.0867241 tigara/istisna 0.265352763 0.0817412 interest coverage ratio murabaha 0.83814381 5.0904723 2.246192 0.0264473 ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 16 tigara/istisna 0.315241667 0.2056607 table 6: correlations (murabaha financing) da spread pr tenor pm tat em fat roa icr da 1 spread -0.27472 1 pr -0.09311 0.092426 1 tenor -0.01075 -0.0843 0.042247 1 pm 0.031218 -0.12306 0.009017 0.082282 1 tat -0.08757 0.116757 -0.03406 -0.06473 -0.11296 1 em 0.249122 -0.00623 -0.04887 -0.17097 0.131437 -0.27927 1 fat -0.14753 0.001317 -0.04144 -0.07998 -0.08376 0.27007 -0.08386 1 roa 0.022575 -0.11195 -0.00483 0.140907 0.92926 -0.00232 -0.00657 -0.06791 1 icr -0.06703 0.081098 -0.00194 -0.15856 -0.05555 -0.02268 -0.04602 0.342279 -0.04688 1 table 7: correlations (istisna financing) da spread pr tenor pm tat em fat roa icr da 1 spread -0.32479 1 pr -0.41417 -0.16076 1 tenor 0.010577 -0.80535 0.554143 1 pm 0.271207 0.121269 -0.31829 -0.30769 1 tat -0.31966 0.068242 0.270035 -0.00617 -0.34183 1 em 0.421303 0.030758 -0.11262 -0.07605 -0.13625 -0.23603 1 fat -0.41584 0.388901 -0.05242 -0.2192 -0.21631 0.36147 -0.06091 1 roa -0.01726 0.040757 -0.10336 -0.19104 0.545513 0.342778 -0.17506 -0.03569 1 icr 0.132256 -0.00123 -0.37336 -0.01824 0.058583 -0.2204 -0.0145 -0.05885 -0.0884 1 table 8: regression equation result model 1 model 2 model 3 model 4 model 5 model 6 murabaha istisna murabaha istisna murabaha istisna dependent variable da spread pr in d e p e n d e n t v a r ia b le s c coefficient 4868653 11337259 1.326763 0.020625 4.883189 4.563633 t-statistic 3.26e+15 1.51e+15 18.01226 7.55e+14 1.21e+15 1.12e+15 prob. 0 0 0 0 0 0 ta coefficient 8.48e-14 1.67e-14 -2.02e-07 5.27e-23 2.20e-19 5.36e-21 t-statistic 6.869016 1.179882 -0.33093 1.021551 6.595607 0.699548 prob. 0 0.2534 0.7418 0.3205 0 0.4932 tl coefficient -9.07e-14 -1.71e-13 -1.53e-07 -6.67e-22 -1.43e-19 -6.73e-20 t-statistic -4.81221 -1.52776 -0.16429 -1.6295 -2.81428 -1.10784 prob. 0 0.144 0.87 0.1206 0.0065 0.2825 sale coefficient -6.97e-15 7.10e-14 -2.15e-07 2.59e-22 2.57e-20 3.68e-20 t-statistic -2.63802 3.38702 -1.6498 3.385334 3.594217 3.239574 prob. 0.0105 0.0033 0.1039 0.0033 0.0006 0.0045 np coefficient -1.17e-14 0 2.06e-08 -1.75e-22 -2.23e-20 8.98e-20 t-statistic -1.19641 0 0.042645 -0.50374 -0.84463 1.736886 prob. 0.236 1 0.9661 0.6206 0.4015 0.0995 ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 17 r-squared 1 1 0.976313 1 1 1 adjusted r-squared 1 1 0.961508 1 1 1 f-statistic 3.51e+30 1.32e+30 65.94629 8.79e+28 2.27e+29 2.16e+30 prob(f-statistic) 0 0 0 0 0 0 durbin-watson stat 3.034791 2.512496 1.515861 2.528205 2.815141 2.240126 table 9: regression equation result periods included: 3 (2016 2018) companies included: 35 for murabaha and 12 for tijara and istisna total panel observations: 105 for murabaha, and 36 for tijara and istisna effects specification: 1. cross-section fixed (dummy variables) 2. period fixed (dummy variables). model 7 model 8 model 9 model 10 model 11 model 12 model 13 model 14 murabah istisna murabah istisna murabah istisna murabah istisna dependent variable da spread pr tenor in d e p e n d e n t v a r ia b le s c coefficient 4868653 11337259 0.022594 0.020625 0.097613 0.096258 147.6912 114.1667 t-statistic 8.68e+14 2.06e+15 5.48e+14 2.38e+15 4.20e+00 4.16e+15 27.96855 9.38e+14 prob. 0 0 0 0 0.0001 0 0 0 pm coefficient 4.92e-08 1.26e-08 2.76e-16 1.90e-16 -1.57e-03 -5.24e-16 -2.507764 -2.04e-12 t-statistic 4.421539 0.3378 3.372805 3.242665 -0.03404 -3.35607 -0.239335 -2.4852 prob. 0 0.7399 0.0013 0.0051 0.973 0.004 0.8116 0.0244 tat coefficient -5.73e-10 2.06e-09 -7.94e-19 3.32e-18 -3.23e-04 -1.12e-17 -0.278474 -1.15e-14 t-statistic -1.41543 1.806613 -0.26658 1.84579 -0.19212 -2.33601 -0.730447 -0.45658 prob. 0.1619 0.0897 0.7907 0.0835 0.8483 0.0328 0.4679 0.6541 em coefficient -1.72e-08 9.48e-11 -1.38e-16 6.71e-19 -9.84e-04 -2.59e-18 0.784259 -5.46e-15 t-statistic -6.62061 0.401951 -7.22397 1.805494 -0.09137 -2.6208 0.320848 -1.04933 prob. 0 0.693 0 0.0898 0.9275 0.0185 0.7494 0.3096 fat coefficient 3.22e-11 1.77e-11 9.01e-20 -4.45e-20 1.35e-05 4.76e-20 0.000389 4.65e-16 t-statistic 1.387443 1.697593 0.528691 -2.71063 0.140065 1.088375 0.017831 2.020786 prob. 0.1703 0.1089 0.5989 0.0154 0.8891 0.2926 0.9858 0.0604 roa coefficient -3.50e-08 -3.96e-10 -2.00e-16 -4.85e-17 2.13e-03 1.93e-16 2.865672 7.85e-13 t-statistic -4.60894 -0.03227 -3.57496 -2.51129 0.06753 3.755108 0.400819 2.899575 prob. 0 0.9747 0.0007 0.0231 0.9464 0.0017 0.6899 0.0105 icr coefficient -8.33e-10 1.02e-08 1.55e-18 6.31e-18 3.68e-04 0 -0.139678 1.55e-13 t-statistic -0.66846 2.291651 0.16934 0.903412 0.071191 0 -0.119114 1.58471 prob. 0.5063 0.0358 0.8661 0.3797 0.9435 1 0.9056 0.1326 adjusted r-squared 1 1 1 1 -0.06035 1 0.897888 1 prob(f-statistic) 0 0 0 0 0.696332 0 0.00 0 durbin-watson stat 2.773731 2.046115 2.793367 2.317264 4.434157 2.275504 4.400719 1.9269 ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 dynamism and mechanism of digital currency (cryptocurrency) towards islamic finance phd candidate, department of finance, international islamic university malaysia associate professor, department of finance, international islamic university malaysia abstract-technology advanced has brought rapid changes in all human activities along with financial activities and tools. digital currency one of the technological innovations which have taken significant focuses from consumers, investors, researchers, entrepreneurs and policy makers around the world. with the trend of changing patterns, islamic finance is rapidly developing all over the world by serving muslims and non-muslims, as a result, it is mandatory for islamic finance to adapt with modern technology systems in terms of providing innovative products and services to the consumers in line with shariah perspectives. as a result, cryptocurrency (digital currency) has taken the focus on islamic scholars in regards of its permissibility. there are many arguments over the permissibility issues. therefore, this study aims to explore those issues and mechanisms of cryptocurrency in order to evaluate with islamic perspective. this study gathered secondary sources from past literatures, books, news and websites with qualitative approach. the findings inclined that there are still lacking in mechanisms of digital currency to comply with islamic perspective such as real asset backed and legal authorization. the findings of this study will benefit the islamic scholars and policy makers along with muslim consumers and investors in regards of permissibility and developing existing cryptocurrency to widely use in the islamic finance and banking sector. keywords: digital currency, cryptocurrency, islamic cryptocurrency, halal currency, islamic financial technology, islamic finance and banking i. introduction the economic world has adopted many changes/innovations in order to maintain the movement of technology development in regards of diversification (biancone, secinaro, & kamal, 2019). the traditional practices of monetary and financial activities are changing rapidly due to the improvement in information technology as well as the information communication system. the technology acceptance model (tam) introduced by davis (1989) asserted that the acceptance of advanced technology determined by the consumers based on the reliability, flexibility and the perceptions (echchabi, 2018; islam, 2011). hence, the world is introducing many new technologies in all aspects of human activities including economic, engineering and societal. as a result, the governing body of the payment system, investment policies and method, monetary controlled and settlement is shifting significantly in order to create the secured and advanced system by adopting technology features. islamic finance is rapidly developing all over the world (mukhibad, 2019) by serving muslims and non-muslims (biancone & radwan, 2018), as a result, it is mandatory for islamic finance to adapt with modern technology systems in terms of providing innovative products and services to the consumers in line with shariah perspectives. in recent times, the world is discussing over crypto currencies as the digital money which brought the positive and negatives issues among the policy makers, economists, academicians and researchers. the crypto currencies are increasing the people’s curiosity in this era of technology (oziev & yandiev, 2018). the intensification of digital currencies are incurred by the excessive demand from the consumers, investors, financial institutions, share market speculators, curiosity and interest in technology based features in payment system (zubaidi & abdullah, 2017). the islamic finance is also aware of the uses of these digital currencies in their transaction and investment. cryptocurrencies are the form of digital fiat currency which is being accepted by the most users that rely on internet. the internet users are increasing over the time and ict (information communication technology) has taken major part of business platform whereas consumers are demanding something not carried and the quickest way to transact. according to jung et al., (2019), there are more than eleven thousands crypto currencies with diverse categories using as medium of exchange globally. ethereum, bitcoin, litecoin, ripple consider as major cryptocurrencies whereas mohammad abdul matin chowdhury1 and dzuljastri bin abdul razak2 ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ‘bitcoin’ is the most popular trading financial asset in the world digital currency market (muedini, 2017). however, conventional finance system is adapting with this digital currencies whereas the islamic finance is struggling to accept it due to the debates over permissibility and the implementation according to the islamic perspectives. in addition, the notion and definition of crypto currencies are still indistinct and extensive (jung et al., 2019) islamic finance also requires filtering the certainty, financial viability, legal transactions complied with shariah rules, permissibility and risks in order to adopt new technological tool or products. hence, the consequences of current situation of islamic financial system are the unavailable evidence and proper guidelines to adopt crypto currency to apply in the transactions and investments perspectives. furthermore, the appropriate guidelines and shariah based innovations are not available in the system whereby islamic finance is reluctant to implement. subsequently, there are very limited research conducted in this stimulating digital currencies permissibility and economic benefits in line with shariah perspectives whereas different findings created havoc among islamic investors and consumers. therefore, this study aims explore possible suggestions and ways to fulfil the gaps and identify the evidence and methods to accept and implement current cryptocurrencies through dynamism and mechanism of advanced financial technology in islamic financial system. the findings of the research incline to be important to islamic scholars, islamic investors and consumers, economists, researchers, and government to make the decision and effective mechanisms in order to accept or decline the new technology based currencies. therefore, this research will be tended to noteworthy for both practitioners and policy makers to evaluate the acceptability and permissibility, economic benefits of using islamic crypto currencies in order to sustain the islamic finance and banking. ii. definition and concept of cryptocurrency cryptocurrency is a piece of innovation of technology world which is a digital or virtual currency that electronically encoded for security which being used for online transactions (bakar, rosbi, & uzaki, 2017; harris irfan, 2019) which is different than historical fiat currency in regards of issuing, origin of issuing and physical subsistence. cryptocurrencies are complete transformation of fiat currency through the technology based innovation that has no border in the world placed in the digital world market trading on crypto assets for the entire twenty four hours (jung et al., 2019). the author also added that these currencies have the issuing company, carried out the physical value through bills or coins. besides being a digital currency, these cryptocurrencies are helping the financial technology system in order to innovate, transform and incorporate better understanding, smoothness, reliability and accountability by the feature of block chain (zubaidi & abdullah, 2017). thus, cryptocurrency exists on the computers similar to bank accounts and the money stored in the bank exists as digits on a computer whereas the fintech has mostly replaced the cash or paper money (harris irfan, 2019). cryptocurrencies are known as token transferred from one party to another party through peer to peer (p2p) online transaction beyond a centralized server whereby it delivers the message to all parties informing the ledgers of transaction and accepted by other recipient. the introduction of first cryptocurrency is bitcoin, a peer to peer (p2p) online cash system which is created in 2008 during the financial crisis (muedini, 2017). furthermore, cryptocurrency is not issued by central banks as paper money, but it is formed through rules of creation or algorithm and decentralized based on block chain technology which exists on millions of computers all over the world, thus, it cannot be printed by any central body (harris irfan, 2019). iii. issues and challenges of cryptocurrency cryptocurrencies are no longer apart from the risks associated with instability of exchange rate, market manipulation and regulatory risk (peters et al., 2016). hence, many creditors are reluctant to support the cryptocurrency firms due to the risk of money laundering (seele, 2018) and tax avoidance, in addition to it, the crypto currencies are not the creation for financial solidity whereas it creates the platform for the digital investors to gather financial benefits through momentary conjecture and gaming through digital world (jung et al., 2019; peters et al., 2016). consequently, jan bergstra (dutch computer-scientist) treated cryptocurrency as money-like informational commodity and the design and concept of it comply with understanding of money concept (bnc, 2018). for instance; there are several governments denied to accept these cryptocurrencies (zubaidi & abdullah, 2017) and against it whereas implemented law on it. chinese government proscribed the initial coin offering (ico) on september, 2017 and banned the cryptocurrency exchanges including ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 restricted people in order to stay away from incurring to exchanges and offering cryptocurrency trading on january, 2018 (jung et al., 2019). european regulator is discouraging the financial institutions and individual to accept and trade using cryptocurrencies (peters et al., 2016). consequently, the state bank of vietnam declared the cryptocurrencies as illegal system under the regulation system and restricted citizen to avoid related transactions and trading as it is criminal offense according to the law, but cryptocurrencies treated as investing assets by the korean people which allow them to take risk of financial loss and unsecured transaction information (jung et al., 2019). not to mention, cryptocurrencies are having several issues while it’s growing all over the world. iv. cryptocurrency in islam researchers and policy makers are aware of this digital currency’s application enhance the financial market risks associated with funding for terrorism (irwin & milad, 2016), security of asset, capital control, hedge and many others along with erupting foreign market interruption and capital market deformation (jung et al., 2019; peters et al., 2016). islamic financial system focuses on only intrinsic and physical values of economic endeavours whereas it is fiat money or any terms being used for financial transactions. as a result, the shariah scholars have various opinions on the implementation of crypto currencies as they have provided both permissibility and prohibition (depietro, 2018). durban based darul ihsan centre, several scholars in turkey, india and uk and egypt’s grand mufti declared cryptocurrency impermissible in islamic finance (aljazeera, 2018). however, depietro (2018) has argued that the crypto currency creating through online put some efforts to secured it and requires signature to make it works and useful through digital mediator. he also pointed the history of the diner (gold) and dirham (silver) creations which needed efforts to make the shape of those currencies, but those currencies were used by only arabs, therefore, they still had to use different currencies outside of arab countries. though, currency is the one that has value, component of account, use as medium of exchange and transferable for the payment consider as money (adam, 2017). similarly, monzer kahf (islamic scholar) opined that cryptocurrency is similar to any other currency which is money within its community and transferable with other currencies is definitely subject align with similar conditions of currency exchanges (bnc, 2018). even, there are many scholars do not treat the cryptocurrencies as genuine money but cryptocurrencies have those values to be considered as digital money that refer to be medium of exchange (muedini, 2017). consequently, jan bergstra (dutch computer-scientist) treated cryptocurrency as money-like informational commodity and the design and concept of it comply with understanding of money concept (bnc, 2018). in islamic economics and finance, the store of value function is a testimony to the validity of medium of exchange (abdullah, 2016). according to the zubaidi & abdullah (2017), cryptocurrencies have no intrinsic value. similarly, bakar et al. (2017) identified that cryptocurrency (bitcoin) has no real form which only exists in a network without intrinsic value which is not redeemable for another commodity. moreover, meera (2018) stated that cryptocurrencies are not backed by real assets, therefore, it is not shariah compliant. interestingly, there is no intrinsic value for several existing money for instance; gold, iron, bead, plastic and paper as these things are not eatable neither drinkable or usable to protect from any environmental calamities but they still have price. bello lawal danbatta ( secretary general, ifsb, malaysia) stated that cryptocurrency offer various advantages to muslim people such cost saving, efficient transactions and include those are un-bankable (bakar et al., 2017; canard & gouget, 2007; whitehead, 2019). cryptocurrencies are not treating as financial innovated pattern by many as it is just a digital product that plays with speculations considering gambling outlay targeted to generate insignificant outcome (jung et al., 2019; seele, 2018). therefore, authors has treated cryptocurrency framework is linked with uncertainty (gharar) (bakar et al., 2017). besides, cryptocurrencies are not fiat money or real money. the study found the existence of uncertainty which can contribute to injustice in the society (meera, 2018).surprisingly, muedini (2018) highlighted the issues of current fiat and paper money to compare with acceptability of virtual currency. muedini, (2017); zubaidi and abdullah(2017) mentioned that inflation, unlimited supply, government abuse and forgery lead fiat currency less suitable for islamic finance. interestingly, they found cryptocurrencies better option for islamic finance due to principles of justice and social fairness that characterized in islamic perspectives. furthermore, jan bergstra (dutch computer-scientist) clarified that there are four principles complied with cryptocurrency among five principles of islamic finance whereas only avoidance of gambling does not observed (bnc, 2018). hence, cryptocurrency is treated as most islamic form of money which was not introduced by islamic finance (harris irfan, 2019). however, the value of money can be reduced that stored in public’s hand through inflation that ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 reduce the consumption power which lead to uncertainty (gharar) that can be led to void contract due to its value (harris irfan, 2019). subsequently, cryptocurrencies are unable to inflated, ease to transport and decentralized which allow users to have freedom and it is also not used for double spent (muedini, 2018). in fact, due to fluctuations of cryptocurrencies cannot be impermissible whereas fiat currencies have the same situation (abubakar, ogunbado, & saidi, 2018). furthermore, cryptocurrency consider as commodity (mal) through fulfilling the conditions of commodity and thus allowed for trading (abubakar et al., 2018). atif yaqub ( muslim block chain expert) explained that individuals are prone to involve in alternative currency beyond the doubt on permissibility of emerging technology (gabriel, 2019). similarly, meera (2018) found cryptocurrency as global choice for that alternative currency even though it is not fiat currency. therefore, the regulators in financial industries require to understand the dynamism and mechanism of financial technology and its impact in order to adapt cryptocurrency which deemed to be popular among community members (arsov, 2017). the grand mufti shaikh shawki alam banned the trading of cryptocurrency as it’s against the islamic principles where it has possibility of money laundering, fraud and financing terrorists, additionally, it has not set any rules which make it void contract (abubakar et al., 2018; harris irfan, 2019). in addition, there are no regulatory authorities from the government all over the world to stabilize the digital currency and protect the trading from negative effects (feng, wang, & zhang, 2018; meera, 2018; peters et al., 2016; zubaidi & abdullah, 2017). furthermore, bakar et al.(2017) found that cryptocurrency is suitable for certain communities and it requires authority to implement in all sectors of economy through validity and reliability on the transaction. there may be a possibility of manipulation of the system without authorization lead to uncertainty (gharar). in contrast, harris irfan (2019) argued that these issues (money laundering, fraud and terrorism financing) mainly facilitated through us dollar. thus, cryptocurrencies do not affect significantly applying in utility, ease, competence and expediency although it is cost saving in regards of allocation and administration expenses due to insufficient knowledge over digital currency by consumers (jung, 2019). but the fiat currency take longer period during its transaction and trading period whereas cryptocurrencies lessen the complicacy of payment services, in addition it enhanced the expediency of payment system which positively affected the performance of cryptocurrencies (jung et al., 2019). surprisingly, cryptocurrency (block chain mechanism) transform the financial transaction from traditional way through significant digital transformation whereas it built trust and authority in a decentralized network than powerful centralized institution (arsov, 2017). similarly, harris irfan (2019) also stated that fiat currency dictated by government without setting rules either and citizen placed their trust in the fiat currency being privileged in the exchange of real goods and services. v. data & methodology this study adopts qualitative approach in nature through collecting, gathering and findings from secondary sources such as research papers, news, websites, books and interview posted online. the study pointed out all important findings, data and suggestions to achieve the objective. and this study adopted interview from dr. mohd daud bakar (the chairman of the shariah advisory council, malaysia) from secondary source (volcan post, 2018). in this interview, he expressed his views on cryptocurrency on both legal and shariah law. a. cryptocurrency is more than just a currency according to him, cryptocurrency is happening globally and it has ways to conserve shariah within this mechanism of it. he explained the mechanism of cryptocurrency which is recorded by more than one party through a ledger system and eventually it aids avert altering. he also treat cryptocurrency as not only currency but also a tool for remittance which save cost and time. b. cryptocurrency could help the fight against money-laundering dr. mohd daud bakar seen the spending through cryptocurrency may help with accountability. for instance, zakat (form of alms giving) payers may ensure that their contributions distributed among those are in need. cryptocurrency can easily detected where it is kept compare to fiat currency specially cash that can easily hide their identities. in this scenario, cryptocurrency may help prevent money laundering if it is applied right and monitored by right authority. c. cryptocurrency can be local currency in malaysia malaysia may turn cryptocurrency as local currency if they want to adapt it similar to dubai where they started to treat it as local currency regardless of borderless or global cryptocurrency. indeed, japan has acknowledged cryptocurrency as legal and dubai has launched its own cryptocurrency in october, 2017. ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 d. cryptocurrency as haram (impermissible) he argued that some islamic jurists consider it as haram due to uncertainty (gharar). but he thinks they have mixed uncertainty and risks together whereas risk is part of shariah that human go through every day in their life, for example, purchasing properties, shares and gold is risky. in addition, cryptocurrency has fluctuation in regards of value which can be go up and down same as value of gold price and it caused several authorities to declare cryptocurrency as haram. he also mentioned that from the fatwa standpoint, a government can treat it as impermissible due to its risk but according to shariah perspective, it cannot be declared as haram due to the risk. e. cryptocurrency and trust cryptocurrency (digital currency) created based on trust or peer-to-peer whereas fiat currency is also based on trust. he explained the role of usd which used as global currency and the value of it fluctuated over the time, losing and gaining trust and also it is being used by the world bank to balance the global exchange. therefore, american may lose their faith in their currency but it is still will be valued as currency. f. malaysian regulators on cryptocurrency he has suggested the regulators to create their own e-wallet in order to understand cryptocurrency whereas they can observe how the eco-system works in e-wallets. vi. findings and discussion from the above literatures and interview, there are few issues were discussed over the dynamism and mechanism of cryptocurrency towards islamic finance. most opponent scholars argued over the legal authority of cryptocurrency whereas it requires legal governor or government to authorize this digital currency. besides that, there is huge debate on store value or intrinsic value of cryptocurrency. in addition, several scholars ignored it as they claimed it has no asset backed. furthermore, some scholars treat cryptocurrency as just a digital mechanism that suitable only for certain people which are still consist of uncertainty and islam prohibits uncertainty from all activities in life. the history of economy has emerged its scopes and practices over the time. in the same time, islamic scholars and jurists have developed and innovated products, services, application of existing islamic contracts and laws in modern aspects and social practices in order to follow the global trend as well as to fulfil the social demands (harris irfan, 2019). in history of islamic practices on money, raw materials such as silver, gold used as coin in the form of money (adam, 2017), and during malik ibn marwan’s ruling period, the regulation introduced in order to issue of coins as a form of money, the transformation of money from gold and silver as coin took several arguments by islamic scholars (adam, 2017; ahmed, 1989), indeed, there was an issue in regards of valuing silver and gold among islamic scholars till the paper currency introduced (siegfried, 2001). however, the movement from silver and gold as currency towards paper money has also raised the issues of permissibility to use it as medium of exchange among the islamic thoughts whereas many scholars accepted it as legal form of money creation while others treated it as completely impermissible according to shariah (adam, 2017; muedini, 2017; zubaidi & abdullah, 2017). for instance; anwar (1993) stated that the creation of paper money is against the islamic principles as the author thinks the government regulation authority whip the property from the people through advanced innovation. the author also added that fiat currency does not have intrinsic value. the supply of dollar has tremendously increased when the world economy transformed from gold standard to one based on several fiat currencies (us dollar as world’s reserve currency) from 1971 (harris irfan, 2019). as a result, the value against new paper money stored by the us dollar implemented in many countries. besides, the history also shown that there were many debates or arguments over any new scientific innovations but over the time, those are accepted and applied in islamic world. for instance, telegraph, loudspeaker, television. the islamic scholars are always debating in regard of issues such as nature of interest, debt, types of donations, financial activities that being used in the economy and social perspectives (muedini, 2017). most of the arguments from opponents scholars are temporary issues which can be mitigate through proper regulation and mechanism by the association of governments (abubakar et al., 2018). thus, islamic finance mainly focuses on shariah permissibility in order to practice any kind of transactions, businesses, investments and financial activities. risks associated with interest, uncertainty and gambling are completely against shariah rules (zubaidi & abdullah, 2017), and as a result, those must be free from any innovative or adopted activities in the islamic finance system. the holy quran explains the role of money. “and do not give the weak-minded your property, which allah has made a means of sustenance for you” (quran 4:5). it can be explained as that property/money created to hold up, preserve and prolong others that allah has created this property powerful to sustain ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 and uphold the system of this. it means money that upholds the entire financial system has no end, ends the one and facilitate others earth (adam, 2017). according to the muedini (2017), the value of money gradually decreases over printing of paper currency that may lead to an inflation (zubaidi & abdullah, 2017) which perhaps affects the value/trust of specific currency. islamic finance is against the inflation. it can be elaborated from the findings of chapra (1996) where islamic finance strongly consider the store value of money and its stability due its fair and loyalty dealings with all financial and social endeavours, in addition, inflation has negative impact on socio-economic fairness and human wellbeing. with the acceptance and trust by the public, currency being exchanged and traded as medium of exchange widely. arsov (2017) presented four characteristics/advantages of bitcoin (cryptocurrency) such as divisibility which can be divisible and making it into uniform pieces which cannot be done to gold; malleability which may enable to combine all bitcoins fit into a wallet and store them into an account; counterferfeit-adversity whereas it can be viewed everyone’s bitcoins if anyone lies through having a copy of ledger; fungibility which denotes the equal value of all parts of same denomination, it is perfectly possible in regards of cryptocurrency, but it is quite impossible for gold bars. nobody may predict or judge gold bar with other same sized gold bar in regards of same purity and worth. interestingly, he also argued that gold acquire through physical mining and cryptocurrency created through virtual mining. moreover, the price of gold is not always stable. it has volatile market price which can be tradable in the market. therefore, the initiative by the government will enhance the popularity and acceptance of cryptocurrencies among the consumers and investors through building trust and confidence (jung et al., 2019). however, there is no literature found where it declares gold-backed cryptocurrencies impermissible in islam whether it can be desirable by community and consistent with maqasid al shariah. dubai based onegram cryptocurrency backed by physical gold which stored in a vault and it limited to speculation (aljazeera, 2018; meera, 2018). hence, ibrahim mohammed (the founder of briton) stated that gold was the first form of money in islamic communities, so this is permissible. not to mention, hellogold was launched with gold backed cryptocurrency in malaysia which is achieving positive signals from islamic advisors (aljazeera, 2018). manuel ho (chief marketing officer of hellogold) stated that hellogold is islamic as the transactions incurred within distinct period which make them less volatile and uncertainty of pricing (aljazeera, 2018). uae has initially experimented halal chain coin which is linked date with permissible goods (aljazeera, 2018). dr. mohd daud bakar pinned the trouble of understanding the concept and nature of cryptocurrency by regulators , similarity, harris irfan (md, cordoba capital in london) mentioned that islamic law scholars find difficulties to understand the complexities of cryptocurrency (aljazeera, 2018). therefore, farrukh habib (research officer isra, malaysia) recommended shariah rulings to deal with one specific cryptocurrency or include all types ignoring their eccentricities as there are hundreds of cryptocurrencies created with different features linked to distribution, mining and trading (aljazeera, 2018). moreover, muslim consumers are prone to accept electronic banking and financial products in recent times (echchabi, 2018). thus, financial technology has become an important tool for conventional finance whereby islamic finance is still under early platform (biancone et al., 2019). not to mention, bello lawal danbatta (secretary general, ifsb, malaysia) stated that islamic cryptocurrency will start to work if only regulators understand how fintech works. he also stressed out the lacking of capable regulators, scholars and standard settings bodies those can oversee the potentiality and understand the islamic finance ecosystem (whitehead, 2019). subsequently, the saudi arabian and uae central banks warned their citizens over the risk of cryptocurrency trading but they did not ban it (aljazeera, 2018). similarly many government bodies are worried and concern over the instability but they are seeking for benefits from this new technology innovation. in this scenario, it is cleared that there is huge potential for developing cryptocurrency as islamic cryptocurrency through shariah compliant mechanism. ziyaad mahomed (hsbc amanah, malaysia) suggested to find out the ways to make cryptocurrency islamic rather than debate on its permissibility (aljazeera, 2018). subsequently, abdul qahir qamar (director, the fatwa department, fiqh academy) stated that academy did not issue any resolution on cryptocurrency but aim to discuss on it in official sessions (aljazeera, 2018). hence, malaysia has started to develop islamic backed block chain currency and it will be introduced once the acceptance of digital currency widely spread out (whitehead, 2019). therefore, it will be benefitted for muslim regulators, scholars and policy makers to develop and adopt the dynamism and mechanism of financial technology towards islamic finance with proper and permissible concept before forced to by the community demand. ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 vii. conclusion and recommendations islam is complete way of life whereas it describes all perspectives and guidelines for human life in this world based on holy scriptures. therefore, muslim practice and live according to islamic teachings and law of shariah that adopted from al-quran, hadith and islamic jurists. thus, a muslim definitely looks for reasonable argument whereas islamic teachings conclude the endeavours as permissible (javed, 2018). so, any type of investment of application and adoption of financial mechanisms definitely required to be compliant with shariah. therefore, islamic cryptocurrency is the demand of modern technology based transaction and trend of ease and cost consuming approach. in addition, muslim entrepreneurs have profound duty on delivering islamic prudence which will portrait a good image, so that other nonmuslims can follow. literature review recommends us to develop and enhance the framework architecture for the crypto currency instead of traditional fiat currency. islamic shariah compliant crypto currency can be feasible if and only if it is able to provide solutions to overcome the current vulnerabilities of crypto currencies related to value creation and regulatory system. gold-backed crypto currencies and payment systems with netting facilities and public regulatory systems are the best form of money for this age. the store of value function of money is a litmus test as to the validity of a monetary economics and in terms of the maqasid al-shari’ah, the protection of wealth (hafiz al-mal). islamic crypto currency can stands for globalization and can be a revolution in economic history if it is developed optimally with the store of value function with islamic shari-ah principles. in fact, many people are benefitted through digital mechanism of currency, therefore, a governing body should step as intermediary as guarantor and provide indemnities despite complexities (arsov, 2017; naqvi, shafique, & khan, 2019). islamic finance and banking, institutions, central banks should promote shariah-backed cryptocurrency along with entrepreneurial start-ups and also individual muslim government should introduce a halal coin. references [1] abdullah, a. 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(2019). shariah compliant model of currency management – expanding landscape of islamic finance from micro to macro level. european journal of islamic finance, 12, 1–14. [27] oziev, g., & yandiev, m. (2018). cryptocurrency from shari’ah perspective. ssrn, 1–18. https://doi.org/10.2139/ssrn.3101981 [28] peters, g. w., chapelle, a., & panayi, e. (2016). opening discussion on banking sector risk exposures and vulnerabilities from virtual currencies: an operational risk perspective. journal of banking regulation, 17(4), 239–272. https://doi.org/10.1057/jbr.2015.10 [29] pikri, e. (2018). is cryptocurrency haram? the chairmain of bnm’s shariah advisory council says no. retrieved september 16, 2019, from https://vulcanpost.com/632153/haram-cryptocurrencysyariah-advisory-council/ [30] seele, p. (2018). let us not forget : crypto means secret . cryptocurrencies as enabler of unethical and illegal business and the question of regulation. humanist manag j, 13, 1–7. [31] siegfried, n. a. (2001). concepts of paper money in islamic legal thought. arab law quarterly, 16(4), 319–332. [32] whitehead, r. (2019). malaysia’s leading shariah scholars support halal cryptocurrency but say islamic finance ecosystem needs to catch up. retrieved september 16, 2019, from https://www.salaamgateway.com/en/story/malaysias_le ading_shariah_scholars_support_halal_cryptocurrency_ but_say_islamic_finance_ecosystem_needs_to_catch_u p-salaam08052019011545/ [33] zubaidi, i. b., & abdullah, a. (2017). developing a digital currency from an islamic perspective: case of blockchain technology. international business research, 10(11), 79. https://doi.org/10.5539/ibr.v10n11p79 ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4389 1 applying risk-sharing to mitigate economic consequences of the covid-19 pandemic abstract—the covid-19 pandemic is expected to have a severe socio-economic impact with significant losses of gdp and high unemployment rates. as a result, governments worldwide are attempting to mitigate these impacts through government intervention. one major method of alleviating the socio-economic impact has been to reschedule or defer loan and mortgage payments to ease the burden off borrowers and mitigate a massive wave of defaults. in other words, the governments are attempting to impose a degree of risk-sharing in the economy. this paper debates the advantages of risk-sharing practices in the financial system in times of economic crisis, and argue that this should instead become the norm in the financial system and not only in times of economic downturns or pandemics. this paper further highlights that, although the principle of risksharing is enshrined in islamic finance, many islamic loans and mortgages do not reflect risk-sharing in practice. instead, only a few genuine examples exist that actually do apply risk-sharing. these examples should be taken as best-practice models substituting the pervasive risk-transfer model that in times of crisis burdens the borrower in specific, and the entire society through government interference in general. keywordsprofit-sharing, risk-sharing, covid-19, government interference, public aid i. introduction the covid-19 pandemic had affected over 150 countries by the end of march 2020 with many countries initiating stayat-home measures (lockdowns) and curfews as well as closing down most aspects of public life [1]& [2]. the effects of covid-19 are expected to have far-reaching effects, first and foremost in the loss of lives occurred and expected. as a second effect 1 , the socio-economic impact is expected to be severe, with losses of up to 2.4% of global gdp expected in 2020 [3]. this has prompted many countries to intervene economically in an attempt to mitigate the worst socioeconomic effects of this crisis. for example, the european parliament has issued a “corona response investment initiative” ensuring funds “will go to healthcare systems, small 1 although i count it as “second”, one must clearly state that loss of human lives cannot be comparable to any socio-economic damages on any humane scale. and medium-sized firms, labour markets and other vulnerable parts of eu countries’ economies” [4] & [5]. similarly, the united states senate has passed the “coronavirus aid, relief, and economic security act” promising $2.2 trillion, with almost half ($1.17 trillion usd) earmarked for businesses in the form of loans or tax cuts, while funding for hospitals and healthcare was budgeted at $180 billion [6].other countries followed suit such as turkey with a $15.4 billion plan [19] and japan followed in the first week of april, with a stimulus package surpassing 20% of japanese gdp [18]. it is expected that by the end of the crisis, many countries will enact similar measures. these public measures to address the socio-economic impact highlight an important drawback of our current economic and financial system: our financial contracts lack any and all aspects of risk-sharing. it is therefore the objective of this paper to debate the drawbacks of the lack of risksharing, and show the merits of risk-sharing in the context of the current crisis, i.e., how risk-sharing could have helped mitigate much of the negative socio-economic impacts of this crisis. most importantly, risk-sharing would have allowed governments to play a much less intervening role in the economic sphere. this paper does not claim to dictate the extent of the role governments should play, but only argues that the required monetary aid would have been lower if risksharing was more prominent.the methodology of this paper is qualitative in nature and deals with the issue in an exploratory fashion. the problem is tackled by debating the advantages and disadvantages of risk-sharing in theory and practice. the main contribution of this paper is to connect the recently growing literature on risk-sharing during covid-19 with the principle of risk-sharing in islamic finance which seems to have been lost amongst the newest literature on the matter. as will be shown briefly below, a number of recent studies on contributions on the issue from well-known entities are struggling with the idea of risk-sharing and trying to identify its problems, although this has all been extensively researched in islamic finance over the years. ahmed mohamed badreldin submitted april 2020, revised december 2020, accepted december 2020 ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4389 2 ii. the principle of risk sharing in the second policy brief of the economics for inclusive prosperity series, anatadmati rightly begins her essay with the sentence “a healthy and stable financial system enables efficient resource allocation and risk sharing” [7], and in another article by the author the idea of risk-sharing as an alternative to debt was discussed in more details [8]. however, it is still worth mentioning what is meant by this principle: fundamentally, risk sharing means that the fates of both the borrower and lender should be tied together. borrower and lender should gain income only in positive economic situations, and both share the risk in adverse economic situations. risk-sharing of this nature reflects the essence of fairness and shariah-compliance in respect to financial dealings and ensures that no party is taken advantage of due to their financial position in the contract. in this sense, mortgages and loans would be tied to the income/earnings of the borrower, and if it would so happen that the borrower loses all sources of income due to an external factor, such as a worldwide pandemic, the lender would be in no position to demand any payments since they are both in a risk-sharing contract. similarly, one must remember that public financing operates in a similar way in almost all tax codes: the government will not collect taxes from firms and companies affected by the shutdown to the extent that they make no profits. this is not a new behavior conditional on the current crisis, but is simply how taxation works. if the taxpayer loses their source of income, they are no longer required to pay taxes. this stands in stark contrast to a conventional interestbased personal loan where the bank requires interest payments during both positive and adverse economic situations equally, thereby isolating the bank from sharing in the risks of the borrower (unless the borrower defaults completely). therefore, the conventional interest-based system is based on risktransfer, where the bank transfers the entire risk of repayment to the customer, and can sit back and expect its legal right to receive interest regardless of external economic conditions. iii. examples of genuine risk-sharing in practice how would such a contract look like in practice? one can find a very small number of companies that actually apply these ideas. a. risk-sharing employment some restaurants that do not offer wages, but instead offer a form of profit-sharing compensation. if the restaurant faces an economic downturn (or a pandemic occurs), the employer would not be required to decide between laying off employees, or paying them their full-wage. instead, the employer is only required to share in profits that are received – if any exist. in a case study of one of these restaurants, it was found that this system enhances productivity and motivation of the employees without overburdening the employer (see [9]). b. risk-sharing student loans a number of student loan organizations, often supported by governments, apply the risk-sharing principle by providing college students with funding, in return for a portion of the students’ income upon full-time employment. in this sense, once again, the student is not required to make payments if they are currently unemployed, thus removing a major source of burden if economic downturns occur (for example see [10]). c. risk-sharing personal loans some private companies or investors provide financing to individuals in return for a set portion of their future incomes. as a result, no payments are required if the borrower is laid off due to an economic downturn (or an ongoing pandemic). on the other hand, higher payments are due if the borrower is promoted during the term of the contract (for example [11]). iv. risk-sharing during the covid-19 pandemic though these examples are currently the exception rather than the rule, one can see the advantages of such a system, which ensures fairness by not imposing undue burdens on borrowers. the latest policies conducted by the united states show how necessary risk-sharing is to alleviating the economic effects of the covid-19 pandemic: the coronavirus aid, relief and economic security act forces banks to share the risk of their borrowers by allowing forbearance of up to 60 days, extendable for four 30-day periods for anyone with a federally backed mortgage loan facing financial hardship during the crisis. no fees, penalties or additional interest are charged for the delays. in other words, payments are simply deferred to a later time when economic conditions are kinder to the borrower. the act also instructs that student loan payments be suspended without penalty or accruing interest through september 30th, and provides loans to mid-sized businesses while requiring no payments during the first six months after loan issuance [12] & [13]. similar measures have also been taken by the italian government, which is allowing selfemployed and freelancers with mortgages to suspend their payments for up to 18 months if they can prove a reduction in income by at least one-third. this will also be applied to commercial rents of business that have been forced to close down [14]. the japanese and turkish governments are reported to have instructed banks and insurance companies to defer payments and dues for 3-6 months [18] & [19]. risk-sharing is also becoming relevant on an international scale, with eu countries suggesting different ways to share risk, whether medical risks, or default risks on their sovereign debt [22]. in a recently published article, ainsworth & mckenzie highlight uses of risk-sharing in higher education in the united kingdom, giving examples of “equity” based funding programs that have been encouraged or actually used and their benefits during the covid-19 crisis [21]. in an article for allianz global investors, it is stated that short-term lending as conducted by banks is witnessing a drop due to covid-19 and as an alternative “partnering for longejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4389 3 term growth” must be encouraged especially for funding of smes. they further state that “partnerships that divide up the risk-return rewards” are required [20]. it is however worth mentioning that this article was published in july 2020, while the ideas of risk-sharing have been suggested long before these observations during covid-19 were made (see examples for risk-sharing in social financing [23], examples in crowdfunding [24]. not only is this idea being considered and put into practice by government entities, but also private mortgage providers are considering plans to suspend mortgage payments during the pandemic, however long it may last [15] & [16]. on a global level, the imf explicitly encourages loan modifications to allow for payment rescheduling, mentioning clearly that these measures are not only meant to benefit borrowers, but even lenders will gain by avoiding high default rates which could lead to a major crisis such was witnessed in 2008 [17]. it is important to mention that the current risk-transfer business model of banks does have advantages as well: it offers plannability and the enticing idea of always receiving a profit regardless what is happening in the economy, i.e., banks are contractually owed their interest payments and could in theory sue for their rights and foreclose people’s homes for defaulting on their mortgages. however, the 2008 financial crisis and the current pandemic both highlight the magnitude of the advantages of the risk-sharing system over the advantages of the risk-transfer system, namely the ability to avoid defaults even if that comes at the cost of reduced plannability and a non-constant payment stream. one should remember that the financial system deals in reduced plannability and non-constant payment streams on a regular basis anyway, namely in equity investments. not only are the advantages of risk-sharing economic, but also for society [8]. v. critique of islamic loans and mortgages on a side note, it is important to mention that the principle of risk-sharing is the key to achieve these improvements, and not simply islamic financial contracts since these do not always include elements of risk-sharing [27]. for example, some islamic mortgage contracts conducted through financing lease (ijarah muntahia bittamlik), installment purchase with markup (murabahah), or even diminishing partnership (diminishing musharakah) do not ensure the fairness of a risksharing structure. these contracts demand stable equal payments along the lifetime of the contract and do not – in their contractual form – allow for payment rescheduling or suspension during times of crisis for the borrower. in other words, these contracts in their current form are just as harmful to the economy during times of crisis as conventional loans and mortgages in terms of the overall burden to the borrower, which can eventually lead to massive defaults. as one study out of pakistan shows, islamic bank managers worry about regulatory issues in terms of overexposure to equity and tend to minimize such contracts as much as possible [26]. a relevant critique, even though not entirely addressed at islamic loans, is mentioned in the article on risk-sharing in higher education in the uk, ainsworth & mckenzie highlight that a degree of moral hazard exists within risk-sharing products which must be regulated and considered in the product design [21]. this is also supported by a recent imf working paper [22] as well as recent publications within the islamic finance literature [25]. vi. conclusion the aim of this paper is to highlight the advantages of risksharing practices in the financial system in times of economic crisis. although the economic measures taken by governments worldwide to lessen the economic burden of the crisis are indeed an aspect of risk-sharing, they are meant to only be temporary. i argue that this should instead become the norm to alleviate socio-economic consequences, not only of the current pandemic, but during any economic downturn which could overburden borrowers causing massive defaults which may force government interference. one must always remember that government intervention is, in its essence, sharing of risk among all taxpayers. this paper further highlights that, although the principle of risk-sharing is enshrined in islamic finance, many islamic loans and mortgages do not reflect risk-sharing in practice. instead, only a few genuine examples exist that actually do apply risk-sharing. these examples should be taken as bestpractice models substituting the pervasive risk-transfer model that in times of crisis only burdens the borrower in specific, or the entire society through government interference in general. references [1] european centre for diease prevention and contorl (ecdc), “coronavirus disease 2019 (covid-19) pandemic. rapid risk assessment – seventh update”, https://www.ecdc.europa.eu/sites/default/files/documents/rra-seventhupdate-outbreak-of-coronavirus-disease-covid-19.pdf, 2020. 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[14] the local, “coronavirus: the financial help available in italy and how to claim it”. https://www.thelocal.it/20200318/coronavirus-the-financialhelp-available-in-italy-and-how-to-apply, 2020. [15] e. flitter, m. goldstein, “mortgage lenders consider plan to suspend payments amid crisis.” new york times, https://nyti.ms/2wxonwb, 2020. [16] c. thorbecke, l. winn, v. ordonez, s. wash, “coronavirus crisis has people struggling to pay bills: here's what you can do.” abc news. https://abcnews.go.com/health/coronavirus-crisis-people-strugglingpay-bills/story?id=69915123, 2020. [17] t. adrian, a. narain. “maintaining banking system safety amid the covid-19 crisis.” imf blog, https://blogs.imf.org/2020/03/31/maintaining-banking-system-safetyamid-the-covid-19-crisis/, 2020. [18] the japan times, “abe unveils 'massive' coronavirus stimulus worth 20% of gdp”. https://www.japantimes.co.jp/news/2020/04/06/business/shinzo-abejapan-massive-coronavirus-stimulus/, 2020. 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[20] d. zurkow, “how will private debt be changed by covid-19?”. allianz global investors, https://www.allianzgi.com/en/home/insights/investment-themes-andstrategy/private-lending-post-covid-19 [21] p. ainsworth, t. mckenzie. „on the benefits of risk-sharing for postcovid higher education in the united kingdom”. economic affairs, vol. 40, no. 3, https://doi.org/10.1111/ecaf.12433 [22] n. batini, f. lamperti, a. roventini. “reducing risk while sharing it: a fiscal recipe for the eu at the time of covid-19”. imf working paper 20/181 https://www.imf.org/en/publications/wp/issues/2020/09/04/reducingrisk-while-sharing-it-a-fiscal-recipe-for-the-eu-at-the-time-ofcovid-19-49614 [23] p. biancone, m. radwan. “social finance and unconventional financing alternatives: an overview” european journal of islamic finance, no. 10 (2018) https://doi.org/10.13135/2421-2172/2818 [24] p. biancone, s. secinaro, m. kamal. “crowdfunding and fintech: business model sharia compliant”. european journal of islamic finance, no. 12 (2019) https://doi.org/10.13135/2421-2172/3260 [25] s. zafar, d. siddiqui. “impact of asymmetric information in islamic financial contract: an empirical analysis. european journal of islamic finance, no. 14 (2019) https://doi.org/10.13135/2421-2172/3301 [26] k. javaria, o. masood. “why islamic banks are not competitive in islamic country: an empirical evidence from pakistan islamic banking sector” european journal of islamic finance, no. 15 (2020) https://doi.org/10.13135/2421-2172/4433 [27] m. chowdhury, m. al masud, m. atiullah, j. tanvir. “contemporary responses to the critisicm of islamic banks in malaysia. european journal of islamic finance, no. 15 (2020) https://doi.org/10.13135/2421-2172/4307 https://islamicmarkets.com/articles/a-way-out-of-debt-reliance-accepting-risk-in-our https://islamicmarkets.com/articles/a-way-out-of-debt-reliance-accepting-risk-in-our https://www.betterfutureforward.org/products https://fundmebff.com/ https://edition.cnn.com/2020/03/25/politics/stimulus-package-details-coronavirus/index.html https://edition.cnn.com/2020/03/25/politics/stimulus-package-details-coronavirus/index.html https://www.hud.gov/press/press_releases_media_advisories/hud_no_20_042 https://www.hud.gov/press/press_releases_media_advisories/hud_no_20_042 https://www.thelocal.it/20200318/coronavirus-the-financial-help-available-in-italy-and-how-to-apply https://www.thelocal.it/20200318/coronavirus-the-financial-help-available-in-italy-and-how-to-apply https://nyti.ms/2wxonwb https://abcnews.go.com/health/coronavirus-crisis-people-struggling-pay-bills/story?id=69915123 https://abcnews.go.com/health/coronavirus-crisis-people-struggling-pay-bills/story?id=69915123 https://blogs.imf.org/2020/03/31/maintaining-banking-system-safety-amid-the-covid-19-crisis/ https://blogs.imf.org/2020/03/31/maintaining-banking-system-safety-amid-the-covid-19-crisis/ https://www.japantimes.co.jp/news/2020/04/06/business/shinzo-abe-japan-massive-coronavirus-stimulus/ https://www.japantimes.co.jp/news/2020/04/06/business/shinzo-abe-japan-massive-coronavirus-stimulus/ https://www.bloomberg.com/news/articles/2020-03-18/turkey-announces-15-4-billion-plan-to-counter-virus-outbreak https://www.bloomberg.com/news/articles/2020-03-18/turkey-announces-15-4-billion-plan-to-counter-virus-outbreak https://www.allianzgi.com/en/home/insights/investment-themes-and-strategy/private-lending-post-covid-19 https://www.allianzgi.com/en/home/insights/investment-themes-and-strategy/private-lending-post-covid-19 https://doi.org/10.1111/ecaf.12433 https://www.imf.org/en/publications/wp/issues/2020/09/04/reducing-risk-while-sharing-it-a-fiscal-recipe-for-the-eu-at-the-time-of-covid-19-49614 https://www.imf.org/en/publications/wp/issues/2020/09/04/reducing-risk-while-sharing-it-a-fiscal-recipe-for-the-eu-at-the-time-of-covid-19-49614 https://www.imf.org/en/publications/wp/issues/2020/09/04/reducing-risk-while-sharing-it-a-fiscal-recipe-for-the-eu-at-the-time-of-covid-19-49614 https://doi.org/10.13135/2421-2172/2818 https://doi.org/10.13135/2421-2172/3260 https://doi.org/10.13135/2421-2172/3301 https://doi.org/10.13135/2421-2172/4433 https://doi.org/10.13135/2421-2172/4307 ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4389 5 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 islamic finance ethics and financial perception of consumers dr samir alamad aston business school, al rayan bank uk abstract-this paper investigates consumers’ perceptions of islamic finance (if) in non-muslim majority markets. building on research was done previously and data from an original survey, the paper carries out a principal descriptive analysis (pda) to construct the main dimensions on which financial consumer agents diverge. five key components emerged from the pda that is interpreted with the help of a survey covering different types of consumers. furthermore, it explores the perceived association of islamic financial values with ethical norms in the west. the findings help us understand how if has been conceptualized by consumers in non-muslim majority markets. the five components identified shed light on the constructs that have informed the growth of if as an ethical option in international non-muslim majority markets. this advocates the view that if should be characterized by multidimensional drivers in the global financial market, rather than a single component of religious values. keywords-component; islamic finance; ethics; social values; principal descriptive component analysis; consumer agents i. introduction since the global financial crisis of 2008, interest in the islamic banking and its financial principles has sharply increased. after the near-collapse of the world financial system and the bankruptcies and government bailouts of several long established financial institutions in the western financial markets (see e.g. plosser, 2009; poole, 2011) the growth rate of if has increased steadily even in western financial markets. the global market for islamic financial services, as measured by shariah-compliant assets, increased by 12% in 2014 to a record $2 trillion. global assets of islamic finance have tripled since the start of the economic slowdown in 2008. the cityuk (2015) expects the market to top $3.0 trillion by 2018. recent key trends in the industry include landmark debut sukuk issuances by governments and the expansion of islamic finance into more countries. it is hence apparent that not only conventional banks, but also local regulators and international financial entities have started to show an interest in stepping into this growing industry. however, despite the increasing involvement of non-muslim financial agents, conventional markets seem to harbour divergent and sometimes even opposing conceptualisations of what shariah compliance represents (fang and foucart, 2013). non-muslim agents’ appraisals of if, and hence their strategies toward this emergent market segment, range from marketing differentiation (see e.g., perry and rehman, 2011 or rethel, 2011) to providing ethically conscious alternatives (e.g., rice, 1999 or naughton and naughton, 2000). the purpose of this paper is therefore to identify, based on an original survey of western financial agents, the essence and role attributed to this new financial approach in non-muslim markets. in addition, to confirm the increasing association of islamic financial values with ethical practices in the west, the findings also provide information as to how the observed growth of the if industry in the past decade has been explained by conventional consumer agents. based on principal descriptive analysis (pda), a variance-based perception, altitudinal and behavioural procedure, the paper identifies and discusses the main aspects on which if values are conceptualized from the perspective of muslim and nonmuslim financial consumer agents. it focuses on five principal aspects. the main aspect, ‘‘islamic finance ethics’’ relates to the recognition of if as an ethical alternative to conventional finance. the second aspect, http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ‘‘endurance and appeal of islamic finance,’’ relates to whether if can be successful and would appeal to muslim and non-muslim consumers alike as a strong relationship building system without converging toward conventional finance. the third, ‘‘dynamic organizational structure’’ accounts for financial agents’ appraisals of the incorporation of ethical concerns as a dynamic organizational structure embedded in the financial market. the fourth, ‘‘inclusivity’’ accounts for the idea that if can only survive in financial markets with muslim co nsu mer s because it corresponds to the specific preferences of muslim market agents. the fifth, ‘‘dependability and security’’ accounts for the possibility that consumer agents of if are simply committed to the ethical components as a basis for their perception of it being dependable or they are driven by pricing rather than loyalty. this contribution presents itself directly into the current debate on if in the global financial market. indeed, as pointed out by various authors contributing from different fields of the social sciences, published work on the islamic finance remains to a large extent polarized between proponents and skeptics (alamad, 2016; perry and rehman, 2011; warde, 2000, 2010), which makes it difficult to hold a ‘‘nuanced or empirically grounded understanding of if (warde, 2010, p. 9); see also maurer, 2005; pollard and samers, 2007). on one side of the spectrum there are contributions that advocate shariah-compliant finance as desirable and are mainly geared toward discussing the implementation of its moral-religious precepts in the modern economy at various levels (see, for instance, lewis and algaoud, 2001; ayub, 2007; azarian, 2011; abdullah and chee, 2010; aziz, 2010). with the advent of recent scandals in the financial markets, this trend became even more obvious as the socially conscious aspect of if was increasingly shining as a desirable normative basis for cultural change in the global financial system (see, for instance, jensen, 2008; ahmad, 2008; aydin, 2009; nienhaus, 2011). at the other end of the spectrum, if is examined and usuall y co mp ar ed with the heuristic tools of ‘‘conventional’’ finance and classical economic theory (metwally, 1997; koyama, 2009; beck et al., 2010; hayat and kraeussl, 2011). however, the religious and normative nature of islamic economic thought and philosophy does not fit well with traditional classical economic assumptions, which are often argued to dismiss ethical concerns and religious beliefs (kolb, 2010; boatright, 2010). as a result, studies that examine whether and how if fits into the global financial system are often criticized for prematurely discarding the viability and social desirability of alternative financial instruments based on islam (warde, 2010). from a practical perspective, this polarization has not kept the field from growing nor conventional agents from getting involved in islamic financial transactions in international markets. a key question that remains unanswered by the current academic debate, in understanding how these two seemingly opposed models to understanding the nature of islamic banking have influenced global economic agents’ assessments of this financial ‘‘alternative model’’ as a part of the global financial system. the findings of this paper then also build on and provide grounds for a principal descriptive analysis (pda) to characterise the main dimensions on which financial agents diverge and a longitudinal comparison with surveys conducted on islamic banking among american and european bankers in the late 1990s (maniam et al., 2000; warde, 1997) and recently in 2012 (fang and foucart, 2013). the paper is structured as follows: ‘‘theoretical framework’’ section briefly defines a microeconomic specification of agents’ valuations of financial products, and ethical and religious concerns, which set the background for the interpretation of the results. the research design is presented as well as some descriptive statistics in ‘‘sample and data’’ section. ‘‘methodology’’ section tha t analyses the results of the pda, matching the findings with the microeconomic specification. ‘‘discussion’’ section then concludes with a discussion of the simultaneity of the aspects identified. ii. theoretical framework this section sets the foundations of the conventional market participant’s assessment of islamic financial products. the purpose of the http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 initial step is to advance a simple model that helps to conceptualize the assumptions based on which non-muslim consumer agents assess taking up these alternative financial products. in this regard, a central question they need to answer is as follows: what types of customers are expected to buy shariah compliant products and for what reasons? the answer thereby derived will then be used as a point of reference in the interpretation of the results in the methodology section. it is assumed that potential customers for shariah-compliant products and services can be categorized into two types. the first one is based on religious beliefs and separates muslim from nonmuslim customers. the second one, on the other hand, is normative in nature and identifies customers that derive satisfaction out of subscribing to socially responsible and ethical products. these two types hence delimit four polar types of customers; (1) muslims consumers who are customers of if; (2) muslims consumers who are not customers of if; (3) non-muslims consumers who are customers of if; (4) non-muslims consumers who are not customers of if. it is assumed that the perception derived by a potential customer from a financial product is contingent upon (1) the pricing, and (2) the type of product. a financial product can either be shariah compliant ethical or conventional. this notation does not imply that, from the perspective of the customer, a sharia-compliant product is perceived non-ethical (and vice versa). given these assumptions, potential customers for islamic financial products are understood to derive varying levels of perceptions from specific financial options, which in turn inform their decision to demand certain types of financial products rather than others. in this context, there exist two types of outside options besides islamic financial products for consumers. the first and most obvious alternative is to rely on the conventional banking market. the second option corresponds to financial products, which means investing in non-islamic ethical assets. for the sake of simplicity, it is assumed that the driver of choice is identical for all consumer agents (fang and foucart, 2013). the first condition, ‘‘religious constraint’’ (rc), relates to whether the islamic option provides a better pricing than the conventional financial option. the second condition, ‘‘incentive compatibility’’ (ic), relates to whether the islamic option provides a higher return than the alternative, non-islamic ethical one and whether the rc condition would play a determining role for muslim consumers and similarly whether the ethical aspect plays a determining role for non-muslim agents. from the perspective of conventional financial institutions, thus, the main driving force behind their involvement in this emerging market segment resides in whether such a product will be selected by some consumers, and if so by which ones, and for what reasons. this refers to the traditional incentive model in microeconomic theory, which traces back to hurwicz (1972). it suggests that the decision of an economic agent to take a specified action is understood to be contingent upon two concurrent conditions. first, in order for an agent to take action to switch from conventional to alternative financial solutions, the new option must make him better off than in the initial instance. second, the new option adopted must be better than any other available options. in order to inform their decision to take up the islamic financial product, non-muslim consumers or investors must make assumptions on the following points:  what are the respective values in relation to pricing or return?  are if products considered an ethical product by non-muslims participants and would that be sufficient for making that decision?  do some consumers care about the level of ethical dimension in a financial product to opt for an if product? these assumptions will be reassessed when we interpret the results of the pda, and will offer specifications compatible with all aspects. http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 iii. research design a. sample and data since this inquiry focuses on the encounter between conventional and islamic financial knowledge at the consumer agent level, it was necessary to delimit a sample population that would provide information related to this conceptual encounter. thus, the target sample here focuses on consumer agents who are muslims, non-muslims, customers and non-customers of islamic banks in western non-muslim markets. the common denominator of interest is their exposure to if knowledge and shariah-compliant products. the survey took place among 500 participants, customers and noncustomers of islamic banks, affluent and non-affluent respondents and muslim and non-muslim respondents. the actual interview obtained was weighted to be in line with the original targets as shown in table i. table i. breakdown of the target sample table i shows that 84 % of the respondents in the sample have knowledge or awareness of shariah compliant financial products and if. it is within this group that we expect the decision to accept or reject shariah compliant products based on projected market demand to have the most tangible impact on its development in the global economy. besides this religious and professional criterion, a geographical boundary is also applied to limit the group of respondents to independent of religious affiliation or cultural background of muslim majority countries. b. survey design concerning the survey method, it stood to reason that the most appropriate medium for data collection would be through a computer-assisted telephone survey (cats). as the survey was conducted on customers and non-customers of if, the actual obtained responses were weighted to be in line with the original sample target. this medium of data collection was important to measure the first spontaneous answer provided by respondents about their perceptions and views in relation to shariah compliant financial products and their ethical dimension (see, for example, alreck and settle, 2004; dillman, 2000; malhotra and peterson, 2001; schonlau et al., 2001; spaeth, 1977; malhotra, 2004; mcdaniel and gates, 2005). the strengths of the cats resides in the higher item completion rates and longer answers to open-ended questions than observed with other mediums such as mail and online surveys (ilieva et al., 2002). on another front, cats surveys give the researcher the ability to probe the respondent further in relation to key data, it to some extent also combines an aspect of interviews method that would provide more accuracy and validation of the responses, as the responses can be checked immediately with each respondent. i t also provides the privacy and anonymity (berry, 2004). it was felt that the respondents might, therefore, be more inclined to provide their personal views on the research topic, rather than giving answers expected either by the researcher or by their affiliated institution. due to the broad nature of the target population, the sampling method used to collect data was based on targeted sample via collaboration with an islamic bank in the uk in order to obtain an access to customers of islamic banks. ‘‘snowball’’ (or ‘‘chain referral’’) sampling was also considered (goodman, 1961; heckathorn, 1997). the benefit of this method for the present investigation resides in its ability to quickly build a sample representative of respondents number of interviews achieved weighted interviews analysed customer of if affluent muslims 105 100 non-affluent muslims 60 50 non-muslims 101 100 non-customer of if affluent muslims 71 100 non-affluent muslims 54 50 non-muslim professionals 109 100 total 500 500 http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 the consumer agents that make up the population of affluent/non-affluent, customers/non-customers and muslim/non-muslims participants. indeed, this ap pr o ach allows the researcher to access a larger focused number of the target population, rather than selecting random population by referral, who could impact the accuracy of the collected data. respondents took an active role in the sampling process, an additional control was applied when compiling the data set to ensure that all inputs collected did, in fact, emanate from the target population. the survey was divided into two distinct parts. the first section attempted to collect information on the respondents’ personal, educational and professional background, and to determine their awareness of if, the depth of their knowledge on the topic and the source of their appraisal of if. in addition to multiple choice questions, this section also included an open question that invited the respondents to express their spontaneous understanding of if and shariah-compliant financial products. in addition to providing room for them to elaborate on their opinions and give more personal and nuanced feedback, this vital question also allowed the researcher to verify, with a larger sample, the intuition obtained from the pilot study on which the research question was based. the second section of the survey was designed to provide the base variables for a pda procedure on the dataset. four key conceptual ideas formed the core of this section, dealing with the main ideas that made up each of the pilot respondents’ appraisals of if in the global economy. in other words, these conceptual ideas represented the basic building blocks of the individual feedback collected during the pilot interviews. respondents in the present survey were then presented with these statements in a random order and asked to rate them on a five-option likert scale ranging from ‘‘strongly agree’’ to ‘‘strongly disagree’’ (likert, 1932). the dataset thereby obtained was then converted into a statistical descriptive analysis. c. descriptive statistics at the end of the collection period, which spanned over 1 2 months, 500 responses had been collected in total. the typical respondent to this survey is a 30-40-year-old professional with a university’s degree, working in a professional sector. in more detail, the geographical reach of this survey is primarily based in the uk (90 %), followed by europe (10 %). the religious background of the respondents consists mainly of muslims (60 %), catholics/ christians (16 %), atheists (12 %), agnostics (6 %), hindu (1 %), other religions (2 %) and (3 %) did not wish to answer this question. regarding gender distribution, (62 %) of respondents were male and (38 %) were female. concerning the distribution in terms of professional fields, ‘‘other profession’’ represented (37 %) and manager, lecturer, it, engineer, accountant, medical sector and solicitor represented (63 %). contrasting with the findings of warde (1997), maniam et al. (2000) and fang and foucart (2013), we found a great awareness of if among conventional consumer agents. while, in the past, the lack of recognition of the existence of if was argued to have contributed to the negative perceptions of the industry, the current situation is markedly different, as only (11 %) of the respondents in our survey had never heard of the existence of this financial and economic alternative. out of those who were aware of if (56 %) showed spontaneous awareness and (44 %) showed top of mind awareness, had at least a ‘‘good’’ knowledge of its main tenets, while the remainder stated that they possessed a ‘‘rough’’ understanding of islamic finance, the latter were mainly from the non-muslim category. the depth (or ‘‘quality’’) of knowledge about if has also improved (see fig. 1). more than 95 % of the respondents were able to name at least one major defining characteristic of if or a financial institution that provides shariahcompliant products in their region. http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 the prohibition of interest and the prohibition of illicit activities were the most well-known attributes as the key ethical tenets of if, followed by profit and risk sharing based financial product as a distinctive characteristic, this is reflected in fig 1. opinions on the viability of alternative practices based on the shariah (see fig 1 ) were also found to be much higher than in previous findings (maniam et al., 2000; fang and foucart, 2013), with approximately 5% of our respondents have no awareness of if and are neutral towards it, albeit they may consider it as nonviable (as opposed to 60 % in 2000 and 20% in 2013). it is interesting to note that, in our survey, out of the 95% respondents who have awareness of if, 90% associated if with an ethical dimension, such as fair, transparent and equity based. the remaining 10% were able to identify it as it does not deal with interest payments in its operations; those were entirely non-muslim consumer agents. these findings not only reflect the respondents’ appraisal of the industry but also, and perhaps more importantly, suggest that the increased attention if has received recently may have inflated appraisals of the size of the if industry. in order to provide comparative grounds for warde (1997, 2000) and fang and foucart (2013) survey in which they summarise the main concepts associated with if in the late 1990s (i.e., ‘‘monolithic’’, ‘‘rigid’’, ‘‘anti-western’’, ‘‘incompatible with modern finance,’’ ‘‘archaic,’’ ‘‘oil money,’’ ‘‘bcci,’’ ‘‘terrorism,’’ and ‘‘arab’’), and in 2012 “viable” “non -viable” respectively, three open questions were included in this present survey to allow the respondents to express, freely and in their own words, their understanding of if. in addition to the obvious comparative purpose, these questions also served as a confirmatory tool for the conceptual questions that followed in the second section of the survey (which were designed based on a pilot study). the dominant answer in these open answer questions was the high frequency of occurrence of two main spontaneous first perception or idea: ‘‘no interest’’ and ‘‘social responsibility’’/‘‘ethics’’. compared to warde’s findings, it is immediately apparent that the attention of conventional agents is now focused on elements that are part of the actual definition of islamic finance, rather than pulling ideas related to cultural or political islam into the discussion. this is also in accordance with the findings of fang and foucart in relation to the integration of ‘‘ethics’’ as one of the defining concepts of if is revealed to be an important change that has taken place over the last fifteen years. however, in contrast to warde and fang and foucart’s findings, our findings measured the responses of consumers who are muslims and nonmuslims, also some of our respondents have a firsthand experience of taking up shariah compliant financial products and dealing with an islamic financial institution. if is now associated with a range of desirable practices in the global economy, in that sense table 2 shows what our respondents think when some secondary statements mentioned to figure 1. details of respondents’ knowledge and awareness about if http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 them about if and to what level they would agree with such statements. the statements are whether they agree that if or islamic banks is a fair provider of shariah compliant and ethical financial products, a dependable and secure, professional, dynamic, inspiring, pioneering and builder of enduring relationships with its customers. table ii. secondary perception of respondents about if table ii shows the percentage of all respondents, which gave a score of 4 or 5 for each image statement about islamic financial institutions. when the figures in the table are added together and divided, a ‘mean score’ of 41% is created. this figure i.e. the “mean score” is therefore used to represent the ‘image’ metric of if based on the collected responses. d. methodology beyond recording the increase in the awareness and knowledge of if among muslims and nonmuslims consumer agents in non-muslim markets over the past fifteen years, this paper also contributes by identifying the divergent and sometimes even opposing characteristics attributed to shariah-compliant financial practices. to do so a pda was applied on the conceptual questions about shariah compliance in finance. as a result of this process, we extract two key dimensions, which contribute toward explaining the complexity and diversity of the current awareness and perception of if. pda is a common mathematical procedure used in diverse fields to analyse data collected via survey in order to extract relevant information from ‘‘confusing datasets’’ (shlens, 2009, p. 1; see also joliffe, 2002; sas, 1998; dunteman, 1989). it relies on a simple, non-parametric method to reduce the dimensionality of the data by reorganizing it into a (smaller) number of uncorrelated variables, which we call here ‘principal descriptive component' while retaining as much as possible of the variation present in the original dataset. in other words, pda is a variable reduction procedure, aimed at identifying the most meaningful way to re-express the data in a meaningful descriptive manner into a lowerdimensional space. this process starts from the idea that redundancy within a group of variables causes some of them to be correlated to other ones as they are measuring the same constructs (sas, 1998). by identifying (obvious and hidden) patterns of correlation within the data, pda allows one to collapse a dataset into a lower number of variables that are linear combinations of the original ones. the underlying elements affecting the phenomenon under investigation thereby emerge from the data and can, therefore, be interpreted by the researcher based on (i) the original variables that contribute to them and (ii) their associated linear coefficients (dunteman, 1989; neil, 2012; fang and foucart, 2013). the five secondary components that were conceptually derived from the two key components are presented in fig 2. it is worth mentioning that an initial finding that needs to be emphasised relates to the high number of components retained following this analysis process. while a factor reduction of the initial data was applied the consumer agents’ constructs still seem to diverge on a large number of sub-questions within the data. figure 2. results of the principal descriptive analysis perception statements % agree a fair provider of sharia compliant and ethical financial products in line with their customers’ faith and/or values 51% a provider that builds strong, enduring relationships, fulfils its promises and delivers an excellent customer experience 38% a dynamic, inspiring and pioneering organization that offers unique products before other organizations 29% a professional provider, people would aspire to join, which delivers high-quality products and services 38% a dependable, secure provider of products and services, with a long term commitment 50% mean 41% http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 this is without doubts an interesting finding, especially when contrasted with the situation of relative homogeneity (on skepticism toward if) identified by maniam et al. (2000) and warde (1997, 2000) in the late 1990s. in this context, the cognitive change that has occurred in the past decade cannot be understood as an evolution from a skeptical to an if-friendly equilibrium. rather, the complexity of consumer agents’ constructs on if, put forward by the high dimensionality of the pda findings, suggests a case of interpretive divergence, in which multiple, concurrent, and overlapping understandings of if have emerged (fang and foucart, 2013). this divergence could be also due to expanding the sample to include muslim agents as well, which was not the case in the contrasted surveys. the five secondary components identified thus provide the main directions for us to understand how constructs on if have altered over the past fifteen years. indeed, assuming that the late 1990s was characterised by a situation of relatively low variance among individuals’ constructs, the identification of contentious factors in the current understanding of shariah-compliant finance allows us to spot the ideas around which islamic financial practices have been constructed. also, this provides insights on what would alter the behavioural driver towards interacting with if and its shariah-compliant products (fang and foucart, 2013). iv. discussion the output of the pda should be framed into contextual meanings by interpreting the five seco nd ar y dimensions with the assistance of the theoretical framework described in the theoretical framework section above. these components are: (a) if as a fair and ethical alternative, (b) builds strong enduring relationships, (c) dynamic and inspiring organizational structure, (d) inclusive, and (e) dependable and secure with long-term commitment to islamic ethical financial products and services. as pda generates dimensions that are statistically orthogonal, the components identified should be interpreted independently from one another. for example, bo th components a and e relate to ethics, cannot be placed in a causal relation but must be understood as describing two uncorrelated dimensions that account for distinct constitutive constructs in financial consumer agents’ cognitive appreciation of islamic financial practices. thus, co nsu mer agents, therefore, consider whether if can be equated to ethical finance (a), and at the same time, they reflect on the possibility of incorporating ethical considerations into market interactions, independently of how ethical they consider if to be. this exploratory method thus generates results that are significantly more complex and less restrictive than simple causal relations between variables (fang and foucart, 2013). a. component a: islamic finance fair and ethical the first component extracted from the data provides a key dimension on which financial consumer agents differ when confronted with the emergence of islamic financial practices in global markets. this is the question that explains the largest part of the variance in the original data collected. it is interesting to observe that the most important component resides in the increasingly ethical aspect of consumers’ understanding of shariah compliant practices, which are driven by islamic ethics. financial consumer agents have focused on the ‘‘moral filter’’ applied by islamic law in assessing whether or not potential customers would be willing to accept if as a positive influence on the current financial landscape. the extent to which if is deemed fair and ethical is thus, contingent upon the compatibility of the main tenets of islamic finance with the moral expectations of individual financial agents. with that regards, some non-muslim respondents may consider interest as a component that has nothing to do with ethics as it is a normative practice in the conventional financial market. if we consider the theoretical framework above, validating islamic finance ethics would suggest that if to be an ethical alternative implies that all ethically conscious unprompted agents are may be drawn to if when there is an additional driver for their decision, such as pricing. in other words, one does not need to be muslim to http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 consider if to be an ethical alternative as 51% of respondents were of that view. if shariah-compliant products were to be introduced to the general public, this would imply that there is an adequate awareness about it and such products can navigate through financial consumers agents with ethical orientation. however, for if to be successful in the conventional market, it should link this key component to some or combine it with the other four components. the rationale behind this main component must be understood on the basis of the encounter between islamic values and conventional financial knowledge. indeed, under islamic law, the ‘‘fairness’’ and ‘‘equity’’ of economic interactions are insured by a set of prohibitions and duties put in place to ban and promote certain types of behaviour and norms in the market. in islam the proper development of human life requires two things: (1) the resources needed to maintain life and fulfil the material needs of both the individual and society; (2) the individual’s knowledge of the ethical principles of individual and social behaviour to allow individual self-fulfilment on the one hand and the maintenance of social justice and tranquillity on the other for a fair financial system (elmelki and ben arab, 2009). this first dimension thus captures the variance in the idea that consumers derive at least a similar level of the factor of shariah-compliant products as they do from both ethical and conventional financial products, given their respective distributions of risk. to this end, islamic finance attempts to limit uncertainty, prohibit speculation and ‘‘illicit activities,’’ and encourage the giving of alms in the conducting of everyday economic interactions. perhaps more important is the need for balance between the demands of this world and the demands of the afterlife (askari et al., 2010). while the moral goals of if appear to have a common ground with mainstream conceptions of social justice, there remain several points of friction that lead financial consumer agents to construct opposing concepts on the ethical status of if. it is based on these points of conflict between the two bodies of knowledge that financial consumer agents place themselves on this first component, by either rejecting or recognizing this alternative representation as an accepted source of ethics in the economy (fang and foucart, 2013). the cardinal point of divergence in this key component is the clear understanding of ethics and what constitutes moral behaviour in financial transactions as this construct would vary according to the understanding of participants in the financial market and their religious background. when evaluating the various aspects of if and the views of the consumers we begin this assessment on the basis of the context of existing financial norms and practices in the traditional financial system. social justice as a principle in islam is embedded in all economic activities. islam emphasises equality among people regardless of their race, gender, faith, social class and wealth (abdul meneam, 1979: 54). islam is certainly clear in its objective of eradicating all forms and traces of inequity from society, injustice, exploitation and oppression. this objective should be observed with due consideration in the financial transactions to ensure financial practices and norms are established on emphasising social justice and avoiding any form of exploitation of any stakeholder, including the environment, in the financial cycle (chapra, 1992). as the shariah rules are comparatively more restrictive in the scope of financial activities than conventional finance, the consumer agents will consider if ethical if the new ‘‘moral filter’’ limits behaviours they perceive as unacceptable. nonmuslim consumer agents might not understand some of the prohibitions of if and would not be able to correlate this prohibition to ethical conduct. for instance, the prohibition on dealing with alcohol as a commodity or providing finance to a producer of alcoholic products is not a clear ethical practice for some consumer agents. this is because such practice is the norm in the western society. on the other hand, muslim agents would see the prohibition of alcohol as an ethical consideration, due to possible negative social outcomes resulting from http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 alcohol, and they see that islam has prohibited this practice for a good reason. therefore, the perception of the ethical dimension in if would vary based on where the consumer agent stands in the religious debate and rationalisation of certain prohibitions. this type of restriction in if contributes to the dissociation of if from what mainly consumer nonmuslim agents consider to be ethical. although, muslim consumer agents consider the closeness of if to the conventional finance as a form of questionable ethical and shariah compliance behaviour, but they would adhere to if from a religious perspective. b. component b: endurance the second component extracted from the pda is the second important for agents based on how they perceive possible loyalty to if. however, instead of focusing on what if is, it distinguishes financial consumer agents based on their understanding of the viability and potential of if as an independent ethical financial system, and whether they would stick with it or not. thus, in contrast to the previous component that focuses on delimiting the nature of shariah-compliant financial transactions, this second one captures diverging views on the enduring relationship that may affect the future of the islamic financial industry. at one end of this component, we find that muslim consumer agents would have a stronger attachment and longer endurance to if as they see it as it is their religious obligation to support if. however, this does not mean that they are all equally believe in it or satisfied with its practices and financial services. this view corresponds to the basic microeconomic theory about the skepticism of shariah-compliant finance identified in the late 1990s (maniam et al., 2000; warde, 2000; and most recently by fang and foucart, 2013). in this context, if is viewed as a random temporarily phenomenon that is not going to last or be a viable alternative in the financial market. this skeptic view acknowledges shariah-compliant financial products as a mimic re-engineered version of their conventional counterparts with an islamic label. this view on the prospect of if, however, cannot be associated with a specific direction for the evolution of if as a potential market alternative, but could, in fact, lead to different interpretations of the findings depending on how consumer financial agents vary on the other components (fang and foucart, 2013). in that context, the best example would be the pricing of financial products as a driver. if the cost of selling a shariah compliant financial product turns out to be higher than that of a conventional one, while its ethical side is not recognised and its cultural specificity is not valued by muslim consumers, then if is expected to simply slow down and shrink. however, if the cost of if is higher but the shariah compliance factor of the financial product is vital to sub-groups of the market (e.g., muslims consumer agents), then the convergence idea could potentially lead to a demand, which leads to growth in if. image and perception of what if represent and the ethical dimension of it would play a game-changing role in the viability of if as an alternative. therefore, in order to achieve that, if should not merely rely on its muslim agents, if should enforce its ethical image and improve understanding of its nature within the non-muslim consumer agents in the financial markets. c. component c: dynamic organisational structure the third component identified by the pda is the consumer financial agents’ view of the inclusion of ethical concerns in the if as a dynamic organisation. this third component provides further information that focuses on the need for additional moral/ethical standards in global finance. by linking this component to component a (islamic finance ethics) suggests the presence of additional cognitive combinations that provide further information on the integration of shariah-compliant financial activities as a dynamic institutional entity in financial markets into the mainstream through the ‘‘ethics’’ pathway. if emphasises the role of all stakeholders and the accountability of if as a dynamic organizational structure for the wider actors in society. if activities should be driven by concepts derived from religious rules. the benefit of the intended financial outcomes and possible harm that http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 11 this could result in for stakeholders in the process, is a key element of evaluation for such ethical orientation. the idea to take into account a stakeholder perspective becomes an alternative to shareholder value maximisation as the principal objective of if as an organizational structure (donaldson and preston, 1995; freeman, 1984; friedman and miles, 2002). this approach focuses on the claims of employees, customers, and community members in areas of corporate activity and the process of financial practices. this element is strongly considered in the processes of providing shariah-compliant products in if. another aspect that is considered is how to embed normative claims on the corporation as a responsible communal citizen. thus, enforcing the corporation's accountability and responsibilities as a member of society, which has strong links with enforced religious rules in if (matten and moon, 2008; george et al., 2012; foss et al., 2007). this becomes an alternative to the idea of unsustainable long-term consequences of choices that may be optimal for maximising short-term profitability by the conventional financial system (kramer and porter, 2006). this aspect, of considering the impact of the business activity on all stakeholders, is clearly emphasised in the economic thought of islam. this consideration of the wider impact aims at driving the activities of if that prioritise stakeholder interests and the wider benefit of society. a strong view in the traditional academic literature (see for e.g. plosser, 2009; duska, 2009 and jameson, 2009) suggests that many conventional financial products, as practiced currently, are the cause of financial fragility and instability as financial institutions aim to circumvent financial regulations through various financial practices. the question posed here is whether if as driven by ethical principle and islamic restrictions, could offer a more viable alternative. in offering a more ethically motivated approach to finance, it could provide the required financial stability and resilience due to its strict rules of adherence to prescribed religious framework for undertaking financial activities. this discussion outlines the evolution of the traditional narrow definition of ethics in finance into the broader one that has re-emerged in the last 15 years (kolb, 2010; boatright, 2010). in this sense, component c explains empirically the theoretical expansion of ethical concerns in the financial system by capturing the variance in the understanding among consumer financial agents on (i) the possibility and (ii) the necessity of including additional ethical considerations in the realm of finance. respondents in our sample are, thus, situated on this dimension based on how much they have departed from the initial understanding of the role of ethics in the financial domain. d. component d: inclusive component d provides further insights into the data collected and respondents’ attitudes in relation to if as it captures the emergence of two different, b u t arguably opposing, ideas through which islamic financial principles have been integrated into mainstream markets. two of the three variables contributing to this component correspond to ideas that, based on the fieldwork, can be understood to represent a ‘‘narrow’’ view on the classical economic aspect (fang and foucart, 2013). in that regard, respondents who are aware and familiar with if have conceptually agreed to the inclusivity of if as a system that would integrate the wider market. on the other hand, some non-muslim respondents who are not aware of if see the markets as efficient, self-regulating and value-free. interestingly, rather than co-varying with expected variables (mainly those focusing on the non-viability of if), these two were linked to the view that if could work in the global financial system provided that it remained exclusive to the muslim population, thereby creating a sub-economy in which the rules of market efficiency would only be amended so as to include the religious preferences of muslim market agents. this view sees if as a religious aspect related to muslims as any other aspect of their faith and has nothing to do with the wider financial market. there was also a view of those who are muslim http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 12 agents and consumers of if that advocates if as an ethical and more stable alternative, which would be a viable option to the troubled capitalism and the existing financial system. based on the identified views in component d, there are different rationales for the existence of a financial system based on the religious dimension. this view could be seen in light of the concept of cognitive dissonance (as suggested by fang and foucart, 2013, see also among others akerlof and dickens, 1982; hosseini 1997), in view of the inconsistency brought about by the increased offering of shariah-compliant financial products in global markets fifteen years ago and around the event of 09/11/2001 in the united states in a fuelled environment with scepticism about anything with an islamic label and its viability (as advanced by maniam et al., 2000; warde, 1997, 2000). the theory of cognitive dissonance suggests that economic agents, when encountered with conflicting ideas (most of the time between what they believe and what they observe), try to reduce the inconsistency in their values by either altering existing cognitions or adding new ones to create consistency (festinger, 1957). in this sense, the differing views as discussed in component d herein are conflicted by what each group of respondents believes and what they observed or experienced in relation to if. they might alter one or another i.e. their belief or their observation to provide more ground to what they advocate or feel strongly about as an answer. e. component e: dependable and secure component e was the fifth and last component to be identified by the pda and is consequently also the one with the widest interpretability among previous components. this component is highly influenced by the belief and observation provided by respondents to the key questions of the survey and their awareness in relation to if. for instance, respondents who feel strongly about if as a viable option with ethical dimension and those driven by religious requirements agree to its dependability as an alternative secure option for them. however, those who are not aware of if see it as possibly dependable and secure for muslim agents as a niche market within the conventional system. for some respondents labelling anything including financial products as ‘islamic’ means it is not for the mainstream market and designed for muslim agents only. this could be the reason for the rebranding exercise that some islamic banks did in the last two years (such as noor islamic bank in the uae that was rebranded to ‘noor bank’ and abu dhabi islamic bank in the uae that was rebranded itself to abu dhabi international bank) in a move to attract the mainstream consumer agents, who could be put off by the label ‘islamic’. f. multidimensionality and interpretive diversity as discussed earlier, an important characteristic of pda output is that components are not only orthogonal to one another, but they also describe coexisting and inter-related concepts (fang and foucart, 2013). this suggests that respondents place themselves on all of these dimensions simultaneously. the focus of these findings, therefore, does not reside in locating causal relations between variables, but rather aims to identify underlying factors. therefore, a simultaneous interpretation of the five components would provide more insight to the discussion as summarised in fig 3. figure 3. multidimensionality and interpretive diversity of the principal descriptive analysis http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 13 fig 3 sums up the diversity and complexity of the findings of this paper, the extracted components highlight the depth of awareness and attitudes in relation to the phenomenon and how respondents see it and act towards it. there seem to be points of contention in relation to points found in the discussion of each component due to a preconceptualised perception about if or any matter branded as ‘islamic' for those who are not aware of if or have not had any interaction with it. this survey unlike previous work identified provides a more comprehensive account on this subject as it explores the views and experiences of a wide spectrum of consumer agents in the market. the overall results show that there is, in general, a positive view about if and its potential growth as an option in the financial market. there is also a strong view that it incorporates ethical dimensions in its approach and is seen as fair and dynamic. some respondents do not see if as a mainstream option that stretches beyond the muslim agents in the market. should this phenomenon have been a straightforward and uncontroversial issue, the pda would have generated different results. in an extreme case of interpretive uniformity in the market, if all economic agents had access to the same awareness and market information and interpret such information, in the same way, this analysis would have been likely to generate a less significant result, since the variance in the data would have been reduced substantially. however, this was avoided by the unique composition of our sample that included muslims, nonmuslims, customers and non-customers of if, which provides a rich data and diverse variance in the dataset. while it would be difficult from a graphical and practical perspective to cover all of these interpretive constructs, it is useful to illustrate the dimensionality of the pda findings with a graph that covers the relation between all five components as depicted in fig 3. v. conclusion cross-border islamic financial transactions have increased in the past decade; islamic financial services have also grown beyond the muslim markets as financial regulators in the west started amending some financial regulations to enable a level-playing field for if in their conventional market. this paper sheds light on the diffusion of if in a non-islamic financial system and the attitudes of various consumer agents towards this trend. the findings of this inquiry are formed around three main areas. this inquiry is designed by contrasting surveys done over the last fifteen years with this one; this comparison suggests that both the level and depth of awareness of if in the western financial market have increased. the second interesting finding of this inquiry is the diverse collection of interpretations and views of if, which have contributed to its growth in the recent years. this has also increased the interest of financial regulators to make the rules flexible in order to accommodate this new financial trend, also academic institutions started offering courses that teach students if. furthermore, conventional financial institutions started offering some shariahcompliant financial products to attract western consumer agents who have an affiliation with if. the findings of this inquiry are based on the views and attitudes of diverse consumer agents in the west, who are affiliated with if in a way or another or none at all. it surveys consumer agents in the west who are muslims, nonmuslims, customers and non-customers of islamic banks to explore their diverse views and attitudes in relation to if, this is a key difference and an added value between this current survey and contrasted surveys that were done in the past fifteen years. the last point that this paper makes is the overlap between if and ‘ethics' or an expected common good as an outcome of if and its financial products. ethics as a dimension, however, is not the only driving force for the growth of if in past years, there are other forces, such as religious, cultural and behavioural. for muslim consumers agents in the west, if provides a sense of belonging and a religious attachment to satisfy their faith in a secular country. however, for non-muslim consumer agents, if is a more ethical form in contrast to a less morally-focused conventional financial system. this encourages moral acceptance of a system that is different and is associated with ethics, or at least have a neutral view about if despite the conception surrounding islam as a religion, due to practices and acts of deviated some muslim extremists. if has to understand the attitudinal dimension of the global market i.e. the non-muslim markets in order to achieve further growth and tap on that huge market. it has to present its distinctive characteristics and principles to show what makes it a potentially better alternative. in order to do that the shariah compliant aspect would not be effective, it has to draw on its ethical and social dimensions and the multidimensional components emerged in this paper as a mutual ground of understanding between its values and the values of consumer agents in non-muslim markets. this can be a subject for further research to be explored based on the identified dimensions in this paper and other possible new dimensions, the potential future growth, and expansion of if and what would influence that growth. http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif 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(2010). islamic finance in the global economy. edinburgh: edinburgh university press. http://www.ojs.unito.it/index.php/ejif http://support.sas.com/publishing/pubcat/chaps/55129.pdf http://support.sas.com/publishing/pubcat/chaps/55129.pdf ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, portsmouth university, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france editorial_board.pdf editor in chief editorial board paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 crowdfunding and fintech: business model sharia compliant department of management, university of turin, italy abstract— focus on a concrete project, share the results, contain the risk. these are some of the precepts of islamic finance. but they are also the cornerstones of crowdfunding. this is why this form of financing is cutting out its space. with an extra pillar: no interests. the resources are still limited, but the muslim crowdfunding ecosystem is diversifying: from the most basic reward based on social lending, with an eye to the fintech. fintech refers to technofinance or financial technology, that is to say, the supply of services and financial products provided through the most modern technologies made available to ict. the services provided by fintech are essentially those of traditional finance: therefore, from simple transactions to payments, to brokering and risk management, typical and exclusive of this sector are the activities linked to electronic currencies such as for example, the bitcoin. keywordscrowdfunding, fintech, islamic finance i. introduction the crowdfunding is a collaborative process of a group of people who use their money in common to support the efforts of people and organizations using internet sites. it is a bottomup microfinance practice that mobilizes people and resources. the term crowdfunding derives its origin from crowdsourcing or collective development of a product. it can refer to initiatives of any kind, from financing an entrepreneurial project to supporting art and cultural heritage, to innovative entrepreneurship and scientific research. collective financing is often used to promote innovation and social change, breaking down the traditional barriers of financial investment. in particular, we talk about equity crowdfunding when, through online investment, we buy a shareholding in a company. therefore, it differs from the other models because of the particular "reward" expected by those who contribute to the project. according to the framework for european crowdfunding, "the rise of crowdfunding in the last ten years derives from the proliferation and the emergence of web applications and mobile services, conditions that allow entrepreneurs, businesses and creatives of all kinds to be able to dialogue with the crowd to get ideas, collect money and solicit input on the product or service they intend to offer ». crowdfunding is an important source of funding each year for about half a million european projects that otherwise would never receive the funds to see the light. in 2013, funds amounting to about one billion euro were collected in europe. exponential increases are estimated in the near future, millions of billions by 2020, thanks to crowdfunding, which finds all the elements to be able to unleash its potential in web 2.0. concepts such as fintech, bitcoin, crowdfunding enter the language of the banking business, including for islamic finance. fintech is the supply of financial services and products through the most advanced information technologies (ict), is one of the most interesting phenomena of recent years. exploded between 2014 and 2015, it has established itself in the banking sector, giving rise to new actors. technological innovation has allowed reducing operating costs, favouring a policy of cuts. the success of fintech and crowdfunding, which open new financial channels and give the customer much-simplified management of their activities, with the consequent cancellation of unnecessary management costs. islamic finance is also affected by this revolution. the islamic financial services board has dedicated an entire section to the rise of the fintech, its applications and the state of the legislation in force in its 2017 stability report to remove entry barriers and provide more financial services to the millions of muslims. the concept and the structure of crowdfunding conform perfectly to sharia and has the same participatory methods that are the cornerstone of islamic finance, investors buy a share in the company by participating in gains and losses. the screening to see if a company is sharia compliant was based on qualitative and quantitative criteria. the qualitative criteria relate to the type of industry in which companies cannot operate: this sector includes all activities not permitted haram, namely: alcohol and pork products, pornography, tobacco, gambling, interest-bearing financial assets, weapons and defence, biology and animal genetics (cloning). in quantitative screening, however, the financial reports of companies are tested for amounts not exceeding certain thresholds and thresholds are different in the percentages and formulas between different global indices. paolo pietro biancone, silvana secinaro, and mohamad kamal ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ii. the object of the research the research aims: to understand the concept sharia-compliant crowdfunding; to discover existing crowdfunding platforms with a concentration on equity and debt crowdfunding in the countries of the islamic world; to analyze the sharia-compliant crowdfunding in terms of the companies financed. iii. the sample currently, the platforms entered in the register are 108. the sample is representative of the islamic crowdfunding platforms in the member states of the organisation of islamic cooperation which brings together 47 countries around the world. iv. design of the research the research methodology follows a path of inductivedeductive analysis, by the assessment of the compliance with the sharia. the evaluation process and compliance are based on criteria, divided into two categories: the first category consists of the quality criteria and the second those quantities. the qualitative criteria are mainly related to the business activities of the company and its eligibility according to the sharia. regarding the quantitative criteria, are a series of reports and financial levels that need to be examined, and their results should not exceed the specified threshold. thus, by controlling the qualitative and quantitative criteria, companies are verified on the basis of their resources "activities" and their financial structures. both categories must be met in order to be classified as shariah-compliant. according to what we had discussed on the main concepts and principles of sharia law, companies must conduct their activities within the lawful activities, which are called halal, and avoid all activities that are not permitted, calls haram activities. the activities must obviously include all the production and sale of their products. the activities not permitted are the following: alcohol, products related to pork, pornography, tobacco. gambling, financial services of interestbearing (ie conventional banks and insurance companies), weapons and defence, genetic engineering biological human and animal (eg. cloning), media and advertising companies, with the exception of news channels, newspapers, and sports. the control of those assets within companies is considered a crucial step and a crucial phase. this step is the classification of the core business of each company. switch this early stage of quality control is to move towards quantitative financial control. as for the quantitative control, the three main aspects that need to be tested are the level of leverage (the ratio of debt ratios), the ratio of interest, the liquidity ratio (cash and credit), and finally the portion of revenue that is generated by noncompliant. these aspects must be respected above all for corporate equity crowdfunding (platforms), which will guarantee a set of evaluation procedures by finance companies of comparable strength. level of debt: any debt based on interest is not allowed according to the principles of sharia. for this reason there is a threshold about the same among all the global indices, however, there are some differences in the calculation formula. if the interest based on the debt does not exceed this threshold then it can be accepted. the level of debt is to measure the ratio of total debt and total assets. according to islamic index, the level of debt ratio is: (total debt / total assets) < 33 % the ratio of interest that head in practice the investment in fixed income instruments and ensures that the income generated is not considered riba. among the indices is equal to the threshold but again the formula is different. according to islamic index, the interest ratio is (cash + interest-bearing securities) / total assets < 33 % liquidity ratio: focuses primarily on tests of liquidity in the company (cash and receivables). in this report, all indices are different and do not have common thresholds. as well as the formula for the calculation is different. some require a certain minimum level of assets. according to islamic index ,the liquidity ratio is: cash + receivables / total assets < 33.33 % income ineligible: a criterion of the final financial report to be verified is based on what is the level of income ratio is not permitted; ie, the income must be generated in order to be admissible accepted, according to the sharia.. according to islamic index, the income ineligible ratio is income not allowed / income < 5 %. v. theoretical background for several years, the financial industry has developed new investment forms under the purpose of diversification. amongst them, some have particular features which could sound a bit innovative. they are the so-called social impact investments (or impact investments). impact investors want to allocate their wealth and savings in investments which could generate positive social or environmental development [1]. impact investments are considered as innovative investment forms since they have gone beyond the common capital allocation framework: investments are usually intended to optimize risk-adjusted financial return while donations are designed to increase social impact. impact investments are those investments whose aim is to create positive social or environmental impact rather than financial return. usually, they take the form of private debt or equity instruments, but other options take into consideration guarantees or deposits, too. there are public listed impact investment instruments, too, but the market is still in a start-up stage even though there are many positive indicators that it will expand soon because of a growing demand from investors and the higher supply of social businesses recipients of impact investing. the biggest portion of listed impact investments socially responsible investments which focus mainly on minimizing negative impact rather than fostering positive impact. the intended impact refers mainly to the so-called base of the pyramid (bop) population which need more resources to improve their living conditions or to environmental issues, too. moreover, the most significant feature is the combination of financial return and social/environmental impact which will encourage businesses to grow in a financially sustainable way. the social impact ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 investing could be considered as an important complementary source of funding together with governmental and philanthropy actions to serve the poorest products and services needs [2]. lehner (2013) has proposed a scheme of operation of crowdfunding in the context of social entrepreneurship that characterizes it [3]. this diagram describes what actors are involved and what factors are involved in the encounter between demand and supply of funds in crowdfunding. in particular, businesses are the borrowers as the crowd as a whole is identified as a lender of funds. the essential element in this context is the recognition of the opportunity by not only entrepreneurs but also crowd funders. this happens through the communication channels offered by web 2.0 and content for users on the platforms of crowdfunding. the meeting between the crowd and enterprises occurs when members (crowd funders) decide to take this opportunity on the basis of the legitimacy of their perceived idea about business. unlike the case with traditional sources of funding where the entrepreneur has to convince a small group of investors, typically through a business plan and forecasts, in crowdfunding creators must be able to communicate the opportunity to a large heterogeneous mass of people, therefore adopting different strategies and the multiple communication tools offered by web 2.0 and platforms. the platforms act as intermediaries, each with its own communication strategy and its business model; social networks that are created within the crowd leverage on these. aspects related to the economy of information (information asymmetry) and the equivalent risk for the individual constitute the so-called block motivational. the outcome of the project is moderated by the rewards (reward), the levels of control and participation offered and also depends greatly on the characteristics brokerage platform. the laws and regulations, in turn, form a further block that serves as a mediator between the crowd, the crowdfunding platform and desire for participation in the project business [4]. the literature on the "herd behaviour" (rational herding) states that individuals to reduce their risk of the face of uncertainty, in this case, associated with a new business idea, interpret the number of people who have invested as a quality signal of the project. the authors argue that the herd effect probably also the case of crowdfunding but the main difference is that the crowd funders not interpret the investment decisions of others as a sign of quality. the propensity to invest in the latter fact undergoes an increase in the final stages of the project as the supporters expect that their contribution will have a greater impact when the project is closer to its target collection and therefore has a higher probability of success. a. crowdfunding the crowdfunding encompasses various types of fundraising that can range from collecting donations to selling equity stakes via the internet. but a clear definition of the term has yet to be proposed. one definition comes from hemer (2011), who defines crowdfunding as an ―open call, essentially through the internet, for the provision of financial resources either in form of donations (without rewards) or in exchange for some form of reward and/or voting rights in order to support initiatives for specific purposes [5]. belleflamme, lambert and schwienbacher (2012), offer a similar definition. the categorization of the four main types of crowdfunding (donation-based, reward-based, lending, and equity) is based on what, if anything, investors receive for their contributions [6]. the legal complexity and the degree of information asymmetry between fundraiser and investor differ significantly depending on the type of crowdfunding [7]. for example, in donation-based crowdfunding, funders donate to causes they want to support, with no expectation of monetary compensation. this can also be considered a philanthropic or sponsorship-based incentive. this form of funding is not complex from a legal standpoint. furthermore, the degree of uncertainty is less important than it would be for other types of crowdfunding because donors presumably already have a positive opinion of the organization. an example of a donations crowdfunding platform is fundly, which allows individuals and organizations to create an online fundraiser solely for the purpose of collecting donations. in contrast, reward-based crowdfunding offers funders a non-financial benefit in exchange for their investment. a prominent example of this type of platform is kickstarter. kickstarter allows fundraisers to raise money by offering non-monetary rewards in return for financial support. for example, a team of product developers raised over the u.s. $10 million. kickstarter by preselling an e-paper watch at a discounted price. lending crowdfunding is another model, where funders receive fixed periodic income and expect repayment of principal. lending crowdfunding platforms, such as prosper, generally facilitate peer-to-peer loans. in other words, individuals receive loans directly from other individuals. the last model is equity crowdfunding, in which investors receive some form of equity or equity-like arrangements (e.g., profit-sharing) in the venture they support [8]. assob is one of the most prominent equity crowdfunding platforms. it enables entrepreneurs to sell equity shares to small investors. for example, an australian high-tech start-up sold approximately 10% of its equity on assob for aud 630,000 (approximately u.s. $645,000) to twenty-three small investors in 2009. we believe that equity crowdfunding is the most relevant empirically for studying entrepreneurial signalling to small investors. this is in contrast to donations crowdfunding, where factors other than potential monetary returns are important for funders, which makes a meaningful comparison among crowdfunding types difficult. therefore, information asymmetries surrounding the entrepreneur’s or start-up’s ability to generate future cash flows are less important in this context [9]. richard harrison (2013), analyzed the economic context in which the equity crowdfunding is developing. in his work explains how the market for raising capital for companies’ internship has changed a lot in recent years [10]. following the financial crisis of 2008, in fact, there was a sharp decline in the availability of bank loans for small and medium businesses a reduction of liquidity on the other traditional financing channels. before 2008 the funding in phases at high-risk start-ups was chiefly through the so-called "love money" that was based on the 5f: founders, family, friends, fans and fools and through state subsidies. in some cases, particularly for companies 'social', part of the loan could be paid from sources philanthropic and altruistic, idealistic and individuals defined as "followers" of the project objectives. these sources also fall within the ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 definition of "love money" issued by hermer (2011) [5]. the equity crowdfunding is the disintermediation of the financial market, a tool that allows direct contact among entrepreneurs and lenders. this source of funding, however, is still evolving, the different characteristics of the instruments traded (financial instruments in effect) than other forms of crowdfunding require that the management of funds meets the standards that regulate the financial markets, which is why the models that led to the success of the other forms of crowdfunding cannot be applied directly to equity crowdfunding. for these reasons, harrison (2013), states that the scenario in which the equity crowdfunding is developing not possible to determine with certainty what the future of this new form of financing if you configure a transformation of the market for financing for startups or vice versa as a tool-less [10]. loan-based or lending-based crowdfunding is a direct alternative to a bank loan with the difference that, instead of borrowing from a single source, businesses can obtain loans from dozens, sometimes hundreds of people willing to lend. investors in this case often bid on the interest rate at which they would be willing to lend. borrowers, therefore, accept loan offers that have the lowest interest rate [11]. to meet lenders with borrowers, internet platforms are used. due diligence is rigorous for every loan request as crowdfunding platforms have a duty to protect the interests of both companies and investors. the platforms usually ask for financial accounts and a picture of the operating results. the main features are: • increased flexibility in interest rates and offer better interest rates to secure the deal; • you can get a loan after a bank did not want to give it to you; • the size of the loans can vary considerably and thus meet most needs; • the loan is repaid through direct payments to the platform which then distributes your repayments to providers; • disclosure requirements are similar to those of a bank. unlike the bank, however, they apply to all lenders; • as with a traditional bank loan, you are legally required to repay the loan [12]. lending-based crowdfunding stands out from other forms of crowdfunding (donation-based, reward based and equitybased) as lenders and borrowers subscribe (directly or indirectly) a debt contract, with which the former provides a sum of money and the latter undertake to return the capital (almost always increased by an interest rate) in a given period of time [11]. the subjects financed are families, non-profit associations and small and medium-sized enterprises (smes), while investors are generally single investors, companies that offer asset management services, institutional investors or banks. the platforms that facilitate the meeting between supply and demand for financing can adopt very different business models, but almost all of them share the following characteristics: (a) they collect the requests for funding from potential debtors , which provide basic information on their identity and on the project to be financed; (b) select potential debtors based on their creditworthiness and assign them a rating, which briefly indicates the probability that the loan will be repaid; (c) allow investors to fund even a small portion of the loan required by each borrower; (d) manage payment flows between debtors and investors (either directly or through the services of a third-party company); (e) use widely standardized and automated processes and services are provided almost exclusively via digital channels; (f) are remunerated by commissions proportional to the amount of the debt and the amount invested[13]. b. fintech & crowdfunding the term "fintech" refers to the financial innovation made possible by technological innovation, which can take the form of new business models, processes or products, producing a decisive effect on the financial markets, on institutions, or on the offer of services [14]. the use of technology is, therefore, a necessary element to make financial innovation possible. the innovations considered within fintech include both financial services and information technology and invest all sectors of banking and financial intermediation [15]: from credit (crowdfunding and peer-to-peer lending) to payment services (instant payment), from currencies virtual (bitcoin) to consultancy services (robo-advisor), in addition to decentralized transaction validation technologies (blockchain or dlt distributed ledger technology), biometric identification (fingerprint, retina or facial recognition), to support delivery of services (cloud computing and big data). fintech, therefore, invests every segment of the banking and financial services markets; it modifies its structure through the entrance of technological start-ups, the giants of information technology and social media (google, apple, facebook, amazon, and alibaba); involves a strategic response of the companies already present [16]. the growth trend of technofinance is exponential: in 2015 grew 75 per cent, or $9.6 billion, to $22.3 billion in 2015 [17]. the geographic composition of the capital collected shows that the largest investments have been concentrated in america and asia. the us operations (the us $ 13 billion for 500 transactions) were concluded to drive investments in america, where there was a growing interest in the startup insurtech and blockchain (with applications in the smart contract and cryptocurrency exchange particular). in asia, the total amount of capital raised by fintech was about $ 8.6 billion for more than 180 deals concluded, so with an average value of $ 47 million, far above the $ 24 million reported in north america, where the market already shows signs of maturity. china has driven these investments more than other countries, so much so that china is the most significant investment on fintech globally: it has raised $ 4.9 billion from the public and private investors [18]. the main activities carried out by fintech to provide a response to the needs of customers to find resources in terms of capital and debt. the first is equity based financing. in fact, equity crowdfunding platforms allow retail investors to access private equity investments, typically start-ups or earlystage companies. crowdfunding is defined as "equity-based" when the online investment acquires a real shareholding in a company: in this case, in exchange for financing, you receive a set of patrimonial and administrative rights deriving from participation in the 'company. innovation, in this case, lies in the channel used for investing (ie platform or portal) and indirect mode, ie without the use of financial intermediaries. the second is debt financing which includes loans and the purchase of debt securities. in this way, fintech offers solutions to customers interested in finding resources. fintech operates directly as a lender, while still using the telematics ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 channel to facilitate customer access and make the services offered quickly available. financial debt, generally by contacting potential fund managers through the online platform (marketplace). there are four main sub-categories: a) lending crowdfunding (or social lending) and peer-to-peer lending (p2p lending). b) short-term financing through invoice discounting (invoice lending) or commercial credit. c) club deal. d) fundraising by qualified or institutional investors through debt securities [19]. fintech has become an important component in conventional finance, while islamic finance is still at an embryonic stage. although islamic fintech is still very limited in number, scale and size, it may grow better with this technology, especially in areas where islamic banks are present [20]. concepts such as blockchain, cryptocurrency, crowdfunding, and peer-to-peer are increasingly penetrating the common language of the banking business, even islamic finance is affected by this revolution [21]. with regard to the bitcoin, it was criticized by scholars of sharia because of the volatility of the exchange rate of its currency against conventional currencies because of the large speculation [22]. c. islamic finance & crowdfunding the islamic religion emphasizes the principle of halal (permitted activity) emanating from the shariah, which governs all activities in the life of muslims. the islamic finance, ideally, is an alternative way of financing based on ethical and socially responsible standards, which ensures fair distribution of benefits and obligations between all the parties in any financial transaction [23]–[25]. the crowdfunding carries these characteristics and provides the ground for new developments in the field, as it can use islamic finance as an ethical and socially responsible tool to promote financing and development. islamic finance and crowdfunding both conceptualize costumers as investors and can potentially provide investment opportunities with higher returns investors take an equity stake in the project and gain returns based on the principle, which ensures a fair distribution between shareholders and entrepreneurs [8]. the sharia-compliant crowdfunding invests in halal socially responsible projects/products, shares the risks of the investment, and is characterized by the absence of an interest rate. the originality of product-based crowdfunding lies in the fact that in return, the investor does not receive interest, but the product itself, which promotes the creation of new products and furthers innovation. investors that pay for a product they wish to have, can track the production process and see how their money is spent through weekly updates on the progress of the projects. transparency is a very important part of the project, and a direct link between the customer and the workshop owner is established from the beginning [26]. islamic finance to comply with the quran requires socially responsible investment, with a real impact on the community, sharia prohibits interest on loans and speculation [24]. whereas islamic finance at the origin is value-oriented and aims at sharing risks and profits: hence the inevitable similarity to crowdfunding and its participatory methods [9]. there are four types of sharia compliance platforms: 1. donation-based crowdfunding: in the case of donation, donors pay rather small amounts for a nonprofit project or a social development initiative through zakat or sadaq, 2. reward-based crowdfunding: donors contribute small amounts of money in exchange for a reward after the completion of the project. the reward is a product generated by the project itself; 3.equity-based crowdfunding: at this stage, investors provide sums of money, so they become shareholders and share profits and losses such as the use of musharakah; 4. debt crowdfunding: the lenders grant a loan and expect the repayment of capital and the distribution of profit, the platform must rely on islamic financial contracts and processes without interests such as the use of murabaha & ijarah [27]. table i. shariah-compliant crowdfunding models and instruments financing for crow model potential beneficiary instrument with end client islamic charity donation microfinance hiba qard-hasan murabaha product reward microfinance small enterprises startups sale investment debt microfinance small enterprises murabaha ijarah investment equity small enterprises startups musharakah source: marzban & asutay, (2014). ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 the islamic finance pools several types of contracts and agreements according to the different needs and is asked to give a solution [28]. thus, there are many models of financing which are linked to crowdfunding, in details, there are mudarabah, musharaka, istisna, salam and diminishing musharaka. one of the most prominent islamic contracts used in equity crowdfunding is musharaka. musharakah is a type of partnership where a group of persons (both physical and legal) carry out a business by conferring both capital and labour and sharing the profits and losses of the business [9]. the most prominent characteristics of equity-based crowdfunding from an islamic finance perspective include: profit and loss sharing; open the field for small and medium investors to enter into the financing process; reduce risk by dividing capital into several companies and projects; financing and supporting start-up companies that in turn help create jobs and economic growth [27]. musharaka implies a partnership in a business or an entrepreneurial business and can be defined as a form of society in which two or more people bring in a capital and labour project to share the result, benefiting from the same rights and responsibilities. this type of contract is considered the best instrument for the financing of important projects, but it is also used in more limited sectors such as the financing of the working capital of a company, the purchase of a house or in microfinance. the bank confines itself to conferring capital and does not care about the management, in the musharaka contract, the bank only provides part of the capital and participates in the agreement as a member with the right to be an active part in the management [29]. debt crowdfunding shariah compliant is based on murabaha, as it connects companies that are looking for funding, with investors looking to get more out of their investments and does not involve loans. this contract is between the crowd, the platform, and an sme [30]. in islamic finance, as repeatedly noted above, classic credit cannot be used together with the payment of an interest: the murabaha contract can then be used for the financing of working capital, such as supply credit and credit for consumption, ie for current financial needs (warehouse, raw materials, and semi-finished products) and also for some medium and long-term investments. from a legal point of view it is a contract for the purchase of an asset up front a deferred payment; in the case of an islamic banking operation the murabaha provides for the intervention of three parts: the bank's client, who is the final purchaser of the asset, the seller who is the supplier of the asset and an intermediary, the bank, which is in the the buyer at the same time towards the supplier and seller to his customer. there are therefore two transactions, one between the supplier of the asset and the bank at the price agreed between the supplier and the customer and the other between the bank and its client at a price equal to the sustained cost plus a margin that it covers both the service and the risk of the transaction and the extent to which the customer is informed before signing the contract. on the basis of the contract, the bank purchases the asset from the supplier paying the price agreed between the customer and the supplier, then transfers the ownership to the customer at the price set in the contract and already including his profit margin. subsequently, the customer regulates the payment at the indicated deadlines: the property passes to the customer only when the payment of the entire amount has occurred. with this double-sale mechanism, the bank provided financing to the client without resorting to a loan with interest, prohibited by shariah. it is, therefore, an operation involving three parts (customer of the bank, seller who is the customer's supplier and bank) and which involves three successive phases: the client's request to the bank to make the purchase; the purchase of the asset by the bank from a seller / supplier; the recovery of the asset at the bank by the customer [29]. in order to understand their compatibility with sharia, it is based on qualitative and quantitative criteria: the qualitative criteria relate to the type of industry in which companies cannot operate: this sector includes all activities not permitted haram, namely: alcohol and pork products, pornography, tobacco, gambling, interest-bearing financial assets, weapons and defence, biology and animal genetics (cloning). about the second one, the quantitative screening. the financial reports of companies are tested for amounts not exceeding certain thresholds and thresholds are different in the percentages and formulas between different global indices [8], [31]. vi. discussion the purpose of the crowdfunding in the muslim world is to relate ideas, people and financial resources by proposing startup projects with exciting and innovative that transmit messages, also a social. a. the qualitative analysis control of those assets within companies sample is considered a key step and a crucial phase. this step is the classification of the core business of each company and reveals no contrast to the sharia. the modus operandi of the platforms has led to the identification of a pattern of operation of the collective funding. the main phases of a recurring and crowdfunding campaign, the creation of a business idea to obtain the funds needed to conduct the: 1) preparatory activities 2) crowdfunding 3) implementation (possible) the prerequisite for the launch of a campaign of crowdfunding is represented by the value proposition that the author intends to launch: despite the practice of funding from the bottom is commonly believed, a highly accessible, disintermediated and transparent, with which to carry out artistic and cultural projects, develop business ideas and to involve the community in a project economically social or public utility, is still an economic act. the main implication of ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 this assumption is clearly the need to structure its proposal the business logic and business creation. the proposer shall not be limited to the launch of a simple idea, he will have to play a series of preliminary activities aimed at identifying the contents of the project and the assessment of its feasibility. a crowdfunding campaign is the initiative of a new entrepreneur in a market, both real and virtual, in most cases the existing competitive and characterized by specific logic. the applicant must, therefore, plan their campaign along a gradual path that starts from the clarification of the idea and the target, will wind along the analysis of market and competition, through the evaluation of the financial and economic underpinning and ending with the clear definition of the primary and secondary objectives that the campaign is intended to reach. along with this path feasibility review, the proponent will develop more critical thinking and communication skills, will be defined in detail and clarity with every aspect of its proposal, amplifying the ability of communication to the public and not thus incurring the risk of frustrating their engineering effort. most active platforms have structured access to their services in a very simple and direct, after the registration phase, the user can access the section dedicated to the publication of the projects and will be guided by a structured form tended to homogenize the submission of projects and highlight the key variables of the project. the role of the platforms of crowdfunding is to focus on online portal viable projects that will attract the interest of the crowd, the platform's ability to attract supporters will also depend on the ability of the applicant to provide a description of their attractive and adequately detailed idea by using different multimedia tools. the main stages of the structuring of the campaign can vary depending on the business model of the platform, it will, in any case, the proponent define: project description, author and title: through images and text, the user can enter the title of the campaign, any authors also non-material and a range of content through the evidence suggests precisely the goal of the project. storytelling: numerous platforms proposers to produce a video aimed to tell the project through evocative images of sensations and feelings that will ensure the emotional involvement of the crowd, and that provide a clear demonstration of the product or service promoted. budget: it will be up to the proposer fix the budget goal of the campaign in relation to the resources that realistically considers necessary for the realization of its vision and taking account of all the charges you pay compared to the campaign and the system of rewards (if provided). rewards: if the crowdfunding campaign is proposed in the segment reward, the proposer will enhance the donations received by him with rewards choices, the value of which varies depending on the size of the donation. promotion: the campaign will be completed by the activation of all the social channels of which the proposer has (twitter, facebook, blogs etc.) to create a constant flow between the platform and the communication and sharing habitually employed by the offeror. b. the quantitative analysis to discover existing crowdfunding platforms with a concentration on equity and debt crowdfunding in the countries of the islamic world; has been taken into consideration the crowdsurfer database. have been found 108 crowdfunding platforms in 32 of the 57 in the countries of the islamic world. because of the duplication of some platforms, the number of crowdfunding platforms is only 80. most of them are donation platforms. after the audit has been selected 14 equity crowdfunding and 13 debt crowdfunding platforms with an active status. among the platforms for the crowdsurfer database, only four islamic financing platforms were found with an active status and one classified as pre-launch. three of the active platforms are a donation crowdfunding and only one is an equity crowdfunding platform. to find out if the platforms can be considered islamic-oriented although they are not explicitly mentioned as such, they have been used websites for all equity and loan platforms which number about 26259 in the member states of the organization of the islamic conference. the results were as follows: the platform that has been considered in crowdsurfer as a shari'ah compliant equity platform for smes and start-ups in malaysia. ataplus did not mention compliance with shari'ah on its own website. the only sign of compliance with sharia was the list of activities and actions in which a fund-seeking entrepreneur should not participate. only one debt crowdfunding platform liwwa in lebanon demonstrates the importance of shariah and provides an explanation of its own business which depends on the murabaha contract on its website. a debt platform in the uae beehive it works in a different way, offering a binary approach: it offers a traditional lending method and sharia-compliant lending method. the shariah option is explained in detail on its website. the shekra platform in egypt, which is one of the most equity crowdfunding platforms and has won many islamic awards. does not explain how shari'a compliance in its work on its website, but published in some scientific papers and in conferences the main ideas. the platform works differently as a “closed investors network”, which is unusual for a crowdfunding platform. indonesia's danadidik platform for student loans adopts a profit-sharing or income-sharing model for investors' returns. although this generally reminds us of the concepts of islamic finance, although the platform calls for and encourages compliance with islamic principles, there is no evidence of adherence to sharia. the precise quantitative analysis of the platforms you cannot bring it because the number of platforms is very modest in the countries of the islamic world which adopted the principles of islamic finance and financial returns for investors are very small. in addition, none of the websites examined ejif – european journal of islamic finance no 12, april (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 provided complete information on its modus operandi, acceptance conditions, and procedures to ensure compliance with sharia. therefore, it is not possible for the observer to know in detail the shariah demands associated with the platforms and understand the most problematic issues in relation to them. it was decided, however, to identify the data and the relevant elements to attract islamic investors, for example, the central bank of bahrain (cbb) has released in 2017 regulations for both conventional and shari’a compliant financing-based crowdfunding businesses. for the first time, it will be possible for small and medium-sized businesses in bahrain and in the region to raise conventional or shari’a compliant financing through crowdfunding. firms operating an electronic financing/lending platform must be licensed in bahrain under the cbb rulebook volume 5 – financing based crowdfunding platform operator. the general regulations are the same for both conventional and shari’a compliant financing based crowdfunding platforms. for the latter, an additional requirement is to ensure that the financing structure is shari’a compliant by engaging a shari’a advisor or outsourcing this function to a third party. the key highlights of the crowdfunding regulations are as follows: minimum capital requirement for crowdfunding platform operators is bd 50,000 ( 111,101.73 eur); only person to business (p2b) lending/financing is permitted; small and medium-sized businesses with paid-up capital not exceeding bd 250,000 ( 555,259.46 eur) can raise funds through crowdfunding platforms; these smes may be based in bahrain or outside; however, in the case of foreign smes the platform operators have to clearly mention the cross-border and jurisdictional risk financiers have to take; it is the responsibility of the lenders/financiers to perform their own creditworthiness assessment on borrowers/fundraisers; crowdfunding platform operators have to comply with the cbb rules on anti money laundering, combating financing of terrorism (aml/cft), consumer protection, etc; only expert and accredited investors are allowed to provide financing through these platforms; they can lend up to 10% of their net assets to a single borrower/fundraiser (and sign a self-declaration form to this effect); retail investors are not permitted to participate given the high-risk nature; platform operators have to clearly and publicly disclose their fees, charges and commissions; platform operators may provide financing to borrowers/fundraisers who use the platform subject to obtaining the required license from the cbb to provide credit and adequate disclosure; if a borrower/fundraiser is unable to raise at least 80% of its crowdfunding offer size the attempt would be considered unsuccessful and any monies received would have to be refunded within seven calendar days; a borrower/fundraiser can raise a maximum of bd 100,000 ( 222,125.70 eur) through crowdfunding in a year; the financing tenor should not exceed 5 years. we expect bahraini entrepreneurs to benefit from the global crowdfunding trend, which provides a viable alternative to bank financing. in particular, the cbb is keen to see bahrain dominate the sharia-compliant financing-based crowdfunding market in the region. the demand for shari’a compliant financing is already high and we expect to see it reflected in the crowdfunding market as well”, said mr khalid hamad, executive director at the cbb. the synthetic results show that both fintech and crowdfunding, in the islamic world are still in their infancy with a relatively small number of participants, are closely oriented to start-ups and there are not enough investors while adopting methods and procedures for the identification of investors and selection of business ideas, which are compatible with sharia. vii. the conclusion and advance in general, crowdfunding is used to finance start-ups, small and medium enterprises, expansion projects and capital increase. it is also used to finance all works, creative ideas and works of art such as films and charity projects such as relief campaigns and others. it is based on the principle of social solidarity to serve an idea or a project, and the redistribution and better utilization of financial resources. this is in line with the essence of islamic finance, which is considered a revolution in the financing methods in the islamic world if properly invested. crowdfunding is still in the islamic world continues to take slow steps for several reasons, including technological decline, the difficulty and slow completion of electronic financial transactions, the availability of liquidity and the high standard of living in the gcc 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[31] p.p. biancone and m. radwan, “sharia compliant ‘possibility for italian smes,’” pp. 1–9, 2014. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 the progress to allow fully fledged interest free banking business in ethiopia mohammed ibrahim department of law, ambo university, ethiopia, ibshi66@yahoo.com abstract-islamic banking refers to banking business in which mobilizing or advancing funds is undertaken in a manner consistent with islamic sharia law. different literature shows the rapid growth of this islamic banking as alternative to the conventional banking. economic globalization, among other things, has led to the flourishment of islamic banking both in muslim and non-muslim countries. there has been increasingly strong public demand for interest free banking products in ethiopia. as a response to this demand, the ethiopian government introduced interest free banking business under banking business proclamation no. 592/2008. following this, the application to establish fully fledged interest free banking business was submitted to national bank of ethiopia. however, the prohibition by national bank of ethiopia for the same, following the enactment of “directive to authorize the business of interest free banking no.sbb/ 51/2011”, forced the withdrawal of the application. now ethiopia is being one ofthe largest muslim populations in the horn of africa, however, has no fully fledged interest free banking business to provide service to the muslim community. the enactment of directive to license and authorize interest free banking business no. sbb/72/2019, however, seems changed the situation. this directive allowed the establishment of fully fledged interest free banking business and following this directive, different banks of the same applied for the formation. hence, the purpose of this article is to analyze the evolution of fully fledged interest free banking business; to analyze the problem related with allowing fully fledged interest free banking business and to analyze the short coming of legal provision relating to fully fledged interest free banking business in ethiopia. the outcome of the analysis shows that the legal provision relating to fully fledged interest free banking business is not enough to deal with the same. it calls for the amendment of banking business 1 “……..43.5 percent of the total population was orthodox christian and 33.9 percent was muslim. protestant and traditional religious group followers accounted for 18.6 percent and 2.6 percent respectively……” see summery of and statistical report proclamation no. 592/2008 and the directive to license and authorize interest free banking business no. sbb/72/2019.the outcome also shows that the authorization of more than one bank of the same at this early stage may bring failure both on the same and other conventional banks. hence it calls to limit the number of authorization for fully fledged interest free banking business at this early stage to not more than one. keyword: islamic banking, interest free banking, islamic banking in ethiopia i. introduction regarding the percentage of the muslim population, from the total population of the country, different organizations provide different percentages. regardless of the difference, the report of 2007 populations and housing census of ethiopia estimated ethiopian muslims at 34% of the total population1. however, until recent time there was no islamic banking product to serve the muslim community. this fact isolated ethiopian muslims from financial sectors specially from holding share in the same for participating on interest bearing financial sectors are against islamic sharia laws. because of strong public demand for interest free banking products2 , when “the licensing and supervision of banking business proclamation no. 84/1994” (here in after called proclamation no.84/1994) is repealed by “banking of the 2007 population and housing census page 19 available at www.ethiopianreview.com/pdf/001/cen2007_firstdraft(1).pdf 2this idea is reflected in preamble of directives to authorize the business of interest free banking no. sbb/ 51/2011 which is enacted by national bank of ethiopia to regulate ifbb. ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 business proclamation no. 592/2008”3 (here in after called proclamation no.592/2008) the ethiopian government introduced the clause for interest free banking business (here in after called ifbb) in the latter. it is stipulated under article 22(2) of the proclamation which states:-“the national bank may issue directive to regulate banking businesses related to non-interest bearing deposit mobilization and fund utilization”. following this stipulation, the application to establish fully fledged interest free banking business (here in after called ffifbb) by the name of zamzam bank was entered, which was able to collect a huge amount of capital within a short period of time by selling shares4 . until the declaration of ´directives to authorize the business of interest free banking no. sbb/ 51/2011´ (here in after called directive no. sbb/ 51/2011), the national bank of ethiopia (here in after called nbe) did not respond to the application5. before the declaration of this directive, the nbe released three (3) consecutive draft directives that allowed ffifbb. latter, when this final directive is enacted, the nbe withdrawn the clause for ffifbb from the same, which was under its three preceding consecutive draft directives and based on this directive the nbe dropped the application. the clause for ffifbb under the preceding consecutive draft directives which was envisioned to make the muslim population beneficial from the financial sectors equally with the rest of the populations was culminated in this manner. the enactment of directive to license and authorize interest free banking business no.sbb/72/2019 (here in after called directive no. sbb/72/2019), however, seems changed the situation. this directive allowed the establishment of ffifbb and following this directive different bank of the same applied for the formation. hence, the purpose of this article is:to analyze the evolution of ffifbb; to analyze the problem related with allowing ffifbb and to analyze the short coming of legal provision relating to ffifbb in ethiopia. to this effect the critical analysis of proclamation no. 592/2008 and the directive no. sbb/ 51/2011 with its preceding draft directives will be made. also the critical analysis of directive no. sbb/72/2019will be made. the legal analysis will be based only on the relevant legal provisions related to the issue at hand, directly or 3 banking business proclamation no. 592/2008, federal negaritgazeta of the federal democratic republic of ethiopia, 14th year no.57, addis ababa,25th august,2008. 4 interview with dr. abdulnasir dino, chair man of zamzam bank, addis ababa, 15 march 2019. he replied that the application was made as per proclamation no.592/2008 and minimum capital requirements for banks directive no. sbb/50/2011. 5 ibid. 6this fact was expressed in august 9, 2011 letter with reference number zzbuf/102/2011 that written to nbe by zamzam bank as: “we believe nbe witnesses our contribution in the initiatives taken to be instrumental for the article 22(2) that include for interest free banking in banking business proclamation number indirectly. from the analysis the author tries to make his conclusion. this article is not concerned with actual problem related to ffifbb on the ground, except the legal analysis made by the author. ii. proclamation no. 592/2008 as it is mentioned above, ethiopia is a country with an abundant number of muslim population. however, up to now no ffifbb products were available to service the muslim community. when the public demand for ifbb reached its climax, the ethiopian government repealed the proclamation no. 84/1994 by proclamation no. 592/2008 that comes with a clause for ifbb. the immediate cause for such changes was the submission of draft proposal for the zamzam bank to different concerned government officials with all details about the need to have ffifbb in ethiopia.6 the clause for ifbb is mentioned under article 22(2) of the proclamation that state: ´the national bank may issue directive to regulate banking businesses related to non-interest-bearing deposit mobilization and fund utilization´. this is the only clause under the proclamation that mention about ifbb and the proclamation port the details to the directive to be issued under nbe. the ethiopian vision to build inclusive financial sector under the second growth and transformation plan, can be taken as a milestone to entertain such demand. as it is understood from this clause it does not allow the establishment of ifbb as of right. it makes the establishment of the same conditional that depend on the enactment of the directive by nbe. this means it can´t claimed as of right except where the nbe enacts the directive for the same. the authorization also did not oblige nbe to enact the directive in the area. the clause gives the nbe extensive right to decide on the matter. the proclamation did not mention as to the type of ifbb that will be allowed. the proclamation also did not mention the purpose/reason to allow and the manner to perform the same. there is also no indication as to whether it is the one that will conduct in line with islamic laws or otherwise. here there is a query as to what will happen if the nbe enacted the directive to authorize ifbb and licensed the same but 592/2008”. chairman of zamzam bankdr. abdulnasir dino said in this regard there is no any preparation to enact law for ifbb from the side of the government. he said we summited the draft proposal of zamzam bank for ffifbb with all the details including its importance for ethiopia. he said we summited this proposal to different top government officials including the then prime minister of ethiopia meleszenawi. he said the prime minister appreciated the proposal and surprised by it. he said the prime minister promised us to enact the law for the same.interview with dr. abdulnasir dino, supra note 5.. ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 arbitrarily repealed the directive and cancelled/withdraw the license. iii. the critical analysis of directiveno. sbb/ 51/2011 and it´s precedes draft directives, and the attempt to establish ffifbb in ethiopia different elements can lead to introduce ifbb in different countries. the purpose can differ in muslim and non-muslim countries. predominantly the driving force in non-muslim countries can be: the need to bring diversity to the market; the danger of having informal islamic institutions, which are feared to finance terrorism; the attraction of countries with oil wealth, many of which are predominantly islam; investing and saving the growing wealth of the muslim minorities, many of whom are unbanked due to the lack of banks which adhere to sharia law7. the development of ifbb in muslim countries mainly emanate from the response to the need of faith-based finance8. the factor that contributes for the development of ifbb in ethiopia is the combination of the above elements as enshrined under the preamble of directive no. sbb/ 51/2011 and it´s precedes draft directives: to create accessibility to muslims who are unbanked due to the lack of banks which adhere to sharia law; to give practical response for globally growing islamic finance, in order to attract the foreign investors from muslim rich countries; aimed to respond to muslims faith based finance which was strongly demanded. as soon as the enactment of proclamation no. 592/2008 that declares the permissibility of ifbb, latter the application to establish ffifbb by the name of zamzam bank was submitted to the nbe9 . since the clause under the proclamation no. 592/2008 is not comprehensive for licensing, it necessitates for the detail under the directive as it is already promised under the same. prior to the directive no. sbb/ 51/2011, the nbe released three different consecutive drafts of the same. in order to enrich the directives and to make the process participatory, the nbe had been deliberating on the drafts with the existing banks and banks under formation including zamzam bank 10. each of these consecutive draft directives will be summarized here in under as follow: the 1stdraft was released on june 11, 2010 and it is named as “directives for conducting interest free banking”. it defines “interest free banking” under article 2(1) as – banking activity in which the acceptance of funds and financing is undertaken in 7mohamed hassan abdullahi(2012), the legal and regulatory framework of islamic banking in kenya: theory and practice, university of nairobi,p.18&19. a manner that is consistent with sharia principles. it also define “interest free banking window” under article 2(2) as a unit within a bank exclusively offering and dealing with activities permissible under sharia principles. following under article 3(1) it states: interest free banking may be conducted in either of the following modes by fulfilling all the requirements stipulated in relevant nbe directives: a. existing banks may create interest free banking window; and b. ethiopian nationals may establish a bank exclusively engaged in interest free banking. when we see article 3(1) (a), the term “existing banks” refers to existing conventional banks which are already licensed by nbe. hence, when it is read in conjunction with article 2(2), it gives the meaning thatthe existing conventional banks which are licensed by nbe can be authorized to provide ifbb through exclusive window reserved for the same. under article 3(1)(b), the term “bank exclusively engaged in interest free banking” refers to the permissibility of establishing ffifbb. when we see article 2(1) and 3(1) conjointly it gives the meaning that: both conventional banks which provides the service through exclusive windows and the exclusive banks which will be formed for the same, shall give the service as per thesharia law. from what is mentioned under this directive, it is clear that the 1stdraft directive, allowed the formation of ffifbb in unequivocal language. the 2nddraft was released on october 8, 2010 and it was named as “directive for authorization of interest free banking”. it defines “interest free banking” under article 2(2) as – banking activity in which the acceptance of funds and financing is undertaken in a manner that does not involve pre-determined interest rate. it also define “interest free banking window” under article 2(3) as a unit within a bank exclusively offering interest free banking services. following, the directive provides under article 4 the requirements for the authorization to engage on ifbb. article 4(2) promised to authorize a person who fulfills the requirements under the provision to establish a new ffifbb; or convert the existing conventional banks to ffifbb; or open a window which shall provide exclusively ifbb along with conventional banking service. this provision is unequivocal and selfexplanatory. it provides three possible option of ifbb formation. the 1stway is establishing new ffifbb; the 2nd way is converting existing 8 ibid 9interview with dr. abdulnasir dino, supra note 5 10 ibid. ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 conventional banks to ffifbb; and the 3rd way is for conventional banks to participate on ifbb through opening windows exclusively reserved for the same. furthermore, under article 5 it comes with 4th liberal idea of ifbb formation. under this article it gives permission for ffifbb that is formed as per this directive, to give conventional banking service through exclusive window reserved for the same. this draft directive declared permission for ifbb with all its exhaustive possible options for its formation. the 3rd draft is released in july, 2011 and it was named as “directives for authorization of interest free banking”. its exact specific date for release was not mentioned on the draft. it defines “interest free banking business” under article 2(2) as – banking business in which mobilizing or advancing funds is undertaken in a manner consistent with islamic finance principles and mode of operation that avoids receiving or paying interest. it also defines “interest free banking window” under article 2(3) as a unit within a conventional bank exclusively offering interest free banking services. article 4 provides requirements for authorization to engage on ifbb. under article 4(2) (a-d), it provides a pre-requisite for those banks which want to form ffifbb. under sub 4(2)(e) of the same article, it provides pre-condition for those conventional banks which wishes to engage on ifbb through window exclusively reserved to the same. this idea becomes more clearer from the following sub 4(3) of the same article which states -the national bank evaluate the application submitted by a bank in view of banking business proclamation, applicable directives issued by it as well as other rules and regulations; and up on its satisfaction may authorize the applicant to: a. engage in exclusively interest free banking business, or b. open an interest free banking window. in short the idea under the 3rddraft is to mean: up on receipt of the application, the nbe evaluate the application in line with banking business proclamation, the pre-requisite set under article 4 of the same directive and other relevant laws of the country, and up on its satisfaction the nbe will issue a license for both ways of ifbb service delivery (i.e. for ffifbb and a unit of window within conventional banks) based on the request. until the end of the 3rd draft release, the ethiopian muslims in general and the stakeholders of zamzam bank (organizers and shareholders) in particular, were fully confident about permission of engaging in ffifbb and approval of zamzam bank. however, this confidence started to erode when the nbe wrote a letter on july 18, 2011 by letter no. fis/bsd/252/11 to zamzam bank that was under formation. the letter states: “as you well know, the directive for ifbb´s is in progress to be issued in the near future. this is, therefore, to inform you to keep your licensing documents with you until the directives under caption are issued”. this letter is requesting zamzam bank to take back licensing application that was launched following the declaration of proclamation no.592/2008 for ifbb. the letter is promising the coming of finally authenticated/ratified directive for ifbb in the near future. there is a query as to why nbe wrote this letter which request taking back the application document. there is also a query as to why nbe request taking back the application document at this juncture while it is telling the forthwith coming of the final directive under caption. another event that exacerbate the suspicion on the nbe and the final directive under caption was, the enactment of “directive no. sbb/50/2011” in september 19, 2011. it is enacted to set a minimum capital requirement for the banks. the provisions for consumption under this directive are illustrated as follow: under article 2(1) of definitional part, it defines “existing banks” as banks licensed by national bank of ethiopia before the effective date of this directive. under sub 2(2) of the same article, it defines “bank under formation” as banking share company under formation which fulfills all of the following as of effective date of this directives: a. its capital has been fully subscribed, b. collected in cash from its founding shareholders a minimum capital of birr 75 million (birr seventyfive million) and deposited in an existing bank in the name and to the account of the bank under formation, c. held its founding general shareholder meeting which elected board of directors and approved articles and memorandum of associations, and d. submitted final application for banking business to the national bank of ethiopia the definition that is given to the “bank under formation” that obliges the fulfillments of all requirements enumerated above excluded zamzam bank from the list of “bank under formation”. because, this directive was issued, while there was zamzam bank’s application pursuant to directive no. sbb/24/99 which was waiting for approvals but not yet approved. the application fulfills the requirements under a & b but not under c & d. this directive was also issued while there was another letter from zamzam bank that was written on august 9, 2011 with reference number zzbuf/102/2011 (following the july 18, 2011 nbe letter that request ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 to take back the application documents) which was demanding for the speedy approvals.11 while there were application and the letter demanding the approval of the same, instead of approving the application which was there, coming with the declaration which did not take in to consideration the application there (i.e. coming with definition which excludes zamzam bank from the bank under formation) showed that something unpleasant was going on12 . the last event that wears away the hope of many for the establishment of ffifbb was the enactment of the final directive under caption that is directive no. sbb/ 51/2011. this directive drops the clause for ffifbb that was under its preceding draft directives. the provisions under the directive that is relevant for the issue at hand is, analyzed as follow: the directive defines “bank” as “a company licensed by the national bank to undertake banking business or a bank owned by the government”. according to this definition the bank is licensed to undertake banking business. the term banking business is already defined under the banking business proclamation no.592/2008. here it is referring to those conventional banks that are already licensed to undertake banking business as per the definition of proclamation no.592/2008. under article 4(1) it states that:-a bank shall obtain a written authorization from the national bank to carry on interest free banking business. when we combine these two articles it gives the meaning: conventional banks interested to carry on ifbb shall obtain a written authorization from the nbe. article 4(2) of the directive provides a list of requirements for those conventional banks that wish to obtain an authorization to carry on ifbb. the wording of the enumeration under the provision is indicative of the same. it became clearer when it is seen in combination with sub 4(3). this article says after evaluating application submitted as per sub 4(2), the nbe, if satisfied, authorize the applicant to open an interest free banking window. ´interest free banking window´ is defined under 2(3) as “a unit within a conventional bank exclusively offering interest free banking services”. looking sub 4(2), 4(3) and 2(3) in combination gives the meaning: if the nbe is satisfied by application submitted as per 4(2), it will give authorization to conventional banks 11the letter says: “………we apply, in fact, for the approval of the selected board members and the beginning of registration and signing of the subscribers that will facilitate the many indoor activities of the bank that needs, ……….we are again requesting your esteemed office to reconsider our application and we were expecting to see something encouraging out this since we were order to take back all the document submitted……”this letter was written prior to one month before the effective date of this directive, following the july 18, 2011 nbe letter, by concerned to carry on ifbb as per sub 2(3). this directive obliges to carrying on ifbb as per sharia law under sub 2(2). however, in no place the directive expressly mentioned about the permissibility/nonpermissibility of ffifbb. nevertheless, it is based on this directive that nbe withdraws the application for zamzam bank which is intended for ffifbb. the reason to prohibit ffifbb is expressed by nbe bank supervision directorate ato solomon desta as follow: “we did not have experienced personnel in ethiopia on sharia-based banking services and product in ethiopia previously that is why we initially opted to start with interest-free window banking services”.13 iv. the otherwise interpretation of directive no. sbb/ 51/2011 we have seen in the above the analysis for this directive. in conjunction to this analysis we have also seen how the application for ffifbb is finally withdrawn. now here we will see the otherwise interpretation of this analysis. this is to mean: the previous analysis is made in probanning for ffifbb. however, here the analysis will be made in pro-permission for ffifbb. to start, the directive defines the term ´bank´ as company licensed by the national bank to undertake banking business or a bank owned by the government. it is referring to the licensed conventional banks to undertake banking business as per the definition of proclamation 592/2008. the indication to this become more clearer when it is seen in line with art.4(1) which says: a bank shall obtain a written authorization from the national bank to carry on interest free banking business. since they are licensed to undertake banking business as per the definition, the second authorization from the nbe becomes to engage on ifbb. had not been for ifbb, they are not required another authorization since they are already authorized/licensed by the nbe as per the definition. ifbb is defined art.2(2) as a banking business which works in compliance with sharia laws. the directive provide a preconditions /requirements for application under art.4(2) to those conventional banks who wishes to engage on ifbb. the directive promises to authorize for interest free banking window under art.4 (3) to those conventional banks, if it is satisfied with the requirement under the application. interest free stakeholders of zamzam bank those who are not happy by message under the letter. 12besides zamzam bank’s application, there are so many conventional banks applications which were approved and started the work while the application for zamzam bank is kept aside. this fact is mentioned in the same letter as: “since the inception of zamzam bank significant number of banks has started their way from non-existence to operation……” 13 see https://www.aljazeera.com/.../islami-banking-ethiopiaoffers-muslims-... ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 banking window is defined under art.2 (3) as: a unit within a conventional bank exclusively offering interest free banking services. when we see article 4(2&3) and 2(2&3) in conjunction, it gives the meaning that: conventional banks those which are authorized to involve on ifbb through exclusive window reserved to the same, shall work as per the sharia laws. from the analysis it become clear that the directive is narrating one side of the story and concerned with conventional banks:it is providing for the ability of conventional banks to carry on ifbb through a unit of window within the same; it is telling the obligation of conventional banks to have prior authorization to engage on ifbb; it is telling the requirement of application for conventional banks to engage on ifbb; it is telling ways of conducting ifbb in conventional banks etc… the directive does not indicate as to the permissibility or the otherwise of ffifbb. here query rises as to those who wish to establish ffifbb: are they allowed to establish ffifbb under this directive as it is silent on this regard? is there any prohibition for ffifbb under this directive that suit for the same? is the silence of directive in this regard can be taken as prohibition? does it necessitate to search the intention of nbe for withdrawal of the clause for ffifbb to determine the issue? as to the author the terminology which is used under this directive does not suffice to prohibit licensing for fffifbb since there no direct/indirect prohibition to the same. in commonly known legal principles anything which is not prohibited expressly or through interpretation is, permissible.14regarding to the definition given to ´bank´, since they are not a licensed conventional banks to engage on business activities, they are not required for the second authorization as per art.4 (1). they appear only as new applicants for ffifbb only as per the proclamation number 592/2008 and directive number sbb/50/2011. if their application is approved accordingly, they carry the business as per the sharia laws. in such circumstances, the remaining skipped provisions of the directive can be applied equally to them. therefore, according to the author there is query as to whether the directive no. sbb/51/2011 really trustworthy to prohibit ffifbb in ethiopia as per the nbe assertion. from this it can be concluded that the inaction of nbe to approve the application for ffifbb based on the assertion that the directive no. sbb/ 51/2011 prohibit the same is not proper. 14aguidetoreading,interpretingandapplyingstatutes,page 4 available at https://www.academia.edu/.../a_guide_to_reading_inte rpret... 15interview with atosintayewdesalegn, chief policy and financial analysis officer of nbe, addis ababa, 5 june 2019. v. directive to license and authorize interest free banking business no. sbb/72/2019 this directive is enacted as a replacement to directive no. sbb/ 51/2011.the directive is a 3page document and includes the following points: both ffifbb and ifbb through windows are permitted; both entities need to follow sharia law; both entities need to follow the same regulations and supervision as the other banks except on the interest rate, which does not apply. as far as both entities are concerned these are the only matter mentioned under the directive. there is no clarity as to whether the existing conventional banks can be changed to ffifbb and vice versa; there is no clarity as to whether conventional banks can deserve exclusively one /some of its branch’s for ffifbb; there is no clarity as to whether ffifbb can give conventional banks services through exclusive windows reserved for the same. both entities are obliged to undertake the business in a manner consistent to sharia/islamic law. at the same time they are obliged to comply with regulatory and supervisory requirement that apply to conventional banks. this regulatory and supervisory exercise can be characterized, on the one hand, by the recognition given to sharia law (islamic finance) and standard modes of operations as a legal and regulatory framework of the industry respectively, and on the other, the application of the default conventional banking regulations and supervisory frameworks on the sector. even if the normative status of islamic finance and the operational guidance of standard practices to the entities has not been denied by the directive, the summary application of the conventional banking regulatory and supervisory framework of the country on these sector, will may pose a risk of sharia incompatibility. in general the directive is very broad and does not provide any specificity in terms of rules and regulations to ensure the proper function of ffifbb. following the enactment of this directive the three ffifbb namely zamzam, hijra and nejashi applied to nbe and their application is pending.15 ifbb is unlike conventional banks it requires sophisticated management16. it needs strong careful, professional intelligent, strategic thinking and strong leadership 16 interview with ato mohammed abdo, human resource director of nbe, addis ababa, 5 june 2019.he replied that it is better to start with one strong islamic bank and latter expand it based on the experience and expertise acquired. he replied further it requires developing islamic banking and finance professionals this is what i have realized in islamic banking training i have attended in foreign country. ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 quality17. it need deep-rooted assessment of other countries experience in terms of legal, economic, financial, management, information technology etc18. in ethiopia we did not have enough experience previously as far as ifbb is concerned. as to the author initially starting with interest-free window banking services rather than ffifbb is goodness. still we did not have enough experienced personnel in ethiopia on ifbb. this being the case authorizing/licensing more than one ffifbb at this early stage may ensue failure. vi. conclusion and recommendations according to 2007central statistical authority of ethiopia, the ethiopian muslims are 34% of the total population. however, until now, no ffifbb products were available to service the muslim community. this fact may affect ethiopian muslims from owning financial sectors since holding a share from interest bearing financial sectors are against islamic sharia laws. this is mainly due to weak government policy to build inclusive economic stakeholder that provide equal opportunity to all. the country vision to become a lower middleincome country by 2025 through realization of inclusive economy in all its aspects under gtp ii can´t resolve economic exclusion that happens in this regard. following, when the public demand for ifbb increased, in respond to the same, the government comes with the permission for ifbb under the proclamation no.592/2008. forthwith the enactment of this proclamation the application for ffifbb is entered to nbe by name of zamzam bank. however, by enacting the directive no. sbb/51/2011 the nbe reduced the application of ifbb to a unit of window within conventional banks and ban the application for ffifbb. the enactment of directive no. sbb/72/2019, however, seems changed the situation. this directive allowed the establishment of ffifbb and following this directive different bank of the same applied for the formation. the proclamation no. 592/2008 only contains a single clause as to ifbb; it does not allow the establishment of ifbb as of right; it makes the establishment of the same conditional that depend on the enactment of the directive by nbe; the proclamation also did not oblige nbe to enact the directive in the area; the proclamation did not mention as to the type of ifbb that will be allowed; the proclamation also did not mention the purpose/reason to allow and the manner to perform the same; there is also no indication as to whether it is the one that will conduct in line with islamic laws or otherwise. regarding to directive no. sbb/72/2019: there is no clarity as to whether the 17 ibid existing conventional banks can be changed to ffifbb and vice versa; there is no clarity as to whether conventional banks can deserve exclusively one /some of its branch’s for ffifbb; there is no clarity as to whether ffifbb can give conventional banks services through exclusive windows reserved for the same; the directive oblige to undertake the business as per the sharia laws. simultaneously it obliges to comply with the regulatory and supervisory rule of conventional banks. here, there is a query as to what will happen if the sharia laws in one way and regulatory and supervisory rules on the other way contradict to each other. in general the directive is very broad and does not provide any specificity in terms of rules and regulations to ensure the proper function of ffifbb. as to the author there is no difference between directive no. sbb/ 51/2011 and directive no. sbb/72/2019 as both is permissive without specificity, not prohibitive to ffifbb. the only difference between the two is that the latter came with unequivocal language as to the permissibility of the same without specificity. hence, it can be concluded that the legal provision relating to ffifbb under proclamation no. 592/2008 and directive no. sbb/72/2019 is not enough to deal with the same. therefore, it calls for the amendment of both proclamation no. 592/2008 and directive no. sbb/72/2019. in this regard the author prefers to follow the approach under the 2nd draft release on october 8, 2010. it provides four possible option of ifbb formation. the 1stway is, it allowed establishing new ffifbb; the 2ndway is, it allowed converting existing conventional banks to ffifbb; the 3rdway is, it gives permission for conventional banks to participate on ifbb through opening windows exclusively reserved for the same. furthermore, it comes with 4th liberal idea of ifbb formation. it gives permission for ffifbb that is formed as per this directive, to give conventional bank service through exclusive window reserved for the same. this draft directive declared permission for ifbb with all its exhaustive possible options for its formation. also the necessary regulatory and supervisory redresses has to be made so that a suitable legal atmosphere would be created for the development of ffifbb. furthermore, since we have no enough experienced personnel in the area of ifbb the authorization of more than one ffifbb at this early stage may causes the flow of personnel from conventional banks that had been serving in exclusive windows to those ffifbb that may ensue the deterioration of the expertise in the conventional bank. even this flow may not satisfy the demand for the expertise in those ffifbb as the demand to the 18 ibid ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 same become huge due to many branches that will be opened in different parts of the country. this fact may causes to send a number of personnel abroad for training and experience sharing from other countries in order to satisfy the short term demand that may ensues the outflow of foreign currency. this factor may seriously affect the country economy especially at this moment where there is high shortage of foreign currency. also it is better for the organizer to come together and organize all the available resource to establish one strong ffifbb throughout the country for the moment. this may help them to learn from its progress and failure to expand another bank of the same in the future. as to the author since the entity is a new for the country in its nature this is the best mechanism to minimize the risk of failure if any. as to the author it is also better to opt at this moment to one ffifbb and focus in the awareness creation as the business is open to muslims and non-muslims equally even if the manner of undertaking the business is in according to islamic laws. this may help to avoid the confusion about the rumour that the establishment of ffifbb divides the society and banks in to muslims and non-muslims. finally, as to the author these and other similar factors may call to limit the number of authorization for ffifbb at this early stage to not more than one. ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 bibliography a guide to reading, interpreting and applying statutes, retrieved from https://www.academia.edu/.../a_guide_to_reading_inte rpret. abd hakim abd razak(2015), the fundamental of islamic banking and finance: a prologue,european journal of islamic finance. banking business proclamation no. 592/2008, federal negarit gazeta of the [2 ]federal democratic republic of ethiopia, 14th year no.57, addis ababa, 25th august,2008. biancone, p. p., & radwan, m. (2015). sharia compliant “possibility for italian smes”. european journal of islamic finance. biancone, p. p., & radwan, m. (2016). european companies: evaluation for sharia compliance “opportunities and challenges”. european journal of islamic finance, (5). biancone, p. p., & radwan, m. (2018). sharia-compliant financing for public utility infrastructure. utilities policy, 52, 88-94. biancone, p. p., & radwan, m. (2018). social finance and unconventional financing alternatives: an overview. european journal of islamic finance. biancone, p. p., & radwan, m. (2019). social finance and financing social enterprises: an islamic finance prospective. european journal of islamic finance. biancone, p., & secinaro, s. (2016). the equity crowdfunding italy: a model sharia compliant. european journal of islamic finance, 5, 1-10. directive to authorize interest free banking no. sbb/--/2011 directive to authorize the business of interest free banking no. sbb/ 51/2011 directive to license and authorize interest free banking business no. sbb/72/2019, directives for conducting interest freebanking no. sbb/-/2010, 2nd draft directives for conducting interest freebanking, no. sbb/-/2010, 1st draft dr. samir alamad (2017) islamic finance ethics and financial perception of consumer, european journal of islamic finance. minimum capital requirements for banks directive no. sbb/50/2011 mohamed hassan abdullahi (2012), the legal and regulatory framework of islamic banking in kenya: theory and practice, university of nairobi spencer j.coopchik, esq(2015), judicial decision-making in islamic banking and finance, european journal of islamic finance. summary of and statistical report of the population and housing census (2007) retrieved from www.ethiopianreview.com/pdf/001/cen2007_firstdraft(1).pdf the licensing and supervision of banking business proclamation no. 84/1994 ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5489 1 customer satisfaction and sharia service quality at surya mart ponorogo: case study from indonesia abstract — this study aims to evaluate the level of satisfaction and service quality through csi and ipa. the type of this study is quantitative approach under case study at surya mart ponorogo indonesia. the sample was 125 respondents. the variables of this study used sharia service quality and customer satisfaction composed of six dimensions: (1) compliance with islamic law, (2) assurance, (3) reliability, (4) tangibility, (5) empathy, and (6) responsiveness, and each dimension has three statement attributes. data were analyzed using importance performance analysis (ipa), cartesius diagram, and customer satisfaction index (csi). the findings of this study are, firstly, the results of the ipa. the second finding is that the top priority attribute (indicated in quadrant a of the cartesian diagram) is sharia service quality. the third is a 75.2% value for customer satisfaction with the quality of sharia services at surya mart supermarket ponorogo, indonesia, under csi analysis, indicating that customers do feel satisfied enough. keywords: customer satisfaction, performance, sharia service quality i. introduction global competition has become an unavoidable phenomenon in commerce characterized by rapid changes in the communications, information, and technology sectors. in that era, production and service desperately require new capabilities to make the company successful in commerce. excellent service has become a demand for each company to compete effectively in the competitive world of commerce. [1] there is a dislocation paradigm from a dominant goods logic to dominant service logic. individuals and organizations exchange services with each other, while goods, money, networks, or organizations being additional mediators or facilitators of this exchange.[2] statistical central agency (bps) ponorogo, indonesia data from 2017 for ponorogo indonesia indicates that there were 913 owners of trade business licenses (siup) issued by the integrated licensing services office (kppt) of ponorogo indonesia. viewed by business sector, most of the listed businesses in the trade sector (36.80%), the agricultural sector (16.43%), and the social services sector (13.47%). it is evident from the development of existing trade businesses that both large, medium and micro-businesses must compete to survive and develop. [3] companies must provide satisfaction to customers to gain competitive advantage in this globalize context, example include better quality, superior products, lower prices and faster services than competitors.[4] it is clear, therefore that the measurement of customer satisfaction is very useful. [5] table i structures of household consumption components in ponorogo, indonesia [6] consumption 2013 2014 2015 2016 2017 n o a b c d e f 1 food, beverages, and cigarettes 36,34 % 35,21% 34,95 % 34,57 % 34,00 % 2 clothing and footwear 3,34% 3,28% 3,22% 3,16% 3,16% 3 housing, tools, equipment, and housekeeping 8,62% 8,58% 8,49% 8,47% 8,46% 4 health & education 8,86% 8,65% 9,04% 9,12% 9,29% 5 transportation, communication, recreation, and cultural 22,69 % 23,67% 23,78 % 23,83 % 24,02 % 6 hotel & restaurant 14,73 % 15,13% 15,17 % 15,46 % 15,62 % 7 others 5,42% 5,48% 5,35% 5,39% 5,45% total consumption 100% 100% 100% 100% 100% source from indonesian statistics publications, 2019 table 1, reveals that the proportion of food expenditure tends to decrease from year to year: from 36.34% in 2013, it decreased to 35.21% in 2014, 34.95% in 2015, 34.57% in 2016, and 34% in 2017. it clearly from table 1 that the highest non-food expenditure was on transportation, communication, recreation, and culture in the range of 22% to 24% of total household final consumption. the highest level shinta maharani, asmak ab rahman, arif dwi septian submitted december 2020, revised april 2021, accepted april 2021 ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5489 2 of household consumption in ponorogo was on food, beverages, and cigarettes. it can purchase in supermarkets. this made supermarkets a focus for the researchers. islam is a religion that comprehensive regulates all aspects of human life, faiths, worship, morality, and muamalah; however, the benefits of muamalah islamic economics tend to be ignored by muslims, requirements concerning riba, maysir, gharrar, and haram. [7] to enable every muslim to feel confident incorporating islamic economic into their lifestyle, producer must achieve customer satisfaction to evaluate their business. customers satisfaction should therefore be measured regarding company services in the islamic business system. table ii growth data of banks in indonesia [8] details 2010 2011 2012 2013 2014 2015 2016 2017 commercial banks national government bank banks 4 4 4 4 4 4 4 4 bank offices 4189 14145 15632 r 16637 17430 r 17809 18106 18262 regional government bank banks 26 26 26 26 26 26 26 27 bank offices 1413 1 472 2 802 r 3254 r 3524 r 3781 3926 4130 national private bank banks 57 56 56 56 56 55 r 52 50 bank offices 6 526 7108 9275 r 9465 r 9226 r 9052 8384 7680 sharia commercial bank banks 11 11 11 11 12 12 13 13 bank offices 1215 1390 1734 1987 2163 1990 1869 1825 foreign and mixed banks banks 24 23 23 23 21 21 r 21 21 bank offices 494 465 502 r 504 r 396 r 331 445 388 amount bank 122 120 120 120 119 118 116 115 bank office 13837 24580 29945 r 31847 r 32739 r 32963 32730 32285 note: correction number 1 exclude bank muamalat source from indonesian statistics publications, 2019 table 2 show that the growth rate increased in existing banks over 2010-2017 by 18%. besides growth experienced by sharia banks, only local government banks grew by 0.3%, other banks decreased by 14%, both national private, foreign and joint venture banks. based on this data, it seems that is increasingly in the interests of indonesians sharia products or for companies to implement sharia concepts. this is also related to the object of this research. since the construction of surya mart supermarket ponorogo indonesia, a muhammadiyah-owned enterprise (bumm) on november 10, 1999, this supermarket has consistently implemented quality sharia services to gain customer satisfaction. although customer satisfaction is abstract, it can be measured through scientific research. ii. sharia service quality (carter) according to zeithaml,[9] service quality is the quality of service received by customers measured by the significant difference between their expectations or desires. this study’s, authors used the carter model formulated by othman abdul awe and lynn owen.[10] this is a variable instrument used to define and measure the quality of sharia services; it is used as a quality assessment tool. the carter measurement mechanism is the same as the 1988 servqual method of parasuraman, berry, and ziethaml, except that the carter method adds a sixth dimension: compliance with islamic law.[11] carter is an acronym for compliance with islamic law, assurance, reliability, tangibles, empathy, and responsiveness. surya mart supermarket ponorogo operates under islamic law and avoids transactions prohibited by islam such as pork, beer, alcoholic drinks, and gharar.[12] “assurance” is the knowledge and courtesy of employees and their ability to convey trust and confidence. it includes verbal and written communication between store staff and customers. in this variable, surya mart supermarket ponorogo should have employees who work well and skillfully to encourage their customers to trust the store; safe from fear, distrust and danger, islamic service should be good and polite. “reliability” is the ability to realise the promise of service, reliability, and accuracy. in this case, surya mart supermarket ponorogo must match customer expectations, be timely in providing services to every customer without errors, have a sympathetic attitude, and high accuracy. “tangibility” is the ability to show promise of service, reliability, and accuracy. in this case, surya mart supermarket ponorogo must match customer expectations, being timely in providing services to every customer without errors, sympathye, and high accuracy. “empathy” is a caring attitude. the store must understands customer problems and interests. surya mart supermarket ponorogo must have understanding and knowledge of its customers. the store should understands specific customer need and also have a comfortable operating time for customers.[13] “responsiveness” is a willingness to help customers and provide fast service. surya mart supermarket ponorogo should help and respond to customers with quick information. customers should not need to wait because this will lead to negative and undesirable perceptions of service quality. ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5489 3 1. relationship between quality of service and customer satisfaction. according to kotler; the relationship between quality of service and customer satisfaction is the ratio of expectations to perceived performance or results. generally, customer expectations are estimates or beliefs about what they will receive when they purchase or consume a product or service.[14] perceived performance is the customer's perception of what they receive after consuming the product they purchased. it can be formulated thus: z = x / y, where z is customer satisfaction, x is the quality perceived by customers, and y is the needs, desires, and expectations of customers. feeling satisfied or dissatisfied is the comparison between customer expectations and the reality of service quality felt by customers. 2. islamic customer satisfaction “customer satisfaction” is the feeling of happiness or disappointment; after comparing the expectations of products or services with performance. if performance is below expectations, then the customer will not be satisfied, vice versa; if it meets or exceeds expectations, then the customer will be satisfied.[15] satisfaction in islam is linked to qana'ah; not only feeling happy or disappointed after comparing the expectations of products or services felt by customers but also after sincerely acceptings whatever conditions are experienced, customers whether rich or poor are always satisfied. [16] qana'ah comprises a flexible quality of satisfaction, that of a person's physical and mental satisfaction, in islam, the goal of consumption is to achieve falah in the world and hereafter. iii. methodology this research uses a quantitative approach.[17] the researchers applied pre-research with a validity and reliability test to initial 30 respondents, with all the data tested and declared valid and reliable. the researchers applied natural analysis techniques, cartesian diagrams, and csi to the data collected. using solvin’s formula, the instrument used in this study was the distribution of questionnaires to 125 respondents from ponorogo’s population. the dependent variable y = customer satisfaction. with the independent variable / x = x1 = compliance with islamic law, x2 = assurance, x3 = reliability, x4 = tangibility, x5 = empathy, x6 = responsiveness. for more details, the model of research represented in figure 1: this research used a non-probability sampling method with accidental sampling to determine a random sample. anyone who met with researchers was addressed as a respondent; the final sample obtained 125 respondents. data was processed using microsoft excel 2010 and spss 16 for windows to test validity and reliability. the ipa method was used to analyse important attributes and performance reports to measure customer satisfaction. the pre-research test comprised 30 respondents asked 18 questions; it used 0.05 or 5% of the r table level of 0.349. for pre-results; the interests and satisfaction above 18 variables from 30 respondents were declared valid. the value of the validity with kpt 12 of 0.888 was the highest, while the lowest kpt 11 was 0.682. the satisfaction validation test's calculated value with kps 7 of 0.888 was the highest, while the lowest kps 3 was 0.481. table iii pre-research interest test reliability reliability statistics cronbach’s alpha n of items 0.961 18 source: primary data processed, 2019 reliability testing is performed after the validity test result. the following are the results of the reliability test of the variables of importance and satisfaction: assurance (x2) reliability (x3) tangible (x4) empathy(x5) responsiveness (x6) csi, ipa, dk customer satisfaction (y) compliance (x1) ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5489 4 table iv pre-research satisfaction reliability reliability statistics cronbach’s alpha n of items 0.948 18 source: primary data processed, 2019 the test results obtained a cronbach's alpha of the satisfaction variable of 0.948> 0.60, which means that data is reliable or consistent. 1. importance performance analysis (ipa) to determine the value of the level of sharia service quality surya mart supermarket ponorogo used the ipa method, an technique that measures the attributes of the level of importance and performance level.[18] analysis of the levels of importance and performance is measured using a five point likert scale. the range for each scale is: number of measurement scales = (xib xik) where: xib = most significant score that could be obtained assuming that all respondents gave essential answers xik = most significant score that could be obtained assuming that all respondents gave unimportant answers. the formula used to determine the priority level of factors that influence customer satisfaction is: where: tki = the level of suitability of the respondent xi = score of customer assessment at the level of performance reports. yi = the score from the customer's rating at the attribute level of interest. the level of suitability is used to determine the extent of customer satisfaction. if the suitability score is above the average value (> 100%), then the customer feels delighted if the suitability score equals the total average, then the customer is not satisfied. 1. cartesian diagram the cartesian diagram is a diagram formed from two axes. the axis (x) represents the performance level score with the importance level score represented by the vertical axis (y). the score used to fill each attribute is the average score obtained by dividing the total score of importance level by the total respondents represented by yi and xi is the result of dividing the total score of performance level by the total respondents, using the formula: ∑ xi ∑ yi n n where: xi = average score of performance level for each attribute. yi = average score of the importance of each attribute. n = number of respondents iv. discussion to determine the value of the level of sharia service quality at surya mart supermarket in ponorogo indonesia in this study, the researcher used ipa to measure the attributes of the level of importance and performance. the attribute “there are facilities such as toilets, prayer rooms, administrative offices and sufficient parking spaces for customers” is a top priority because has lowest suitability score of 83.09%. surya supermarkets do not sell illicit products such as liquor and pork which is the attribute with the highest conformity level, with a value of 93.48% approaching 100% score of perfect. this attribute is thus the lowest priority because it has the highest conformity value. the 16 other attributes have a percentage level of suitability that is below 100%, so customers are not completely delighted. in general, the average level of appropriateness for all service attributes provided has not reached 100%. however, it could be argued that the level of performance of surya mart supermarket at ponorogo is relatively good because it is almost 100%. the researcher succeeded in analyzing the quality attributes of sharia services at this supermarket by grouping them thus into four quadrants: x= y= ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5489 5 figure 2 analysis of cartesian diagram 2, 2. level of customer satisfaction at surya mart supermarket ponorogo, indonesia. the customer satisfaction index of surya mart supermarket ponorogo indonesia is 75.2%, with a value in the csi value range from 0.66 0.80, meaning that overall customers are satisfied with the services provided there. although customer satisfaction is abstract, ephemeral, and relative, the presence of this research could provide scientific clarity relating to the level of customer satisfaction [19] at surya mart supermarket. to understand the needs and measure customer satisfaction, surya mart supermarket at ponorogo indonesia must keep customers loyal, not moving to other stores. for more details, see the table v below: table v customer satisfaction index (csi) no nomor atribut mean of importanc e (y) weighte d factor (wf) (per centage) mean of performan ce (x) weighte d score (ws) 1 kpt/s 1 4,37 5,66 a 3,89 0,22 b 2 kpt/s 2 4,45 5,76 4,16 0,23 3 kpt/s 3 4,29 5,55 3,89 0,21 4 kpt/s 4 4,29 5,55 3,73 0,20 5 kpt/s 5 4,19 5,42 3,79 0,20 6 kpt/s 6 4,23 5,47 3,81 0,20 7 kpt/s 7 4,33 5,60 3,82 0,21 8 kpt/s 8 4,29 5,55 3,80 0,20 9 kpt/s 9 4,32 5,59 3,69 0,21 10 kpt/s 10 4,14 5,36 3,44 0,24 11 kpt/s 11 4,28 5,54 3,70 0,22 12 kpt/s 12 4,16 5,38 3,71 0,22 13 kpt/s 13 4,29 5,55 3,70 0,21 14 kpt/s 14 4,34 5,62 3,71 0,19 15 kpt/s 15 4,25 5,50 3,89 0,21 16 kpt/s 16 4,36 5,64 3,79 0,20 17 kpt/s 17 4,29 5,55 3,66 0,19 18 kpt/s 18 4,32 5,59 3,74 0,20 19 total 77,19 100 67,92 3,76 c 20 weighted total (wt) 21 customer satisfaction index (csi) 75,2% d a. (4,37 : 77,19 x 100) = 5,66 b. (5,66 x 3,89) : 100 = 0,22 c. 0,22 + 0,23 + 0,21 + 0,20 + 0,20 + 0,20 + 0,21 + 0,20 + 0,21 + 0,24 + 0,22 + 0,22 + 0,21 + 0,19 + 0,21 + 0,20 + 0,19 + 0,20 = 3,76 d. (3,76/5 x 100) = 75,2% v. conclusion based on the table v, three things can be concluded related to the formulation of the problem: 1. based on the ipa analysis at the level of conformity, given the priority order of the gap from the results of the gap analysis or gap between the level of importance and performance at surya mart supermarket ponorogo, indonesia, it can be deduced that the attributes in quadrant a of top priority are sharia service attributes, which should therefore be prioritized. in order to increase customer satisfaction, the employees of surya supermarket must assure six sharia service attributes: (4) maintaining politeness towards their customers, (9) reliable preparation of goods, which are easier for customers to buy, (13) served with sincerity (14); customers needs and desires are fulfilled, (17) responsively in receiving complaints and (18) employees are disciplined in serving. according to csi analysis, the value of ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5489 6 customer satisfaction in the quality of sharia services at surya mart supermarket ponorogo indonesia is 75.2%, which means that customers are satisfied. 2. the management of surya mart supermarket, ponorogo, indonesia must prioritizes improvement of the performance of sharia services' quality attributes included in quadrant a (top priority). to increase customer satisfaction the attributes in quadrants b, c, and d only need to be maintained and do not need to be prioritized and for improvement. management should provide better islamic service innovation because the level of customer satisfaction in the quality of sharia services is 75.2%, indicating that customers feel that their satisfaction can be increased into the range of 80%–-100%, as very satisfied. customer satisfaction is abstract and ephemeral. it needs to be refreshed to make services even better. research related to the analysis of customer satisfaction on the quality of sharia services must be conducted from time to time so that surya mart supermarket ponorogo indonesia can evaluate its service sector's performance to increase customer satisfaction and loyalty. acknowledgment thanks to the university of malaya for the opportunity of a post-doctoral research fellowship, and the state institute of islamic studies, ponorogo, indonesia for the opportunity. references [1] freddy rangkuti, measuring customer satisfaction (jakarta: gramedia pustaka utama, 2002), pp. 8. [2] fandy tjiptono, service management mewujudkan layanan prima, edisi 2 (yogyakarta: andi, 2012), pp. 5. [3] badan pusat statistik kabupaten ponorogo, statistik daerah kabupaten ponorogo 2018, katalog 1102001.3502, nomer publikasi 35020.1826, 20. [4] supranto, pengukuran tingkat kepuasan pelanggan (jakarta: rineka cipta, 2011), pp.1. [5] freddy rangkuti, measuring customer satisfaction, (jakarta: gramedia pustaka utama, 2002), pp.5. [6] badan pusat statistik ponorogo, produk domestik regional bruto kabupaten ponorogo menurut pengeluaran 2013 – 2017, catalog: 9302023.3502, nomor publication: 35020.1803, pp. 38. [7] mardani, fiqh ekonomi syariah fiqh muamalah, cet. 2 (jakarta: kencana, 2013), pp. 5-6. [8] https://www.bps.go.id/statictable/2015/09/28/1856/bank-dan-kantor-bank-2010---2017.html accessed november 12, 2018. [9] zeithaml et. al. in fajar laksana, quality service in marketing management (yogyakarta: graha ilmu, 2008), pp.88. [10] abdul othman qawi & lynn owen. “adopting and measuring customer service quality in islamic banks: a case study in kuwait finance house” in international journal of islamic financial service, (vol. 3 no. 1), pp.10. [11] parasuraman and zeithaml. spring (1988), servqual: a multipleitem scale for measuring consumer perception of service quality. journal of retailing.volume 64. number 1 [12] ahmad muhammad yusuf, himpunan dalil dalam al-quran dan hadits, 5 (jakarta: pt segoro madu pustaka, 2008), pp.16. [13] fandy tjiptono, service management mewujudkan layanan prima, edisi 2 (yogyakarta: andi, 2012), pp.175. [ 1 4] philip kotler, marketing management 14th edition, pearson, global edition. [15] fandy tjiptono, service management mewujudkan layanan prima, edisi 2, (yogyakarta: andi publisher). pp.175. [16] ahmad muhammad yusuf, jilid 4, himpunan dalil dalam al-quran dan hadits, jilid 5 jakarta: pt segoro madu pustaka, pp.329. [17] sugiyono, (2016), metode penelitian kuantitatif, kualitatif dan r&d, alfabeta. [18] freddy rangkuti, measuring customer satisfaction, (jakarta: gramedia pustaka utama, 2002), pp. 109 [19] biancone, p p, and radwan m. 2019. “social finance and financing social enterprises: an islamic finance prospective.” european journal of islamic finance 0 (0). https://doi.org/10.13135/2421-2172/3176. https://www.bps.go.id/statictable/2015/09/28/1856/bank-dan-kantor-bank--2010---2017.html https://www.bps.go.id/statictable/2015/09/28/1856/bank-dan-kantor-bank--2010---2017.html ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5489 7 paper title (use style: paper title) takaful industry and blockchain: challenges and opportunities for costs’ reduction in islamic insurance companies 1. department of management, university of turin (italy) 2. centre for entrepreneurship, university of st. gallen (switzerland) abstract— takaful insurance is increasing its consideration. islamic insurance provides mutual aid and protection. however, the different model does not always make the business efficient. several studies have shown the difficulty of takaful companies in limiting their operating costs and having efficient borders. to reduce such operating costs and reach economies of scale, this paper assesses the adoption of the blockchain technology as a critical value for the islamic insurance industry. building upon a literature review and drawing on the swot framework, this paper outlines internal strengths and weaknesses as well as external opportunities and threats. our analysis reveals that the blockchain technology can help in the reduction of fraud, increase timeliness of actions for customers, allow for faster and more efficient management of claims and improve the risk management. theoretical and practical implications are discussed. keywords: takaful, islamic finance, blockchain, distributed ledger technologies i. introduction takaful aims to offer an islamic and shari’ah alternative to conventional insurance models [1]. there are three main differences between conventional and islamic insurance. first, the most significant feature is the nature of the contract, which oversees the relationship between policyholders and companies. conventional insurance is based on the risk transfer idea, the person who needs protection from a specific event transfers the risk to the insurance company in exchange for the payment of a cash premium [2], [3]. instead, the islamic insurance tool provides mutual aid and protection for both individual and corporate bodies [2]. takaful is a contract in which the participants regularly contribute to a mutual fund and subsequently guarantee each other the compensation of any specific risks [1], [4]. second, as a consequence of the first, in takaful, insurances changed the relationship between insured person and insurer [5]. this difference is determined indirectly from shari’ah law which through the precepts of gharar (uncertainty), maisir (gambling) and interest rate (riba) not allowing the recognition of traditional insurance [6]–[8]. third, as with conventional insurance, takaful generates profits. instead of being distributed to shareholders, these profits are given to the protection fund itself according to the mutual and cooperative purpose of the contract [1], [2], [9]. also, the manager of the operations receives a remuneration which is a percentage function of the operating surplus carried out [5]. briefly, according to the related literature the first takaful was set up in malaysia by “the islamic insurance company” in 1979 after a long process of discussion between academics and professionals [5]. so, islamic insurance is relatively new and after first experiences in malaysia, also saudi arabia, uae and bahrain established and recognized takafuls as a eligible medium [9]. despite this limited period, according to the report of shereen et al. (2018) takaful assets have grown from us$31 billion in 2012 to us$46 billion in 2017 with a cagr of 6%. moreover, the same report predicts that takaful's assets will reach us$72 billion in 2023 making the topic critical for research. at the same time, this growth is partly opposed by conflicting studies in terms of costs efficiency compared to traditional insurance companies [11]. the study of akhtar (2018) highlight that takaful companies in saudi arabia tend to outperform in terms of efficiency scores. however, there remain some problems in terms of the additional costs to be incurred in order to be shari’ah compliant. although with opposite results, studies also argue that takaful companies should control operating costs and make economies of scale to increase efficiency [13], [14]. one of the most important technologies in the last years allowing for increased efficiency and transparency is blockchain. the term means a chain of block which links together different peer-to-peer computers that are able to share information [15]. due to its technical characteristics as decentralization and authentication, blockchain allows replacing the management of the firm’s traditional information system [16]. with a general and distributed ledger, different computers (nodes) could add and share information among the maha radwan1, davide calandra1, paris koumbarakis2, federica lanzara1 ejif ± european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 network reducing operative costs and increasing transparency [17]. given these benefits, this paper explores the possibility of using blockchain, as a critical value for the islamic insurance industry, in order to reduce operating costs and reach economies of scale. for this reason, the research question is: how blockchain could be useful for the takaful industry by reducing costs? the paper aims to assist takaixo¶v�lqvxudqfh�pdqdjhphqw� in the challenge of reducing costs maintaining competition with the traditional insurance sector. the paper is organized as follow. section 2 outlines general and takaful structures. section 3 analyses the main characteristics of blockchain. section 4 explains the practical applications that blockchain could have in takaful insurance. section 5 discusses and concludes using the swot analysis framework considering internal strengths and weaknesses; as well as, external threats and opportunities of blockchain in takaful industry. the section also provides limitations and future implications. ii. takaful 7kh�,vodplf�lqvxudqfh�³7dndixo´�lpsolhv�³vrolgdulw\´��lv�vhw� up in a cooperative model and incorporates social welfare ideals [1]. compared to the traditional insurance in which an lqglylgxdo�lqvxuhg�sd\v�d�suhplxp�lq�h[fkdqjh�iru�wkh�ulvn¶v� shift, the islamic model is based on the sharing of risk within the same social group [1], [5]. the differences concerning the conventional model include several elements. first, the islamic approach considers the payment of the insurance premium and awaiting any adverse event a gamble. this element goes against the principle of gharar (uncertainty) [18], and is admitted through the tabarru, which is a financial disbursement in terms of donation made by the participants [19]. second, the islamic perspective considers traditional insurance as gambling and for this reason, prohibited (maysir) [2]. third, it frqfhuqv�lqyhvwphqwv¶�phwkrg�ri�suhplxpv�zklfk� do not respect the islamic finance rule of riba the prohibition of interest rate [6], [18]. fourth, for insurance companies, profit derives from the management of the risk of the insurance contract and not from the assumption of the risk [18]. the main structures that will be explained are the mudarabah and the wakal models. the template is used to format your paper and style the text. all margins, column widths, line spaces, and text fonts are prescribed; please do not alter them. you may note peculiarities. for example, the head margin in this template measures proportionately more than is customary. this measurement and others are deliberate, using specifications that anticipate your paper as one part of the entire proceedings, and not as an independent document. please do not revise any of the current designations. iii. mudarabah model according to the mudarabah model, the participants of the fund (rabb al-mal) contribute the capital to another person who is delegated to carry out investment actiylwlhv��7dndixo¶v� manager mudarib), and to share the profits according to a predeterminate ratio [1], [5]. if there are losses, they will be shared among the fund participants, in case of negligence, and the manager takaful will also participate [9]. as shown in figure 1, the underwriting of takaful policies provighv� suhplxpv¶� fuhglwlqj� lq� d� vhsdudwh� dffrxqw�� zklfk� lv� tabarru [18]. this account belongs to the participants, the manager participates if profits are made. the model is particularly favourable for use in life insurance [2]. therefore, the insured amount depends on the payments into the tabarru account and on the profits obtained, always considering the minimum guaranteed in case of adverse event [18]. fig. 1. mudarabah model source: [18] iv. wakala model the wakala model is based on the agency contract [9]. the participants in the takaful insurance fund (wakil) delegate one person (takaful operator) who manages the risk of the fund [1]. upon subscription by the participants, through a donation, the wakil will be authorized to carry out two activities: underwriting takaful and investments activities [5]. the wakala model provides for the subscription of the investment fund and the risk fund based on the tabarru [18]. the agency agreement provides for the payment by the participants of a percentage fee of the managed funds (wakala fee) to cover management costs and a performance fee. part of the donated sum will be invested and managed in halal assets, typically public securities and securities of financial companies [18]. the amount managed by the investment fund will be paid to participants in case of an adverse event, while those of the identify applicable sponsor/s here. if no sponsors, delete this text box. (sponsors) ejif ± european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 risk fund will be used for refunds. in the case of surplus or profit, the balance can be distributed to the wakil in proportion to the donations made by them [1]. fig. 2. wakala model source: [18] v. blockchain according to rainero et al. (2019), blockchain is one of the most persistent characters in the last year. the definition is confirmed by a large number of applications as reported by the systematic analysis of casino et al. (2019). the essential characteristic of blockchain is related to the logic of consensus [22]. blockchain is set up by many interconnected nodes (peerto-peer computers). effectively, blockchain is a communication protocol made up of a series of blocks identified by a hash, a non-reversible algorithmic function. as summarized in figure 3, each new transaction or information must be validated through a consensus mechanism before being recorded in the shared ledger. the validation process, based on the decision of the connected nodes, decides whether to validate or not the transaction. the confirmation of a transaction contributes to the creation of the blockchain. by contrast, in case the validation process is not favourable, it is not inserted in the blockchain. in order to create a new block, preventive control and validation by the network are necessary [22]. this requires the uhvroxwlrq� ri� pdwkhpdwlfdo� sureohpv� e\� ³miners´�� zkr� dovr� contribute to making the information entered cryptographically non-attachable. fig. 3. validation process of transaction using blockchain source: dxwkruv¶�hoderudwlrq in the blockchain, there are different levels of consensus. one of the best known is proof-of-work (pow), which requires the resolution of high intensify mathematical problems to ensure verifiability and immutability of transaction, and which for this reason require a large amount of energy [23]. alternatively, the proof-of-stake (pos) algorithm can be used. in this case, the creation of a new block, and therefore, its consensus is entrusted through selections of random combinations to the network [24]. the analysis of the literature highlights various types of %orfnfkdlq�ghshqglqj�rq�wkh�fuhdwlrq¶v�uxohv�� first, public blockchain is characterized by a participatory and democratic process [15]. everyone can carry out operations and create a new node in the blockchain (after verifying consensus). secondly, private blockchain is built-in private ecosystems and the actors involved in validating and entering transactions are carefully selected and authorized. this allows to increase the level of privacy but goes against the original idea of public and distributed registry [25]. vi. the use of blockchain in takaful industry after one of the essential elements of blockchain is transparency, which is also relevant for islamic finance [6], [22]. other advantages and disadvantages can be highlighted from the application of blockchain within the islamic insurance industry. first, the management of claims by the unchangeable and distributed register will contributes to the reduction of fraud between insurance companies through the integrated analysis of complaints received. one of the direct implications is towards the motor insurance branch. using iot systems and sensors, it will be possible to identify adverse events. this contributes on the one hand to the reduction of fraud and, on the other, increases the timeliness of actions towards the customers. this could be possible by including in the network also other subjects such as experts and police forces able to verify the truthfulness of the information provided. secondly, the presence of a shared and immutable ledger will allow for faster and more efficient management of claims by companies using intelligent contracts. in the same way, the management of the payments of the donations will allow a saving in terms of time for the islamic companies. thirdly, the presence of shared public databases will allow companies to identify information on the risk merit of all takaful participants. fourthly, claims management will allow clients to monitor the process in real-time, avoiding elements of uncertainty and lack of transparency, also through the valid proof of the terms of issuance of policies. ejif ± european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 vii. discussion and conclusion following the primary blockchain literature, the potential lies in the possibility of reducing costs, increasing transparency and reducing the information asymmetry between contractual counterparties [15], [22]. the implementation of blockchain in the at the insurance level can potentially decrease repetitive actions and thus decrease the gap compared to traditional insurance companies [8], [18]. the use of the blockchain at first can be implemented for the management of payments by subscribers. besides, this would also allow the creation of a single decentralized database capable of perceiving any fraud due to repeated claims. with the creation of the transaction, all the information will be shared in the network. this paper aims to support the strategic choices of managers of takaful insurance companies. for this reason, table 1 shows the swot analysis of the implementation of blockchain in the takaful industry [26]. one of the main strengths of blockchain is the accessibility of information in real-time and distributed [15]. in the insurance field, this allows for an increase in transparency, as established by gharar [7]. moreover, insurance managers could implement blockchain also in order to reduce fraud by sharing and verifying distributed records. on the other hand, the use of blockchain may also have weakness issues. as stated by conte de leon et al. (2017) and mehar et al. (2019), in june 2016 the registers distributed on the network of blocks were hacked in this way violating the code and information present in the intelligent contracts. in addition to causing damage of 50 million dollars. furthermore, the resolution of high intensifies mathematical problems to ensure verifiability and immutability of transaction required a large amount of energy [23]. externally, the opportunities appear to be countless. managers will be able to invest resources in the creation of pilot projects aimed at reducing operating costs. therefore, at least in the short term in case of operations, reduce the gap in terms of efficiency highlighted by the contributions of various researchers [8], [12]±[14]. at the same time, the possible implementation of the blockchain is not free from threats. first, due to the primary use of technology in insurance, this may lead to failure and loss of investment. finally, as shown, blockchain is not free of threats, which is why it will be necessary to establish guidelines for the privacy of insured persons. table i. swot analysis of blockchain in takaful insurance industry strengths weakness 1. accessibility of information 2. increasing transparency in favour of the halal precepts 3. reduce fraud by sharing and verifying distributed records 4. improving operational efficiency 1. verification of consensus and possibility of data manipulation 2. energy consumption opportunities threats 1. creation of pilot projects on individual insurance products 2. reduction of operating costs 3. gap reduction compared to traditional insurance companies 1. early stage adoption 2. investment costs 3. need to define guidelines for the privacy of information source: dxwkruv¶�hoderudwlrq at the same time, the possible implementation of the blockchain is not free from threats. first, due to the primary use of technology in insurance, this may lead to failure and loss of investment. the paper has various limitations. given that this research is still in a very early phase future empirical analyses are necessary and planned in form of case studies. moreover, further research is needed in order to highlight whether managers of takaful companies will be willing to make investments in blockchain acknowledgment authors are grateful for the useful discussion during the european journal of islamic finance workshop held in october 2019. references [1] masud h. 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(2019). a systematic literature review of blockchain-based applications: current status, classification and open issues, telematics and informatics, vol. 36, 55±81. doi: 10.1016/j.tele.2018.11.006. [22] iansiti m., lakhani k. r. (2017). the truth about blockchain, harvard business review. available at: https://hbr.org/2017/01/the-truth-aboutblockchain. [23] coyne j. g., mcmickle p. l. (2017). can blockchains serve an accounting purpose?, journal of emerging technologies in accounting, vol. 14, n. 2, 101±111. doi: https://doi.org/10.2308/jeta-51910. [24] kiayias a., russell a., david b., oliynykov r. (2017). ouroboros: a provably secure proof-of-stake blockchain protocol, in advances in cryptology ± crypto, 357±388. [25] 2¶/hdu\ d. e. (2017). configuring blockchain architectures for transaction information in blockchain consortiums: the case of accounting and supply chain systems., intelligent systems in accounting, finance & management, vol. 24, n. 4, 138±147. [26] jackson s. e., joshi a., erhardt n. l. (2003). recent research on team and organizational diversity: swot analysis and implications», journal of management, vol. 29, n. 6, 801±830. doi: 10.1016/s01492063_03_00080-1. [27] conte de leon d., stalick a. q., ananth jillepalli a., haney m. a., sheldon f. t. (2017). blockchain: properties and misconceptions, asia pacific journal of innovation and entrepreneurship, vol. 11 i, n. 3, 286± 300. doi: https://doi.org/10.1108/apjie-12-2017-034. [28] mehar m. i. (2019). understanding a revolutionary and flawed grand experiment in blockchain: the dao attack», jcit, vol. 21, n. 1, 19± 32. doi: 10.4018/jcit.2019010102. ejif ± european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4441 1 benchmarking of the tax situation of islamic financial instruments (*) university of turin, italy – valter.gamba@unito.it (**) university of turin, italy – eros.defilippis@unito.it (***) university of parma – veronica.tibiletti@unipr.it abstract— the ever-increasing trend of "islamic finance" has prompted many european countries to implement very different solutions to meet the needs arising; in particular, the regulatory systems have been implemented with legislative measures, or rather, financial administration has introduced interpretations so as to regulate the tax burden on islamic financial instruments. the contribution is addressed to the analysis of the current italian legislation namely to the investigation of the tax effects generated by islamic financial instruments on the different players by comparing with other countries such as the united kingdom and france, whose experience in this regard has proved to be important to achieve an accurate understanding of the evolution of the rules governing such instruments. this paper is therefore aimed at suggesting simplifying guidelines (given the economic and financial implications) to be implemented in terms of legislation, with a view to providing an italian standard for islamic financial instruments so as to leverage the different synergies arising from the regulation of such instruments. keywordstaxation; islamic financial instruments; europe; italy i. introduction the consolidated use of financial instruments in compliance with 1 the islamic religion (shari'ah) has required an extensive regulatory effort, aimed at determining not only each instrument within the legal systems of different countries in europe, but also at identifying the relevant tax system. the purpose of this paper is to evaluate the availability of a tax harmonization process in europe (eu and non-eu) in order to encourage, among other things, the free exchange of capital through the widespread use of such instruments in commercial 1 the commonly used term is shari’ah compliant [1]. and financial exchanges among economic and/or private players located in different countries. the purpose of this paper is to assess a process of tax harmonization at european level (eu and non-eu) to foster, inter alia, the free exchange of capital through the widespread use of such instruments in trade and financial exchanges among economic and/or private traders located in different countries. therefore, having focused on the details of the method, the countries which have implemented regulatory measures 2 were identified in order to select italy, france and the united kingdom as reference countries. such countries have been identified through a careful analysis of the regulations and procedures in force in each of the european union member states and a reference sample has been identified according to whether or not there have been significant measures governing the taxation of such instruments. while not attempting to examine the fundamental principles underlying islamic finance, such as the impossibility of lending money by receiving interest or signing random contracts, the following instruments have also been identified as targets of regulatory measures: murabaha, is a (goods) purchase agreement where the costs associated with the realization of the goods and the 2 even if not thoroughly analyzed, the presence of a direct correlation, within each state, between the spread of rules governing islamic instruments and the commercial exchange with islamic countries, as well as the presence of a population respectful of the religious prescriptions of the sharia'ah, is likely to exist. prof. valter gamba*, dr. eros de filippis** and prof. veronica tibiletti*** submitted april 2020, revised december 2020, accepted december 2020 ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4441 2 relevant margin are clearly defined so as to identify the sale price. such preliminary analysis removes any doubts about the characteristics of the goods to be sold; mudaraba and musharaka, are partnership agreements where the capital contributor is not entitled to a specified remuneration (due to the above-mentioned limitations on the interest right) but rather to a profit on the transaction, as well as losses incurred by each business participant; sukuk, are securities with specific characteristics, i.e., not linked to bonds entitled to a pre-set interest, but rather to a shareholding (undivided holding) of a property or assets. usually issued by investment funds which in turn hold a stake in the capital of a company. ijarah is a transaction whereby the bank is committed to purchase, upon customer's request, a specific asset from the supplier by leasing it to the customer in exchange for the recurring payment of a rent based on the cost of the asset plus a pre-set margin. in essence, the ownership of the asset is held by the bank and the right to use such asset, until the contract expires, belongs to the customer. istisna’a a transaction whereby the contract provides for an asset not yet existing (i.e. being produced or built) therefore the bank enters into a sale and purchase with the producer and then resells the asset to the customer against payment of a price equal to the cost of the asset plus a pre-set margin. payment can also be made in instalments, whereby the ownership right is assigned to the customer upon payment of the last instalment. concluding this paper, therefore, the main aims were to: evaluate the degree of evolution and harmonization of the different tax systems (italy, france and united kingdom) with regard to the taxation of islamic financial instruments; identify suggestions for a possible legislative evolution for countries experiencing significant regulatory and/or procedural weaknesses and gaps. ii. comparative analysis of the taxation of main countries' islamic instruments as a preliminary point, it should be emphasized that the methodological approach used in this article in order to achieve the beforementioned objectives of the research is comparative law 3 , as it is to be considered the most suitable in the present case. in fact, such methodology can compare different regulations with a specific content or a set of legal issues, specifically it is possible to analyze, at a first stage, one or 3 the methodology of comparative law is a relatively young academic discipline (the writings of david and brierley, [5] and schlesinger [6] are cited as a reference) that since its foundation, the main concern was to examine the main differences between systems [7]. more foreign legal systems and then match with other legal systems [2], often including, in that analysis, the national systems of those that make the comparison (although, in several studies, it has been noted that researchers have compared two or more foreign systems without any reference to their national jurisdictions [3]. a further line of research regards the analysis of an international system by comparing it with one or more national systems which have undergone a process of harmonization [4]. it is exactly from this comparative analysis between the different states that it is possible to understand the small differences between the law and – if it is considered effective – to improve in the country of those that carry out the survey. on the basis of this methodology, it was decided to make a comparison of two countries of europe, with particular regard to the united kingdom and france that introduced islamic financial instruments and related guidelines for their taxation, in order to be able to identify the peculiarities and then understand the best law for the italian system therefore, this paper revealed how the different countries govern the taxation of islamic financial instruments according to two different approaches: the first involves the adoption of a specific legislation for islamic finance with substantial amendments to the relevant tax rules, while the other provides for some further information from the tax authorities, without issuing or amending the legislation on the taxation of financial instruments [2]. although pursuing two different approaches, those countries which have introduced islamic finance into their system are consistent with the principle of the prevalence of substance over form with respect to islamic financial instruments, the purpose of which is to avoid the application of disproportionate tax burdens, thus favoring the spread of such instruments throughout the country. the united kingdom (which is no longer part of the european union since the february 1st, 2020) is undoubtedly the most cutting edge 4 among all the countries in europe with the strongest experience in the field of islamic financial instruments 5 . as a matter of fact, it has been able to attract the most important islamic banks, not least, thanks to the considerable islamic resident population (a direct consequence 4 just think that london launched the first app for muslim savers [8] 5 the most advanced countries, besides great britain, are hong kong and malaysia; nevertheless, many other countries are tackling "the issue no tax administration in the oecd has yet decided to challenge this issue, starting with the us, considering it to be off limits. according to a research of the last ifa congress -international fiscal association held in london in september 2018, roughly every single consultant in the western world will be affected in the coming years by the problem of compliance with islamic finance. just from great britain come the first case-study about the meaning of trying to integrate, from the tax point of view, schemes which have nothing of homogeneous, indeed [9] ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4441 3 of the strong historical connections with many middle-eastern countries), to the remarkable expertise of the financial professionals and to the high level of globalization of the english market. the english lawmakers have regulated islamic finance for tax purposes, classifying it among the so-called “alternative finance arrangements” transactions, including in this category a range of islamic instruments and, in particular: transactions for the purchase and resale of goods and properties (murabaha), partnership agreements (mudaraba), diminishing shared ownership (musharaka), profit-sharing agreements (wakala) the issue of securities (sukuk) 6 . uk tax law has evolved over time with several developments as shown in figure 1 below: figure 1: regulatory development of islamic finance in the uk [11] the choice to make the substance prevail over the form has led to the revenues from islamic financial transactions being processed, in tax terms, in the same way as interest paid on money loans. in short, treating the “alternative financing arrangements” as financing transactions makes it possible to treat the proceeds generated, for example, by murahaba operations as interest, as results arising from the provision of capital rather than as capital gains. in the same way, the proceeds of a mudaraba transaction, which, although derived from a partnership agreement, are not treated as dividends or equity profits, but rather as income assimilated to interest. whereas sukuk for tax purposes is regarded as security when specific legal conditions are met 7 . 6 ireland is the country whose approach has been the same as the united kingdom, i.e. through the implementation of specific rules in its legal system, and in fact islamic financing transactions are treated in the same favorable way as conventional financing transactions. [10] 7 in particular the following (“investment bond arrangements”): “(a) they provide for one person (“the bond-holder”) to pay a sum of money (“the capital”) to another (“the bond-issuer”), thus, direct tax legislation does not modify the nature of the financial arrangements, nor does it in any way attribute the interest or consider it to arise where it does not exist. in other words, the lawmakers can be considered to have introduced a specific code for the tax treatment of transactions falling within its definitions. table i below sets out the concepts created by tax law and islamic finance comparable: table i. similarities between the english tax law and the various islamic financial instruments [13] tax law islamic finance purchase and resale murabaha deposit mudaraba profit share agency wakala diminishing shared ownership diminishing musharaka alternative finance investment bond sukuk furthermore, it should be noted that through this assimilation between islamic and traditional instruments, the avoidance of double taxation on transfer taxes has been achieved. in particular, the transfer of ownership and the leasing of real estate are subject to the so-called “stamp duty land tax” [“sdlt”], therefore, in the case of islamic finance (b) they identify assets, or a class of assets, which the bondissuer will acquire for the purpose of generating income or gains directly or indirectly (“the bond assets”), (c) they specify a period at the end of which they cease to have effect (“the bond term”), (d) the bond-issuer undertakes under the arrangements (i) to dispose at the end of the bond term of any bond assets which are still in the bond-issuer’s possession, (ii) to make a repayment of the capital (“the redemption payment”) to the bond-holder during or at the end of the bond-term (whether or not in instalments), and (iii) to pay to the bond-holder other payments on one or more occasions during or at the end of the bond term (“additional payments”), (e) the amount of the additional payments does not exceed an amount which would be a reasonable commercial return on a loan of the capital, (f) under the arrangements the bond-issuer undertakes to arrange for the management of the bond assets with a view to generating income sufficient to pay the redemption payment and additional payments, (g) the bond-holder is able to transfer the rights under the arrangements to another person (who becomes the bondholder because of the transfer), (h) the arrangements are a listed security on a recognized stock exchange, and (i) the arrangements are wholly or partly treated in accordance with international accounting standards as a financial liability of the bond issuer or would be if the bondissuer applied those standards.” [12] ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4441 4 operations based on the “transfer” of a real estate property, the sdlt could have applied more than once in a single transaction. an example can be found in murabaha transactions where a double transfer of the same asset occurs. in cases as such, the regulatory framework required sdlt to be applied only once, specifically to the original transaction, while the subsequent resale by the lender to the third party (the beneficiary of the asset) is exempt from sdlt, as is the case for the sale with resale agreement, sdlt-exempt. [14]. despite the financial leadership of the united kingdom, france is the leading european country in terms of resident muslims, with half of these residents being full-fledged french citizens and often second or third generation migrants. given such a significant muslim population, in 2007 the authorities issued reforms to align the french banking system with shari’ah law so as to bring islamic products onto the market. afterwards, the french ministry of economy addressed tax issues by issuing a number of interpretations designed to favor islamic financial instruments at the beginning of 2008. indeed, on december 18th, 2008, the ministry published a set of interpretations relating to two types of islamic financial transactions, murabaha and sukuk, thereby structuring a favorable interpretation of the current rules of the french tax code (code général des impôts, cgi) with regard to such transaction. such interpretations were finally published as official administrative guidelines in the bulletin officiel des impôts on february 25th, 2009. such guidelines were thoroughly revised during an extensive industry-wide consultation that led to the release of updated guidelines for murabaha and sukuk transactions and new guidelines for ijara and istisna transactions on august 24th, 2010 [15]. eventually, further clarifications were examined in 2012 [16]. these administrative guidelines, while complying with the existing rules of the french tax code without modifying its content, define the conditions to be met in order for these specific islamic financial instruments to benefit from the same tax treatment as comparable conventional financial instruments [17]. as pointed out above, the french ministry of finance has also elected to maintain the principle of substance over form, since sukuk are considered for tax purposes until any conversion into shares as debt securities, so that the remuneration paid to sukuk investment holders is treated for tax purposes as interest according to the standard rules 8 . while in the case of murabaha, the lender is considered to be a real intermediary in a financing transaction and the income 8 in particular, if: “(i) sukuk should entitle their owners to be reimbursed before the shareholders of the issuer; (ii) sukuk should not grant any voting right or any right in the liquidation profits to them; (iii) the amount of the remuneration paid to investors should be based on the underlying asset and remain limited to a market rate with a markup; (iv) the reimbursement of sukuk may be partial” [18]. received from the latter as a result of this activity is considered as interest, attributable for tax purposes according to a maturity principle. from this study it emerged that the different countries regulate the taxation of islamic financial instruments by identifying two types of different approaches: one of them consists in the adoption of specific legislation for islamic finance with significant changes to the relevant tax rules while the other consists in providing only some clarifications from the tax authorities, without issuing or changing the legislation concerning the taxation of financial instruments [19]. however, while following two different approaches, the states that have introduced islamic finance into their system are in line in asserting the principle of the “prevalence of substance over form” on islamic financial instruments whose purpose is to avoid the application of excessive charges of a fiscal nature, thus favoring their diffusion in the territory. iii. the italian tax situation for islamic financial instruments nowadays in italy, islamic finance is experiencing greater interest 9 , since the last parliamentary activity which had no further results dates back to law proposal c. 4453 submitted to parliament on may 2nd, 2017, which dealt with the “provisions regarding the tax treatment for islamic financial transactions” 10 whose purpose was to identify some of the 9 however, it is a strongly growing sector: according to the islamic finance outlook 2020 edition the islamic finance is worth almost 2100 billion, resulting in a growth in the twoyear period 2019-2020 thanks to 3 important factors: standardization; the use of technology in the financial sectors; alignment between islamic finance and the principles of sustainability, also environmental, of the traditional financial sector [20]. it should also be noted that a further research has provided evidence that by 2030 most of the muslim population will be located between asia and africa, countries with strong growth in development [21]. 10 specifically, "article 1 of the bill sets out the aims of the law, which is intended to regulate for tax purposes specific transactions that otherwise would not be carried out in our country. article 2 provides the definitions governing the transactions examined, aligning them with the current legislation; in particular, it defines: a) the bank or financial intermediary carrying out the transaction; b) the user; c) the fee received by the bank, which must not in any case exceed the limits set out in article 2, law no 108 march 7th, 1996; d) the manufacturer, producer or supplier as a natural or legal person manufacturing or selling the goods to be financed; e) the item covered by the transaction; ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4441 5 most important transactions provided for by islamic finance consistent with the principles of islamic law (shari’ah) so as to provide for their regulation within the italian legal system to attract huge amounts of capital that would otherwise have passed elsewhere; in other words, greater tax revenue would have been achieved through such regulations. therefore, the italian legal system as mentioned above has no regulatory structure as in the united kingdom and ireland and there are no administrative documents governing tax treatment as in france. on that point, it is worth pointing out that in italy the ministerial approach, which derives mainly from the tax authorities, is not binding on either the taxpayer or the court and does not, above all, provide a source of law 11 . this principle has frequently been reiterated by the italian supreme court having ruled on the legal effectiveness and the possibility of challenging such activities 12 . as a consequence, a french-like approach in an italian system is certainly not applicable; on the contrary, a system such as the british and irish ones is more suitable. in this respect, the aforementioned proposal for a law to create specific rules in order to finally “seal” the civil-tax treatment of islamic finance appears to be more appropriate. actually, in the opinion of the authors, a specific set of provisions can be identified through a root and branch reform of the entire italian tax system. undoubtedly, the system is f) the margin, as remuneration received by the bank; g) the transaction. article 3 deals with three financial transactions, currently not considered in the italian legal system, murabaha, ijarah and istisna'a, regulating their tax treatment and classifying them in our legal system. article 4 defines the sukuk as securities, framing them in the single text of financial brokerage provisions under legislative decree no. 58/1998, and regulating the public offer thereof. again with regard to sukuk, article 5 regulates the characteristics and tax aspects of sukuk, including the provisions relating to the tax treatment of sukuk issues, consistent with the current regulations. article 6 states that the transactions referred to in articles 3, 4 and 5, in any case, shall be subject to ongoing monitoring and to the obligation of suitable control, enhanced, pursuant to and for the purposes of article 28 of legislative decree no. 231 dated november 21st, 2007. the proposed law does not contain a provision on financial hedging, as the transactions introduced in our system, being currently not feasible, will only constitute an increase in revenue for the public treasury". 11 in addition, it is customary for the tax authorities, once a measure has been issued with instructions to the taxpayer, to challenge its content during the assessment phase resulting in a tax litigation. 12 sup. court n. 6185/2017 and sup. court n. 10915/2015. outdated nowadays, considering also that the inland revenue agency is encouraging efforts towards this approach 13 . while from a strictly tax standpoint, the framework of islamic finance must take into account which type of approach to choose, whether formal or substantial. the first approach would lead to a disadvantage compared to the "standard transactions" one and would lead to a potential increase in taxation for the islamic finance transaction; through the substantial approach, the results would be more acceptable with reference to direct taxes, but there would be more problems with indirect taxes, such as, for example, the registration tax, which is due to each single transaction [22]. on the strength of this choice, the line of the other countries with a greater experience in the past as highlighted in the previous paragraph is to apply the principle of the substance prevailing over the form with regard to the islamic financial instruments 14 . for a better understanding of the aforementioned elements table ii outlines the differences between the two countries together with the pros and cons of the "strategies" applied: table ii. comparative analysis countries strategies adopted by the countries surveyed positive aspects found in italy by country strategies negative aspects found in italy by country strategies common ground united kingdom adoption of a specific legislation regulatory certainty bureaucracy and timing in setting up tax legislation principle of prevalence of substance over form france issuance of clarifying documents by tax authorities bureaucracy reduction possibility to recast the procedure during the assessment phase by the tax authority 13 interview with the director of the revenue agency dr. ruffini of august 25, 2020: "we do not have a tax system. we are in a jungle impossible for anyone to be understood, completely out of control. over the years, financial laws have literally shaken it, creating absurd fragmentations. now the house has to be rebuilt...". 14 moreover, regarding this key aspect, italian legislation has undergone a revolutionary change, in particular legislative decree no. 139/2015 introduced a new paragraph 1-bis in art. 2423-bis whereby "the recognition and presentation of items must be carried out taking into account the substance of the transaction or contract", setting the ground for a harmonization of the ita gaap representation rules with those of companies adopting ias/ifrs within the italian territory. ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4441 6 that being said, given a substantial approach, most of the proceeds relating to islamic financial instruments (murabaha, ijarah and istisna’a) can be included in article 44(1)(h) of legislative decree 917/86 [consolidated income tax code "tuir"] which provides that: “capital income includes: [...] (h) interest and other income arising from other relationships involving the use of capital, except for those transactions through which positive and negative ratios may be generated as a result of an undefined event”. with regard to the provision under consideration, care must be taken as not all capital investment ratios are capital income generating; actually, those ratios through which positive and negative ratios can be achieved depending on an undefined event are excluded by specific regulatory provision [23]. moreover, interest deriving from such transactions must be included in the deductibility threshold of 30% of the operating result set out in article 96 tuir so as not to create inequalities with traditional instruments 15 , specifying that paragraph 12 of the said article excludes from this threshold financial intermediaries, insurance undertakings and parent companies of insurance groups, while paragraph 13 requires a different threshold for the deductibility of interest equal to 96% of their amount for insurance undertakings and parent companies of insurance groups as well as mutual fund management companies and securities brokerage firms referred to in legislative decree dated february 24 th , 1998, n. 58. sukuk rules are different as the income from this instrument could fall under both article 44(2)(a) and (2)(c) of the consolidated income tax code (tuir) if it were to be compared to shares or bonds, respectively. however, the sukuk instrument is not generally similar to shares 16 and consequently a regulation aimed at equating this instrument to debt securities would eliminate this uncertainty, since article 44(2)(c) of tuir [25] would apply. furthermore, attention must be paid to the transactions of islamic finance focused on profit and loss sharing (e.g. mudarabah and musharaka) whereby the remunerations granted to the investors are set in relation to the results of the enterprise or of a given transaction; in such a case, transactions based on the "profit loss sharing" can be fiscally recognized as forms of profit sharing with the own treatment of the dividends for the recipient, and as non-deductible costs for the payer pursuant to art. 109, paragraph 9 of the tuir [26]. finally, and for the sake of completeness, the subject is more sensitive on the indirect taxation level; indeed, double taxation could be created in the field of registration taxes, and in particular article 20 of the interpretation of transactions states that: “the tax shall apply according to the specific nature 15 for the sake of completeness of analysis, the "limitations of article 96 of tuir are inspired by the purpose, which has remained unchanged even after the implementation of the atad directive, to ensure a "reasonable" deduction of interest according to the regular indebtedness ability of the company" [24]. 16 in principle subject to specific conditions states consider such instruments as debt securities and legal effects of the transaction submitted for registration, even if the security or the evident form of the transaction does not correspond to it, on the basis of the elements inferable from the same transaction, without prejudice to the provisions of the subsequent articles” 17 . accordingly, in islamic finance where several consecutive steps may be taken to finalize the existing transaction, the article in question would give rise to the taxation of such steps. therefore, inspired by the uk experience with sdlt, where taxation takes place only once, this could be an acceptable solution also in italy or, since the substantial approach of the existing transaction can always be considered, recent case-law on lawfulness 18 has considered a set of transactions resulting from different legal effects in a single transaction at a time when these could be considered a single legal effect, resulting in a single taxation. such remarks can also be broadened to include mortgage and cadastral taxes. in short, the predominance of substance over form is the best solution with regard to direct and indirect taxes, as indeed the other states being investigated have applied albeit with different methods in their legislation. iv. conclusions a comparison among the three different tax systems: italy, france and the united kingdom, with regard to the regulations on islamic financial instruments, reveal the following: there is no harmonization of tax systems at european or community level to regulate islamic financial instruments 19 , since, even if the subsidiarity principle is respected, it could not automatically be precluded the identification of a suitable regulation to precisely define the same instruments. furthermore, the grounds for this more or less extensive regulatory activity carried out by each state so as to regulate islamic financial instruments are manifold, but in fact can be traced back to two aspects: a real market demand from the users of such instruments, with a steady increase in their spread, mainly due to the presence and the increase of the population that follows the principles of sharia'ah and that looks for, and uses, such instruments; 17 law no. 145 dated december 30th, 2018, in amending article 1(87)(a) of law no. 205 dated december 27th, 2017, has consequently provided (with article 1(1084)) that "article 1(87)(a) of law no. 205 dated december 27th, 2017 represents an effective interpretation of article 20(1) of the consolidated provisions of presidential decree no. 131 dated april 26th, 1986". 18 sup. court 19.6.2013 n. 15319 19 although there has been real harmonization of indirect taxation alone (ex-article 93 of the ec treaty, for example with regard to vat) at community level, the different measures (directives) on direct taxation: double taxation, parent and subsidiary taxation, royalties, savings income (interest), etc. should not be ignored. ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4441 7 the willingness by all countries to attract in the first place foreign capital and, furthermore, to increase tax revenues for the reasons outlined above, it is not possible, as of today, to refer to a harmonization of the three tax systems subject to comparison with reference to the taxation of islamic financial instruments, since each single state, for the reasons outlined above, has diverging needs; in other words, always starting from the hypothesis of a steady increase in the use of such financial instruments, there are legal systems which tend to contain the tax pressure in order to attract more capital, with respect to a need for tax revenues with negative effects on the capital movement. however, it is worth pointing out that the regulatory developments in the three countries examined were based on the same common factor: the substantial aspect definitely prioritized over the legal form of a single transaction. based on the closing overviews outlined above and although this paper should be further enhanced by a research phase the italian legislative system could be improved and better developed through the mutual experience of the different countries that are adopting islamic financial instruments, as well as through a wise effort to review and update both civil and tax legislation. the study, therefore, suggests guidelines, in the legislative field, for the introduction of legislation on islamic financial instruments in the italian civil system, and through the principle of substance on the form, in the tax field, to create an appropriate law, as happened in the united kingdom. paradoxically – being a common law country – this last model is more suitable for our legal system than the french, since the latter, although it is established on the principle of substance on form, is based on usual procedures, which, for our system, are not considered to be suitable for the reasons set out before. finally, the introduction into our legal system of appropriates rules for these financial instruments would have a threefold effect: regulating a capital market, where new and rapidly expanding financial instruments are entering; it would allow an undoubted advantage for the revenue authorities, considering the tax revenue that they could potentially generate; a first step towards the international harmonization of legislation, assuming that the anglo-saxon model is to be taken as an example; . following these conclusions, therefore, there will be a further research activity aimed at monitoring the evolution of the tax regulations in the three states examined and whether the presence of a careful regulation of the islamic financial instruments, together with a moderate tax pressure, points out a connection with a greater presence of financial intermediaries who manage such instruments references [1] ali r., “islamic finance: a practical guide”, global law and business, rahail, 2008, pag. 3-33. [2] i. calboli, “a call for strengthening the role of comparative legal analysis in the united states”, john’s law review, vol. 90:3, pp. 609 – 638, 2016. [3] e. j. eberle, “the methodology of comparative law”, roger williams university law review, vol. 16:51, pp. 5172, 2011. [4] i. calboli, “a call for strengthening the role of comparative legal analysis in the united states”, john’s law review, vol. 90:3, pp. 609 – 638, 2016. [5] r. david e i. brierley, “major legal systems in the world today”, 2d ed., 1978. [6] r.b. schlesinger, hw baade, m.r. damaska e p.e. herzog, “comparative law”, 5a ed., 1988. [7] u. mattei and r. pardolesi, “law and economics in civil law countries: a comparative approach”, international review of law and economics, 11, pp. 265-275, 1991. [8] filippetti s., “a londra la prima app per i risparmiatori halal”, il sole 24 ore july 9 th , 2019, p. 27. [9] galimberti a., piazza s., vallefuoco v., “il fisco alla prova della finanza islamica” il sole 24 ore october 13 th 2019, p. 10. [10] pwc, tax facts, 2019 p. 23. [11] uk excellence in islamic finance, 2014, p. 11. [12] corporation tax act 2009 (c. 4). part 6 relationships treated as loan relationships etc chapter 6 alternative finance arrangements, p. 242. [13] pwc, taxation of conventional and shariah compliant mortgages, november 2008, p 10. [14] p. flora, “la finanza islamica: principi generali ed esperienze internazionali” in fiscalità internazionale n. 2/2009, pp. 109 ss.; j. cape, “general legal framework applicable to the taxation of islamic finance”, derivatives & financial instruments, ibfd, september/october 2010, p. 40-48. [15] a. de brosses and f. burnat, “france – islamic finance”, in derivatives & financial instruments, ibfd, september/october 2010, p. 33. [16] for further details refer to the documents: boi-djc-fin-20120912; boi-djc-fin-10-20120912; boi-djc-fin-20-20120912; boi-djcfin-30-2012209012; boi-djc-fin-40-20120912. [17] n. mohan, islamic finance and eu law – part 2 in european taxation, ibfd, june 2019, p. 276 ss. [18] b. delaigue, a. reillac, “france adopts tax measures to promote islamic finance”, in european taxation, may 2009, p. 287. [19] a. franco and c. sallustio. “the taxation of sukuk in the italian context: is italy’s tax system ready for islamic financial instruments?”, in ejif – european journal of islamic finance. n.7, july 2017. [20] negri della torre a., benarafa j., “resistenza by design alla crisi – il caso della finanza islamica”, diritto 24 n. 4/2020, gruppo sole 24 ore [21] pwc, islamic finance – creating value, 2013, pp. 3 – 33. [22] f. di cesare, “la possibile fiscalità delle operazioni di finanza islamica” in la gestione straordinaria delle imprese 2/2016, pp. 130 – 133. [23] m. leo, le imposte sui redditi nel testo unico, giuffrè editore, 2016, pp. 633-634. [24] m. leo, le imposte sul reddito nel testo unico, book ii, giuffrè francis lefebvre, 2020, p. 1789. [25] p. p. biancone, “finanza islamica e impatti fiscali, lo stato dell’arte in italia”, in amministrazione & finanza n° 8-9/2016, p. 25. [26] f. di cesare, “l’impatto degli strumenti giuridici della finanza islamica sul regime delle imposte dirette”, fiscalità e commercio internazionale n. 8-9 del 2012, p. 36. ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4441 8 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 the use of cryptocurrencies for hawala in the islamic finance abstract—this paper aims to evaluate where the application of new fintech solutions like blockchain and cryptocurrencies can be considered as an opportunity to build bridges between islamic and western culture in order to create a trusted money transfer with low commission and a big transparency and trust. the research question is: can an hawala systems based on dlt technologies be considered compliant both with anti-money laundry regulations and with sharia values? this is a conceptual paper relying upon an understanding of the literature in the fields of technology, sociology, anthropology, criminology and regulatory, as applied to the topic of islamic practice known as hawala and emerging new disruptive technologies like distributed ledger technology. the research has been conducted by a literature reviewing on scopus data base by searching the following keywords: islamic finance, cryptocurrencies, hawala, stablecoin, globalcoin, money laundering, blockchain. the searching period was set on the last 10 years. the paper discusses some scenarios to define new fintech hawala system in an evolving scenario of cryptocurrencies, social network commitments and different type of blockchain where it can be digitally transformed by using new fintech technologies while became compliance with anti-money laundering regulations with the respect of islamic values. as practical implications, this paper could help to encourage researcher and entrepreneurs to evaluate and propose a digital transformation approach with the aim to maintain ancient tradition and, at the same time, apply new technology that improve the life of citizens. as social implications this paper expands upon the understanding of how new fintech solution can be easily be integrated in the real life by using common devices like a mobile phone to be used as wallet for the daily expenses and to receive money from relatives from western countries. the originality/value of this paper is that it covers the literature gap in the field of new fintech solutions applied to islamic finance by providing a likely proposal by integrating popular tradition, regulations and new technologies. the research limitations and implications are related to that this is a conceptual paper; case studies haven’t been treated, so it is not able to say definitively if the outcomes discussed can be defined as an effective solution and can be developed in the real global society, in a future prospective it’ll be possible to continue to make researches in this field of application with fintech technologies and islamic finance. i) introduction in next 10 years many analyst and financial institutions, claim that the islamic economy will have a big grow and widespread recognition from muslim communities that assert their religiosity traditional values. this paper aims to analyze how the innovative technology “blockchain” and the potential of blockchain-based cryptocurrencies can adhere to the concept of “halal” within the islamic finance practices and ethics. thomson reuters estimates that the islamic economy in the 2030 is calculated around 1$ trillion and the islamic finance sector will reach $3,8 trillion in 2022. there is an increasing interest in cryptocurrencies worldwide and also in the specific field of islamic finance. however, digital currencies are objects of speculation and not always is compatible with the religion and the sharia principles and values. this paper puts a specific focus on money transfer systems known as “hawala”, used to transfer money through a network of mediators (“hawaladars”) located mainly in the middle east, north africa and south asia. the hawala system is perceived as a potentially dangerous practice for terrorist financing, money laundering and tax evasion by many western governments. through the blockchain, leveraging its transparency, traceability and security features, it is possible to reduce the risks of fraudulent use, remaining true to the halal ethics and adding some typical features use of cryptocurrency. we analyzed possible scenarios about the use of dlt technologies as an evolution in the "fintech" sector and more generally in the islamic economy. where we‟ll describe the types of cryptocurrencies called "stablecoin" that can be more appropriate to support the hawala system because, despite to the famous crypto currencies like bitcoins, the value of stablecoins are related to fiat currencies like us dollar, euros or gold, ensuring value stability, like “onegram” considered the first cryptocurrency shariah complaint. further analysis has been conducted to the new cryptocurrencies, called "globalcoin" as those proposed by the giants of social networks such as libra (proposed by facebook through a private blockchain managed by a private foundation) and gram (proposed by telegram, on a public blockchain called “ton”). this paper focuses on analyzing how innovative technology “blockchain” and the potential of blockchainbased applications like cryptocurrencies can be successfully valeri m., fondacaro r., de angelis c., barella a. ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 used for islamic finance and how the dlt technologies can be adopted as an evolution in the "fintech" sector and more generally in the islamic economy. ii) methodology to answer the research questions, we have conducted a systematic review of both academic and practice literature. we used scopus database using the following keywords:  “stable coins”: one paper  “islamic finance” and “blockchain”: two papers  “hawala”: thirty paper in the area business and management, economic, econometrics and finance. the literature review has been completed by search how the western rules face the hawala practice on the anti-laundry money regulations, finally we tried to figure out how the fintech big player are going to design a new currency system based on a global currency build on dlt technologies and finally if this system can be considered as a new sustainable “hawala” system both compliant with government regulations and islamic values. iii) framework a) islamic finance islamic finance is based on values and principles of islamic law, known as “shariah”. these values are mainly based on the prohibition of financial interest, and contractual uncertainty and the promotion of ethical investments. shariah compliant financing constitutes financial practices that conform to islamic law. islamic institutions are similar to the other typical financial institution with some differences. the islamic finance can be better defined and understood by elaborating its distinctive features as below:  religious basis. while conventional finance has no religious restrictions, islamic finance is based on rules and regulations derived from faith and islamic law. all islamic banking and financial contracts must be subject to sharia law.  no interest. islamic finance prohibits the gain of interest or an addition to the loan amount over time. earning money is not allowed.  link to real assets. to avoid money earning more money, all islamic financial transactions are linked to a real asset and there is an exchange of goods and services, making them less risky.  bank as a partner. islamic banks act as a partner to both the depositors and borrowers. islamic banks also operate as a seller in certain financial transactions.  profit and loss sharing. an islamic bank shares in the profit of the client to whom it provides financing and is also required to share in any loss incurred by the business. on the deposit side, the islamic bank shares its profit and loss with the depositors, pro rata to their deposit amounts.  productive investment. islam encourages muslims to invest in productive enterprises rather than hoarding their money, since idle money cannot earn any interest income. as such, muslim depositors are encouraged to finance as partners, enjoying profit as well as bearing loss. this stimulates the economy and encourages entrepreneurs to put in their best efforts to succeed, which finally benefits the community also.  unnecessary and excessive risk. islam prohibits any transactions that are based on excessive and unnecessary risk-taking leading to uncertainty. as such, speculative transactions are not allowed in islamic finance. [7]. b) the “hawala” system the equations are an exception to the prescribed specifications of this template. you will need to determine whether or not your equation should be typed using either the times new roman or the symbol font (please no other font). to create multileveled equations, it may be necessary to treat the equation as a graphic and insert it into the text after your paper is styled. hawala is an arabic can be translated as „„transfer‟‟, the word means „„transform‟‟ or „„change‟‟ [19].the first tracks of hawala of can be found as early of 11 th century in india, where the first bank (the bank of hindustan) was established around 1770 in calcutta. in the hawala exchange system the money is transferred through the mediators known as hawaladars, they process a small fee as payment for the service, the hawaladar can reside in different countries and this guarantees efficiency to international money consumption even between countries with an inefficient banking infrastructure or excessively bureaucracy or corruption. the exchange is based on trust, as the insurance between debits and credits between the various intermediaries will be settled in the future data and is guaranteed only by the honor of the debtor. a typical use of this system are the migrants' remittances in favor of their country of origin. hawaladars are financial intermediators who manage financial transactions, often without an official bankers‟ license or government control. the hawaladar transfers cash from one location to another location to another hawaladar. the hawala system often is operated without the real transfer of money. the system works when the hawaladar get in touch with a courier in that country informing him of the details of making the payment. the hawala system is untraceable. the estimation of hawala networks is about over than 500 billion usd flows [25]hawala network is built on the following: anonymity, low costs, efficiency and trust. hawala is largely driven by the code of honor, reputation, trust and personal relationships, connecting hawaladars and users. the study conducted by sharif, mahama, & farooqi, has demonstrates that there is no formal governance and management control system in place for managing hawala network, trust acted as ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 the most important control mechanism with a high level of the efficiency, effectiveness and lower transaction costs. trust is the relational mechanism which held the network together and acts as an effective cohesive force. in the hnets the transaction cost is very low comparing to the traditional money transfer system. an hawala transaction does not rely on any third-party monitoring as hawaladars only deal with one another. in addition, trust is the platform on which open communicationfor confidential and sensitive information sharing is built [25]. from the ethical dimension, the question that tried to answer is “is hawala a financial practice that deserves moral respect or rather, should it receive a disapproving judgment form an ethical point of view?”. [19].the answer provided is that hawala is a financial practice founded on islamic basis, and it‟s strictly related to its ethical values. since hawala is considered one of the most used informal value transfer system (ivts) where a big amount of legitimately earned money go through this channel. hawala is also considered as an underground parallel banking system, it extends to countries in south-east asia , in the indian subcontinent, and in the middle east, north america, europe and africa [35] c) money laundering and terrorism financing money laundering is the attempt to disguise the sourceof capital, often obtained from illegal activities, with the aim to appear as a legitimate it. it is usually accomplished through some complex financial transactions [26].the most common perception from the majority of western financial institutions andgovernment is that hawala is closely related to money laundering and terrorism. it‟s a common perspective that money laundering often is based on close relationship-based transfers like “hawala”[20]. the eu commission has been released a report about the risk of money laundering and terrorist financing on the internal eu market [4]. the eu has defined common rules by establishing a framework called “eu anti-money laundering/counter terrorism financial aml/cft” and eu financial intelligence units fius). the report presents the main risks for the internal eu market in a wide range of sectors and the horizontal vulnerabilities which can affect such sectors.hawala pose a specific threat, particularly in the context of terrorism financing. the directive 2 (psd2) rules payment services, it states that all operators providing payment services should be appropriately registered and regulated. hawala is usually qualified as illegal since isn‟tofficially registered and do not comply with the requirements of psd2. within the mitigating measures to address the identified risks, one of the eu policy initiatives, is related to address the technology-enabled services and business models, by and internal fintech task force to determine whether existing rules and policies are adequate. the commission has set alsoafintech task force to assess developments on technology-enabled services and business models, like, crowdfunding, digital currencies, blockchain and digital identity. in may 2015 the european parliament and the council have released a directive related on money laundering or terrorist financing. in may 2018 the eu has amended the directive 2015/849, with the release of the eu directive (eu) 2018/843, where at the article 10 says that “member states shall prohibit their credit institutions and financial institutions from keeping anonymous accounts or anonymous passbooks” and extends the due diligence to all customers to all exchange and wallet service providers that operate on virtual currencies. hawala networks, are considered an alternative channel that operates outside regulations.hawala operators are concerned that customers don‟t appreciate the verification on the origin and the destination of funds.another issue about the hawala money transfer is that often the bank transfer is not possible due to the lack of banking structure in the country of destination [37]. d) cryptocurrencies between 2007 and 2008, the world was shaken by the financial turmoil caused by the chain of financial collapses built on bad debts that triggered a crisis that had not occurred since the “great depression”. during this period, the world observed the fragility and instability of a closely interconnected and heavily indebted global financial system. in response to these events, in october 2008, satoshi nakamoto published a white paper, introducing the topic of blockchain to the world, outlining the benefits of a currency exchange system called bitcoin. bitcoin and other cryptocurrencies are probably the most commonly recognized use case of blockchain [8]. the blockchain was initially conceptualized by satoshi nakamoto to solve some problems related to electronic transactions. in 2008, nakamoto introduced two ideas that had a substantial impact, offering opportunities for further innovations. the first idea refers to the"bitcoin" currency, a digital currency that operates on a peer-to-peer, decentralized, cryptographically secure, immutable, without any government or other central support. the second idea was the notion of blockchain. that has been defined in several ways: the main accepted definition is that it is a distributed ledger. distributed ledger technology (dlt) is a generictermthatdescribesalltechnologiesthatdistributeinformat ionacrossmultiplesites, countries or institutions and includes blockchain. a blockchain refers to an open, shared, decentralized, and distributed ledger in which transactions are recorded and added in chronological order with the goal of creating tamperproof permanent records [13].dlt technologies does not require a central server to store data. as long as the network reaches consensus on what transactions have occurred in the past, it collectively acts as a server to host the data. if a dishonest participant decides to edit the previous data, the majority of the network quickly excludes it [8]blockchain technology differs from most existing information systembyincludingfourkeyfeatures;decentralization,security, ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 intelligent execution and verifiability [21].two main types of blockchain stand out in terms of access control: the blockchain can be public or private (bitcoin uses a public version). within a public blockchain, each transaction is public ("without authorization") and users can remain anonymous. each user can join without requiring permission from other members. the blockchain has an incentive mechanism to encourage participants to join the network. access to the blockchain is controlled by the consortium's blockchain, composed by members[30]. most researchers state that the most popular cryptocurrency, the bitcoin, which is not regulated from a central bank or institution, guarantees anonymity for buyers and sellers and the using of bitcoins in the dark web (e.g. tor) presents advantages for criminals and cyber terrorists. both bitcoin and tor provide features like anonymity and provide opportunities and protection for criminal activities on crimeware marketplaces [26].in relation with money laundering and terrorism finance, in cryptocurrencies the public keys are “pseudonym” it‟s encrypted, an abcd public key it‟s owned by the person/entity who own the private key. every user could generate many couple of public/private keys, this will complicate the analysis to find the realowner.every transaction is public since it‟s registered on a public distributed ledger (dlt), it‟s possible to read every (since creation) cryptocurrencies change in possession using blockchain explorer. “a blockchain explorer is a web application that operates as a bitcoin search engine, in that it allows you to search for addresses, transactions and blocks and see the relationships and flows between them. popular blockchain explorers include: [1]  blockchain.info  blockexplorer.com  insight.bitpay.com  blockr.io” nowadays forensics are helped by specialized company who analyzed blockchain and follow change in possession of cryptocurrencies. on the other side the research for a deeper anonymity is developed by some specialized cryptocurrencies like monero(www.getmonero.org/), and zcash (z.cash/thebasics/), or mixing service where provider mix coins from different owners using other and property wallet. some analysis shows potential use of cryptocurrencies by terrorist or criminal but poor daily use. e) stable coins stablecoin is a cryptocurrency whose value is fixed to a non-volatile asset like fiatcurrency, aprecious metal, oil or other. the idea of a stablecoin is to produce a crypto asset whose value isn‟t disposed to to extreme volatility. this characteristic contrasts with the high volatility (marked price changes in short periods of time) typical of the most wellknown cryptocurrencies, like bitcoin. the issuers of stable coin are used to make this link through a reserve of the underlying (collateralized/backed) and guaranteeing the possibility for the holders of the crypto to convert on demand and without limitations, a system very similar to the gold monetary standard of the early 1900s.less successful and widespread have been cryptocurrencies guaranteed by precious metals or raw materials, also because they are more difficult to manage. imagine what and how many activities are needed to buy or sell gold, oil or precious stones daily to adapt the reserves to the amount of money in circulation. or how to guarantee the conversion of the cryptocurrency into the underlying asset in the case of physical delivery. however, there are examples of cryptocurrencies of this type even though their capitalization is a fraction of that on a fiat basis. libra will also adopt this principle of stabilization, but the reserves will be realized by a basket of currencies/bonds of various countries. the main uses have been identified in:  currency refuge, in the case of speculative activity there are moments in which an investor wants to disinvest from cryptocurrencies but wants to be ready to repurchase them, instead of converting his assets into fiat currency with significant costs and long times can buy stable coins treated by almost all exchanges (which is not true for fiat currencies) and avoid swings  currency for arbitrageurs, when a crypto currency presents different prices on different exchanges, it is common practice to buy it where it costs less and to quickly try to resell it where it costs more, to do this it is necessary to transfer the currency or at least its value, for what purpose the stable coin are ideal since the transaction is fast and cheap and not subject to fluctuations during the transfer time (albeit short).  currency for access to exchanges that do not accept usd / eur. almost all exchanges that accept fiat currency deposits submit their customers to the alm and kyc regulations, some exchanges while being very efficient in managing a large number of cryptocurrencies do not accept payments to fiat, the most efficient and risk-free system for moving their own assets from one to another is to transfer stable coin. uses of stable coin under development:  remittances from migrants  payments in the digital economy  payments in the non-digital economy http://blockchain.info/ http://blockexplorer.com/ http://insight.bitpay.com/ http://blockr.io/ https://www.getmonero.org/ https://z.cash/the-basics/ https://z.cash/the-basics/ ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 the main element of a stable coin as mentioned is its underlying guarantee, it is in fact the certainty of the existence and consistency of this underlying the subject of greater discussion by detractors of these currencies. an independent audit on the guarantee reserves is the desired solution to clear these currencies definitively, also for payment uses in the non-digital economy. f) stable coins global coins (gram and libra) the standard cryptocurrencies features join with the low volatility of stable coins has waked up the international players interest for these financial instruments. the possibility of create property "payment system" independent from national currencies and with a huge user‟s base has become an attractive project for internet giants. a global coin expresses the concept of a cryptocurrency with the main characteristic to be globally recognized. the first known global coin projects are: libra which brings together some multinationals with facebook and gram (or ton) the cryptocurrency promoted by the telegram instant messaging platform.on june 18, facebook came out and published libra's white paper [11],self-defined “new decentralized blockchain, a low-volatility cryptocurrency, and a smart contract platform that together aim to create a new opportunity for responsible financial services innovation “ whose target is “a stable currency built on a secure and stable open-source blockchain, backed by a reserve of real assets, and governed by an independent association”. the proposed structure includes a libra virtual currency and a non-profit libra association based in geneva that will manage the currency. in addition, a second libra investment token to be assigned to those who invest in the project at least $ 10m. currentlythere are 28 investor/founder members, including calibra, the facebook subsidiary created specifically for this purpose. the founding members are: mastercard, mercado pago, payu, stripe, visa, booking, ebay, facebook/calibra, farfetch, lyft, spotify, uber technologies, inc., iliad, vodafone group,bison trails, coinbase, inc., xapo holdings limited, andreessen horowitz, breakthrough initiatives, ribbit capital, thrive capital, union square ventures, creative, destruction lab, kiva, mercy corps, women‟s worldbankingthe global coin main problem is the globality, the incompatibility of a global currency with a world fragmented from a regulatory point of view. the need to be compliance with national regulations can limit the use of currency globally. finma, the swiss government agency for the control of financial assets has recently [6]write, libra is “a swiss paymentsystem is automatically subject to the anti-money laundering act. money laundering standards would need to be ensured throughout the ecosystem of the project. the gram (or the ton) is the principal cryptocurrency of the telegram open network (ton) blockchain [16]is based on the popular messaging system telegram. telegram is planning to make gram digital wallets available to the 200 million to 300 million global users of telegram messaging applications. iv) results a) blockchain and cryptocurrencies in islamic finance is islamic finance and blockchain are fully compatible with each other? in 2018 egypt‟s grand mufti shawki allam said in an official fatwa that trading with bitcoin was "unlawful" according to islamic rulings. egypt was not the only country prohibiting bitcoin. a saudi minister, assim al-hakim, announced that the currency is forbidden in the country because “it is a cryptographic form of money that is vague and gives namelessness to crooks”. “we know that bitcoins remain anonymous when you deal with it, which means that it‟s an open gate for money laundering, drug money and haram (forbidden) money,” he said. “muslims should not get involved in such dubious transactions simply to make a quick buck, to make a quick profit. this is not an islamic concept,” warned hakim. some researcher affirms that blockchain would incorporate some islamic values into finance. theadoption of dlt technology will allow islamic finance to adapt to the changing landscape of modern economic transactions [36]. hussein elasrag in a recent study affirms that blockchain made the process of charitable zakat, trackable, auditable, and immutable [3]. the use of cryptocurrencies in islamic finance could be more appropriate medium of exchange than riba-backed central bank fiat currencies, because of lower transaction fees than mainstream money transfer, this could be useful for more than 2 billion of people with poor infrastructure banking systems, providing the access market of goods and services and payment system. the use of cryptocurrencies could facilitate small scale cross border trade. fait muedini, in his paper [11].has tried to answer the most common question that islamic scholar, analyst and other asked on bitcoin and islamic finance: “is bitcoin compatible within the regulations of islamic finance?” in his conclusions, muedini wrote that bitcoin and other digital currencies seem to be aligned to the most valued characteristics in islamic jurisprudence and this new system of finance called fintech is highly compatible with islamic finance and islam‟s message of justice. b) onegram a sharia’s compliant cryptocurrency onegram is the first cryptocurrency that has been certified in compliance with the ancient islamic rules called sharia‟s. it is inherently regulated by rules imposed on financial operations in the islamic world”. onegram “have chosen the proof of stake (pos) blockchain technology as it uses 10 times less energy than proof of work (pow) protocols. on top of that, it is very fast, it takes only a few ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 seconds to carry out a transaction. delegates and validators are democratically elected by the community of onegram stakeholders. despite significant recent developments and innovation, the market for cryptocurrencies remains somewhat niche. cryptocurrencies have shortcomings that currently discourage mainstream use, in particular, high volatility and barriers to entry and exit. onegram aims to solve these issues by creating a business ecosystem to solve the entry and exit issues. backing each coin/token with one gram of gold at launch to address the volatility issues and use blockchain technology to solve any outstanding problems. in short create a unique cryptocurrency. in addition, each transaction of the onegram coin/token (ogc) generates a small transaction fee (1%) which is reinvested to purchase more gold (net of admin costs), thus increasing the amount of gold that backs each onegram coin/token (ogc). therefore, each ogc increases in real value over time. this alone makes onegram unique not only among cryptocurrencies, but all other currencies worldwide v) discussion c) the hawala based on blockchain hawala is based on the same principles as the blockchain, trust, community, privacy, and decentralization. the blockchain can be used to improve the efficiency and speed of hawala using digital processes, while maintaining the respect of traditions and islamic values. blockchain can be applied to be a natural evolution for hawala, event because in the next 10 years is estimated that over 6 billion people will be online, we assume that it will be possible to transform and digitalize the hawala processes by using a stable coin cryptocurrency. we will find more people with a smartphone and an internet connection than people with a bank account. it isn‟t matter of “if but just matter of “when” money will go mainly on internet using cryptocurrencies. in a cryptocurrency blockchain the nodes can be seen as hawaladar, where nodes and miners, that maintain the network through mutual trust and consensus. due to the problem of “under banking” for more than 1,8 billion people, it is reasonable that such hawala system can be developed over a mobile app, could be a messaging system like whatsapp (using libra) or telegram (using gram) to be used as payment and money transfer system, also where there are poor banking infrastructure and electronic payment systems. an hawala digital system based on blockchain can solve most of the problems related to money laundering and terrorism finance, because of traceability of transactions, identification of users (through the authentication and identification operated by exchangers). regards the cryptocurrency to be used with this hypothetical hawala system, the use of a stablecoin can reduce the risk of speculation and currency fluctuation, which are against the islamic values. in the next table, we tried to provide a parallelism between the hawala system and a stable coin: table i. parallelism between the hawala system and a stablecoin characteristic hawala stable coin rapid yes yes cheaper yes yes distributed yes yes centralized partially centralized trusted yes trustless halal yes yes in our opinion, an hawala system based on blockchain by using a globalcoin based on a stablecoin, like libra, can be easily adopted by billions of people, by ensuring the transfer of money by using a very common mobile app, like a messenger (facebook or whatsapp). even in some countries where there is lack of money exchangers (to convert libras in local coins) or lack of bank infrastructures (atm) and lack of electronic payment systems (pos), the coins received from the hawala system can be spent by using the “cryptowallet” provided by the mobile messenger app, where the purchaser can send money to the seller in any shops, without the need to exchange the currency. the governments could see the introduction of a global cryptocurrencies as a partial lack of control in monetary policy. anyway, even now local currencies of developing countries oftenhave partial use by citizens who prefer foreign currencies (usd/eur). however, it is not easy to accept this new paradigm.we have already seen clumsy attempts to combine cryptocurrencies with the control of the currency itself. in venezuela in december 2017 the petro was announced as the first statecryptocurrency (www.petro.gob.ve/files/petro-whitepaper-english.pdf). the petro should have emancipated the state of venezuela and the venezuelan citizens from the official international payment circuits and from the dollar both controlled by the united states. the attempt to date is a fail, also due to the excessive control that the government wanted to impose on money, as if it were a national currency simply turn digital. the capitalization and circulation of the petro (ptr code) is today on the international markets equal to 0 http://(www.petro.gob.ve/files/petro-whitepaper-english.pdf). ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 vi) conclusions and limits the research described in this paper is a tentative to evaluate how a digital transformation concept to an ancient and very traditional practice like hawala. we have analyzed how the application of a fintech solution like blockchain and the cryptocurrencies can define an evolution that represents an important evolution with a series of potential benefits for the modernization of this practice in order to make it perfectly legal with respect to anti-money laundering laws and regulations and against the financing of international terrorism and at the same time respect for religious traditions, in line with the values of islam. the use of stable coin cryptocurrency can ensure the value of the transactions while the use of a global coin can allow a diffusion in those countries where the banking infrastructures are not yet adequate, while respecting the needs of traceability and identification of the users of the money transfer circuit, through the use of an app instant messaging provided by the most popular social networks. the possibility of institutionalizing the solution, for example, through a global central bank, could also guarantee the absence of private interests and maximum transparency regarding operations. in conclusion, this approaches can be considered as an opportunity to build bridges between islamist and western culture in order to create a trusted money transfer with low commission and a big transparency and trust, where western government and regulators can watch at hawala practice as a modern and fair solution to be included in the western practice while they are assured about safety and transparency, while islamic culture can see at this typical western technologies as a halal financial system. the limit of the research described in this paper is that the “globalcoin” are, at the time of this study a conceptual model only, so libra and gram haven‟t been yet released and is notpossible to verify the real applicability of the theorized model to the hawala practice. references [1] antonopoulos, andreas m.(2010). mastering 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(2015). sharia compliant "possibility for italian smes". european journal of islamic finance, (1). ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4582 1 debt forgiveness and debt relief for covid-19 economic recovery financed through gdp-linked sukuk abstract— this paper proposes alternatives for governments to deal with the current pandemic crisis today. it suggests ways to deal with the increasing debt levels as a result of the fiscal stimulus issued to cushion the effects of a tremendous shock to the economy. firstly, the paper proposes to protect the vulnerable group (based on debt-to-income ratio or its debt-servicing ability) through debt forgiveness and help smes through debt relief via debt restructuring for their outstanding loans. to finance this, we propose to convert the increased public debt from these initiatives into equity through a gdp-linked sukuk to stabilise a sovereign’s debt to gdp ratio. the repayment on these sukuk will be in proportion to the country’s gdp whereby the repayment automatically declines when growth is weak and increases when gdp is strong. in doing so, an anticipated deep recession caused by the global pandemic slowdown will makes it less likely to trigger a sovereign debt crisis. secondly, such a strategy would provide the issuing government with economic reprieve when growth weakens and tax receipts decline. at the same time, investors can view these sukuk as an alternative asset class through exposure to the real economy, given the low interest rate environment. both sides are incentivized by the debt-stabilising effects of issuance that would make sovereign defaults less likely and balance risk-taking. keywords debt limits, fiscal space, growth-linked sukuk, sovereign debt management. i. introduction combating the covid-19 pandemic has elicited radical responses from governments and world health officials, which has resulted in some of the most drastic strategies that we have seen in our recent history. the consequential lock-down of the suspected originating city in china, have quickly expanded extreme measures to the quarantine of entire provinces and entire countries, slowing down economic activities substantially. to ensure that all countries can do what is necessary to fight the economic fallout of the pandemic, the fiscal costs of this global crisis for each nation has been great. many governments have already pledged billions in grants to support health care, liquidity to the private sector (credit lines to smes), short-time work schemes and stimulus packages. in order to do so, governments have to dig deep into their reserves and for others, resort to debt. the need for stable capital flows to help moderate the path to economic recovery requires support for the real economy and dealing with potential sovereign defaults, if capital runs out before the economy recovers adequately. it is therefore important to develop and utilize market instruments that can boost the recovery curve. this paper investigates the stimulus alternatives that are being implemented at the moment and suggests ways to deal with the increasing debt levels as a result of the fiscal stimulus issued to cushion the effects of a tremendous shock to the economy. it proposes the conversion of public debt into equity through gdp-linked sukuk to ―stabilise a sovereign‘s debt to gdp ratio and makes it less likely that a deep recession will trigger a debt crisis and cause a default‖ [3] based on the findings of various research on gdp-linked bonds. a. objectives of research in this pandemic, our current lack of knowledge about the virus is our greatest weakness in combating it. not knowing who has been infected, or who is a carrier without symptoms, contributes to higher infection rates. not knowing enough about the virus delays our ability to treat those infected, or release those from quarantine with absolute confidence. it hinders our judgement to restart the economy and leaves us little choice but to take a measured approach in getting people back to work and to allow businesses to return to operations. containment measures to ―flatten the curve‖ are still enforced and loosened in phases in order to prevent a second wave, hazik mohamed and m. ashraful mobin submitted june 2020, revised december 2020, accepted december 2020 ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4582 2 which historically had been more deadly than the first 1 . adjustments to work-from-home (wfh) orders and socialdistancing has transformed business-as-usual to such an extent that shifts in the economy will be inevitable. also, within the next few months, there will be companies, both big and small, that will file for bankruptcy and there will be sovereign defaults as countries face drying liquidity. in order to prevent undesired outcomes, we propose that governments can do two things, on top of what have already been implemented. (1) identify the ‗most vulnerable group‘ within their communities and assess their household and personal debt levels for consideration of debt forgiveness. (2) allow micro, small and medium enterprises (smes) to restructure their corporate debts or renegotiate for new terms as a form of debt relief. these two initiatives will be funded through a gdp-linked sukuk issued by the country. the financial burdens lifted by these initiatives will have positive effects on the economy as capital which would have been used to pay down the debts will instead be utilized as spending or consumption for the vulnerable groups and necessary expenditure for the smes. this cycle of spending will in turn contribute towards gdp growth and, directly and indirectly, save jobs and limit unemployment. ii. review on gdp-linked bonds and sukuk a. creating sustainable sovereign instruments in order to finance the proposed debt forgiveness for households and debt relief for smes, governments can issue public debt instruments such as sovereign sukuk [13; 7]. however, doing so creates more fiscal indebtedness. gdplinked sukuk is one way to convert those debts into equity repayments based on gdp performance of the country. such growth-linked financial instruments are a type of security akin to a ―stock on a country‖ in the sense that it has ―equity-like‖ features. similarly, it pays more ‗dividends‘ when the performance is better and pays less when it is worse than expected. 1 there were three waves in the spanish flu pandemic of 1918: the first occurred in the spring, the second in the autumn/fall and the third in winter. it is unclear what triggered the second wave. https://www.cdc.gov/flu/pandemic-resources/1918-commemoration/threewaves.htm https://fullfact.org/online/spanish-flu-second-wave-quarantine/ figure 1: simplified structure of gdp-linked sukuk (source: author‘s own) tax revenues investors governments through gdp-linked sukuk investments in revenuegenerating projects debt relief, debt forgiveness, fiscal stimulus taking into consideration experiences from other financial instruments, especially the argentina's successes with inflation-linked sukuk as well as their failings with "gdp warrants", we recommend a gdp-linked sukuk that will incorporate the following principles in its design: (i) simplicity — keeping conditional payment triggers simple to avoid failures of trading out of the money for long periods as well as hindering fair-value pricing; (ii) recognizability — maintaining the industry-standard terms present in inflation-linked sukuk contracts and adapting them where necessary; (iii) pliability — with a flexible term sheet template designed to accommodate the range of emerging and advanced economies with slight adjustments; (iv) balanced risk-sharing — with the investor sharing the rewards of the upside as well as the risks of the downside, which reinforces the debt-stabilising physiognomies of this structure for the issuer as well as incentives for return and repayment. b. debt limit and fiscal space we discuss the work done on gdp-linked bonds by imf researchers [10; 22] where they show ―how the structure of sovereign debt can alter the payment capacity of a government, which delivers a calculation of the maximum level of debt that a sovereign is likely to be able to sustain before it risks facing a crisis‖. the concept of the debt limit captures the understanding of fiscal fatigue where ―an improvement in a country‘s structural characteristics or economic growth rate raises its debt limit, while the occurrence (or recognition of the possibility) of a negative shock could push an otherwise sustainable debt level to the unsustainable territory‖. they found evidence of fiscal reactions where ―governments face debt limits beyond which debt cannot be rolled-over‖. they used these findings to compute ―fiscal space‖ which is ―defined as the difference between projected debt ratios and debt limits‖, allowing for further increases in public debt without undermining sustainability. the mechanism through which gdp-linked bonds (and similarly, sukuk) help to increase fiscal space arises because ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4582 3 the evolution of sovereign debt ratios is affected by stochastic variation in gdp. during lower-than-expected growth, the creditworthiness of sovereigns fall because the poor ratings due to higher-than-expected debt ratio raises default risk. if the debt contract could be varied to modulate the debt service during bad times (e.g. economic shocks such as the covid-19 pandemic), default risk would decline. such flexibility in exchange for an increased rate of return during good times, would allow the debt contract to be written with a lower average interest rate. kim and ostry [18] ran simulations that suggest fiscal space gains in the order of 10-60% of gdp for a representative advanced economy, assuming investor risk neutrality. simulated gains in fiscal space are larger for counter-cyclical fiscal policy because, holding constant the extent of growth uncertainty, more countercyclicality in policy amplifies stochastic variation in the debt ratios by more for nominal bond than for gdp-linked bond. in their research, bank of england researchers [3] focused on the ―amount gdp-linked bond that can potentially increase debt limits, rather than the absolute value of the debt limits themselves‖. even with the simplest model set-up used, they found that ―gdp-linked bonds have a substantial impact on a sovereign‘s debt limit – raising it by around 100% of gdp‖. pienkowski [23] found that ―even issuing relatively modest amounts – say 20% gdp-linked bond of the total debt stock — can have a significant impact on the debt limit‖. from figure 2, it is observed that for advanced economies (aes), ―the debt limit would rise by around 15% points of gdp, which would be enough to accommodate the median fiscal costs of a systemic banking crisis 2 ‖. emerging markets (ems) have a maximum debt limit when gdp-linked bonds make up around 80% of the debt stock. beyond this, the cost of issuing these instruments outweighs the benefits, and the debt limit begins to fall. ―for aes, the debt level continues to increase with the share of gdp-linked bond‖ [24]. for low-income countries (lics), however, there is no change in the debt limit (relative to the case where 100 percent of debt is local currency denominated). 2 amaglobeli et al. [1] estimate that the ―direct fiscal cost of a systemic banking crisis recapitalisation and asset purchases) has a median of 6% of gdp; while the median increase in public debt associated with these events is around 14% of gdp‖. ―an 8%-point increase in the debt limit for ems is also substantial, enough to accommodate additional borrowing through a typical recession‖ [16]. figure 2: change in debt limits with variation of gdp-linked bond to the total debt stock for lics, ems and aes (source: pienkowski, 2017) the results of the various gdp-linked bond composition research suggest that ―there is no one-size-fits-all debt structure that all countries should target‖. for lics, with the lowest ‗baseline‘ debt limit, results seem to suggest that ―focus may be best directed at reducing exchange rate risk through local currency debt issuance and building institutions that can raise the maximum sustainable primary balance‖ [23]. for ems, when they have adequately diminished exchange rate risk, the benefits from gdp-linked sukuk become obvious. but pienkowski‘s results show that aes benefitted the most, ―with debt limits rising by 15% points when gdp-linked sukuk make up one-fifth of the debt stock‖. from a cost-benefit approach, government issuers may consider starting at lower levels of the debt stock, since the ‗marginal benefit‘ (in terms of the change in the debt limit) reduces across the board for all countries. it should be noted that the ―results presented are sensitive to the parameter assumptions, perhaps the largest uncertainty involves the risk premium required by investors to hold local currency and gdp-linked bond‖ [23]. also, a useful consideration is to ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4582 4 incorporate a long maturity debt into the tenure of the model, or even to contemplate perpetuity. other valuable considerations would include capturing the various policy frameworks in different countries such as currency union. such countries have considerably less latitude to control nominal gdp through monetary and fiscal policy, and hence the perceived benefits of gdp-linked sukuk based on the study may be impaired. iii. coping with the economic repercussion of the pandemic and increasing levels of sovereign debt as mention in the earlier section of this research, we propose that governments do two things, on top of what have already been implemented so far in terms of austerity measures to save lives. in the subsequent phase of this pandemic, the next order of business is to save the economy. in order to prevent further undesired outcomes, (1) identify the ‗most vulnerable group‘ within their communities and assess their household and personal debt levels for consideration of debt forgiveness. (2) allow micro, small and medium enterprises (smes) to restructure their corporate debts or renegotiate for new terms as a form of debt relief. these two initiatives will be funded through a gdp-linked sukuk issued by the country. the financial burdens lifted by these initiatives will have positive effects on the economy as capital which would have been used to pay down the debts will instead be utilized as spending or consumption for the vulnerable groups and necessary expenditure for the smes. this cycle of spending will in turn contribute towards gdp growth and, directly and indirectly, save jobs and limit unemployment, on the road to economic recovery. a. debt forgiveness consumer debt is a concern today because it has reached record levels [2] and because its rise comes as powerful trends 3 shape how debt is incurred and the consequences it has for financial security. we see the issue of consumer debt as a necessary challenge, different in many ways than the more widely understood mortgage debt (borrowing to buy a home) that precipitated the great recession of 2018. our definition includes all forms of non-mortgage debt such as student and auto loans, credit cards, and non-loan obligations including medical debt and money owned to local governments that have come to use such fines and fees as a key revenue source. the scope of this mounting crisis is troubling: for example, debt in collections now appears on one-third of consumer credit reports. the approach to these can be worked out through a framework that is built on the analyses of historical patterns, contemporary drivers, and differences among demographic groups. the vulnerable group can be defined via its debt-toincome (dti) indicator — the higher the number, the more vulnerable the group is. based on this information, the classification of the outstanding debts and its volume, the debt 3 trends such as stagnating incomes, new forms of credit availability, and structural changes in medical and education markets. forgiveness can be applied to the group below a certain dti value. targeted forgiveness of household debt held by borrowers whose loans are most likely to undermine their financial security (i.e. the low-income debtors determined through the dti value). for illustration purposes, we have taken the debt-to-income ratio (dti) and debt service ratio (dsi) for european countries for the year 2017 4 only. from figure 3, we can see that the bottom 20% of greece (gr), cyprus (cy), netherlands (nl) and slovenia (si) are 3 times in debt against their income. overall, indebtedness is highest across all sections of income levels for cyprus and netherlands, with most of them owing about 200% (and exceeding) of their income. but before we determine the most vulnerable group and apply a cut-off, we need to understand the debt-to-service ratio of these groups. figure 3: dti and household debt outstanding 0.0 100.0 200.0 300.0 400.0 500.0 600.0 700.0 be de ee ie gr es fr hr it cy lv lt lu hu mt nl at pl pt si sk fi bottom 20% 20-40% 40-60% 60-80% 80-90% 90-100% note: the debt to income (dti) ratio is the ratio of total debt 5 to gross household income 6 . * for full country abbreviation list, refer to appendix a. source: household finance and consumption survey (year 2017). from figure 4, we can observe that although netherlands is one of the two countries that is considered to have high debt to income overall, its debt-to-service ratio is typical of other european countries, except for its bottom 20% which far exceeds all others. from here, we can determine the most 4 for a better cross-sectional study, the investigation can be extended to 5 years or more. debt tenure typically exceed 5 years, so the debt outstanding does not change very much in shorter time spans. 5 total debt includes mortgages collateralised on household's main residence, mortgages collateralised on other real estate property owned by the household, non-mortgage loans (consumer credit loans, private loans and other loans not collateralised on household's real estate property), credit lines/bank overdrafts debt and credit card debt (outstanding amount on which interest is paid at the end of the billing period) unless otherwise specified for a given country (see country notes below for more detail). 6 total gross household income is calculated as the sum of the employee income, self-employment income, income from public pensions, income from private and occupational pensions and income from unemployment benefits (items collected for households members aged 16+) and income from social transfers other than unemployment benefits, regular private transfers (such as alimonies), rental income from real estate property, income from financial investments, income from private business or partnership and regular income from other sources (items collected at the household level). ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4582 5 vulnerable group by setting the cut-off as 25% or 30% of dsi, i.e. about a quarter of their monthly incomes goes to repayment of debts. the next approach for this debt forgiveness for most vulnerable households policy is to assess if (1) dissolution of household debt capped at a certain value per borrower (e.g. $50,000–$100,000), or (2) full termination of all household debt for the extremely vulnerable group, where we can set as those with 25% or 30% of dsi. figure 4: dsi and household debt outstanding 0.0 10.0 20.0 30.0 40.0 50.0 60.0 70.0 80.0 90.0 be de ee ie gr es fr hr it cy lv lt lu hu mt nl at pl pt si sk fi bottom 20% 20-40% 40-60% 60-80% 80-90% 90-100% note: the debt service to income ratio is calculated as the ratio between total monthly debt payments and household gross monthly income 7 , among households with debt payments. source: household finance and consumption survey (year 2017). b. debt relief or debt restructuring governments and nations have good reason to fear economic distress in smes, because economic and health crises can produce massive unemployment and stunt economic recovery. smes are the backbone of most economies in the world — in asia alone, they account for more than 70% of all businesses and between 32 and 87% of total share of employment outside the agricultural or farm-based workforce in asia 8 [15]. an analysis of individual countries in europe reveals that the ―support smes receive from financial institutions to help finance their businesses does not reflect their contributions to their country's gdp and employment, despite being the critical drivers for growth‖ [9]. in general, sme loan volumes in the euro region are less than 40% of their contribution to gdp, 7 total gross household income is calculated as the sum of the employee income, self-employment income, income from public pensions, income from private and occupational pensions and income from unemployment benefits (items collected for households members aged 16+) and income from social transfers other than unemployment benefits, regular private transfers (such as alimonies), rental income from real estate property, income from financial investments, income from private business or partnership and regular income from other sources (items collected at the household level). 8 asia-pacific employment and social outlook 2018: advancing decent work for sustainable development by international labour organization, 2018. https://www.ilo.org/wcmsp5/groups/public/---asia/---ro-bangkok/---srobangkok/documents/publication/wcms_649885.pdf and constitute less than 20% of total loans, according to imf data. figure 5: small loans (< €250k) with respect to total nfc lending (nbv*), by percentage and country source: eif (2019) based on ecb data warehouse huerga et al. [14] show that ―small loans are a good proxy for the sme lending market‖. in the eif report [9], it was observed that ―small loans are relatively more important in the credit market of vulnerable countries‖. from figure 3, in spain and portugal, for example, ―small loans make up 40% and 35%, respectively, of new loans granted to non-financial corporations (nfcs). for september 2019, both shares stayed roughly constant compared to the same month in 2018. also, in italy this share is relatively high at 25%. in austria, the netherlands, slovakia, belgium and germany, the proportion of small loans in total new business volume is much smaller and does not exceed 10%‖. the next approach for this sme debt restructuring policy is to calculate the cost of delaying the monthly payments for their sme loans. this can be easily calculated through the banks‘ data. options are (1) to retain the same monthly payments by offering moratoriums, or (2) renegotiate monthly payment premiums based on longer tenures or reduced monthly borrowing rates. iv. benefits and advantages of gdp-linked sukuk the idea of issuing gdp-linked sukuk is similar to having some kind of insurance against unprecedented economic shocks in very uncertain times. past debt crises that involved countries like portugal, ireland, greece and spain over a decade ago would have been less severe if their debt had been coupled to their gdp. investment in gdp-linked instruments allow for risks to be more acceptable, given the unlimited upside to investing in entire economies. in addition, global investors can achieve the benefits of diversification by holding gdp-linked sukuk of nations tied to their growth and survival. embracing gdp-linked sukuk puts pressure on delivering performance for sovereign debt managers but rising public debt burdens should incentivise many of them to consider new forms of borrowing that appeal to a wide range of investors. this includes ones with limited exposure to conventional sovereign sukuk. outreach by the gdp-linked sukuk working group suggests there is potential demand for the new ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4582 6 instruments from pension funds, sovereign wealth funds, insurance companies, equity funds and hedge funds [4; 17]. there are important advantages to issuing gdp-linked sukuk for both the issuing countries and the investors, as discussed in this research (see also [11]). the system-wide benefits afforded by growth-linked instruments far exceed those that can be achieved by individual investors or countries. gdp-indexed securities can be viewed as desirable vehicles for international risk sharing and for avoiding the disruptions arising from formal default. the dead-weight costs of long debt restructuring at times of crises would be avoided, as debt was automatically modified. gdp-linked sukuk have characteristics of a public good as they generate systemic benefits above those accruing to individual investors and countries. if gdp-linked sukuk lowered risk of default, they would make remaining conventional sukuk safer, in the same country [11]. by reducing likelihood of defaults, they would also benefit a broader range of investors than just those directly affected, along with economies not issuing them, but which would reduce their chance of contagion from other countries, as well as economies and multilateral institutions. the reality is that, despite its demonstrated benefits, gdpindexed debt has not been widely issued, beyond countries having difficulties in servicing their debts. the inertia caused by financial innovation coupled with the complexity of implementing new financial inventions may be the impediments. but like most things worth accomplishing, it takes time and effort to pursue an innovation until its successful implementation. perhaps, the current economic dire straits caused by the pandemic may provide the impetus and motivation to do so. v. conclusion with the increasing levels of sovereign debt levels and diminishing reserves, ―gdp-linked debt is an attractive instrument for this purpose because it can ensure that debt stays in step with the growth of the economy in the long run and can create fiscal space for countercyclical policies during recessions‖ [18]. thus, gdp-linked debt would give governments more room to maneuver in its fiscal policy space, which would be especially valuable at a time like the present when fiscal space is scarce, and immediate solutions are urgently needed. while such sukuk market development is still not widespread, the debt capital markets have come a long way since the brady bonds of the late 1980s and early 1990s. the ability to protect the vulnerable group and smes at this crucial time where most countries are restarting their stalled economies, such instruments also help investors manage country risks and further raises its desirability. gdp-linked sukuk could also allow risk to be shared across borders more efficiently and safely, while potentially reducing the need for international bailouts of sovereigns and so reduce morally hazardous behaviors and agency risks. acknowledgment we acknowledge the idea from prof. dr. abbas mirakhor who initially proposed it as a solution to protect the most vulnerable households and smes. appendix country code belgium be germany de estonia ee ireland ie greece gr spain es france fr croatia hr italy it cyprus cy latvia lv lithuania lt luxembourg lu hungary hu malta mt netherlands nl austria at poland pl portugal pt slovenia si slovakia sk finland fl references [1] d. amaglobeli, n. end, m. jarmuzek and g. palomba, from systemic banking crises to fiscal costs: risk factors, imf working paper no. 15/166, 2015. [2] aspen epic, lifting the weight: consumer debt solutions framework, november 14, 2018. [3] d. barr, o. bush, and a. pienkowski. gdp-linked sukuk and sovereign default. bank of england working paper no. 484, 2014. [4] j. benford, t. best, and m. joy, sovereign gdp-linked sukuk, bank of england financial stability paper no. 39, 2016, pp. 13. [5] c. burnside, and d. dollar, ―aid, policies, and growth‖. american economic review, 90 (4), 2000, pp. 847-68. [6] e. borensztein, and p. mauro (2004), ―the case for gdp-indexed bond‖, economic policy, vol. 19, no. 38, april 2004. [7] a. diaw, o. bacha, and a. lahsasna, public sector funding and debt management: a case for gdp-linked sukuk, 8th international conference on islamic economics and finance, 2011. [8] emn-mfc. microfinance in europe: survey report 2016-2017. december 2018. [9] european investment fund. european small business finance outlook, december 2019. working paper 2019/61. luxembourg. ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4582 7 [10] a. ghosh, j. i. kim, e. g. mendoza, j. d. ostry, m. s. qureshi, fiscal fatigue, fiscal space and debt sustainability in advanced economies, nber working paper 16782, 2011. [11] s. griffith-jones, and d. hertova, gdp-linked securities, in bergsten, c. f. and c. r. henning (eds.), global economics in extraordinary times; essays in honor of john williamson, piie, 2012, washington dc. [12] s. griffith-jones, and k. sharma, gdp-indexed sukuk: making it happen, desa working paper no. 21, 2006. [13] n. ul haque, and a. mirakhor. the design of instruments for government finance in an islamic economy. 1999. mpra paper no. 56028, posted 20 may 2014. [14] j. huerga, j. puigvert, and c. rodriguez, enhancements on ecb mfi interest rate statistics. in oecd – the statistics newsletter. issue no. 55. march 2012. [15] ilo, asia-pacific employment and social outlook 2018: advancing decent work for sustainable development. bangkok, thailand. [16] imf, debt: use it wisely, imf fiscal monitor. 2016. [17] m. joy, gdp-linked sukuk, sovereign gdp-linked sukuk: design, investor response and open issues. ad hoc working group on the london term sheet discussion paper, bank of england, 2017. [18] j. kim, and j. ostry, boosting fiscal space: the roles of gdp-linked debt and longer maturities, imf working paper series, no.18/04, 2018. [19] k. l. mckay, and d. kingsbury. student loan cancellation: assessing strategies to boost financial security and economic growth. the aspen institute epic. april 2019. [20] j. mohrenweiser, s. srikantan, and t. wan (2017), insurance-linked securities rating criteria, fitch ratings, 2017, pp. 15 [21] e. neumayer, is good governance rewarded? a cross-national analysis of debt forgiveness. world development, 30 (6), 2012, pp. 913-30. [22] j. ostry, a. ghosh, j. kim, and m. qureshi, fiscal space, imf staff position note, spn/10/11, 2011, international monetary fund, washington. [23] a. pienkowski, debt limits and the structure of public debt, imf working paper 44913, 2017. [24] a. pienkowski, ―debt limits and the structure of public debt‖, journal of globalization and development, volume 8, issue 2, 2018, walter de gruyter gmbh, berlin/boston. [25] m. schularick, and a. taylor, credit booms gone bust: monetary policy, leverage cycles, and financial crises, 1870-2008, american economic review, 2012. ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4582 8 the effects of ownership and regulation on bank earnings quality: an investigation of the conventional and islamic banks in mena region a higher institute of management, university of tunis, tunisia. khawlabourkhis@hotmail.fr b al itqan islamic finance, ariana, tunisia. najarfinanceislamique@yahoo.fr abstract— the study aims to examine the relationship between shareholding ownership structures, national institutional factors and earnings quality of banks across mena countries (middle east and north africa). using four distinct earnings quality measures that detect different aspects of earnings properties on a sample of 158 banks (44 islamic banks and 114 conventional banks), the study finds that all four measures of earnings quality are higher for listed and widely held banks; and, that state-owned banks have less persistent, less predictable, and less managed earnings. moreover, islamic banks in mena countries appear to have significantly higher quality of earnings than their conventional counterparts in terms of earnings persistence, cashflows predictability and income smoothing using loan loss provisions. the study shows also that tighter supervision improves earnings reporting quality by reducing earnings management practices even in the presence of large shareholding. keywordsownership structure; bank regulation; earnings quality; earnings management; islamic banks i. introduction financial reports constitute the primary information source for stakeholders of both banking and non-banking firms. financial reports including balance sheet, income and cash flow statements provide information regarding bank performance, solvency and soundness. hence, reporting financial accounting information need to be with high quality to insure reliability, accuracy and informativeness. incomes represent the most important accounting information that investors, managers, directors and regulators rely on in their decision making process. earnings are the primary information source for investors rather than any other performance indicators such as dividend and cash flows (francis et al., 2004)[36]. consequently, reporting quality of earnings is crucial for the well-functioning markets. investors, analysts and policy makers require credible accounting information to assess the real firm’s economic performance and take subsequently optimal decisions. penman and zhang (2002) [57] consider that earnings with high quality if, before extraordinary items that are freely identified on the income statement, it is a good indicator of future earnings. dechow et al. (2010) [26], further, indicate earnings with high quality if it provides more information about the features of a firm’s financial performance that are relevant to a specific decision made by a specific decision-maker. more broadly, earnings reporting quality refers to the ability of accounting earnings to signal future firm’s earnings and cash flows (francis et al., 2004; chen et al., 2007; giao and raposo, 2011; demerjian et al., 2012) [36, 21, 37 & 28]. mainly, earnings are considered as high quality if they are predictable and easy to forecast. yet, fraudulent reporting is absolutely low quality. kanagaretnam et al. (2014) [44] examine earnings quality from two different perspectives: an informative and an opportunistic earnings management perspective. the informative perspective indicates that earnings quality is improved when managers report less noisy earnings by taking reporting actions that reveal accurate and precise information about firm’s real performance. however, earnings quality decreases if managers behave opportunistically and intervene deliberately in the earnings reporting process by altering the firm economic performance to mislead outsiders and/ or increase their own welfare at expense of investors. thereby, earnings management has a lot in common with earnings quality. highly managed earnings are definitely low quality. literature on financial reporting quality and banking industry shows that banking institutions often manage their accounting earnings through the use of loan provisions or the security gains and losses for several motives: income smoothing, regulatory incentives, signaling purposes and tax payment (beaver and engel, 1996; ahmed et al., 1999; anandarajan et al., 2007) [12, 5 & 9]. prior researches demonstrate that bank earnings management is a worldwide phenomenon (shen and chih, 2005) [61] but its level depends on various internal and external factors. banks risk level and governance mechanisms are the most widely analyzed (cornett et al., 2009; wan mohammad et al., 2011; abaoub et al., 2013) [24, 67 &1]. for instance, it is shown that bank executives’ compensation contracts increase managerial incentives to manage earnings (uygur, 2013) [66]. however, the internal control systems increase accounting quality and limit discretionary behavior (altamuro and beatty, khawla bourkhis a and mohamed wajdi najar b mailto:khawlabourkhis@hotmail.fr mailto:najarfinanceislamique@yahoo.fr ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 2010) [7]. further, bouvatier et al. (2014) [16] indicate that european banks with higher level of ownership concentration display higher intensity of income smoothing through loan loss provisions (llp). however, this negative association appears attenuated among countries with stronger supervisory regimes or higher external audit quality. cross countries analyses such as fonseca and gonzalez (2008) [35] and kanagaretnam et al. (2014) [44] have highlighted the role of institutional environment and supervisory regimes in enhancing bank earnings quality by reducing earnings management. auditing quality, changes in accounting standards and bank listing status are also revealed as important determinants of earnings management in the banking industry. this study aims to examine whether differences in ownership status could explain variations in the quality of bank earnings across mena countries. our research question is therefore: is there a relationship between mena bank ownership structure and the content information of earnings? we suppose that mena region constitutes a favorable field of research for three key reasons: firstly, mena banking institutions are well characterized by highly concentrated ownership structure with the predominance of government ownership (kobeissi and sun, 2010; farazi et al., 2011). [47 & 34]. however the limited existing literature does not provide consistent findings on the implications of this distinctive ownership structure. there is no study in our knowledge examining mena bank earnings reporting quality and its association with their ownership structures. secondly and despite the noted higher ownership concentration that complicates the governance of banks, mena legal institutions do not sufficiently protect minority shareholders’ interests against expropriation risk. mena countries suffer from the weak enforcement of shareholders rights (naciri, 2008) [56]. nonetheless, several studies such as caprio et al. (2007), shehzad et al. (2010), haw et al. (2010) and busta et al. (2014) [19, 60, 39 & 18] prove that legal environment impacts significantly conflicts of interests between controlling shareholders and minority shareholders. finally, banking system in mena region is characterized by the co-existence of islamic banks and conventional banks side-by-side. islamic banking assets1 in mena countries are about 1,197.9 billion dollars in 2014, it accounts for more than 20 percent of banking system assets in 10 countries. mena region constitutes so an adequate sample for a comparative analysis between the two groups of banks. the principal objectives of the present research study are therefore described as follows: firstly, the analysis aims to assess the quality of bank’s reported earnings and measure the extent of bank earnings management in the mena region. secondly, we intend to determine whether and to what extent shareholding ownership concentration matters in bank earnings quality. thirdly, the study tries to explore whether certain types 1 islamic financial services industry stability report, may 2015. of majority shareholder are particularly conductive to lower quality of earnings of mena banks. fourthly, the study will determine to what extent islamic religious values affect earnings reporting quality. lastly, we will highlight the impact of regulation and banking supervision in emerging economies on bank earnings quality. we employ four distinct earnings quality measures that detect different aspects of earnings properties (earnings persistence, ability to predict cash flows, income smoothing through loan loss provisions and small positive net incomes on a sample of 158 banks (44 islamic banks and 114 conventional banks) from 15 mena countries observed over the period (2000-2013). to control the mena institutional environment and evaluate its role in enhancing the earnings reporting quality, we use three indicators: investor protection index, official supervisory power index, and private monitoring index. our empirical findings suggest that all four measures of earnings quality are higher for listed and widely held banks; and, that state-owned banks have less persistent, less predictable, and less managed earnings. the study shows also that tighter supervision improves earnings reporting quality by reducing earnings management practices even in the presence of large shareholding. moreover, islamic banks in mena countries appear to have significantly higher quality of earnings than their conventional counterparts in terms of earnings persistence, cash flows predictability and income smoothing using loan loss provisions. the rest of the paper is organized as follows: section 2 provides a discussion on relevant literature and develops research hypotheses. data and research design are explained in section 3. section 4 presents empirical findings. section 5 concludes the paper. ii. literature review and hypotheses development a. share ownership structure and bank earnings quality it is highly argued in the literature that corporate share ownership structure has a significant impact on the agency costs inherent in the stockholder-manager relationship, in the extent that it influences the efficiency of the implemented monitoring mechanisms. both agency theory and empirical evidence suggest that owners’ ability and incentives to carry out monitoring effort and mitigate agency problems vary with the control ownership structure. prior studies, for instance, show that single investors with small ownership stakes have little incentive to control the firms. however, blocked shareholders with large ownership stakes gain control power and have more incentive to monitor management activity (schleifer and vichny, 1986) [63]. additionally, managerial ownership is deemed as relatively useful in aligning management and shareholders’ interests and reducing hence agency conflicts (morck et al., 1988) [55]. two competing views have been suggested by the literature regarding ownership concentration and earnings reporting quality association. on the one hand, http://www.ojs.unito.it/index.php/ejif ownership concentration alleviates agency costs between managers and shareholders (jensen and meckling, 1976; shleifer and vishny, 1986) [41 & 63]. in fact, being large owner with a considerable number of shares creates strong incentives and gives more power to oversee firm management and evaluate executives in order to assure that shareholders’ interests are protected. in addition, demsetz and lehen (1985) [29] deem that majority ownership is an effective mechanism to mitigate managerial expropriation. one form of this managerial expropriation is represented in the lower financial and accounting reporting quality. thereby, carrying on control over firm management definitely includes control over accounting information and reporting policies; and this is in order to reduce the scope of managerial opportunism. large block holders therefore can force managers to adequately report financial information. however, managers of firms with widely dispersed ownership are assumed as in a better position to adopt discretionary accounting practices that serve their self-interests. in consonance with the monitoring hypothesis, many of the previous empirical studies reveal that the concentration of ownership leads to better quality of accounting numbers. for example, warfield et al. (1995) and alves (2012) [69 & 8] find that ownership concentration enhances the quality of reporting earnings by reducing the levels of earnings management. similarly, dechow et al. (1996); yeo et al. (2002) and jung and kwon (2002) [27, 70 & 42] point out that block holders of share improves the credibility, reliability and informativeness of financial information. on the other hand, block holder ownership can generate unluckily an entrenchment behavior against minority shareholders (jensen and meckling, 1976; shleifer and vishny, 1986) [41 & 63]. when ownership control is high enough, largest shareholders have the incentive to expropriate small shareholders’ wealth. they might possibly put pressure on managers to engage in earnings management practices in order to expropriate firm resources at the expense of outside investors. in the east-asian context, fan and wong (2002) [32] reveal that earnings informativeness, proxied by the accounting earnings-stock returns relationship, decreases with ownership concentration. the study shows that controlling owners report accounting information for self-interested purposes, causing hence the reported earnings to lose credibility to outside investors. in addition, leuz et al. (2003) [50], in a sample of 8000 firms from 31 countries, indicate that managers and controlling shareholders can use their control over the firm to benefit themselves at the expense of other stakeholders. for nyse firms, zhong et al. (2007) [71] too reveal a positive association between block-holder ownership and discretionary accruals. further, kung et al. (2010) [48] find in the sample of listed chinese companies a negative relationship between block ownership and earnings conservatism. drawing on the above discussion and on the recent empirical evidence from the banking sector (isenmila and elijah, 2012; tsai and hsieh, 2013; and bouvatier et al., 2014) [40, 65 & 16] showing that banks with higher ownership concentration conduct more earnings management and income smoothing that lower the quality of earnings than banks with low ownership concentration; we postulate that: h1: ownership concentration lowers earnings quality of mena banks. religious ethical values are deemed as one of the monitoring mechanisms considered in the literature in limiting opportunistic and unethical corporate behavior (dyreng et al., 2012) [31]. for instance, kennedy and lawton (1998) , conroy and emerson (2004) and longenecker et al. (2004) [46, 23 & 53] have emphasized the role of religion in constraining unethical practices in the business organizations. lewis (2001) [52] argues that religion plays an important and constructive role in guiding and controlling human behavior, it provides values of truthfulness, honesty, morality, justice and accountability. religious beliefs and codes are in fact the source of ethical and moral behavior. in that way, religious identity of the organization is appeared to mitigate opportunistic behavior among managers and enhance as a result financial information reliability and the integrity of the financial reporting process (abdul rahman, 2012) [3]. prior studies such as mcguire et al. (2012) [54] assert that religion-influenced firms are less likely to engage in financial reporting irregularities. they find a negative association between religiosity and abnormal accruals. earlier literature on islamic finance and banking suggests that islamic banking firms are subject to an additional layer of governance in the form of shariah governance. abdel karim (1990) [2] argues that the shariah supervisory board could be viewed as similar to the independent company auditors in limiting discretionary behavior. further, quttainah et al. (2013) [58] find that islamic banks employ less earnings management than their conventional peers. in contrary to the above conclusions, other researches such as (zoubi and el ghazali, 2007; taktak et al., 2010; ben othman and mersni, 2014) [72, 64 & 13] indicate that earning management is not much different between islamic and conventional banking institutions. we postulate therefore that: h2: islamic banks display higher earnings quality than their conventional counterparts. empirical research examining the role of government shareholding in financial reporting quality is scant and, to the extent available, it is inconclusive. starting from the role of government ownership in the economic and financial sectors (social, political and agency views) diverse relationships are expected. under the development or called also the social view of state ownership, government intervene in the financial markets to promote macroeconomic growth and cure market financial failures. government is assumed as powerful and has incentives enough to safeguard stakeholders’ interests and improve consequently the general welfare. government is accountable to the public to monitor public firms since the latter are authorized to use public funds. then, monitoring stateowned enterprises management and more specifically accounting information quality is deemed as crucial to avoid robbery and corruption. thereby, state-owned companies have ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 to exhibit good financial reporting quality. consistently with the development hypothesis, abdul rahman (2012) [3] find that malaysian firms with high concentrated government ownership have higher accounting conservatism and lower degree of discretionary accruals. in the chinese context moreover, wang and yung (2011) [68] note that chinese state-owned firms have better accounting earnings quality (better accruals quality and lower levels of abnormal accruals) than privately owned firms. similarly, bo and wu (2009) [15] find that level of incomeincreasing earnings management is lower in state-owned firms than in privately-owned firms. conversely, the political view of state ownership supposes that state-owned enterprises are created to satisfy personal and political objectives rather than to maximize social welfare. shleifer (1998) [62] argues that state shareholding has detrimental effect on corporate performance. government acquires ownership in highly sensitive sectors to ultimately serve its political agendas. unlike the development theory of government shareholding, the political view assumes that politicians and bureaucrats are self-interested individuals and pursue their own personal objectives at the expense of the state (sapienza, 2004) [59]. they often seek to stay in power and maintain the perquisites of their positions (shleifer, 1998) [62]. thereby, monitoring decisions or expropriating corporate resources for the benefit of supporters is mainly influenced by various political and individual concerns. for example, politicians mostly in developing countries abuse their power to transfer some corporate resources into the hands of their supporters (kung et al, 2010) [48]. furthermore and in order to gain public trust and support, executives in state-owned companies can manage financial reports to mask large losses. in china, chen and yuan (2004), ding et al. (2007) and aharony et al. (2010) [20, 30 & 4] find that government ownership is more associated with earnings management practices than private ownership. no consensus is provided in the banking literature about the impact of the largest owner identity in the financial reporting process. bouvatier et al. (2014) [16] show that income smoothing via llp is independent to whether the ultimate owner is an institution, a family or an industrial firm. following tsai and hsieh (2013) [65] who suggest that large government shareholding in the bank may limit earnings increasing management, we postulate that: h3: state ownership in mena banks is associated with higher earnings quality. b. bank earnings quality and the regulatory environment prior literature on banking firms displays international differences in earnings quality, suggesting, therefore that the latter could be affected by differences in the institutional environment and banking regulation. investor protection, regulation, supervision and financial development have shown 2 we refer to the world bank group doing business reports to identify mena countries (algeria, bahrain, egypt, iran, iraq, jordan, kuwait, lebanon, libya, malta, morocco, oman, qatar, saudi arabia, palestinian authority, syria, tunisia, united arab emirates great effect on earnings management and income smoothing behavior. cross-countries studies such as biurrun (2010) and kanagaretnam et al. (2014) [14 & 44] indicate negative relationship between banking regulation and supervision, and earnings management. fonseca and gonzalez (2008) [35] who find significant influence of investor protection and legal enforcement in reducing incentives to smooth income, argue that banks with higher incentives to shift risk in the event if bank run, have higher incentive too to manage earnings to hide their risk-shifting. since efficient bank regulation and supervision proves to be in limiting bank risk, then it will prove to be in limiting income smoothing. in that way, bank regulators and supervisors who have greater power to reduce bank risktaking through monitoring and disciplining management will obviously reduce banks’ incentives to smooth earnings. based on what precede, we suggest that banking regulation matters and works to constrain banks’ earnings management. we postulate therefore that: h4: stronger bank regulation improves mena bank earnings quality. iii. data and methodology a. data description for the purpose of the current investigation, we build a multivariate database on banks’ individual ownership information, bank-specific variables and some country characteristics. we collect data of islamic and conventional banks operating in 15 mena countries2 namely (bahrain, egypt, iran, jordan, kuwait, lebanon, malta, morocco, oman, palestine, qatar, saudi arabia, tunisia, uae and yemen) during the period 2000 to 2013. we retrieve bank accounting data from bvd bankscope and macroeconomic data from the world bank. for the time period covered by this study, we can collect full data for only 158 banks (see table 1). the regression analyses are conducted by using stata 11.1. b. ownership measures bank ownership database is particularly difficult to construct. initially, we rely on bankscope, union of arab banks, zonebourse, gulfbase and zawya databases to define the ultimate bank owners. these sources provide information for only one year while we have to detect variation of ownership structure over the time period of this study (2000-2013). hence, and to compile ownership data, we use earlier bank annual reports and/or national institutions publications such as central banks, stock exchange and ministries of finance. in order to fulfill the gaps in our database, we tape into the online archives of business magazines and pull up articles about previous bank merger and acquisition event3 that occurred in the mena region during the period of the study. collecting data on ownership constitutes a fundamental contribution of this and yemen). nonetheless, algeria, libya, syria and iraq are excluded from our sample due to missing data. 3 about 6 bank mergers took place in our sample of country-years. http://www.ojs.unito.it/index.php/ejif research. we have hence four variables widely: is a dummy variable that equals one if no legal entity owns 10 % or more of the voting rights, and zero otherwise. control right: equals the fraction of the direct and indirect bank’s voting rights, if any, owned by its controlling shareholder. control right equals zero if the bank is widely held. cash flow right: equals the fraction of the bank's cash-flow rights owned directly and indirectly by its controlling shareholder. cash flow right equals zero if the bank is widely held. state: is a dummy variable that equals one if the state (or a foreign state) is the controlling shareholder, and zero otherwise. table 1: distribution of banks in the sample number of banks number of listed banks number of islamic banks bahrain 16 10 8 egypt 19 15 2 iran 8 0 8 jordan 12 11 3 kuwait 11 10 4 lebanon 19 5 0 malta 4 2 0 morocco 6 5 0 oman 7 5 0 palestine 2 1 1 qatar 9 8 3 saudi arabia 6 5 4 tunisia 15 10 1 uae 20 17 7 yemen 4 0 3 total 158 104 44 c. regulatory index to provide information on the legal environment quality, we use three indicators:  strength of investor protection index: obtained from the world bank doing business database. it measures the strength of minority shareholder protections 4 the index is based on 9 answers to yes or no questions from the survey: 1. are auditors required to communicate directly to the supervisory agency any presumed involvement of bank directors or senior managers in illicit activities, fraud, or insider abuse? 2. does the banking supervisor have the right to meet with the external auditors and discuss their report without the approval of the bank? 3. in cases where the supervisor identifies that the bank has received an inadequate audit, does the supervisor have the powers to take actions against the external auditor? 4. do banks disclose to the supervisor off-balance sheet items? 5. does the supervisory agency require banks to constitute provisions to cover actual or potential losses? 6. does the supervisory agency require banks to reduce or suspend dividends to shareholders? 7. does the supervisory agency require banks to reduce or suspend bonuses and other remuneration to bank directors and managers? 8. does the supervisory agency have the powers to perform the following problem bank resolution activities? a) declare insolvency b) supersede shareholders' rights c) remove and replace bank senior management and directors. 9. can the supervisory authority force a bank to change its internal organizational structure? yes/no responses to the previous questions are coded as 1/0. responses to questions 7, 8(b) and 8(c) are multiplied by 2. index= 1+2+3+4+5+6+(7*2)+8(a)+(8(b)*2)+(8(c)*2)+9 against directors’ misuse of corporate assets for personal gain. ipi ranges from 0 to 10, with higher values indicating more investor protection.  official supervisory power index: drawn from the world bank’s regulation and supervision databases cihák et al. (2012) [22] (survey iv). the index measures the degree of official supervisory power in a country. it indicates the extent to which supervisory authorities have the power to take prompt actions to prevent, correct problems, and restructure and reorganize troubled banks4. higher values imply greater power.  private monitoring index: drawn from cihák et al. (2012) [22] (survey iv), it covers audit requirements, the extent to which banks have to be rated by international and domestic rating agencies, and whether and to what degree depositors are protected by an explicit deposit insurance scheme5. higher values imply more private oversight. d. testing for earnings quality the principal objectives of the current study are to assess earnings quality of banks across mena countries; and examine its relation between share ownership structures and national institutional factors. to successfully perform them, several traditional proxies of earnings quality are required. dechow et al. (2010) [26] define three categories of earnings quality proxies, namely properties of earnings, investor responsiveness to earnings and external indicators of earnings misstatements. consistently with the object aimed and because of limited data availability and accessibility, we decided hence to focus only on the earnings properties as an indicator of earnings quality. ahrens (2010) [6] identifies three essential properties of earnings that should be verified to qualify earnings reporting as a good quality: current earnings should represent firm current 5 the index is based on 12 answers to yes or no questions from the survey: 1. is an audit by a professional external auditor required for all commercial banks in your jurisdiction? 2. does the external auditor have to obtain a professional certification or pass a specific exam? 3. how many of the top ten banks (in terms of total domestic assets) are rated by domestic credit rating agencies? 4. how many of the top ten banks (in terms of total domestic assets) are rated by international credit rating agencies (e.g., moody's, standard and poor)? 5. does accrued, though unpaid, interest/principal enter the income statement while the loan is non-performing? 6. does accrued, though unpaid, interest/principal enter the income statement while the loan is still performing? 7. are bank directors legally liable if information disclosed is erroneous or misleading? 8. do banks disclose to the public off-balance sheet items? 9. do banks disclose to the supervisors governance and risk management framework? 10. are bank regulators/supervisors required to make public formal enforcement actions, which include cease and desist orders and written agreements between a bank regulatory/supervisory body and a banking organization? 11. is subordinated debt allowed as part of tier 2 capital? 12. is there an explicit deposit insurance protection scheme? yes/no responses to the previous questions are coded as 1/0. for questions 3 and 4: 100%=1; otherwise 0. index=1+2+3+4+5+6+7+8+9+10+11+12 ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 performance, current earnings should be an indicator for future earnings, and finally current earnings should be free from earnings management. to better assess these properties, we resort henceforth to four widely used measures by the reputed literature altamuro and beatty (2010), kanagaretnam et al. (2011, 2014) and fang et al. (2014) [7, 43, 44 &33] namely earnings persistence, cash flows predictability, income smoothing through loan loss provisions, and small positive net income. a) earnings persistence (eq1): is defined as the coefficient on last period earnings before taxes in a regression of current earnings before taxes on last earnings before taxes. a positive and significant coefficient α1 indicates earnings persistence. higher coefficient implies more persistent earnings stream. i,j, t = i,j,t-1 variables of interest + control variables i,j,t-1 + e (1) i,j,t = earnings before taxes of bank i in country j during year t scaled by total assets at the beginning of the year (i.e. at year t-1). e: error term b) cash-flow predictability (eq2): measures earnings’ ability to predict current cash flows as the coefficient from a regression of current earnings before taxes and loan loss provisions on last period net income before taxes. a positive and significant coefficient signifies that earnings are able to predict future cash-flows. pi,j,t = i,j,t-1 variables of interest + control variables i,j,t-1 + e (2) ebtpi,j,t = earnings before taxes and loan loss provisions of bank i in country j during year t scaled by total assets at the beginning of the year (i.e. at year t-1). e: error term c) income smoothing through loan loss provisions (eq3): measures whether bank managers use the llp to smooth bank earnings. consistent with kanagaretnam et al. (2004), taktak et al. (2010) and bouvatier et al. (2014) [45, 64 & 16], we use an equation that explicitly models the nondiscretionary portion of llp which is expected to cover credit losses and exhibits a cyclical pattern. we use total loan (loans), non-performing loans (npl) and the gdp growth rate (gdp). the expected signs of the coefficients on these variables are as follows: an increase in total loans is likely to result in an increase in the llp due to doubtful loans. an increase in nonperforming loans is likely to result in an increase in the provision for loan losses. both total loans outstanding and nonperforming loans are proxies for the default risk of the bank. at macroeconomic level, negative relation of loan loss provisioning and gdp growth reflects higher riskiness of the credit portfolio when the business cycle goes down (procyclical behavior). in order to capture the discretionary component of llp, we use earnings before taxes and loan loss provisions scaled by total assets ebtp to test if banks use loan loss provisions to smooth their income; a positive relationship between ebtp and llp would be consistent with the income smoothing hypothesis. bank managers play down (exaggerate) llp when earnings are expected to be low (high). moreover, banks can use the llp for capital management objective. even its occurrence is limited to basel 1 and in some extent basel 2, banks could manipulate the provisions accounts to keep their capital ratio adequate. negative relationship between equity to total assets ratio (equity) and llp validates capital management hypothesis. llpi,j,t = llpi,j,t-1 + ebtp i,j,t + ebtp*variables of interest + equity i,j,t + loans i,j,t + npl i,j,t + gdp j,t + e (3) d) small positive net income (eq4): burgstahler and dichev (1997), leventis and dimitropoulos (2012) and hamdi and zarai (2012) [17, 51 & 38] use the frequency of the small positive net income as a metric of managing towards positive earnings. managers in fact make every possible effort to report small positive net income rather than negative net income (loss avoidance). spos equals 1 if net income deflated by lagged total assets is between 0 and 0.25% for each given year and 0 otherwise. after estimating the dichotomous variable, we introduce it as the dependent variable in the following logit regression model: logit (spos i,j,t) = 0 +1variables of interest + 2ebt i,j,t +3size i,j,t + 4loans i,j,t + 5equity i,j,t + 6listed +  7islamic +  8gdp j,t +e (4) iv. empirical results a. descriptive statistics to start our analyses, we report first in table 2 descriptive statistics of both bank characteristics and macroeconomic variables used for the different models of earnings quality and collected for 158 banks operating in 15 mena countries during 2000-2013. http://www.ojs.unito.it/index.php/ejif table 2: descriptive statistics of bank–specific variables num of obs mean std. dev min max ebt 1752 0.0193 0.0323 -0.2530 0.4752 ebtp 1751 0.0222 0.1475 -6.0153 0.4752 income 1756 0.0170 0.0311 -0.2530 0.4752 llp 1755 0.0038 0.1157 -0.0564 0.3862 npl 1231 0.2332 3.0225 0.000036 0.8455 size 1917 7.9291 1.5533 3.6467 11.7104 equity 1917 0.1541 0.1444 0.000047 0.9944 loans 1915 0.5304 0.2815 0.0059 0.9934 deposits 1879 0.6675 0.3776 0.0020 0.9426 gdp 1901 0.0501 0.0401 -0.1508 0.2617 note: definitions of variables are as follows: ebt is earnings before taxes of bank i during year t deflated by lagged total assets; ebtp is earnings before taxes and loan loss provisions of bank i during year t deflated by lagged total assets; income is the net income of bank i during year t deflated by lagged total assets; llp is the ratio of loan loss provisions to total assets of bank i during year t; npl is the non-performing loans to total assets ratio of bank i during year t; size is the log of total assets; equity is the ratio of bank equity to total assets of bank i during year t; loans is the total loan to total assets ratio of bank i during year t; deposits is deposits to total assets ratio of bank i during year t; gdp is the gdp growth rate of country j during year t. because of the unavailability of some bank-level variables for some countries such as (non-performing loans for tunisia and iran); and the use of one-year lagged values for other bank characteristics variables, sample distributions as noted in tables 3 and 4 differ between the four measures of earnings quality. the samples for earnings persistence (eq1) and cash-flow predictability (eq2) tests are relatively smaller than the sample for small positive net income test (eq4) because of the use of lagged values. the sample for income smoothing test (eq3) is the smallest one due to the more data requirements. table 3: distribution of bank-year observations by year eq1 eq2 eq3 eq4 2001 _ _ 60 110 2002 109 108 61 111 2003 110 110 66 119 2004 117 117 69 131 2005 128 128 71 132 2006 134 134 79 142 2007 142 142 84 147 2008 144 144 96 151 2009 149 149 108 156 2010 154 154 117 154 2011 151 151 117 154 2012 143 143 115 146 2013 85 85 71 103 total 1566 1565 1114 1756 regarding the regulatory environment, the investor protection index (ipi) has a median of 4.3 and ranges from 2.7 (for morocco during the period 2006-2010) to 6.7 (for saudi arabia during the period 2009-2013). official supervisory power ranges for our sample from 6 (morocco) to 14 (jordan). private monitoring index ranges from 6 (yemen) to 10 (bahrain). we note a little difference between mena countries regarding the investors’ legal protection and banking regulation; both are high on average. table 4: distribution of bank-year observations by country eq1 eq2 eq3 eq4 bahrain 155 155 117 173 egypt 215 214 63 234 iran 77 77 8 89 jordan 131 131 122 145 kuwait 98 98 95 120 lebanon 202 202 193 225 malta 34 34 35 41 morocco 53 53 30 59 oman 70 70 77 83 palestine 20 20 6 22 qatar 92 92 100 101 saudi arabia 51 51 48 57 tunisia 130 130 7 145 uae 201 201 192 221 yemen 37 37 21 41 total 1566 1565 1114 1756 ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 to conduct our research, we opt to split the full sample into two subgroups (high and low) based on the cross-country median values (above-median and below-median) of each variable (investor protection index, official supervisory power and private monitoring index) table 5: descriptive statistics of country-level regulatory environment b. earnings persistence and cash flow predictability to obtain full insight on mena banks’ earnings streams, we firstly employ two related but distinct measures of earnings quality: namely, persistence of earnings and cash flows predictability (ability of current earnings to predict future cash flows). tables (6 and 7) report regressions results for those two measures. following previous research on bank earnings quality altamuro and beatty (2010), kanagaretnam et al. (2011, 2014) and fang et al. (2014) [7, 43, 44 & 33], we use as control variables bank specific characteristics (size, leverage, deposits and loans) and country level variable (gdp growth). time and country effects are also included in the models. regarding the estimation method, we use ols regression with clustered robust errors to account for serial and cross sectional correlations in the residuals kanagaretnam et al. (2014) [44]. our results show (from specification (a) to specification (j)) that current earnings before taxes is positively and significantly associated with past earnings (ebtt-1) at the 1% level (see table 6). for the second measure of earnings quality, specifications summarized in table 7 display that bank current cash flows are positively and significantly associated with past earnings (ebtt1) at 1% and 5% level. these results indicate that mena banks are characterized by persistent earnings able to predict future cash flows. further analyses focusing on potential dissimilarities of earnings properties exhibit significant variations between different groups of banks depending on listing status and bank category. in fact, t-values of the interaction term (islamic*ebt) show that islamic banks tend to have more persistent (significant at 1% level) and more predictable earnings (significant at 5% level) than their conventional peers (see columns (e) and (f) in each table 6 and 7). moreover, regression results show that (at 1% level of significance) listed banks maintain more persistent earnings stream than unlisted banks (see specifications c and d in table 6). this finding is fully consistent with the usefulness of earnings to equity investors; more persistent earnings would yield to higher equity valuations (dechow et al., 2010) [26]. turning now to our main concern, all regression models that control for ownership concentration variables in tables (6 and 7) show negative and significant coefficient on the interaction variable (control right*ebt). the estimations results reveal therefore that, at 1% level of significance, banks with higher ownership concentration exhibit lower quality of earnings (less persistent and less predictable). in order to compare between state-owned banks and private banks’ earnings quality, we include an interaction term (control right*state*ebt) in the regression models. columns (g) in tables 6 and 7 show that state-owned banks have less persistent and less predictable earnings than their private counterparts (significant at 1% and 10% level respectively). in the aim to examine the effect of banking regulation and supervision as an external governance mechanism on earnings quality; we include additional interaction variables (high ipi*ebt; high official*ebt; and high private*ebt). columns (h, i and j) in tables (6 and 7) show that banks in countries with higher private monitoring have more persistent earnings than banks in countries with lower private monitoring index; but banks in countries where the investor protection index is high disclose less persistent earnings. c. income smoothing through loan loss provisions referring to dechow et al. (2010) [26], persistence of earnings is dependent to a large extent on firm’s fundamental performance and accounting measurement system. although separating the role of each is not so obvious, we aim to study to what extent the perceived earnings persistence is achieved by engaging in earnings management practices (fang et al., 2014) [33]. our third measure of earnings quality will subsequently focus on the accounting process; and try to capture earnings management using the largest accounting accrual for banks (loan loss provisions). earnings management is accordingly a specific dimension of earnings quality. in order to examine the determinants of loan loss provisioning practices for mena banks and test the income smoothing and capital management hypotheses, we use bouvatier et al. (2014)’s [16] regression model that allows for dynamic adjustments of loan loss provisions. we apply the generalized-method-of-moments country investor protection index’s mean official supervisory power index private monitoring index bahrain 4,7 11 10 egypt 3,55 11 7 iran 3,08 n.a n.a jordan 3 14 8 kuwait 5 11 8 lebanon 5 7 7 malta 5,7 12 8 morocco 3,24 6 9 oman 5 13 7 palestine 5,3 9 8 qatar 4,3 9 7 saudi arabia 6,32 n.a n.a tunisia 4,7 9 7 uae 4 9 7 yemen 4 12 6 http://www.ojs.unito.it/index.php/ejif (gmm) estimators appropriate for dynamic models of panel data. the panel estimator controls for potential endogeneity using instruments applied to the lagged dependent variable. we present in table 2 descriptive statistics of both bank characteristics and macroeconomic variables used for the income smoothing test. across all sample countries, the mean of loan loss provisions is 0.38% and the mean of earnings before taxes and provisions is 2.22%. regression results reported in table 8 for specifications (a, b, c, e and f) show positive and significant (at 1 % level) coefficient on the earnings before taxes and loan loss provisions (ebtp). this finding indicates that banks in mena countries use discretionary loan loss provisions to smooth their incomes, they play down (exaggerate) provisions when earnings are expected to be low (high). further, equity to total assets ratio is found to have a negative and significant coefficient at 1% level in all specifications (table 8), implying that mena banks use loan loss provisions for capital management objective. these results are consistent with the majority of academic evidence pertaining that commercial banks in all over the world manipulate loan loss provisions for the purpose of income smoothing and capital management (anandarajan et al., 2007; taktak et al., 2010; ben othman and mersni, 2014; curcio and hasan, 2015) [9, 64, 13 & 25]. regarding the non-discretionary component of loan loss provisions, data reveals that the lagged dependent variable (llpt-1) is positively significant which indicates that banks dynamically adjust their provisions according to the credit risk level and macroeconomic conditions to cover future potential losses. therewith the coefficient of non-performing loans capturing the credit risk is positive and significant. gdp growth coefficient is negative and significant at 1% level. concerning the listing status of banks, specification (b) in table 8 shows a negative and significant coefficient of the interaction term (listed*ebtp) implying that listed banks use less loan loss provisions for income smoothing. consequently, we deem that unlisted banks engage more aggressively in earnings management than listed banks. this finding contradicts the common opinion that publicly traded banks have more incentives for income smoothing to signal their private information about future bank prospects (beatty et al., 2002; anandarajan et al., 2007) [11 & 9]. a plausible explanation is that relatively to unlisted banks, listed banks in mena countries are more monitored by regulators and official supervisions authority. extensive supervision and scrutiny reduce thereby incentives to manage earnings and improve table 6: regression results for the earnings persistence test (ebt t ) (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) intercept -0.0113 (-2.27)** -0.01 (-1.95)* -0.0076 (-1.53) -0.0082 (-1.67)* -0.0118 (-2.41)** -0.0107 (-2.20)** -0.0117 (-2.37)** -0.0090 (-1.83)* -0.0095 (-1.94)* -0.0094 (-1.93)* ebt(t-1) 0.5028 (21.95)*** 0.6066 (23.49)*** 0.3185 (8.33)*** 0.5026 (8.96)*** 0.2612 (7.21)*** 0.3833 (7.65)*** 0.5496 (22.70)*** 0.7216 (11.87)*** 0.6039 (23.30)*** 0.4761 (10.76)*** control right*ebt -0.3733 (-7.79)*** -0.2846 (-4.57)*** -0.2158 (-3.82)*** -0.4005 (-8.07)*** -0.3920 (-7.75)*** -0.2859 (-5.34)*** control right * state*ebt -0.2609 (-5.05)*** listed 0.0004 (0.28) 0.001 (0.67) listed*ebt 0.2501 (5.72)*** 0.1075 (1.93)* islamic -0.006 (-3.44)*** -0.0038 (-2.12)** islamic*ebt 0.3625 (8.45)*** 0.2660 (5.14)*** high ipi *ebt -0.1183 (-2.09)** high official*ebt 0.0548 (1.16) high private*ebt 0.1533 (3.62)*** size 0.00035 (0.71) 0.0004 (0.86) 0.00006 (0.13) 0.00023 (0.46) 0.00073 (1.50) 0.0007 (1.42) 0.00052 (1.05) 0.0003 (0.78) 0.0004 (0.88) 0.0003 (0.64) equity 0.0387 (5.59)*** 0.0379 (5.60)*** 0.0400 (5.84)*** 0.0386 (5.69)*** 0.0382 (5.61)*** 0.0370 (5.47)*** 0.0409 (5.94)*** 0.0375 (5.54)*** 0.0373 (5.49)*** 0.0368 (5.45)*** deposits 0.0042 (2.38)** 0.0038 (2.23)** 0.0037 (2.11)** 0.0036 (2.10)** 0.0045 (2.63)*** 0.0042 (2.45)** 0.0035 (2.04)** 0.0037 (2.19)** 0.0038 (2.22)** 0.0044 (2.60)*** loans 0.0039 (1.67)* 0.003 (1.26) 0.0026 (1.10) 0.0022 (0.93) 0.0052 (2.23)** 0.004 (1.75)* 0.0035 (1.50) 0.0029 (1.25) 0.0028 (1.20) 0.0037 (1.61) gdp 0.0653 (3.82)*** 0.0537 (3.21)*** 0.0607 (3.59)*** 0.0534 (3.19)*** 0.0670 (4.00)*** 0.0589 (3.54)*** 0.0614 (3.63)*** 0.0573 (3.41)*** 0.0547 (3.26)*** 0.0642 (3.79)*** num of banks 157 157 157 157 157 157 157 157 157 157 observations 1550 1534 1550 1534 1550 1534 1534 1534 1534 1534 adj.r² 0.3620 0.3855 0.3780 0.3872 0.3899 0.4034 0.3714 0.3868 0.3856 0.3904 * significant at 10% level ** significant at 5% level *** significant at 1% level ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 earnings reporting quality (fonseca and gonzalez, 2008) [35]. additional analyses show that islamic banks exhibit less income smoothing behavior through loan loss provisions than conventional banks. t-value of the interaction term (islamic*ebtp) is negative and significant at 1% level (see specification (c) in table 8). this finding is inconsistent with zoubi and el ghazali (2007), ben othman and mersni (2014) and ashraf et al. (2015) [72, 13 & 10] but it converges with taktak et al. (2010) and quttainah et al. (2013) [64 & 58]. focusing now on our main concern which is whether differences in ownership concentration explain differences in the level of earnings management, estimation (d) show that banks with higher concentrated ownership display higher degrees of income smoothing through loan loss provisions (ebtp*control). going deeper in our research, we introduce in the regression model three dummy variables reflecting three groups of banks with different level of ownership concentration. widely includes banks with no controlling owner; group 1 includes banks in which the controlling shareholder holds between [10%, 25%] of the voting rights; group 2 includes banks in which the controlling owner holds between] 25%, 50%] of the voting right. we leave group 3, which includes banks in which the controlling shareholder holds more than 50% of the voting rights, to be the reference group. similarly to bouvatier et al. (2014)’s [16] findings, specification (f) in table 8 shows (at 1% level of significance) that banks without majority shareholder (widely) and banks with low and medium level of ownership concentration (groups 1 and 2) behave differently from banks with higher ownership concentration in the way they use loan loss provisions to smooth their incomes. these banks display a lower level of income smoothing behavior than banks with higher ownership concentration (group3). in particular, banks in group 3 display the income smoothing behavior previously observed for the overall sample with a coefficient (0.79) that is significant at 1% level. due to their large shareholdings (more than 50% of control rights), controlling owner have higher incentives to engage in income smoothing practices. these findings support our table 7: regression results for the cash-flow predictability test (ebtp t ) (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) intercept -0.0569 (-1.89)* -0.0553 (-1.01) -0.0533 (-0.98) -0.0544 (-0.99) -0.0576 (-1.04) -0.0566 (-1.03) -0.0575 (-1.05) -0.0543 (-1.00) -0.0553 (-1.01) -0.0552 (-1.00) ebt (t-1) 0.4109 (2.99)*** 0.5132 (9.57)*** 0.3045 (2.48)** 0.5289 (4.85)** 0.1907 (2.29)** 0.3277 (3.62)*** 0.4601 (7.09)*** 0.7130 (5.02)*** 0.5120 (9.31)*** 0.4110 (5.81)*** control right*ebt -0.3671 (-2.90)*** -0.3450 (-2.92)*** -0.2375 (-2.05)** -0.4143 (-3.06)*** -0.3753 (-3.31)*** -0.2986 (-2.71)*** control right* state*ebt -0.2751 (-1.95)* listed 0.0105 (1.08) 0.0115 (1.17) listed*ebt 0.1162 (0.64) -0.0615 (-0.37) islamic -0.0035 (-0.62) -0.0001 (-0.16) islamic*ebt 0.3272 (2.62)** 0.2174 (1.59) high ipi *ebt -0.2056 (-1.29) high official*ebt 0.0243 (0.19) high private*ebt 0.1201 (1.18) size 0.0061 (2.03)** 0.0061 (1.04) 0.0052 (0.98) 0.0054 (1.01) 0.0064 (1.10) 0.0064 (1.09) 0.0062 (1.06) 0.0061 (1.03) 0.0061 (1.04) 0.0060 (1.02) equity 0.0928 (2.23)** 0.0927 (2.17)** 0.0954 (2.21)** 0.0948 (2.17)** 0.0915 (2.22)** 0.0910 (2.19)** 0.0959 (2.21)** 0.0920 (2.16)** 0.0925 (2.17)** 0.0919 (2.12)** deposits 0.0017 (0.16) 0.0014 (0.46) 0.0007 (0.20) 0.0007 (0.20) 0.0021 (0.73) 0.0018 (0.62) 0.0011 (0.35) 0.0013 (0.41) 0.0014 (0.45) 0.0019 (0.59) loans 0.0233 (1.63) 0.0225 (1.28) 0.0192 (1.30) 0.0189 (1.27) 0.0243 (1.42) 0.0233 (1.36) 0.0230 (1.31) 0.0224 (1.28) 0.0224 (1.27) 0.0231 (1.32) gdp 0.0541 (0.53) 0.0432 (1.67)* 0.0469 (1.89)* 0.0396 (1.58) 0.0553 (2.17)** 0.0471 (1.87)* 0.0506 (1.91)* 0.0494 (1.74)* 0.0436 (1.70)* 0.0514 (2.03)** num of banks 157 157 157 157 157 157 157 157 157 157 observations 1549 1533 1549 1533 1549 1533 1533 1533 1533 1533 adj.r² 0.0288 0.0293 0.0302 0.0302 0.03 0.03 0.0288 0.0295 0.0293 0.0295 * significant at 10% level ** significant at 5% level *** significant at 1% level http://www.ojs.unito.it/index.php/ejif predictions on the effects of share ownership structures on income smoothing; that is higher ownership concentration lowers earnings quality by increasing income smoothing through loan loss provisions. nonetheless, this relationship is reversed when the controlling owner is a state. estimation (e) in table 8 indicates that banks with higher state ownership display lower degrees of income smoothing through loan loss provisions. the t-value of the interaction term (control*state*ebtp) is negative and significant at 1% level. regarding the role of the regulatory environment (see table 9), regression analyses reveal (at 1% level of significance) that banks in countries with stronger supervisory regimes and higher private monitoring engage less in income smoothing practices through loan loss provisions. however, banks in countries where the investor protection index is high use more discretion in loan loss provisioning. these findings are in consistent with fonseca and gonzalez (2008), biurrun (2010) and bouvatier et al. (2014) [35, 14 & 16]. tighter official supervision and greater private oversight improve earnings reporting quality by reducing earnings management practices. d. small positive net income since our main concern is to investigate ownership concentration effects on bank earnings quality, we test by a logistic regression whether the occurrence of small positive profits is associated with the existence of blocked shareholders with large ownership stakes. to be consistent with the literature burgstahler and dichev (1997), shen and chih (2005), kanagaretnam et al. (2011), leventis and dimitropoulos (2012), hamdi and zarai (2012), quttainah et al. (2013) and fang et al. (2014) [17, 61, 43, 51, 38, 58 & 33 ]; we include along with our variable of interest (ownership concentration) bank specific variables (size, equity, ebt, loans, listed) and a set of yearly and country dummy variables in the logistic model. initially, logistic regression’s results summarized in table 10 do not find evidence that banks with higher control concentration are more likely to report small positive earnings (column a). however results reported in columns (b, c and d) show significant coefficient at 5% and 1% level with a positive sign table 8: regression results for the income smoothing test llp t (a) (b) (c) (d) (e) (f) llp t-1 0.1327 (1.83)* 0.1624 (2.15)** 0.1627 (2.13)** 0.1682 (2.14)** 0.1227 (1.87)* 0.1465 (1.90)* ebtp 0.7925 (131.76)*** 0.7974 (126.76)*** 0.7934 (158.45)*** 0.1093 (1.11) 0.7942 (179.59)*** 0.795 (388.88)*** listed 0.0278 (8.75)*** listed*ebtp -0.7128 (-12.24)*** islamic*ebtp -0.6264 (-13.92)*** control*ebtp 1.1241 (6.98)*** control*state *ebtp -0.8431 (-5.33)*** widely 0.0184 (2.50)** widely*ebtp -0.7773 (-13.60)*** group 1 0.0144 (2.02)** group 1*ebtp -0.6466 (-10.12)*** group 2 0.0119 (3.13)*** group 2*ebtp -0.6169 (-7.34)*** equity -0.1216 (-4.68)*** -0.0804 (-2.57)** -0.1055 (-3.87)*** -0.1042 (-3.52)*** -0.1045 (-4.27)*** -0.0984 (-3.38)*** loans -0.0015 (-1.24) -0.00005 (-0.08) -0.00089 (-0.79) 0.00024 (0.19) -0.0018 (-1.53) -0.00024 (-0.31) npl 0.0001 (2.19)** 0.0001 (3.00)*** 0.0001 (2.41)** 0.00008 (2.07)** 0.0001 (3.12)*** 0.00012 (3.16)*** gdp -0.0373 (-3.51)*** -0.0227 (-3.01)*** -0.0231 (-2.82)*** -0.0251 (-2.77)*** -0.0328 (-3.33)*** -0.0254 (-3.11)*** constant 0.0053 (1.74)* -0.0076 (-1.63) 0.0047 (1.47) 0.006 (1.76)* 0.0072 (2.51)** 0.0022 (0.53) number of banks 130 130 130 130 130 130 observations 1102 1102 1102 1093 1093 1099 r² (within) 0.99 0.9956 0.9912 0.99377 0.9918 0.9942 * significant at 10% level ** significant at 5% level *** significant at 1% level ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 12 table 9: income smoothing and regulatory factors income smoothing (eq3) (g) (h) (i) llp t-1 0.1519 (1.95)* 0.1396 (1.94)* 0.1553 (2.03)** ebtp 0.5228 (4.13)*** 0.7960 (362.23)*** 0.7959 (350.84)*** widely 0.0138 (1.73)* 0.0120 (1.84)* 0.0186 (2.50)** widely*ebtp -0.5693 (-5.66)*** -0.5422 (-7.46)*** -0.7649 (-12.19)*** group 1 0.0151 (2.06)** 0.0101 (1.53) 0.0112 (1.58) group 1*ebtp -0.6011 (-8.32)*** -0.4165 (-4.40)*** -0.5126 (-5.48)*** group 2 0.0125 (3.18)*** 0.0112 (3.41)*** 0.0095 (2.55)** group 2*ebtp -0.5865 (-6.72)*** -0.5548 (-6.27)*** -0.4896 (-5.66)*** high ipi*ebtp 0.273 (2.16)** high official*ebtp -0.3095 (-4.42)*** high private*ebtp -0.2737 (-2.85)*** equity -0.1015 (-3.41)*** -0.0954 (-3.40)*** -0.0955 (-3.28)*** loans -0.0007 (-0.80) -0.0005 (-0.64) -0.0001 (-0.25) npl 0.0001 (3.98)*** 0.0001 (3.07)*** 0.0001 (3.08)*** gdp -0.035 (-3.67)*** -0.0301 (-3.80)*** -0.0254 (-3.14)*** constant 0.0025 (0.61) 0.0041 (1.06) 0.0030 (0.76) num of banks 130 130 130 observations 1090 1099 1099 r² (within) 0.9946 0.9944 0.9943 * significant at 10% level ** significant at 5% level *** significant at 1% level for the “cash flow rights” variable, indicating that the propensity of reporting small losses increases as the cash flow rights held by the controlling shareholders increases too. this finding suggests that, in case of financial difficulties largest shareholder owning more cash flow rights has more incentives to aggressively maintain positive earnings; because in case of loss he will bear high fraction proportional to his cash flow stakes. largest owner hence will put pressure on bank managers to make all possible efforts to boost earnings and avoid losses. the logistic regression reveals in addition a significant negative relationship between earnings before taxes (ebt) and loss avoidance (column a, b and d), but no significant association with (ebtp) earnings before taxes and provisions (column c). this implies that banks are much more likely to report small net income in the interval ]0; 0.0025] when their earnings before taxes is decreasing. in addition, the insignificance of earnings before taxes and provisions (ebtp) indicates that bank managers are engaged in loss-avoidance management of earnings using extra techniques other than managing loan loss provisions. with regard to bank-level controls, our data prove evidence that highly leveraged banks and banks with higher loans are more associated with loss avoidance. high economic growth is negatively associated with the likelihood of small positive earnings. intuitively, bank profits increase as the economy improves. state-owned banks are not associated with loss avoidance earnings management (estimation d). the negative coefficient on the dummy variable “listed” indicates that listed banks report less frequently small positive income to avoid losses than unlisted banks (results significant at 1% level). this is consistent with our previous finding concerning income smoothing using loan loss provisions (eq3). listed banks exhibit higher quality of earnings as opposed to the unlisted banks. further results indicate that islamic dummy variable is positively and significantly associated at 1% level with loss avoidance. islamic banks report more frequently small positive earnings to avoid losses disclosure than their conventional peers. this result converges with hamdi and zarai (2012)[38] study showing that, in term of loss avoidance metrics, islamic banks are more engaged in earnings management practices than conventional banks. finally, estimation (f) shows that banks in countries with stronger supervisory regimes exhibit less loss avoidance than banks in countries with weaker supervision. v. conclusion this study aims to examine the relationship between shareholding ownership structures, national institutional factors and earnings quality of banks across mena countries. we use a sample of 158 banks from 15 mena countries observed over the period (2000-2013). we focus on the essential properties of earnings that should be verified to qualify earnings reporting as a good quality (earnings persistence, ability to predict cash flows, income smoothing through loan loss provisions and small positive net incomes). those selected measures are supposed to be complementary and not repetitive. we conduct consequently four different regression models that control for the effect of ownership structure and regulatory regime on the banks’ earnings quality. overall, our findings show that mena banking institutions are characterized by high quality of earnings in term of persistence and ability to predict cash flows. however, they use loan loss provisioning to smooth incomes, and conduct loss avoidance earnings management. concentrated ownership have large impacts on the content information of earnings. in effect, our empirical study reveals significant and negative impact of the majority ownership on banks’ earnings quality. banks with controlling owner display less persistent and less predictable earnings than banks with widely held shares. http://www.ojs.unito.it/index.php/ejif furthermore,our data shows that closely held banks have more incentives to manage reported earnings in both forms (income smoothing and loss avoidance) than widely held banks. these findings are supporting the entrenchment hypothesis of ownership concentration. controlling owners intervene in the earnings determination process in order to conceal from minority shareholders, debt-holders and regulators their abilities to extract private benefits of control. these results validate our first research hypothesis that is ownership concentration in the mena banking sector lowers earnings quality. concerning the state ownership, our analyses find evidence that state-owned banks have less persistent and less predictable earnings than their private counterparts. however, state-owned banks conduct less earnings management in term of loan loss provisions and loss avoidance. in comparison with conventional banks, islamic banks have significantly higher earnings quality in term of earnings persistence, cash flows predictability and income smoothing using loan loss provisions. nonetheless and consistently with the findings of hamdi and zarai (2012) [38], islamic banks are more likely to manage earnings to avoid losses. these findings lead us to partially validate the third research hypothesis that is islamic banks display higher earnings quality than their conventional counterparts. lastly, our findings converge with those of shen and chih (2005), fonseca and gonzalez (2008) and biurrun (2010) [61, 35 & 14] regarding the role of banking regulation and supervision in improving the quality of earnings even in the presence of large shareholding. this validates our fourth research hypothesis. however, higher protection of minority shareholders proxied by the investor protection index does not appear as an efficient mechanism to reduce dominant owner opportunism. this research has emphasized the relative effectiveness of the bank governance mechanisms in mena countries. the study reveals that legal shareholder protection as measured by the investor protection index is insufficient to protect small bank shareholders interests from the discretionary behavior of the controlling shareholders. as well, we do not find evidence supporting the investor table 10: logit regression of small positive income logit (spos) (a) (b) (c) (d) (e) (f) (g) control right 0.370 (0.87) cash-flow right 0.999 (2.29)** 0.894 (2.12)** 1.452 (3.65)*** 1.487 (3.78)*** 1.518 (3.84)*** 1.496 (3.83)*** ebt -17.749 (-4.60)*** -18.020 (-4.66)*** -18.832 (-5.30)*** -19.010 (-5.36)** -17.816 (-4.91)*** -19.564 (-5.47)*** ebtp 0.0153 (0.03) state 0.1478 (0.65) high ipi -0.070 (-0.25) high official -0.753 (-2.49)** high private -0.370 (-1.25) size -0.058 (-0.61) -0.073 (-0.76) -0.1431 (-1.49) -0.0367 (-0.48) -0.025 (-0.33) -0.016 (-0.21) 0.0163 (0.20) loans 0.758 (2.47)** 0.777 (2.46)** 0.697 (2.20)** 0.4675 (1.43) 0.484 (1.53) 0.507 (1.69)* 0.527 (1.72)* equity -4.009 (-2.93)*** -4.138 (-3.07)*** -5.167 (-3.40)*** -5.206 (-4.10)*** -5.076 (-3.99)*** -5.313 (-3.97)*** -4.923 (-3.84)*** islamic 0.851 (2.60)*** 1.010 (2.97)*** 1.017 (3.09)*** 0.670 (2.81)*** 0.656 (2.68)*** 0.993 (3.73)*** 0.812 (3.10)*** listed -1.313 (-4.48)*** -1.161 (-4.06)*** -1.265 (-4.54)*** -0.818 (-3.17)*** -0.837 (-3.25)*** -0.932 (-3.59)*** -0.871 (-3.38)*** gdp -7.100 (-1.78)* -6.890 (-1.72)* -9.237 (-2.34)** -4.092 (-1.28) -4.026 (-1.24) -5.053 (-1.55) -3.834 (-1.19) intercept -4.320 (-2.96)** -4.676 (-3.22)*** -4.145 (-2.90)*** -3.130 (-3.85)*** -3.100 (-3.48)*** -3.086 (-3.76)*** -3.462 (-4.14)*** num of banks 158 158 158 158 158 158 158 observations 1719 1719 1718 1719 1719 1719 1719 log likelihood -329.847 -327.515 -336.498 -342.695 -342.875 -339.527 -342.100 pseudo r² 0.1984 0.2040 0.1821 0.1672 0.1667 0.1748 0.1686 * significant at 10% level ** significant at 5% level *** significant at 1% level ejif – european journal of islamic finance no 6, feb (2017) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 14 protection role in curtailing opportunistic earnings management for banking firms. we argue therefore that shareholder protection laws do not enhance bank governance of mena counties. regulators have to concern more about an effective enforcement of shareholders rights that would mitigate diversion behavior of dominant owners and reduce incentives for earnings management. stronger protection of minority shareholders would limit the negative influence of insider shareholding. references [1] abaoub, e., homrani, k. and gamra, s. b. 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(2007), empirical testing of the loss provisions of banks in the gcc region, managerial finance, vol.33, n°7, pp: 500-511. http://www.ojs.unito.it/index.php/ejif ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, portsmouth university, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france editorial_board.pdf editor in chief editorial board paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 islamic finance and social finance, an opportunity for social enterprises abstract— social enterprises are defined as the real engine of social innovation because they have in their veins the objective of creating social impact and they are the companies with the best structure in the panorama of the third sector. after the recent crisis, social hardship has become more and more frequent in all situations, from health care to housing, for example. poverty is another existing social phenomenon that has critical effects on the ecosystem. this leads to a decrease in the protection of the quality of life by increasing the need for health services, social assistance, housing and of course social aid on necessities. the engine that could encourage change is the grafting of socially disadvantaged people into the workplace, but the companies themselves need ideas and especially resources to assimilate more staff. it is essential to grow the companies for impact, but it is not always easy for them to access funding. in order to guarantee a constant increase in social impact, the company's attention must always be combined with performance to ensure survival into the business. progressively, in these years, there has been a growth of the financial instruments tied to the islamic finance and these could have an important role not only for the moslems, but also for the non-muslim countries. the constant search for alternative ways of financing is always alive, more so by the companies that make up the third sector, which are open to instruments that respect ethical principles. to support this aspect, there is an evolution of the instruments of social finance and islamic finance, both of which have the same values. this document, through an empirical analysis, wants to demonstrate how, through the meeting of the islamic finance and social finance instruments, it is possible to restart the process of social innovation through the companies which are currently the major players in this field: the social cooperatives. keywordsislamic finance; social finance; social enterprises; social impact; accounting i. introduction islamic religion calls for a comprehensive development of an economy and puts emphasis on social welfare and urges for maintaining social justice, equity, and poverty alleviation [1], [2]. its teachings stresses on the duties of muslims towards humanitarian and social welfare [2], [3] social welfare, social justice, equity and poverty reduction are the points on which the islamic religion places the accent [3]– [5]. the teachings of this religion refer to humanitarian and social assistance [6], [7]. islamic financial instruments should follow all the dictates of sharia law. sharia is the set of rules derived from the main koran and sunna resources and from other sources such as ijma and qyias (consensus and analogy) that cover all aspects of the life of a muslim [8]–[10]. islamic finance has a vast range of products which go from the islamic micro loan and micro finance to the emission of "sukuk" (islamic bonds) [11]–[13]. a social enterprise is the subject oriented with prevalent mutuality, trying to maximize the values of social impact, such as human well-being, but always trying to maximize profits. social enterprises are defined as the real engine of social innovation because they have in their veins the objective of iannaci daniel 1 , and gideon mekonnen jonathan 2 1 university of turin – department of management 2 stockholm university department of computer and systems sciences (dsv) ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 creating social impact and they are the companies with the best structure in the panorama of the third sector. after the recent crisis, social hardship has become more and more frequent in all situations, from health care to housing, for example. poverty is another existing social phenomenon that has critical effects on the ecosystem [14]–[16]. this leads to a decrease in the protection of the quality of life by increasing the need for health services, social assistance, housing and of course social aid on necessities. the engine that could encourage change is the grafting of socially disadvantaged people into the workplace, but the companies themselves need ideas and especially resources to assimilate more staff. it is essential to grow the companies for impact, but it is not always easy for them to access funding. in order to guarantee a constant increase in social impact, the company's attention must always be combined with performance to ensure survival into the business. progressively, in these years, there has been a growth of the financial instruments tied to the islamic finance and these could have an important role not only for the moslems, but also for the non-muslim countries [17]–[19]. the constant search for alternative ways of financing is always alive, more so by the companies that make up the third sector, which are open to instruments that respect ethical principles. to support this aspect, there is an evolution of the instruments of social finance and islamic finance, both of which have the same values [4], [20]. this document, through an empirical analysis, wants to demonstrate how, through the meeting of the islamic finance and social finance instruments, it is possible to restart the process of social innovation through the companies which are currently the major players in this field: the social cooperatives. the objective is to investigate how, through the meeting of islamic and social finance instruments, it is possible to restart the process of social innovation through the companies that are currently the major players in this field: social cooperatives. the document is structured as follows: the second section illustrates the literature review, the third section the research methodology, the fourth section the context of the case study, while the fifth section provides the presentation of the results, sixth discussion and finally the seventh section concludes. ii. literature review a. islamic finance islamic religion places emphasis on social welfare, social justice, equity and poverty reduction [2], [3]. the concept of the maqasid al sharia (purpose of sharia) upholds the principle of serving the public interest of maximizing benefit and reducing harm of the community. thus eradication of poverty, socio-economic justice are among the primary goals of islam [9] that is based on adl (social justice) and ihsan (benevolence) [5], [21] which makes islamic finance attractive to the western countries working in an ethical way [8]. in addition, islamic finance with it various financial products is not limited to muslims but on the contrary available to everyone [19] and this is confirmed by its diffusion and ability in attracting the attention of the investors, financial institutions and regulators as a valid alternative to conventional one [22]. islamic financial instruments should all follow the sharia dictates. sharia are the set of rules derived from the main resources quran and sunna and other sources like ijma and qyias (consensus and analogy) covering all aspects of a muslim‘s life [23], [24]. sharia prohibits: riba (usury/interest), gharar (speculation/uncertainty), maysir (gambling), investing in haram (unpermitted) activities and business like alcohol, tobacco, pork-related products, adult entertainment (pornography), and weapons [8]. moreover, some other concepts should be maintained like: investments should be asset-backed or identified to an underlying tangible asset; application of the profit and loss concept (pls); fulfilling the obligation of zakat (charity) towards the poor and needy. the islamic finance have a various array of products from islamic micro lending and microfinance to the issuance of ―sukuk‖ (islamic bonds) [25]. given the main problem is lack of financial access, alleviating poverty will be creating wealth through development of social enterprises. islamic tools could support social enterprises to empower the poor and graduate from poverty through micro financing, zakat which is obligatory, and waqf as a voluntary charity. zakat is an annual charitable obligation to donate that includes at least 2.5% of the income or wealth paid by all muslims who have their income or wealth above a certain threshold. zakat can play an important key role in reducing and eliminating poverty by redistributing wealth to all society. the world value of zakat alone is potentially from 200 billion to 1 trillion dollars a year. however, this extraordinary potential has yet to be fully realised, even in the field of the world's largest muslim-majority country, because informal zakat delivery remains much broader than contributions made through formal islamic organizations. thus, a change of model is necessary in the management of zakat, moving from a focus on the charitable act of giving its impact on expanding the rights of recipients. consumer spending for basic needs, with greater attention to the following aspects of productive activities [5], [25], [26]. b. social finance all organisations create economic, social and environmental value [20], [27]. the crisis that has hit the ecosystem in recent years has made it more difficult to achieve balance in all three values. from moments of difficulty and discomfort, new opportunities usually arise, and this is for example the case of the birth of new financial instruments. an overview has already been given of the innovation that crowdfunding has brought to the economic system [13], [20], [28]–[37]. the world of finance, however, has had the opportunity to learn about the emerging instruments linked to the theme of ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 social finance, in which ethical values are put ahead of other performance indicators to which we are accustomed with conventional instruments, becoming fundamental tools for the success of the impact value chain defined by clark et al. (2004). it is an economic moment in which there is the grafting of another theme in which ethics is at the first place and is the expansion of the culture of islamic finance [18], [38]. the social enterprises, given the predominant role they have within social innovation and the propensity intrinsic to their social object of ethics, seem to be the best candidates on which to push for the approach to these instruments [11], [17], [18], [38]. as nicholls et al. (2015) says, the british government has certainly played a fundamental role in the last ten years through policies aimed at increasing the sectors of social enterprise and social finance. the tools that social finance provides are many and above all innovative. when new themes and instruments are grafted onto an ecosystem, this gives rise to new realities such as the definition of the impact economy [20], [32], [39]. calderini et al. (2018) has been able to give life to a concept that is currently defined impact economy as a new entrepreneurial and financial paradigm. by overcoming the traditional notion of social responsibility, it proposes to implement initiatives with a high social impact and capable of exerting a transformative force in society (calderini et al., 2018a; carree and thurik, 2010; etzkowitz et al., 2000; isenberg, 2011). businesses and social impact investments are initiatives that intentionally pursue measurable social impact and at the same time economic sustainability and financial returns. although ethics is put first, a guarantee that can be given by a social enterprise that intends to use one of the above instruments can give greater security if it manages to guarantee a certain propensity for technology and the innovation that it entails [40], [41]. attention to performance is an indicator of survival within the market and this consequently allows the generation of social impact as the actor is active [42], [43]. a not insignificant factor is also the attention that the company pays to internal management in order to guarantee that it puts the same meticulousness outside as the management of the entire plan of security compliance [44], [45]. moreover, the action of companies and investors is characterized by additionality [35], [46]–[52] additionality means operating in sectors that are undercapitalised because they are penalised by traditional market mechanisms. third sector organisations that grow, structure and intensify their skills, technologies and capital [18], [53]–[55]. iii. research methodology this research employs a case study approach [56], [57]. the case-study approach is suitable for investigating why or how phenomena occurred and the relationships among these phenomena [57]. through case study, one may better understand a novel phenomenon and concept [56]. in line with the purpose of this article, the methodology was adopted by preparing a longitudinal and explanatory case study [58], [59]. the empirical evidence for this article comes from the search for cases of third sector companies legal in the north-west of italy. the phenomena of crisis that have affected the nation and the strong presence of social cooperatives on the territory has made concentrate the area of selection in a very specific that will be interesting to replicate in future research for other areas. the objective is to investigate how, through the meeting of islamic and social finance instruments, it is possible to restart the process of social innovation through the companies that are currently the major players in this field: social cooperatives. the criteria for the selection of the 317 social cooperatives through ―aida bureau van dijk‖ were as follows: 1) the companies had to be social cooperatives with registered offices in italy (11,206 cases); 2) the companies had to be still active within the market (7,109 cases); 3) the companies had to represent the north-west of italy and therefore valle d'aosta, piedmont, lombardy, liguria (1,122 cases); 4) the companies had to have the willingness to analyse the balance sheets closed in 2018 (331 cases). iv. case study – context the analysis carried out involves the social cooperatives that are part of the north-west of italy, which includes the regions of valle d'aosta, piedmont, lombardy and liguria. in table i it is possible to see the distribution. table i. distribution of social cooperatives by region region total liguria 30 lombardy 252 piedmont 31 aosta valley/vallée d'aoste 4 source: our production through a systematization of all sectors indexed according to the code ateco 2007 which is an italian categorization of the working sectors. we believe that they are the most representative and the nomenclatures adopted are representative of the sector. table ii shows the distribution of the 317 social cooperatives analysed, the most numerous being those dealing with healthcare, social welfare services, social welfare and education. the table shows that the sum of all activities categorized according to the volume of business in four sizes: less than 10 thousand, from 10 to 100 thousand, from 100 to 500 thousand and finally from 500 thousand and ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 up. the result is very interesting and leads to future reasoning that will be exposed in discussion as the section of most populous cooperatives is the one with more than 500 thousand annual revenues and graph 1 helps in the representation. table ii. distribution of the number of social cooperatives by activity and income revenues from sales (thousands of euro) ateco 2007 less than 10 from 10 to 100 from 100 to 500 more than 500 all growing of crops and production of animal products, hunting and related service activities 0 0 1 4 5 forestry and use of forest areas 0 1 0 0 1 food industries 0 0 0 1 1 beverage industry 0 0 1 0 1 manufacture of wearing apparel; manufacture of leather and fur articles 0 0 0 1 1 manufacture of wood and of products of wood and cork (except furniture); manufacture of articles of straw and plaiting materials 0 0 1 0 1 printing and reproduction of recorded media 0 0 2 2 4 manufacture of rubber and plastic products 0 0 0 1 1 manufacture of other non-metallic mineral products 0 0 0 1 1 manufacture of fabricated metal products (except machinery and equipment) 0 0 0 2 2 manufacture of electrical and nonelectrical household appliances 0 0 0 1 1 manufacture of machinery and equipment nca 0 0 1 0 1 others manufacturing industries 0 0 0 3 3 waste collection, treatment and disposal activities; material recovery 0 0 0 9 9 construction of buildings 1 0 0 1 2 specialised construction work 0 0 0 2 2 wholesale and retail trade and repair of motor vehicles and motorcycles 0 0 1 0 1 wholesale trade (except of motor vehicles and motorcycles) 0 0 1 2 3 retail trade (except of motor vehicles and motorcycles) 1 1 1 2 5 land transport and transport by pipeline 0 0 0 1 1 warehousing and transport support activities 0 0 0 1 1 postal services and courier activities 0 0 0 1 1 accommodation 0 0 0 1 1 food service activities 0 0 1 5 6 activities of information and other information technology services 0 0 1 1 2 activities of management and management consulting 1 0 0 4 5 scientific research and development 0 1 0 0 1 service activities for buildings and landscape 1 1 6 25 33 office support activities and other business support services 0 0 3 4 7 education 0 2 12 33 47 healthcare 0 1 3 6 10 social work services with accommodation 0 1 3 30 34 social work without accommodation 2 8 18 80 108 creative, artistic and entertainment activities 0 0 1 0 1 activities of libraries, archives, museums and other cultural activities 0 0 2 1 3 sports, entertainment and entertainment activities 0 1 2 2 5 repair of computers of personal and household goods 0 0 0 1 1 others personal service activities 0 0 2 3 5 all 6 17 63 231 317 source: our production graph 1 representation of the number of social cooperatives divided by revenues sales revenues (thousands of euro) 1. less than 10 2. from 10 to 100 3. from 100 to 500 4. more than 500 in addition, table iii gives a picture of the situation in the area of research conducted by the research group made available through the database of knoema corp. the data are necessary to make the reasoning resulting from the emerging situations of the budgets of social cooperatives and the recognition of problems and emergencies has the territory and understand if the meeting between islamic finance and ethical finance the solution can be. based on the category, synthesis columns have been organized with the total and the average of ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 the four italian regions, with the possible increase or decrease compared to the year preceding the one under analysis. in addition to data on population and life expectancy are health, work, transport and science and technology. the representation is important because health has been said to be a major problem and the data confirm it, the "labour" as employment because you need to know if the territory can absorb the emerging workforce that could be triggered with the right financial instrument. transport is often one of the most used activities by social cooperatives in the area that want to help disadvantaged people. finally, with "science and technology" we can understand the orientation towards research and development because in order to be able to receive innovations such as those that this research wants to demonstrate the territory must be prepared. table iii. overview of the search area demography (knoema corp.) total average total population (p) in 2018 16.090.901, 00 0,15 % 4.022.72 5,25 0,04% life expectancy (y) in 2016 330,40 2,69 % 82,60 0,67% life expectancy at 18 years (y) in 2016 263,40 5,38 % 65,85 1,35% life expectancy at 65 years (y) in 2016 82,90 9,40 % 20,73 2,35% number of deaths (n) in 2018 15.990,00 4,34 % 3.997,50 1,09% number of live births (n) in 2018 9.014,00 19,60 % 2.253,50 4,90% number dying between 0-1 year (n) in 2016 1.286,00 8,64 % 321,50 2,16% number dying between 0-64 years (n) in 2016 2.722,00 53,17 % 680,50 13,29 % health death rate (crude death rate per 100,000 inhabitants) in 2015 4.772,60 42,56 % 1.193,15 10,64 % deaths by chronic liver disease (crude death rate per 100,000 inhabitants) in 2015 33,70 15,64 % 8,43 3,91% deaths by accidents (crude death rate per 100,000 inhabitants) in 2015 143,10 40,00 % 35,78 10,00 % labor employment (ths) in 2016 7.271,80 1,46 % 1.817,95 0,37% employment rate (%) in 2017 262,00 3,47 % 65,50 0,87% unemployment (ths p) in 2017 551,40 30,91 137,85 7,73% % unemployment rate (%) in 2017 32,80 28,06 % 8,20 7,02% long-term unemployment (ths) in 2017 289,20 30,36 % 72,30 7,59% transport stock of utility vehicles (n) in 2016 1.270.811,0 0 30,01 % 317.702, 75 7,50% stock of passenger cars (n) in 2016 9.863.118,0 0 5,62 % 2.465.77 9,50 1,41% passenger cars per 1000 population (per 1000 p) in 2016 2.960,00 6,48 % 740,00 1,62% stock of motor coaches, buses and trolley buses (n) in 2016 19.506,00 0,22 % 4.876,50 0,05% stock of lorries (n) in 2016 1.044.433,0 0 31,67 % 261.108, 25 7,92% length of railway lines with double and more tracks (km) in 2015 1.870,00 0,50 % 467,50 0,13% total length of railway lines (km) in 2015 4.154,00 0,05 % 1.038,50 0,01% sсience and technology r&d expenditure (mln €) in 2016 8.397,30 4,48 % 2.099,33 1,12% share of r&d expenditure in regional gdp (%) in 2016 5,66 0,83 % 1,42 0,21% r&d expenditure per inhabitant (€) in 2016 1.809,10 6,36 % 452,28 1,59% share of human resources in science and technology (%) in 2016 7,10 1299, 75% 1,78 324,94 % share of human resources in education sector of science and technology (%) in 2016 1,70 9,73 % 0,43 2,43% number of patent applications (n) in 2012 1.407,85 22,87 % 351,96 5,72% number of patent applications per million inhabitants (per mln inhabitants) in 2012 294,95 23,28 % 73,74 5,82% number of r&d personnel and researchers (p) in 2016 143.043,00 1299, 78% 35.760,7 5 324,95 % source: our production v. presentation of results the results in table iii and iv show the economic and financial picture of the area analysed. as in the previous table, in order to improve the use of the material, a summary is offered by region as a total and as an average of the social cooperatives that make up the territory. table iv shows the balance sheet. the data used for the scientific analysis are inherent to the solidity of investments of the companies through the monitoring of the role of tangible fixed assets and the relationship with the total assets. ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 moreover, the real wealth of the company, its net worth and, subsequently, the role of bank debts within the cluster of selected companies are monitored and analysed. table v instead shows the data grouped using the same method but from the profit and loss account of social cooperatives, highlighting revenues and ebitda. through the economic and financial analysis of the most significant items (table iv), it emerges that tangible fixed assets are more present in the social cooperatives that populate piedmont and lombardy, while by monitoring wealth through equity, lombardy is the most significant. the item which, as mentioned above, is important for our analysis is "payables to banks". as emerges from the studies of boudt et al. [60] for islamic finance, they can be considered if they are lower than 33% and the research data show that the area analysed is perfect for this condition as they are all lower. as a propensity for higher sales revenues (table v), piedmont and liguria are the regions with the best data, looking at the average in order to eliminate the problem of the number of people and, finally, the profit reflects what is the trend of revenues. ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 table iv. key balance sheet data for the 4 regions n region employees total tangible fixed assets thousands of euro tangible fixed assets / total assets total assets thousands of euro equity thousands of euro last year available total debts thousands of euro last year available total liabilities thousands of euro last year available. payables to banks thousands of euro last year available debts to banks / total assets debts to banks / total debts total liguria 1.918 7.716 10% 77.287 21.031 43.079 77.287 15.235 20% 35% average liguria 66 257 8% 2.576 701 1.436 2.576 609 8% 13% total lombardy 14.639 166.837 35% 472.206 148.604 226.117 472.206 62.483 13% 28% average lombardy 58 662 23% 1.874 590 897 1.874 329 11% 22% total piedmont 4.738 58.529 46% 127.180 38.152 72.247 127.180 31.891 25% 44% average piedmont 153 1.888 20% 4.103 1.231 2.331 4.103 1.276 11% 21% total aosta valley/vallée d'aoste 105 1.419 41% 3.505 2.206 934 3.505 130 4% 14% average aosta valley/vallée d'aoste 26 355 39% 876 552 233 876 43 9% 20% source: our production table v. key figures from the income statements of the 4 regions n region employees sales revenues thousands of euro last year available net income/loss for the year thousands of euro last year available ebitda thousands of euro last year available. total liguria 1.918 99.374 2.832 5.371 average liguria 66 3.312 94 179 total lombardy 14.639 501.226 7.316 26.628 average lombardy 58 1.989 29 106 total piedmont 4.738 154.443 2.315 8.362 average piedmont 153 4.982 75 270 total aosta valley/vallée d'aoste 105 3.137 88 192 average aosta valley/vallée d'aoste 26 784 22 48 source: our production ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 the situation of the companies analysed shows that the more revenues increase, the more debts decrease, and therefore it can be translated that after the initial period of difficulties has been overcome and that social cooperatives become indebted, they acquire a structure that makes them independent and so much so as to reduce demand. in the discussion is presented the condition that the graft of new financial instruments can lead to evolve companies and therefore the economy of the territory and in this social innovation. vi. discussion according to the pew research center, islam is the second largest religion in the world as a growth rate, in addition to the muslim population in europe, was 44 million in 2010 [61] estimating nearly 30% of the world's population in 2050 reaching 71 million [62]. islamic finance could bring high liquidity to italy in general and obviously in the section studied, obtaining capital from muslim countries, which should not be underestimated [6]. products in the financial field are emerging and are always more innovative, both in islamic finance and in the finance of impact, so much to make us imagine a path along the same road. for example, they are prominent products of islamic micro loans and micro finance for the issue of "sukuk" (islamic bonds) [10], [25]. the studies of karake-shalhoub [63] confirm that the islamic financial industry has an accelerated growth rate at world level where islamic financial activities are expanding with shariahcompliant activities of over 1,000 billion dollars. islamic markets also provide various tools that serve as a basis for the development of a wide range of sophisticated, highly innovative financial instruments [5], [64]. the existing instruments in the panorama of the islamic finance is already rich, such as, for example, waqf, zakat, sukuk waqf, crowdfunding in conformity with the sharia, and, furthermore, the whole concept of the micro-finance tied to the guarantee of granting sustainable financing for the need of social impact. for example the adoption of zakat and the waqf instruments aim to combine the two following aspects: religious duty of charitable expenditure and economic development [38]. as emerged in the introduction, poverty is a real problem that will generate inefficiencies and hardship in multiple fields as the case study shows from the results through the increase of social cooperatives operating in the field of health and education where there is a need for greater grafting of help from society. islamic finance seems to be an excellent opportunity for the case study and for the italian territory, using the potential of the financial instruments and the for-impact business fabric of which italy is made up. a previous study by biancone and radwan [25] shows that investors have appreciated strategies and approaches to leverage islamic financial instruments, such as sukuk and microtakaful and other relevant instruments. biancone and radwan [38] they continues, that to reach the sdgs, between 3 trillion dollars and 4.5 trillion dollars are necessary, while the current investments in the relevant sectors is of about 1.4 trillion dollars. governments alone cannot achieve the sdgs goals and the increased need for access to social business opportunities. islamic finance has various sets of social tools demonstrated in waqfs, microfinance, and sukuk and many others that are able to offer the possibility of realizing sdgs, embodying socially responsible development and creating a bridge between opportunities for economic growth and social welfare, especially for the poorest and most vulnerable. there are significant points in common between zakat and other forms of islamic finance, and sdgs, with their common goal of alleviating poverty and hunger and reducing inequalities through the redistribution of wealth. as stated in the literature, the zakat can be a good tool on which to focus for social innovation. the results show that as revenues increase, the debt to banks decreases, therefore the companies that make up the analysed territory are well structured on average and show that, with the right initial help, they are then able to lead an average successful business life. one of the points of the islamic finance is the debt, which cannot exceed 33% of the total, and the table shows that in the four regions of italy they lend themselves to this philosophy because they are all with values below this threshold. moreover, it should be added that the mission of all these social cooperatives gives all for impact and have all the characteristics sought by islamic finance within their natural orientation to mutuality. vii. conclusion with the aim of answering the question "how, through the meeting of islamic and social finance instruments, it is possible to restart the process of social innovation through the companies that are currently the major players in this field: social cooperatives", the result is positive and stimulating for future challenges. the companies show a part of the italian panorama and having all, on average, a good balance sheet situation, they show that the position that they could assume with regard to the banks as potential clients is good as they have all the necessary characteristics for the islamic and ethical finance. given the situation of the sectors, a mobility of capital is necessary, which requires liquidity for development, given that social entrepreneurs are considered the engine of social innovation. the meeting between the demand that the territory makes for social finance instruments and the characteristics of the islamic 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[65] s. secinaro, l. corvo, v. brescia, and d. iannaci, ‗hybrid organizations: a systematic review of the current literature‘, international business research, 2019. ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 12 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5039 1 covid-19 and the role of halal food 1 islamic economics department, tazkia institute and smart indonesia. email: aamsmart@gmail.com 2 shariah economic law department, tazkia institute, indonesia. abstract—this study aims to determine the map of the development of research on the halal food industry's theme in the covid-19 pandemic published by indexed journals. the study was conducted in august 2020. the analysis focused on the trends of the topics, keywords, authors and journals. the data analyzed were more than 50 digital object identifier equipped papers. the object of the study is a published journal published from 2019 to 2020. the data is then processed and analyzed using the vosviewer application program to determine the bibliometric mapping of the development of covid-19 research and the role of halal food. the results showed that the number of articles discussing the theme of halal food has been quite large in the last two years. bibliometric visualization shows that the map of the development of covid-19 research is divided into 4 clusters. cluster 1 consists of 12 topics, cluster 2 consists of 12 topics, cluster 3 consists of 8 topics, and cluster 4 consists of 8 topics. this study's findings are that there is special attention to the halal industry's development, mostly halal food, to mitigate the prolonged health crisis's impact.this study provides an overview of trends in the most popular topics, keywords, journals and authors in articles on halal food, thus providing information for researchers focused on research in the field of halal food. in the end, this theme has the potential to continue to be developed keywordscovid-19, halal food, bibliometric i. introduction the whole world is currently experiencing a prolonged crisis due to the covid-19 pandemic since the beginning of 2020. the virus, which first originated from china, has resulted in severe economic damage [1]. inflation experienced by indonesia in march 2020 was recorded at 0.10% (month to month) and 2.96% (year on year). this pandemic impacts the exchange rate of various countries' currencies against the us dollar and the problem of meeting the availability of food materials and other supporting commodities properly [2]. the covid-19 pandemic period shows enormous urgency in needinga hygienic food supply, especially halal food [3]. this is because the cause of the covid-19 pandemic is the problem of food that has not been paid attention to its health, so that the rules applied by islam in the recommendations for choosing food are fundamental to pay more attention to [4]. epidemiological studies conducted on primary covid-19 cases showed that the cases that occurred were exposed to the food market in huanan, wuhan. this food market is known to provide food from animals that are not halal for consumption. another study also states that halal food consumption in a sustainable manner can reduce the risk of a pandemic such as covid-19 in the future [5]. covid-19 has also caused the demand for halal food consumption to increase, so that food needs to be considered so that what goes into a muslim's stomach is food that is truly guaranteed to be halal so that it produces good energy and is protected from various diseases [6]. the issue of food security is also one of the government's challenges during this pandemic, how to adequately meet the people's food needs[7]. more than 50 scientific research papers were published by various journals, both national and international, in the early 2020 observation period until the time this paper was written, august 2020, which discusses covid-19 and the role of halal food. paper with this theme is interesting to discuss considering the importance of scientific research to be carried out to generate ideas and innovations that can answer the country's economic problems. the rapid development of halal food research is interesting to research in bibliometric analysis in line with the development of demand for halal food worldwide. this research aims to analyze the mapping of bibliometric characteristics of the development of trend topics, authors, keywords, authors and journals in papers on halal food published until august 2020. this research is structured as follows—the second part reviews, in general, the research method, namely the bibliometric method. the third section presents and reports the results of descriptive research while providing content analysis of each cluster category in a meta-analysis consisting of the number of published papers on the theme of covid-19 and the role of halal food, the methodological approach used, research topics, top authors, top institutions and countries as top objects of study. then explain bibliometric mapping aam slamet rusydiana 1 , aisyah as-salafiyah 2 submitted august 2020, revised december 2020, accepted december 2020 ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5039 2 visualization starting from keyword trends, authors to journals that publish covid-19 theme papers, and the role of halal food. the fourth part is the closing of the paper, which contains a summary of the main discussion and conclusions. ii. literature review the halal industry, especially halal food, is becoming a new and popular topic of conversation in the business world, both in indonesia and in other countries. even the value of halal products currently traded is around the us $ 254 billion [8]. the halal industry concept was born from islam's concept as a religion that is a blessing for all nature (rahmatan lil alamin), where islam regulates all aspects of human life, not only about worship but also about worship also all aspects of life. the word halal comes from arabic, which means permissible, justified and welcome to be consumed according to islamic law rules, while tayyib means quality and does not endanger health. all types of products, especially food and beverages, are lawful except for some of the argument's prohibitions [9]. if it is related to industrial products, halal can be interpreted as products that are allowed to be consumed by a muslim [10]. the obligation to consume halal products is stated in the holy qur'an surah al-maidah verse 88, which shows an explicit command to consume halal food. in islam, foods that are considered dangerous for consumption are prohibited are pork, blood, alcohol, carcasses that are slaughtered by names other than allah, which have been regulated by sharia. this shows that halal is a religious term related to islam, where the rules regarding halal are contained in al-quran and sunnah's arguments and have become part of the islamic tradition. globally, the market for halal-certified food and products is increasing rapidly. halal products have received worldwide recognition as a scale for food safety and quality assurance. besides, the halal concept includes requirements undersharia, including aspects of islam, aspects of hygiene, sanitation and safety [11]. halal products' need continues to increase every year, especially in the halal food industry for the muslim community's primary needs[12]. the belief that halal food is healthier, safer and tastier is why muslim and non-muslim consumers consume halal food [13]. also, the muslim community's awareness, especially in the role of market consumers to carry out their religious obligations, is a factor that increases the demand for halal food, so it gets excellent attention in the global market [14]. iii. methodology bibliometric mapping is an important research topic in the bibliometric field [15]. two different bibliometric aspects are the construction of the bibliometric map and the graphical representation of the map. in the bibliometric literature, the most significant concern is in the construction of the bibliometric map. research of bibliometric related to the effects of differences in similarity measures [16, 17, 18]and tested with different mapping techniques [19, 20, 21]. the graphic representation of the bibliometric map has received less attention. although some researchers seriously study issues related to graphical representations [22, 23, 24], most articles published in the bibliometric literature rely on simple graphical representations provided by computer programs such as spss and pajek. this study uses paper publication data sourced from various journals with research on covid-19 and the role of halal food. data collection through tracing papers within the last year. from the search results, there were 52 published articles. data in the form of the number of published papers on the theme of covid-19 and the role of halal food, methodological approaches, research topics, top authors, top institutions that contributed to publishing published articles were analyzed using microsoft excel 2010. as for the development trend of covid-19 theme publications and industrial issues, halal food was analyzed using vosviewer software. vos determines the location of items on the map by minimizing: 𝑉 𝑥𝑖 , … , 𝑥𝑛 = 𝑠𝑖𝑗 𝑥𝑖 − 𝑥𝑗 2 𝑖<𝑗 (a) become: 2 𝑛 𝑛−1 𝑥𝑖 − 𝑥𝑗 = 1𝑖<𝑗 (b) therefore, vos's idea is to minimize the number of weights of the square of the distance between all pairs of items. the similarities between the weight of the items the square of the distance between pairs of items. to avoid worthless solutions, restrictions are imposed so that the average distance between two items must be equal to one. iv. covid-19 and the role of halal food a. meta-analysis there were 52 papers published in the observation period of the last year. the distribution of papers with a large number dominates the themes in economic and social journals. the publication of papers on the theme of covid-19 and the role of halal fooduntil august 2020 are totaling 52 papers. however, because 2020 has not been completed until the period of december 2020, the number of papers is still possible to increase and increase, the data collection of papers studied in this study is until august 2020. the following table 1 shows some specific topics in the research paper on the theme of covid-19 and the role of halal food. based on the following table, it can be seen that the top 3 research topics used in this theme paper over the past year are 41 papers related to halal food consumption, then the topic of halal food development is 38 papersand the topic of the halal food industry totaling 36 papers. each paper can contain more than one topic, so the number is more than the number of papers used as the object of research. ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5039 3 table i. research topic topics total halal food consumption 41 halal food development 38 halal food industry 36 halal food system 35 halal food safety 34 halal food service 33 halal food standard 33 halal food awareness 30 halal food policy 28 halal food supply chain 27 halal food and tourism 24 halal food and pharmaceuticals 22 halal food certification 19 halal food operators 17 halal food and travel 17 halal food security 12 halal food equity 6 author, 2020 the topic with the lowest number of discussions was 6 papers on halal food equity, so it needs to be considered for researchers to reproduce then quality research related to this topic. the absence of relatively complete and comprehensive data may be why research related to the above topics is not widely published in the covid-19 theme paper and the role of halal food. based on punch [25], there are 3 types of research approaches, namely a qualitative approach, a quantitative approach and a mixed methodology approach. table 2 below shows the research methodology used by each published paper on the covid-19 theme and the role of halal food. in this observation, the most used research approach was a qualitative approach, namely 29 papers (55.8%), followed by a quantitative approach with 15 papers (28.8%) and a mixed approach with 8 papers (15.4%). the research findings show that the number of researches on the covid-19 theme and the role of halal foodthat is empirical is less than that of conceptual or mixed research. the research model that is widely used in qualitative methods is descriptive. the empirical research model that is widely used is multiple regression modeling. then several papers collaborate both qualitative and quantitative approaches. the total number of institutions affiliated with the paper's authors is 74 institutions from various countries worldwide. the most productive author-affiliated institution, in the first place, was the university of malaya, which produced 15 authors, followed by the second rank, namely baqiyatallah university of medical sciences, which produced 10 authors. the third rank was universiti teknologi mara and sepuluh nopember institute of technology with 7 authors. interestingly, institutions from malaysia and indonesia are quite productive compared to other countries' institutions in researching the theme of covid-19 and the role of halal food. suppose authors from malaysia and indonesia dominated the covid-19 theme paper and the the role of halal food last year. in that case, the countries that are objects of research in the published paper on the theme of covid-19 and the role of halal food, which is also still malaysia and indonesia, are dominated by the top 2 rankings. the ranking of the countries that were the objects of research in the covid-19 theme paper and the role of halal food in the last year as follows; in the first place, malaysia surpassed other countries with the number of that examined 12 papers. then the second rank is occupied by indonesia with 10 papers, then the third rank is india, iran and thailand with 2 papers each and the rest 12 countries have been the object of research once. b. bibliometric analysis this part will present a graphic visual mapping of the covid-19 theme paper's publication and the role of halal food. the keyword mapping analysis results form the basis for the co-occurrence mapping of important or unique terms contained in a particular article. mapping is a process that allows a person to recognize elements of knowledge and their configuration, dynamics, interdependencies, and interactions. related to bibliometrics, science mapping is a method of visualizing a field of science. this visualization is done by creating a landscape map that can display topics from science. the visualization of the co-word map network for the publication of the covid-19 theme paper and the role of halal food can be seen in figure 1below. ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5039 4 figure 1. bibliometric keyword mapping in this mapping, several keywords that have often appeared in the covid-19 theme paper and the halal food industry in the past year are displayed and their relation to other keywords in 4 clusters, namely: • cluster 1 in red consists of 12 keywords: attitude, better understanding, determinant, evidence, government, intention, marketer, marketing strategy, opinion, religiosity, theory, and variable. • cluster 2 in green consists of 12 keywords: author, business, country, covid, demand, food, halal certification, halal standard, majority, muslim, number, and review. • cluster 3 in blue consists of 8 keywords: addition, development, halal food industry, halal food supply chain, halal industry, halal product, malaysia, and risk. • cluster 4 in yellow consists of 8 keywords: analysis technique, company, design methodology approach, factor, impact, influence, price, and primary data. the keywords divided into the 4 clusters above are arranged in a colored circle indicating the clusters. this data can be used in determining the trend of the keywords in the last year. the bibliometric analysis shows several keywords widely used in the paper, which is the object of study. the keywords that appear in the larger circle indicates the most. meanwhile, the line relation between keywords shows how much it is related to other keywords. it was found that the most familiar keywords are covid, food, country, attitude, halal product, intention. furthermore, using the vosviewer software, we found the authors' bibliometric mapping as in figure 3 below. the bigger the circle of the author's name, shows the more papers he has published in the covid-19 theme paper and the role of halal food in the last year. the cluster density view is the item (label), marked the same as the visible item. each item dot has a color depending on the density of the item at that time. this identifies that the color of the map points depends on the number of items associated with other items. this section is handy for obtaining an overview of the bibliometric map's general structure by paying attention to which parts of the items are considered essential to be analyzed. through this worksheet, we can interpret the authors who have written the most publications. ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5039 5 figure 2. bibliometric author mapping based on these results, a density map is displayed, which results from an analysis using all published articles on the covid-19 theme paper and the role of halal food, both related and unrelated. there are many clusters sorted by author (indicated by colored circles). the most popular authors write publications related to the covid-19 theme and the role of halal food based on bibliometric mapping, namely iranmanesh and mostafa. the order in this mapping may have a difference with the author's top-ranking if we calculate manually, but in addition to calculating the number of papers published on the covid-19 theme and the role of halal food, vosviewer also takes into account the number of linkages and citations with other authors. furthermore, the visualization of the journal mapping is depicted in bibliometric figure 4. based on this image, several journal clusters appear to be listed in a glowing circle, indicating the journal's productivity in contributing to publishing its paper on the theme of covid-19 and the role of halal food. ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5039 6 figure 3. bibliometric journal mapping most journals are counted in terms of the number of publications and number of links to other journals, where a paper author can write many papers in different journals. the ranking of the most popular journals shown by the bibliometric mapping results is the journal of islamic marketing. v. findings the availability of halal food in various countries is undoubtedly different, whether influenced by the level of religiosity, prevailing norms, community behavior [26], education about halal from the available information media [27], the origin of the halal food brand [28], to image, trust and customer satisfaction [29]. this influence makes each country different in the halal food supply level, one of which is shown by the minimal availability of halal products in china [30] and currently, halal food is popular in indonesia and malaysia [31]. a report from the state of the global islamic economy 2018 shows that indonesia ranks first as the largest consumer of food products in the world with a value of usd 154.9 billion. however, the indonesian government has not been able to maximize this market potential, as indicated by indonesia's ranking that is still at tenth place in the category of world halal food-producing countries [32]. therefore, indonesia needs to improve the quality and quantity of halal food supply, especially during this pandemic, because the increasing demand creates opportunities. for example, tourists who visit certain countries are asked to remain in the room during the quarantine period but are still allowed to order food through room service [33]. unlike indonesia, in america, there are many communities, both individuals and organizations that have begun to coordinate long-term anticipatory actions from the impact of covid-19, one of which is carried out by feed buffalo, an emergency food pantry or public kitchen that provides healthy and halal food for the community. durban, one of the cities in kwazulu-natal, has also begun to pay attention to providing halal food for its people by improving halal food access services. even durban was chosen to host the world halal day 2020, whose implementation was delayed due to covid-19 [34]. the halal food industry in europe has also continued to develop rapidly in the past few years. islamic shops that provide halal food are in great demand because the needs, according to muslims' condition, are still not widely provided in shops in general [35]. one reason for this development is the increasing demand for halal certification and quality assurance in line with the tourism sector's development[36]. however, halal food development also needs to be balanced with halal meat provision in line with the increasing demand for meat in europe [37]. on the other hand, understanding halal food's meaning and urgency influences consumer behavior and their purchase intention concerning sustainable consumption, so knowledge ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5039 7 and education about halal food need to be improved. many companies have produced islamic products, but their business is still related to the production process that is not acceptable in islam [38]. a trust-based supply chain, such as a halal supply chain, is essential. because, even though the food substance is halal, the process of getting it is not following the sharia, then the food is not allowed based on maqashid sharia [39]. halal food is universal. it can be consumed by anyone, not only the muslim community, while the muslim community cannot consume non-halal food, even though, in fact, nonmuslim consumers rarely want to buy halal food products [40]. however, the halal food industry still has good prospects going forward. halal food began to experience a stable reputation since the millennium and has its research niche [41]. vi. conclusion this research focuses on finding out the development of the covid-19 theme and the halal food industry's issue in the world. the results show an increase in the number of published papers on this theme compared to other themes. until august 2020, there have been more than 50 studies on this theme during the past year. the top three research topics widely used are halal food consumption, halal food development and the halal food industry. the bibliometric mapping visualization shows that the map of research development in the covid-19 field and the role of halal food is divided into 4 clusters. one of the critical findings is, the period of the covid-19 pandemic shows that there is enormous urgency in the need for a clean food supply, especially halal food. the covid-19 pandemic cause is the problem of food that has not been paid attention to its health.the rules applied by islam in food selection recommendations are essential to pay more attention to.thefirst covid-19 case shows were exposed to the food market in wuhan,china. this food market is known to provide food from animals that are not halal for consumption. consumption of halal food in a sustainable manner can reduce the risk of a pandemic such as covid-19 in the future.from the perspective of islamic economics and finance, currently, it is a momentum to develop the halal industry, especially the halal food industry.in addition, several islamic social finance schemes [42] can be used to mitigate the impact of covid-19. the results show that the number of articles on halal food published by the journal doi equipped is quite large and can increase along with the development of the demand for halal food and the muslim community's awarenessin the world. the results showed that several popular topics and keywords were used in this theme and could be developed further. some of the most productive journals and authors can also be used to reference researchers who will develop research on this theme. this study has several limitations. this research only focuses on knowing the development trend of topics, keywords, authors, and journals published on halal food. of course, there are still many parts that can be explored. it should also be noted that the number of article collections studied was limited from 2019 to august 2020, so it is still possible to continue to experience changes and developments in the future. suggestions for further research are to carry out a complete bibliometric analysis with more elements understudy or more diverse software to produce more comprehensive results. recommendations for practitioners are the need to improve the quality and quantity of halal food production and the application of innovation in the system to provide more varied product choices for the consumer community to meet the demand for halal food. the recommendation for academics is to research developing the halal food industry by continuing this bibliometric research with various other software such as r biblioshiny and increasing its limitations.research with these tools can be found, for example, research by bollani and chmet [43] related to mapping islamic finance research. references [1] brodeur, a., gray, d., islam, a., & bhuiyan, s. j. 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(2020). bibliometric analysis of islamic finance. european journal of islamic finance. second special issue for ejif workshop. https://doi.org/10.13135/2421-2172/4936 ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5039 9 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 bitcoin-blockchain phenomenon: an investigation on news titles influence rainero, christian (1) & modarelli, giuseppe (2) (**) (1) associate professor, department of management, university of turin, e-mail: christian.rainero@unito.it (2) ** ph.d. student, department of management, university of turin, e-mail: giuseppe.modarelli@unito.it **corresponding author abstract the research purposed would explain, not the bitcoinblockchain (btc-bc) phenomenon per se, considering a good level of knowledge on the themes, but focusing the attention on two implicit connotations that these “disruptive technologies” involve. the investigation conducted by the authors considers a sentiment analysis on news titles influence during the period 2015-2018 supported by a field analysis. that approach based on framing activity would intersect different study areas from innovation, economics, psychology, behavioral analysis, marketing and decision-making. innovations should be studied under different aspects considering their probable wide range impacts on several fields. the exploratory approach to investigate something new would be interesting and useful to open windows of discussion and interpretation. the research focuses the two main factors of marketing strategies: scarcity and persuasion. the aim would be to validate these concepts in btcbc phenomenon as a kind of implicit marketing strategy. keywords: bitcoin-blockchain, media influence, scarcity, persuasion, decision making “their principal merit, however, arises from their beauty, which renders them peculiarly fit for the ornaments of dress and furniture. no paint or dye can give so splendid a colour as gilding. the merit of their beauty is greatly enhanced by their scarcity”. -smith, 1776 i. introduction the ever increasing news about bitcoin, the huge breakout in prices during the end of 2017 and the media ferment about the “disintermediated money” (rainero et al., 2019) assume the trigger role to this research. in that direction, the word-ofmouth (wom) (kozinets et al., 2010) communication moves and attracts marketers‟ attention (hsieh, hsieh & tang, 2012). the authors bases the research design on the fact that bitcoin could be considered more in general as a social learning phenomenon (rainero & modarelli, 2019). in specific ambits it could represent financial and economic phenomenon or on the side of its underlying technology (blockchain), an organizational one. in these perspectives, bitcoin would influence real life in its entirety. news about it could be able to modify or manipulate people decisions. it is true that the decision making process is quietly rational, but on the other hand, internal and external influences (that case) can occur. what mentioned above gives to bitcoin a strong force to generate impact not so much related to its intrinsic entities and characteristics, but in its communicative outcome. the research objective would be very focused and concise in verifying the presence of external influences (positive, negative, neutral, not congruent or double) (wilson, wiebe & hoffman, 2005; bandura, 1965; bryant & zillman, 2002; mcquarrie & phillips, 2005; mcquail, 1979) through sentiment analysis (pang & lee, 2008) on news titles collected thanks to btcworldnews.com from january 2015 to january 2019. the authors would confirm the assumptions on the presence of scarcity and exclusivity perception, higher perceived value and persuasion (cialdini, 1983; o'keefe, 2002) as a kind of implicit marketing strategy behind bitcoin success and its powerful social impact also through blockchain technology application.the authors opt for a validation survey in which people would affirm their perceptions about bitcoinblockchain (btc-bc). ii. referring scenario and research objectives nowadays, people would be affected by advertising campaigns. the aim would be to increase human desire to possess objects. according to reinforcement on the attractive power of products, marketers uses words and figures to promote objects, sometimes linking values, appeal and status symbols. mailto:christian.rainero@unito.it mailto:giuseppe.modarelli@unito.it ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 another attractive method in marketing strategies would be to suggest scarcity or limitation of quantity. in fact, limited editions (i.e. related to books, cars, cellphones etc.) are continuing to appear on the media. the limited editions often costs more than the standard products (worchel, lee & adewole, 1975). this view suggests that something of interest would be appreciated in scarcity perception able to increase the attractive force on customers. the perceived value of scarce products (i.e. commodities, rare goods etc.) would be a weapon of influence (cialdini, 1983). brock (1968), used scarcity as crucial focus point of his study. brock (1968) used the term “commodification” referring to the situation able to set the perceived scarce availability related to an object. he focused the research on the persuasive power of communication. in 1975, research conducted by some american professors (worchel, lee & adewole, 1975) required several persons to evaluate chocolate biscuits. a certain number of cookies has been placed in a jar and a scarce number of them (the same type) has been placed in another one. the scarcer amount of cookies received a higher interest than the larger ones, but they were exactly the same product without differences out of quantity. that experiment would be exhaustive to explain the idea that poorly available products would be more appealing and interesting than the others. as suggested by cialdini (1998), through the influence process and persuasion, people would generate and manage changes in social life. each process could be handled to foster growth and to move people manipulating habits in different directions (cialdini & trost, 1998). according to what aforementioned, the authors‟ aim would be to provide an answer to the following research questions. rq1: are news about bitcoin-blockchain phenomenon considerable persuasive? to answer that question the authors provide a precise analysis based on a specific period 2015-2018, segmenting it in three parts with the objective to provide a clear frame of advancement state in multiplicity of news appeared on the different media, collected by btcworldnews.com. rq2: could news titles about bitcoin-blockchain phenomenon reflect an implicit marketing strategy based on perceived innovation value through scarcity and persuasion affecting decision-making? to answer that question the authors provide a precise analysis based on the specific period above mentioned. at theoretical level, the authors lead back the discourse to the concepts of scarcity and persuasion, well explicitated in economics, marketing, strategies and other fields as psychology. the aim would be to shape the lines of btc-bc phenomenon, on one hand due to scarcity connected with the desirability and value perception, that intrinsically characterize bitcoin and on the other one, to the rq1 through sentiment and field analysis. the first part of the paper considers the literature review on scarcity and persuasion perception strategies under different lens, but especially marketing related to the rqs. the second part focuses the attention on btc-bc phenomenon based on scarcity and persuasion supported by a sentiment analysis and a framing approach to build the methodological paradigm that includes coding maps and influence perceptions. results and discussion conclude the paper through the field analysis validation, considering a sample (38 males and 29 females) selected through specific characteristics. the age fixed between 18 and 29 years old students (n.21 of economics and n.46 others faculties; total sample n.67). the decision to apply a questionnaire to these subjects is due to the higher impact that the innovation investigated would have in the future for them and to generate heterogeneity of the probable user and applicant population. to avoid other influence, exogenous, the sample shows predominant characteristics of medium knowledge on the theme. iii. scarcity perception strategy the merriam-webster dictionary defines scarcity as the quality or state of being scarce. scarce would be the deficiency in quantity or number compared with the demand: not plentiful or abundant becoming unavailable, in other words, not possible to get or use. by contrast, the definition of available would shape the presence or ready for immediate use available resources. restrictions to the opportunity to possess something or to do experience through objects would signify a kind of freedom loss. facing this loss of freedom, people would have the tendency in desiring limited objects. this loss also would influence the perceived value and desirability motivation that move people to possess those objects. researchers shows that purchase restriction strategies would be used as informational cues by customers to evaluate offers (aggarwal, jun & huh, 2011; howard, shu, & kerin 2007). promotional strategies including messages about scarce availability of a product would create a sense of urgency/anxiety in buyers‟ behaviours. scarcity messages can help raise a product‟s perceived value, and consequently, influence the consumer‟s intention to purchase it. cialdini (1983) expressed that the idea related to potential loss in freedom perception linked with decision-making process, plays a crucial role in human habits and decisions. in fact, people would be moved and more motivated by the thought of losing something than by the thought of gaining something of equal value. in this case, people think that rare objects would be typically better than those that are of easier ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 availability. in fact, people often use objects‟ availability to decide about their quality (perceived). so when scarcity tends to increase, or something/someone interfere with people possibility to acquire an object of desire, they tend to react against these obstacles and try to acquire the object desired with more passion, more motivation than before, as a question of honor. when people freedom reach to acquire something limited and/or the object of desire tends to be less available, the desire to acquire it would be increased and enhanced. it would be possible for marketers to artificially reduce the availability of products offered giving a false signal of quality perception among customers (lee & mukherjee, 2011). the scarcity effect has been conceptualized by cialdini (1987) during his study on social influence. cialdini (1987) suggested that the "scarcity", or the limited availability of a product, would generate a strong desire to acquire this scarce good. that process would unavoidably affect decision-making. in fact, in addition to the media persuasion would have been generated the cause of the rush and competition to acquire (also at huge price) btc, moved by the motivation of profit opportunity for a good, that per se, shows zero value (cheah & fry, 2015). in the same way, it would be observable the increment of interest and applications of blockchain technology in large spectrum for every sector. in other words, it seems that people tend to establish a mental association in terms of the rarer a product would be, the more value (perceived) it would have. scarcity would be a fundamental concept in economics. economists are concerned with both the scarcity of means (represented by budget lines) and the scarcity of goods (represented by supply curves). according to the traditional micro-economic theories of price and demand, the scarcity of goods lead to higher prices (lynn, 1989). something of limited availability due to market circumstances were perceived as more costly and more unique than something abundantly available (i.e. gold and diamonds). availability of goods influences consumers' preferences, and this effect is mediated through perceptions of uniqueness and cost evaluations (verhallen & robben, 1994). lynn's (1991) meta-analysis shows, following brock's (1968) commodity theory, that scarcity would enhance the value of what could be possessed. the scarcer a good would be, more value would be acquired increasing its level of desirability and the motivation to possess it. a good could be made more desirable, and with more perceived value through the manipulation of its scarcity, not always true, often only thanks to perception tricks (verhallen & robben, 1994). researchers in different fields suggests that scarcity would affect in a positive manner consumers‟ perceptions and behaviours in decision-making, modifying the product power of attraction (szybillo,1975). other researchers add to the discourse concepts as expensiveness and desirability, perceived quality and taste (west, 1975; lynn, 1989; verhallen & robben, 1994; fromkin, williams & dipboye, 1973; atlas & snyder, 1978; ringold, 1988;; worchel, lee, & adewole, 1975). researchers shows that many brands implement scarcity messages and campaigns promoting limited editions of specific products (balachander & stock, 2009; gierl & huettl, 2010). typically, brands can implement two types of scarce availability for some products: (1) limited-time and (2) limitedquantity (cialdini, 2008). these kind of strategies are both present in btc system (guttmann, 2014). as assumed by atlas and snyder (1978) people would tend to associate scarcity with higher prices. the same considerations have been made by fromkin et al. (1971) and worchel et al. (1975). on the other hand, expensiveness would enhance the desirability of goods because higher priced items would be status symbols and synonym of higher quality (monroe and petroshius 1981; veblen, l965). these observations would suggest a kind of equation in which scarcity means expensiveness; expensiveness would enhance quality perception and status symbols, increasing motivation (deci, 1971; ryan & deci, 2000) to acquire. the following model explains the concept in a graphical way facilitating to understand the nexus existing between the scarcity and motivation to acquire something (table. 1). table i. representation based on scarcity perception and decision-making source: our elaboration often people do not have access to all the information able to create a knowledge context in which accurately evaluate products in its entirety and those of the competitors. when people activate the mental representation based on scarcity and higher perceived value (sometimes enhanced by marketing influencing strategies), the desirability force immediately would generate a choice to buy on the wave of emotion. ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 iv. persuasion perception strategy emotion and persuasion would be an interesting and an old topic especially in psychology field (ray & batra, 1983), but not only. over the last 50 years, social scientific persuasion research has flowered. in fact, relevant researches have been conducted in different fields about social sciences (i.e. sociology, political science, communication, psychology, and anthropology, environmental studies, public health, medicine, marketing, advertising, law, business, education etc.). this would reflect the pervasiveness of persuasion in human social life, assuming that human decision-making would be shaped by persuasive communication. the merriam-webster dictionary defines the verb to persuade as the possibility to move by argument, entreaty, or expostulation to a belief, position, or course of action, and persuasion as the ability to persuade. effective advertising, in other words, persuasive advertising would win in competitive situations thanks to persuasion force and multiplicity of influencing messages due to repetition. born in psychology field, the concept of persuasion is becoming important in advertising and behavioral analysis (o'shaugnessy & o'shaughnessy, 2004). that would have greater impact on the people's inferences and behavior (ray & batra, 1983). persuasive messages would be involved in promotions, for example press releases to the media. these strategies would be incentives organizations use to modify or manipulate in a certain way the good or service value perceived by the customers. a coupon, contest, reward, or price discount would be all sales promotions. for example personal selling, now filtered by media, would involve face to face persuasion to sell product as the case of door to door sellers. these strategies are identifiable as sources shaped to persuade the receiver in taking actions or making decision in the present or in the future. advertising repetition is concerned with the presentation of the same message repeatedly. the importance of repetition and message coordination in advertising highlight the major distinction between viewing advertising as a solitary standalone stimulus versus seeing it as an ongoing campaign. to make advertising effective and more relevant, it would be necessary to consider multiple exposures over an extended time period and from various sources (rodgers & thorson, 2012). in fact, the marketers‟ challenge is to make advertisements relevant to as many people as possible. the persuasive press inference suggests that public opinion would be influenced by the media content. news articles had a significant effect on participants' judgments of public opinion (gunther, 1998). so communication content may be viewed as an end product, the content useful to be investigated would be words or images from online sources or traditional ones (i.e. newspaper, as the case object of study) (riffe, lacy & fico, 2005). laad & lenz (2009) during their study suggest an interesting view on influence and persuasion that newspaper would have on people opinion. the case bases on using panel data on prominent british newspapers before the 1997 united kingdom general election. they studied the persuasive power of the news media. by comparing readers of newspapers and not readers of these ones, they estimated that several papers would be able to persuade a considerable share of their readers to vote for labour. on that empirical base, at methodological level, the authors decides to conduct a content analysis on news titles influence, focused on bitcoin and blockchain themes, that would be reciprocally interconnected. v. btc-bc scarcity and persuasion in marketing studies and campaigns, “scarcity” is used to influence customers‟ behaviours. campaigns and messages based on limited quantities indicate that scarce availability generally has a positive effect on product evaluation. that would be due to the customers perception on superior value (lee & mukherjee, 2011) scarcity would have a more profound effect on a person‟s behavior when it is created a direct competition among customers. when customers compete each other, the seller would reach benefits from that competition. marketers often create competition and urgency sense in buying habits, in addition to perceived scarcity through limited term and quantity strategies. aggarwal, jun & huh (2011) suggest that in the case of limited term strategies buyer do not compete. their advantage deriving from promotional offers starts by meeting the deadline set by the seller. by contrast, limited quantity strategies would restrict the set of units. each purchase decreases the number of available units of the others. that would create a sense of uncertainty. the uncertainty would make a sentiment of “special buyer”. this perception would amplify the value of the product indirectly due to the limited number of items available. the motivating effect (deci, 1971; ryan & deci, 2000) would go beyond its monetary value (schindler 1989). in bitcoin and blockchain application the sense of uniqueness would be replaced respectively by the perception to be “a smart investor” and “a smart user or early applicant”. the interesting aspect refers to the finished stock of 21 million units of “virtual coin”. the majority of bitcoin production took place in the first two years. in 2024, about 94% of the total stock will be on market. from 2024 to 2140 the overall offer will be finally completed (capoti et al., 2015). paradoxically, the “bitcoin rush” becomes faster both on the supply side and on the demand one thanks to the system based on a finite stock, able to function due to a “labor market” based on inversely proportional incentives for the “miners” (rainero et al., 2019). the sense of scarcity, that characterizes bitcoin (capoti et al., 2015), and exclusivity around a new controversial ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 technology, added to a pervasive media ferment, would have been able to create the peak of interest, on one hand in investments, and on the other one on the possible tool application in different fields. as reported in the findings part, according to the field analysis, the frequency related to the value perception of bitcoin would appear highly focused on “profit opportunity”. perceived value and profit opportunity would be interconnected with scarcity concept. marketers often use scarcity appeals in advertising and promotion. products would be different as vehicles, coins, pens etc. produced in limited quantities and promoted as rare, scarce, difficult to obtain and less available. the pervasiveness of this scarcity would make the behavioural impact on decision-making, affecting customers‟ perception and their evaluations and judgements: the so called “scarcity effect” (lynn & bogert, 1996). that would be the core topic of the study. the scarcity would be, on one hand, an intrinsic character of bitcoin and blockchain related to few applications nowadays existing in several fields (i.e. blockchain application for food & beverage sector by the first multinational in europe) not necessarily to be validated, by contrast, persuasiveness would be considered through news titles quantity among the years about the themes. o'keefe (2002) suggests that printed texts would be visual objects (i.e. new titles) (even if not accompanied by pictures) that would have a little systematic persuasion. the authors purpose a sentiment analysis based on news titles influence and a field analysis on people perceptions to validate assumptions. considering the qualitative connotation of the analysis, the heterogeneity of the observation and possible subjections to perceptive variability, the authors try to follow a categorization approach based on titles coding about arguments and related behavioural influence that words used in news titles appeared on web between 2015 and 2019 could have created a kind of positive persuasion on decision-making. the concept of message frames and framing effect, continue to permeate research methodology in social sciences. on that consideration, it would have been possible to shape a sentiment analysis as a task able to identify positive and negative opinions, emotions, perceptions, influences and evaluations. the majority of works structured on sentiment analysis has been conducted at the document level. a typical approach to sentiment analysis would start through a lexicon of positive and negative words and phrases. under these conditions words would be considered with an ex ante prior polarity, totally decontextualized (wilson, wiebe & hoffman, 2005). the analysis conducted by the authors would base a starting point on the words that evoke something positive or negative and not congruent, implementing a second phase including double influence and neutral. the news titles not congruent and with double and neutral influence have been eliminated because, for the former, the news titles lack of reference about btc-bc, that would be present in the content not considered in the type sample, equally indexed by the website btcworldnews.com; the latters (double and neutral) have been eliminated because of their dubious influence. that has been possible thanks to the words interpreted through the context and sensitive approach of meanings. problems on salience and multiplicity of news from different sources can occur in sentiment analysis. to face these problems, it has been conducted the research and subsequent analysis human sensitivity-based on news titles (from january 2015 to january 2019) extracted by the web site btcworldnews.com. on one hand, the web site used as instrumental tool for the study, has been treated as a filter hub in collecting the major notices about bitcoin, and consequently its relation with blockchain from different sources. at methodological level the authors uses framing approach (entman, 1993) through news titles. in this sense, news titles would appear as a framed selection of contents, synthetized and powerful in their impact on human perceptions and subsequent influence on decision-making. as attested by entman (1993) framing essentially involves selection and salience. in this sense, to frame would mean to select some aspects of a perceived reality making them more salient in textual communication. in fact, framing activity highlights some parts of information about an object that would be the subject of a communicative approach. according to what mentioned, the framing activity would elevate salience of information. an increase in salience would enhance the probability that receivers will perceive the information discerning meaning, processing it and storing it in memory for further decisions. in the authors‟ approach, news titles assumes that role enhanced by filters adopted in the searching engine provided by the web site investigated as crucial hub. vi. sentiment and field analysis findings some researchers observe that the area of sentiment analysis and opinion mining have recently enjoyed by academics (pang & lee, 2008). if on one hand sentiment analysis considers the emotions through the words expressed by customers, affecting decision-making about companies‟ marketing strategies, the same analysis could be conducted on the sentences, phrases, metaphors, used to influence behaviours, emotions and decision-making in customers‟ habits, as an interrelated connection. thanks to a parallelism, btc-bc, could be investigated through the influence effect operated by news and text influence (o‟ keefe, 2002). as stated by bryant & zillman (2002) the news media would be not the only source of information or orientation to issues of public concern. mcquail (1979) affirms that the mass ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 media would be highly diverse in content and in forms of organization and include a very wide range of activities which could have effects on society. the authors, focus the attention on news titles, provided by online sources, because of the actual routinely behaviours in information seeking on the web. meho and haas (2003) suggests that the 88% of respondents to their research uses to seek information on electronic resources. before explication of data, a distinction would occur between effects and effectiveness. mcquail (1979), separates the former referring it to the consequences of mass media operation, the latter to the capacity in achieving certain objectives, attracting large audiences or influencing opinions and behaviours. that consideration would enhance authors‟ focused observational channel. the media ferment about btcbc in the last two years (n.3.122 in total of which with positive influence 1.615 from 2017 to 2018), probably creates kind of mass media influence (bandura, 1965; giles & shaw, 2009; bryant & zillman, 2002; mcquarrie & phillips, 2005; mcquail, 1979), like implicit persuasion-based marketing strategy on human behaviours related to an innovation tool. usage of metaphors, may be advantageous because they would be able to render the customer more receptive to multiple and distinct positive inference about the tool object of advertisement (mcquarrie & phillips, 2005). in the same way, to write an article and individuate a title for it, would be able to reproduce a marketing strategy, rendering receptive the reader (ricketson, 2004) and subsequently influencing its perceptions. the authors analyze the probable humans‟ behavioural influence due to news titles about btc-bc through humans‟ perceptions accuracy. reproducing tversky and kahneman (1981) purposal based on negative and positive messages framing their impact on decision-making behaviour. the authors, filtering the referring period and the subject (bitcoin-blockchain), extracts n. 5.138 news titles through the analysis conducted. the method provided favors a textual interpretation, using the reader capabilities in discerning the possible influence. through that approach, it has been possible to code each title relating it to a specific topic (tab. ii) and types of influence provided related to the number of news have been graphically reported (tab. ii, iii, iv, v). the results of the amount complexity of news title analyzed and influence provided have been reported in graph.i (news quantity trend 2015-2018) and graph. ii (news positive influence trend 2015-2018). table ii. news titles analysis: influence and argument code influence argument code positive news titles explaining how bitcoin-blockchain works news titles attesting to the use of bitcoin-blockchain at institutional level and / or in large private companies news titles that proves motivated interest in bitcoinblockchain at institutional level and / or of large private companies news titles about opening websites / stores / banks etc. that accept / exchange bitcoin and/or use blockchain news titles on future perspectives and applications for bitcoin-blockchain usage news titles about bitcoin-blockchain process improvements news titles about increasing price/ value / interest on bitcoin-blockchain negative news titles about arrests and scams on bitcoinblockchain news titles of closing sites / stores / banks etc. that accept / exchange bitcoin and/or deny blockchain application news titles about hacking to blockchain systems and bitcoin wallets news titles on bitcoin tax regulation news titles on issues and warnings related to bitcoinblockchain news titles about excessive consumption for mining activities on bitcoin-blockchain skeptical news titles about bitcoin-blockchain neutral news titles containing neutral influence effect double news titles containing double influence effect as: “bitcoin is worth more than ever, but it is losing strength”; “bitcoin: the future of money or just hype” source: our elaboration table iii. news titles analysis influence percentage (2017-2018) influence positive negative not congruent neutral double total 1615 717 211 496 83 3122 51,73% 22,97% 6,76% 15,89% 2,66% 100% source: our elaboration table iv. news titles analysis influence percentage (2016-2017) influence positive negative not congruent neutral double total 1159 295 3 7 12 1476 78,52% 19,99% 0,20% 0,47% 0,81% 100% source: our elaboration table v. news titles analysis influence percentage (2015-2016) influence positive negative not congruent neutral double total 440 96 0 1 3 540 81,48% 17,78% 0,00% 0,19% 0,56% 100% source: our elaboration graph.i news quantity trend (2015-2018) ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 source: our elaboration graph.ii news positive influence trend (2015-2018) source: our elaboration the highest amount of news has been observed in the last period (2017-2018 coinciding with the highest price peak of bitcoin). on the field analysis side, the sample has been involved to answer questions about their perceived influence after reading eight different news titles blocks about btc-bc themes. the sample has been called to answer and grading the perceived influence on a pentenary likert scale. the investigation has been interesting to frame people perceptions and influence on btc-bc, but also at methodological level the field analysis conducted on the sample in relation to news title influence (graph.iii), has been useful to shape the referring paradigm to categorize the kind of influence pushed (tab.ii). the results have been reported in the following graph.iii. to facilitate reading, the authors‟ aggregates answers grades reporting scarce, not much and indifferent influence through the scale from 1 to 3 and 4-5 representing higher level of influence (perceived). graph.iii news titles influence on the sample source: our elaboration the table vi reports the news titles purposed for the field analysis to the sample. table vi. news titles purposed t1. blockchain revolution: how new technology will change our lives t2. blockchain: 5 companies test the new technology t3. the economist who predicted the 2008 crisis: "bitcoin the biggest bubble in history" t4. central bank of south africa starts bitcoin regulatory experiments starbucks now accepts bitcoin t5. professor of economics: "bitcoin will make many millionaires" t6. bitcoin: bubble or earning opportunities? t7. bitcoin is a good cover against the system and could be the new gold bitcoin is expected to increase by 165% thanks to d. trump t8. bitcoin mining is a family business for both father and son a high school student becomes a millionaire thanks to bitcoin source: our elaboration t1. the answers to the title 1 purposed shows the 85,07% of influence. that kind of result would be probably due to the direct effect that words used would have on people lives (direct interest). t2. shows 76,12% of influence, probably due to the interest related to the few starting application of blockchain technology (perceived scarcity) and future interest about the tool. t3. and t5. have been selected because of their source dependence characteristics. the authoritativeness of the source (professor of economics for both t3.-t5.) and the conflicting content about btc: t3.bubble (negative influence) and t5. profit opportunity (positive influence), reach about the same percentage of perceived influence, respectively 79,10% and 62,69%. the latter probably mitigated by the scarce risk propensity of the sample involved. t4. appears scarcely influence-based (41,79%) probably due to the source dependence of the news title purposed that on one hand, widely recognized at institutional level, but perceived in a distant way from the place of the investigation (italy). ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 t6. would represent a doubt, a kind of double influence, that in this case shows a positive influence (77,61%), but ignored by the sentiment analysis to avoid confusion. t7. shows 56,72% of positive influence. this level could have been affected by the political connotation of the news titles content (a political subject added to two positive influences about btc). t8. the news titles purposed could create the base for a positive influence on decision-making due to the frame of family business for father and son, that shapes a kind of simple activity perception added to the possibility to be millionaire thanks to btc as a high school student. in fact, the results related to perceived influence appears 52,24%. the data would be probably mitigated by the lower risk propensity of the sample involved. the field analysis has been conducted to extract additional data and information about behavioral influence of words, specifically to validate the assumptions related to influence due to persuasion, higher level of perceived value and scarcity that characterizes btc-bc phenomenon. the table vii reports data about frequency of expressed perception by the sample. the 61,19% of the sample affirms (at perceptive level) that btc would be profit opportunity. perceived value and profit opportunity would be strictly connected with the scarcity concept in investment system and commodities (i.e. gold). on the other hand, the medium-scarce knowledge of the sample about the theme, would explain the polarization on the “profit opportunity” (tab.vii). that, would implicate the higher perceived value due to scarcity and competition to acquire a certain quantity of the btc good, ignoring the scarcity perception that would intrinsically characterize bitcoin (“good for collectors” and “scarce good” by origin), unconsciously related to “profit opportunity” and associated to “future money”, probably because of external influence. table vii. btc perception answers frequency (%) good for collectors 4 5,97% scarce good 6 8,96% profit opportunity 41 61,19% future money 23 34,33% scam 10 14,93% source: our elaboration vii. critical interpretation of findings according to the research approach, it would be possible to affirm the existence of different points of view, intersecting different fields of study, epistemiologies and perspectives that contribute to build a wide range of interpretative paradigms around the referring frame in which would be possible to operate and to research taking in place relationships, interconnections and reciprocal influences. in the authors‟ view and under the lights of the data, the perceived value of bitcoin-blockchain phenomenon, could be interpreted as a kind of marketing strategy. the people interest would have enhanced thanks to unconscious (implicit) persuasive and massive campaign of news ferment, as well as price level (in the case of bitcoin), and further application of its underlying technology (in the case of blockchain). that implicit strategy has been probably able to modify people decision-making through perceived value about btc-bc. the news amount would appear greater in quantity among the period referred to the bitcoin price breakthrough (2017 2018). the number of news (attesting persuasion) would reveal the interest on the themes, according to the assumption of bitcoin and blockchain as an implicit marketing strategy, the pillar of persuasiveness would be validated by the multiplicity and repetitiveness of the news messages in the referring period. on the other hand, an interesting point of view has been reported in graph.ii. the positive influence of the news titles would tend to decrease in the last period observed (2017-2018). that would be probably due to the more consciousness, awareness and the increased criticism and skepticism about controversial themes (bitcoin – blockchain) that acquire more social interest starting from november 2015 and may 2017 (rainero & modarelli, 2019). viii. limits and future perspectives on one hand, the limit of research could be underlined about the difficulty to map the whole news scenario on bitcoinblockchain. the authors refers only to a specific notices hub, that could operate a gatekeeping selection. on the other hand, the accuracy of human perception could be mined by subjectivity around the analysis and the difficulty (also adopting a coding scheme and criteria to frame the arguments) that would be present in categorizing influence. in fact, the analysis could not precisely define and shape the influence on certain persons. guilford (1959) assumed that personality would be a unique set of traits. in psychology, researchers suggest that traits influence behavior and perceptions (endler & magnusson, 1976; menkhoff, schmidt & brozynski, 2006; bargh & pietromonaco, 1982). in this sense, news titles attesting fraud thanks related to bitcoin-blockchain would create a positive influence on criminal traits and negative on the others. in the same way, news about tax regulation could be appreciated or not, depending on people traits. these cases have been reconducted to negative perspectives on that base: (1) for the first case, assuming that fraud would create repulsion to generalized sample of people, and deviant propensity to crime would be a minority; (2) for the second case, the tax regulation could have a negative effect on perception and decision making, creating repulsion against external role imposition (oliver, 1991). ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 other perspectives able to enhance the research could enact statistical words analysis and the possibility to investigate with the same methodology a wider sample of news titles. on the other hand a content analysis, if possible, could furnish deeper study on the theme. ix. conclusions the research purposed shows the bitcoin-blockchain (btcbc) phenomenon under the lens of external influence, the media influence affecting decision-making. the authors focus the attention on two main connotations proper of marketing strategies: scarcity and persuasion. at methodological level a sentiment analysis has been conducted and in addition a field analysis would validate the theoretical assumptions. the former has been conducted on news titles influence during the period 2015-2018 thanks to the support of btcworldnews.com used as specialized filter-hub collecting the main news on the theme around the world. the field analysis conducted with questionnaires, would validate the considerations discussed in the results. the approach used to construct the sentiment analysis bases on framing activity to create a code map discerning the different perceived influence through human sensitivity (positive, negative, not congruent, neutral, double). the research intersects different study areas from innovation, economics, psychology, behavioral analysis, marketing and decision-making. innovations require to be studied through different methods and especially through exploratory approaches, considering every single aspect of their probable wide range impacts on social life. the research provided would open a new horizon of discussion according to the interpretation of the btc-bc phenomenon as a kind of implicit marketing strategy in which scarcity perception and persuasion would be the trigger of decision-making and breakthrough of interest level about these themes around the world. attachments table viii. news titles analysis (2017-2018) source: our elaboration table ix. news titles analysis (2016-2017) source: 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(1975). effects of supply and demand on ratings of object value. journal of personality and social psychology, vol.32, 906-914. web sites (https://www.merriam-webster.com/dictionary/scarcity) (https://www.merriam-webster.com/dictionary/scarce) (https://www.merriam-webster.com/dictionary/unavailable) (https://www.merriam-webster.com/dictionary/available) (https://www.merriam-webster.com/dictionary/persuasion) (https://www.merriam-webster.com/dictionary/persuading) about:blank about:blank about:blank about:blank about:blank about:blank http://www.ojs.unito.it/index.php/ejif issn 2421-2172 12 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4913 1 covid-19 and islamic banking services: digitalization as a post-crisis solution (case of morocco) 1 interdisciplinary center for research in performance and competitiveness, faculty of legal, economic and social sciences souissi, mohamed v university, rabat, morocco, oumniya.amrani@gmail.com 2 interdisciplinary center for research in performance and competitiveness, faculty of legal, economic and social sciences souissi, mohamed v university, rabat, morocco, a.najab@um5s.net.ma abstract—movement restrictions and the resulting social distancing, as measures to flatten the curve of the spread of coronavirus disease 2019 (covid-19), highlighted 'electronic business models' (e-bm) as well as the importance of digital transformation of banking services. this article aims to empirically explore the new business opportunities offered by the digitalization of islamic banking services as a solution to revitalize post-covid-19 activity and overcome the difficulties of the period. the article presents the results of an opinion survey conducted among moroccan citizens to collect and analyze their perceptions and expectations about the digital transformation of participatory banking services. this is the first exploratory study in morocco focused on customer’s expectations regarding the digitalization of participatory banking services. the results of the survey highlighted a significant interest from customers and prospects for digital transformation of the services offered by the actors of this new banking industry, in particular through mobile banking application. however, there is still a part that prefers traditional on-site banking services .furthermore, digital transformation also presents some risks such as cyber security and issues of non-compliance with banking regulations relating to opening a bank account remotely. to manage these risks and reshape their bm, it is recommended that participatory banking institutions set up an integrated digital strategy, improve their internal processes and equip themselves with a robust, interactive and locked information system. keywords: covid-19, electronic business model, digital transformation, participatory banking services, expectations of moroccan citizens, opinion survey. i. introduction coronavirus disease 2019 (covid-19) is a global health crisis that threatens both human health and the economy of countries.around the world, this pandemic is costing many lives, affecting livelihoods and threatening recent progress towards the development goals the world has set for itself. on the other hand, according to the international monetary fund (imf), this crisis is unlike any other. according to its forecasts, the world economy is likely to experience its worst recession since the great depression of the 1930s,witha recession of 3%that is more severe than the one observed during the global financial crisis a decade ago[1]. while the global financial crisis of 2007/2008 originated in the financial ecosystem of developed economies, this terrible economic and financial shock inflicted by covid-19 pandemic impacted all sectors of the global economy with violent and consequent repercussions on the real sector. in the wake of this storm and the strong doubts surrounding its extent and its implications for the international economy, all economic actors, especially banks, find themselves forced to take up an enormous challenge to maintain the continuity of their activities and to minimize the economic and financial impact of the crisis on their results. according to the islamic financial sharia board (ifsb), islamic banks are not immune from the obvious and expected consequences of this pandemic given their exposure to the real economy, which could have implications for their resilience and performance levels[2]. thus, banking institutions must provide concrete responses to the difficulties they are currently experiencing to capture market share from a banking industry that has been doubly devastated by a sudden halt in economic activity against a backdrop of recession. in the light of the pandemic, they will have to make changes on a proportionate scale. with a global islamic banking market estimated at 2.5 billion dollars at the end of 2019, this segment of islamic finance remains embryonic in morocco [3]. officially referred to as "moroccan participatory banking institutions", the effective start of their activities took place during the second half of 2017. currently, the moroccan banking landscape has eight participatory banking institutions, including five banks and three windows. at the end of 2019, these establishments oumniya amrani 1 and amal najab 2 submitted july 2020, revised december 2020, accepted december 2020 mailto:oumniya.amrani@gmail.com ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4913 2 recorded total assets of 7.3 billion dirham against 2.6 billion dirham a year earlier. however, the total net result remains negative at -420 million dirham, mainly due to the high launching costs which consume a huge amount of their resources [3]. moreover, in these exceptional circumstances relating to covid-19, digital technology is taking an important place in the daily lives of the world citizens, especially with the increasing number of calls by various public and private institutions to give priority to remote services, to achieve the containment measure, considered in the absence of a vaccine, as the only way to control the spread of the pandemic. according to the world health organization (who), covid-19 is the first pandemic in human history in which technology and social networks are being used on a massive scale to keep people safe, productive and connected without being physically in contact [4]. the aim of this article is to explore and analyze the opportunities offered by the digital transformation of participatory banking services in morocco. it is a part of the approach to propose a solution that can help the actors of this new banking industry to boost their business and overcome the consequences caused by covid-19. to achieve this objective, the methodology adopted is double: literature review and opinion survey. first, in the form of a literature review, we will analyze, in the first part, the evolution of business model (bm) to electronic business model (e-bm),as well as the temporal circumstances related to this change. then, we will highlight the evolution of digital banking to analyze the achievements, define the areas of risk and project ourselves into the future challenges related to the switch to a digital bank. then, the second part will be devoted to providing the empirical study and the presentation of the results of the opinion survey that we conducted among moroccan citizens. the objective is to explore their perceptions regarding the eventual switch to digital participatory banking institutions. the article ends with a discussion of the contributions, challenges and limitations of the study. ii. literature review: from business model to electronic business model a. the evolution of the business model concept desmarteau and saives (2008) locate the first use of the term "business model" in a text by bellman in 1957 where it corresponded to a mathematical modeling of revenue sources in the context of a business game[5]. moreover, the earliest and most conclusive attempt to define the concept of bm dates to 1996 and is attributed to viscio and pasternack[6]. in their definition, the bm is made up of elements internal and external to the company with their expected objective in terms of performance. it is thus composed of five elements forming a value system whose overall value exceeds the sum of the parts: the core, business units, service delivery, governance and linkages. several authors have subsequently expanded this conceptual vision of the bm. according to [7], it is a structure grouping together resources, products, services, potential benefits on the one hand, and the different actors and the detailed description of their roles in the model on the other. for [8], the bm reflects a good and tacit understanding of how all components of the firm must act to produce and make profit loilier and tellier (2011), for their part, consider that bm can be assimilated to the way in which the firm creates value[9].verstraete, krémer, et jouison-laffitte (2012) conclude that the bm is an agreement, a form of collective representation or a common frame of reference of what business is[9]. thus, to accurately reflect this agreement, every bm should have at least three generic components: generating market-valued value (which is what marketers call supply), paying for that value, and sharing success with the value network, or stakeholders in the business. for these authors, the grp model (generation, remuneration and sharing) facilitates the determination of the components of a bm and allows the different stakeholders to imagine the business, to analyze it and to project themselves into it[6]. overall, the bm concept is dynamic, evolutionary and interactive with the environment in which the firm operates. it is constantly revised and challenged by market conditions, changing technologies, and the efficiency of the objectives achieved. b. the transition from business model to electronic business model with the advent of start-ups in the new information and communication technologies (nict), the expression bm has become a buzzword [6]. while the literature on bms only began to grow in the mid-1990s, a peak was reached in 2004 with 114 articles, listed in the ebsco database, where the word bm appears in the abstract [6]. this growing interest of researchers in this subject is concomitantly linked to the bursting of the bubble on technological values in 2000. since then, the literature related to this topic has evolved towards the increasing use of expressions such as "new business model", "internet business model", or "electronic business model" (e-bm). by analogy, the term "electronic business model" has emerged in the literature to describe ebusiness. a concept derived from that of bm, it is also difficult to define and can be understood in different ways [8]. many authors (table 1) have tried to define it using a heuristic approach based on dimensions they have observed on the market: ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4913 3 table i. examples of e-bm classification dimensions authors dimensions timmers (1998) -level of functional integration (from a single function to multiple functions); -degree of technological innovation and its impact on the value chain. applegate (2001) -market structure; -target market (business to business or business to customer). mahadevan (2000) -the sources of differentiation (online sales, products offered and level of personalization, etc.); -sources of income; -the costs incurred. novak and hoffman (2001) -income models; -value models to customers. source :arlotto, sahut, and teulon, 2011 these dimensions were followed by another step in the literature of describing the elements of bm rather than listing its components or identifying different models of value. in particular, for weill and woerner (2013), e-business dimensions consist of content, experience and platform [10] :  content (what is consumed?): product information, price and use details, etc.; digital products, such as ebooks, e-saver accounts, movies, software.  experience (how is it packaged?): experience can include customer-facing digitized business processes, community and customer input, expertise for informed decision making, recommendations, tools and interface.  platform (how is it delivered?): other business processes, customer data, technology; proprietary hardware, public networks, partners. customer experience is therefore a fundamental part of bm’sevolution [11]. the platform generally deployed as a digital artifact makes it possible to study user behavior. in this context, it is necessary to rethink the business model of the organization to adapt to new digital uses of customers and employees[12]. companies are therefore invited to rethink their processes and how they interact with their stakeholders. moreover, the digitalization speeds up decision-making as well than information overload. the client "experience block" is subdivided into three sub-blocks. the first block is understanding the customer thanks to an authorized proximity through social media and feedback from the big data [13]. these data allow to better know the customer, his environment, its location, the segment to which it belongs and its satisfaction level regarding the company services or products. then, comes the potential block of growth. it is developed through digital tools such as tablets that allow signatures of official acts and then store the document in the corporate cloud. the customer accesses easily and at will to this digital document in its private and secure space. the tools crm 1 type facilitate the centralization of information customers and serve as a 1 customer relationship management. privileged internal and external communication channel while ensuring the traceability of requests [14]. finally, the third block announced by davenport et al. (2012) concerns interoperability with social networks. they initiate a connection of internal company data and external customer data [15]. moreover, the commercial development of the internet has accelerated the creation of new bms and redefined existing ones[16]. this is because the internet affects all activities in the value chain, both core and non-core, and has spawned new ways of doing business known as "electronic business"[17].the internet can reduce the time it takes to transmit orders by automating both customer and supplier relations, thus enabling true integrated management [7]. since the 2000s, the global economic landscape is undergoing an upheaval linked to the perpetual evolution of digital technology [18]. as a result, the global economy has been totally transformed with the disappearance of many industries and the emergence of new digital-oriented businesses such as e-commerce [19]. c. evolution of digital banking the digital transformation of any institution, including financial ones, is driven by new trends in the digital world. all these changes are likely to upset the old model of banks as we know it, to give birth to a new style of connected digital banks [20]. in addition to the large-scale expansion of the internet and technological advances, we are also witnessing the democratization of computers and smartphone, which are increasingly powerful, compact and feature-rich [21]. the digital boom is having a significant impact on many industries and is accompanied by a change in consumer behavior. the latest statistics published by the international telecommunication union (itu) confirm that internet use continues to grow worldwide, with 4.1 billion internet users at the end of 2019, or 53.6% of the world's population[22]. similarly, almost the entire world population (97%) lives within range of a mobile cellular signal[22]. as a result, users with access to the internet are using more mobility in their daily lives, particularly to carry out traditional banking transactions or to adopt the digital services of digital banks, fintech and neo-banks. furthermore, lavayssière (2015) considers that, in the banking environment, the traditional bm which initially evolved in relatively stable environments have been forced to be reinvented [23]. in fact, the disruption in traditional banking first occurred in the payment sector with the appearance of fintechs 2 . they were the first stunt against the traditional banking industry by imposing change on all its businesses. they invest every segment of the banking and financial services markets and modify its structure through the entrance of technological start-ups [24].with flexible structures and low costs, the fintechs are, therefore, developing at high speed and 2 startups applying new technologies from the digital revolution to the banking sector. ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4913 4 are concentrating on niche markets where banks do not offer services or perform poorly. digicash, paypal and kickstarter are examples of successful fintechs with online banking[25]. in china, for example, the market share of the giants of retail payments technology exceeded 50% in 2017 compared to only 2% in 2012. on the other hand, with the mobile as an ally, the neobanks3 disrupted the system with innovative, fast and secure digital solutions [26]. in 2018, according to [27], the size of the global digital banking market reached usd 5,180 million and is expected to reach usd 16,200 million by the end of 2025, as shown in fig. 1. figure 1. global digital banking market size, status and forecast (20182025) source: digital banking market research report 2019 the digital revolution in banking is underway, disrupting the relevance of traditional banking services. it is creating better, faster and cheaper banking services that make life easier for customer[21]. according to deloitte digital banking benchmark, approximately 3 billion users worldwide will have access to retail banking via smartphone, tablets, pcs and smart watches by 2021[28]. having initially ignored the impact of digitalization on their business, banks are increasingly being forced to embrace the demands of digitalization and accelerate their digital transformation process to retain and grow their customer base. digital banking involves the digitalization of traditional banking services such as current accounts, credit cards, lending, wealth management, etc. by using online channels to supply them to customers [29]. while the traditional brick-andmortar, in-branch banking still exists today, the move to digital has been momentous. both old-school traditional banks and modern, tech-driven new entrants have been transforming basic banking products and services so that they fit within the new digital age, making them more accessible, easier to understand and quicker to manage. now, the smooth functioning of digital banking services is no longer a choice but a necessity for survival. 3 100% digital banking institution iii. islamic banks and digitalization challenges due to the emergence of fintechs and the new consumer lifestyle, traditional banks (islamic and conventional) should opt for digital transformation to remain competitive. a. islamic banks intermediation model the intermediation model of islamic banks is presented as a financial innovation that integrates ethics and social dimension into contemporary banking practices[30]. islamic financing mechanisms have different forms from the conventional financial institutions and must be sharia compliant. there are two alternative mechanisms of financing namely equity financing (mainly mudaraba and musharaka) and debt financing (mainly murabaha, ijara and istisnaa)[31]. furthermore, the customer relationship is of great importance in the bm of islamic banks. reference [32]summarized the relationship between islamic banks and their depositors in three main categories:  a debt relationship in which the bank guarantees the principal amount of the deposits;  an agent-principal relationship in which the bank shares profits and losses with its depositors, who in this case are partners and not creditors;  and when the bank provides administrative services and information, the relationship is called an administrative services relationship. the difference between islamic banks and conventional banks can lead to differences in financial intermediation. in fact, it does not boil down to simple loan-borrower relationships, but it develops a dual agency relationship between the bank and the depositor on the one hand and the bank and the entrepreneur on the other hand[29].however, the intermediation of islamic banks, although special, faces many challenges. the organizational structure of most islamic banks is not conducive to participatory intermediation, which is more affected by their small size [33]. property rights systems are poorly defined and insufficiently protected in muslim countries, making it impossible to share profits and losses themselves [34]. so far, islamic commercial banks have limited themselves to a virtual replication of the conventional bankingbm and based on a banking intermediation structured around the use of customer deposits [18]. however, at a time when technology is changing the way customers interact with their banks, islamic banks now face competition not only from conventional banks but also from the emergence of non-conventional bms based on fintech. with the advent of new technologies and the democratization of the internet, we see a growing gap in banking distribution. as consumer behavior has also evolved, customers are more sophisticated, more demanding and less loyal as they become very solicited and courted. customers want more speed in processing their requests and they are also increasingly informed. ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4913 5 thus, rethinking their bm through the implementation of new tools, processes and strategies focused on digital is fundamental for the development of the customer portfolio of islamic banks. while this will help islamic banking to respond to the changing economic structure and customer expectations, it will also have a positive impact on financial inclusion and improve value-based intermediation. islamic banks are now called upon to offer innovative products and services in a way that takes advantage of technological progress and promotes financial inclusion without compromising the fundamental sharia premise on which islamic banking is built or violating its essential elements of fair value-based intermediation. b. digitalization challenges the banking world has begun the shift to digitalization to get to know the customers better, to support them in a new paradigm and anticipates their needs. it is the bm itself that is changing, moving from what is usually presented as a vertical organization (around products) to a horizontal organization (around customers). the digitalization of a bank does not stop with the creation of a website for remote banking (e-banking) or the development of a mobile application (m-banking) that can be downloaded to its customers' smartphone. it is the entire organization that needs to be reviewed so that data can play its full role, that there is hyper automation of operations, management through analytics and optimal service to the customer. the consultancy firm trusted advisors, which has been closely following the digital evolution of the banking sector in africa and the middle east for several years, conducted an indepth study in 2019 of certain banks in this geographical area that have begun the process of digital transformation. for a bank to succeed in its digital transformation on a solid and sustainable basis and take full advantage of the benefits of digitalization, the study identified several levers for success that we summarize in the following points [35]:  digital strategic vision transcribed into an in-depth transformation plan and implementation trajectory;  dematerialization of internal processes: towards an acceleration and optimization of internal exchange flows (with an it/business/network synergy to be created and maintained) and flows between the bank and its customers or partners;  reinforcement of customer relationship management: towards an improved time to market for the greatest satisfaction, thanks to the integration of new analytical tools;  building a competitive advantage: leveraging an institution providing financial services (mass retail, fintech, etc.), creating an attractive appealing product (such as a savings account with a high interest rate) or an innovative service are the main ways to build a competitive advantage;  a sustainable federation of an internal innovation ecosystem based on the digital acculturation of employees and enabling the continuous development of new digital banking services and products. nevertheless, the digital transformation presents risks for the bank, such as cyber-attacks, malware, hacking and spoofing attacks. according to the general council of islamic banks and financial institutions (cibafi), technological risks are the biggest risks faced by islamic banks in 2019 with a score of 3.56 for cyber-attacks, a worsening compared to that recorded in 2018 (3.41)[36]. this upward trend in technology risk scores is plausible given the growth of e-banking and related threats. it is therefore crucial that as banks strive to expand their customer base and offer new financial products and services, they put in place the tools to control cyber security risk and enhance the security of customers' personal data. addressing customer needs in an increasingly digital world means disrupting existing business models for a fresh customer experience. therefore, any investment in this area has to be made wisely. iv. empiracal study :digitalization perspectives of moroccan participatory banking institutions a. inventory of the developpement of digitalization of banking services in morocco in recent years, especially after morocco’s ministry of industry, investment, trade, and digital economy created the agency for digital development (add) in 2017, the digitalization sector has boomed. governmental institutions and several major companies launched a digital transformation process to meet their customers’ needs. moroccan financial institutions were the first to become aware of digital transformation’s role in cutting costs, improving customer experience, and competing with global companies. in fact, information technologies and digital innovations have enabled players in the banking sector to conquer new market shares. however, moroccan banks have not yet succeeded in establishing and maintaining a regular relationship with their customers through digital channels. drating has evaluated the features of 10 major moroccan retail banks websites and mobile applications[37]. two main elements of the digital client relationships are the web and mobile applications. the web category covers 81 indicators, including functionalities and features available on the public websites, the web traffic and other technical parameters over website performance. while the mobile application category includes 26 scores, related to the client satisfaction on mobile application stores, usage and engagement metrics and technical properties. according to the results of the study , the top 3 scores on these two categories are displayed in the charts (fig.2). ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4913 6 figure 2. scores of digital performance of moroccan banks : client experiene on digital channels source: numerization of moroccan banks, may 2018 (d-rating). cih bank appears on the top 3 web and mobile application and positions itself as the moroccan bank with the highest level of use of digital channels in its relationship with prospects and clients. the effort made on its digital transformation clearly reflects on its fully-digitalized acquisition process and its multidisciplinary program in open innovation « cih open innovation ». regarding the mobile application, there is a strong performance contrast between the different banks regarding the mobile application channel. some banks’ mobile application like al barik bank and attijariwafa bank have managed to satisfy their clients and obtained a good score. while other banks from the panel still struggle with very low satisfaction levels. on the other hand, the same gap sits still for social media channels. some banks have not even reached this opportunity yet (such as crédit agricole du maroc), even though they are a very valuable source of information to obtain customers feedback, whereas other banks are extremely active. cfg bank and cih generate interactions and engagement on facebook, at the same level as the best european banks present in the area. the results show that these outperforming banks have succeeded to take advantage of the full potential of social networks and more particularly of facebook (which has a penetration rate of 63% in morocco and an average 71% in europe) and turn this popular media into to a real client acquisition machine [37]. though, the current environment is undoubtedly challenging for banks. the behavioral and economic effect of the coronavirus crisis is profound, and come on top of lingering financial, operational and consumer pressures. but, with the right strategy, banks have a unique opportunity to succeed in the long term. pursuing advanced technology and digital ecosystems will be key to that success. with these elements in place, banks will cut costs and drive efficiencies, helping them weather the coming storm and redefine their value to customers in a shifting market. b. research methodology and hypotheses this study aims to focus, for the first time in morocco, on the potential of the digital transformation of participatory banking services. therefore, to collect the perceptions of moroccan customers regarding the switch to a digital participatory banking services, we conducted an opinion survey. to carry out the research and provide the most solid answers possible, we have chosen to put forward hypotheses that are broad enough to mark out the subject of the study in an exhaustive manner, but which remain very precise, and above all, all oriented towards post-covid-19 banking digitalization. the research hypotheses retained are as follow: 1) digital banking is of much more interest to the young people; 2) digital banking is indispensable in times of crisis as well as in normal times; 3) the digitalization of participatory banking services is a great opportunity and a competitive advantage over conventional banks; 4) digitalization will enable participatory banks/windows to improve their customer relationships and increase their post-covid-19 market share; 5) digitalization of participatorybanking services should be integral. along with that of the previous similar studies in this area (e.g. [38] and [39]), the survey is made up of two parts: general questions and specific questions relating to the digitalization of participatory banking services in morocco. the data was collected via an adapted questionnaire using social networks (facebook and whatsapp groups) and emails. the choice of these two channels was dictated by the confinement circumstances imposed by the moroccan government as part of the health emergency linked to covid-19. c. survey results the target sample size was 500 respondents. the details about the respondents are presented as follow (table 2): table ii. survey respondennts criteria criteria dominants percentage gender women 52% age range -between 18 and 30 years old -more than 40 years 59% 23% socioprofessional category -students -employees and civil servants 47% 40% banking -clients of conventional banks -clients of participatory banks or windows 80% 20% source: constructed by the authors based on survey results ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4913 7 more than half (59%) of survey respondents are young, with an average age of 24 years. likewise, survey results show that 81% of respondents prefer remote banking through website (29%) and mobile banking application (52%). furthermore, during the confinement and curfew period, 75% of the respondents to the survey used remote banking services. a large proportion (86%) confirmed that digital banking services are useful in times of crisis as well as in normal times. in addition, more than 80% of respondents are not clients of a participatory bank or window, however 61% (fig. 3) of them believe that digital technology will improve their relationship with this new industry. they also believe that the digitalization of most of the services offered by the participatory banks and windows will constitute a competitive advantage over traditional banks. figure 3. digital transformation and moroccans interest in paraticipative banking institutions source: constructed by the authors based on survey results it should be noted that the doubt on the conformity with sharia of the services and products offered by the participatory banks and windows, is the second main reason for the small number of customers of these institutions. the first reason is the problem of proximity of branches to customers. moreover, even among the clients of these institutions, 30% of them confirm that the branches where they have opened a bank account are far from their home and work. as for the current remote banking services offered by some participatory banks and windows, 43% of respondents (fig.4),having a bank account both in a participatory and conventional bank, confirm that remote banking services (ebanking and m-banking) of these institutions are poorly developed compared to those offered by conventional banks. figure 4. developpement degree of remote bankig services of participatory banks and windows source : constructed by the authors based on survey results on the other hand, to enlighten the actors of the participatory banking sector in morocco on the most important criteria to consider when setting up the digitalization process of their services, we devoted part of the survey to this question. according to the results, the respondents put forward five criteria: • free services as part of digital banking, • diversification of remote banking services; • security of personal data; • speed and immediacy in the processing of requests and operations; • control of technical breakdowns; furthermore, most respondents (79%) believe that digital transformation of participatory banking services should only be partial and not integral, given that there would still be a part of the population that prefers on-site banking. thus, the table 3 summarizes the results of the confrontation of the initial hypotheses with the empirical study. table iii. the researchhyotheses confronted with survey findings hypotheses findings digital banking is of much more interest to the young people; confirmed digital banking is indispensable in times of crisis as well as in normal times; confirmed the digitalization of participatory banking services is a great opportunity and a competitive advantage over conventional banks; confirmed digitalization will enable participatory banks/windows to improve their customer relationships and increase their post-covid-19 market share; confirmed the digitalization of participatory banks/windows should be integral. not confirmed source: constructed by the authors based on survey results d. results discussion : inputs, implications and limitations ofresearch the results of our study have indeed confirmed that the digitalization of the services offered by participatory banking institutions is one of the best solutions for these institutions to increase their market share and become more competitive in the moroccan banking market. the digital transformation will allow participatory banks and windows to rethink and reshape their bm by implementing new tools, processes and strategies. 3% 43% 37% 17% not developped little developped developped very developped 61%19% 20% more interested less interested still not interested ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4913 8 given that young people are the category most interested in digital banking, these institutions must take this criterion into consideration while redefining their bm and develop remote banking services adapted to the needs of this important category. survey respondents want the banking services offered by participatory banks to be free of charge. instead of that, as they were launched only two years ago and have not yet made any profits, these new institutions should improve their performance in the coming years. to overcome this double constraint, participatory banks can draw inspiration from the pricing model followed by most online banks and neo-banks. this is a model that combines free everyday services (bank cards, account maintenance fees) with specific services that are paid for on a pay-per-use basis (e.g. unauthorized overdraft) and products that are paid for by all (financing, transfers above a certain threshold). for day-to-day banking products, some are implementing a "freemium" model in which a free basic offer coexists with a "top-of-the-range" offer that provides access to certain additional services. however, there may also be conditions under which the services are free of charge, which require regular use of the account or the choice of the institution as the main bank. indeed, digital banking works to strengthen and simplify human relations and provide the best possible customer experience. however, the transformation of the customer experience is only the submerged face of the digital transformation of participatory banks/ windows, which impacts to a large extent their operational processes. the digitalization of a large part of the processes is indeed a strong growth opportunity for the participatory banks and windows, enabling it to shorten and simplify banking procedures. it is therefore a revolution both external and internal to the bank that enables innovation and the success of the digital transformation. however, this transformation also presents some challenges and risks such as cyber security risks, fraud risks and problems of non-compliance with banking regulations relating to the opening and management of bank accounts remotely. to best master and manage these eventual risks, it is recommended that participatory banking institutions implement an integrated digital strategy, improve their internal processes and equip themselves with a robust, interactive and locked information system. in april 2020, the central bank of morocco (bam) has published a circular letter (no. 1/dsb/22020) setting out the application modalities of the provisions of the circular no. 5/w/2017 and particularly its article no. 20 which stipulates the opening of remote accounts, including by electronic means[40]. thus, banks are required to implement reliable and secure technological means to ensure the equivalence of vigilance ensured by physical presence. bam also requires that control measures be put in place to ensure the protection of personal data and to mitigate the risk of fraud linked to the use of technology. participatory banks are also affected by this new circular and must procure the appropriate means to take advantage of the benefits of this new legal improvement. furthermore, digital transformation only makes sense if it is seen as a win-win between customers and the bank. according to the results of the study carried out by trusted advisors group in 2018, all moroccan banks are unanimous on the fact that the customer experience must remain at the center of concerns. likewise, at all levels questioned in that study, it is understood that the approach to evolution and digital transformation can only be effective if it is collective. therefore, this collective approach also includes the involvement of the client in the thinking process. this will ensure the anticipation of customer needs in all responsiveness and innovation. in the same sense, we conduct this current study. it is the first exploratory research of its kind in morocco that was interested in the potential of the digital transformation of participatory banking institutions which have been recently launched in the national banking sphere. the study highlighted the important interest of customers and prospects in digital transformation of the services offered by the actors of this new banking industry. thus, this study has implications for moroccan participatory banking institutions. it could serve as a benchmark to help them achieve several objectives, mainly the following: • be aware in advance of the expectations of the moroccan population regarding the digitalization of the participatory banking services; • get inspired by the results of this survey when setting up the digitalization process of their services; • rethink their bm through the implementation of new tools, processes and strategies focused on digital; • cut costs, drive efficiencies and redefine their value to customers; • build a competitive advantage by being reactive and more responsive to the needs and the requirements of their clients ; • revitalize post-covid-19 activity and overcome the difficulties of the period . however, this study has its own limitations. as with any survey, estimates must be understood within the constraints of the survey instruments, the sampling design, the main limitation lies in the small size of the sample. it could constitute a gap, in particular regarding the extrapolation of our inferences on the opinion of moroccan population about the topic of the study. though, this limit is due to the circumstances in which the study was conducted. in other words, due to movement restrictions and the resulting social distancing as measures to flatten the curve of the spread of covid-19, the only way to distribute the survey was through social media and emails. people were disturbed by the health and economic consequences of the pandemic and few of them bothered to respond to the survey. on the other hand, this study focused on customers’ expectations regarding the digitalization of participatory ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4913 9 banking services in morocco. thus, to have a global vision of the subject, it would be interesting to complete the study by surveying the decision-makers of the moroccan participatory banking institutions regarding their willingness and intentions to opt for the digitalization of their services and then to analyze their respective digital strategies. v. conclusion movement restrictions and the resulting social distancing as measures to flatten the curve of the spread of covid-19have accelerated the need for digital transformation of banking services. the analysis of the literature review related to the switch from bm to e-bm and the evolution of digital banking, shows that rethinking bm by implementing new digitalfocused tools, processes and strategies is no longer a choice but a necessity for all banks. this would not only help them overcome the challenges of the post-covid19 economic environment, but also help them to even develop their customer portfolio and improve value-added banking intermediation. the current environment is undoubtedly challenging for banks. the behavioral and economic effect of the coronavirus crisis is profound, and come on top of lingering financial, operational and consumer pressures. but, with the right strategy, banks have a unique opportunity to succeed in the long term. pursuing advanced technology and digital ecosystems will be key to that success. with these elements in place, banks will cut costs and drive efficiencies, helping them weather the coming storm and redefine their value to customers in a shifting market. as part of the search for solutions that could help moroccan participatory banking institutions to revitalize post-covid-19 activity and overcome the difficulties of the period, our article focused, for the first time in morocco, on the digital transformation of participatory banking services. to gather customers perceptions on the eventual switch to a digital participatory bank and window, we conducted a survey among the moroccan population. more than half (59%) of survey respondents are young, with an average age of 24 years. similarly, the survey results showed that 81% of respondents prefer remote banking via websites (29%) and mobile applications (52%). furthermore, a large part of the respondents (86%) confirmed that digital banking services are useful in times of crisis as well as in normal times. moreover, although more than 80% of the respondents are not clients of a participatory bank or window,61% of them believe that the digitalization will improve their relationship with this new industry thus, despite the 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[40] bam, ―de nouvelles dispositions pour les comptes à distance,‖ [online]. available: https://www.boursenews.ma/article/maroc/bam-de-nouvellesdispositions-pour-les-comptes-a-distance[accessed: 17-may-2020]. https://itu.foleon.com/itu/measuring-digital-development/internet-use/d https://itu.foleon.com/itu/measuring-digital-development/internet-use/d https://reports.valuates.com/market-reports/qyre-auto-4n473/global-digital-banking-market-size-status-and-forecast-2019-2025 https://reports.valuates.com/market-reports/qyre-auto-4n473/global-digital-banking-market-size-status-and-forecast-2019-2025 https://reports.valuates.com/market-reports/qyre-auto-4n473/global-digital-banking-market-size-status-and-forecast-2019-2025 file:///c:\users\dell\desktop\doctorat\articles%20ecrits\article%20covid-19\%0darlotto,%20jacques,%20jean-michel%20sahut,%20et%20fr�d�ric%20teulon.%202011a file:///c:\users\dell\desktop\doctorat\articles%20ecrits\article%20covid-19\%0darlotto,%20jacques,%20jean-michel%20sahut,%20et%20fr�d�ric%20teulon.%202011a https://www.moneythor.com/2020/07/30/digital-banking-101/ https://www.transformersawards.com/rapport2018 https://www.d-rating.com/post/digital-morocco-banks https://www.d-rating.com/post/digital-morocco-banks https://www.boursenews.ma/article/maroc/bam-de-nouvelles-dispositions-pour-les-comptes-a-distance https://www.boursenews.ma/article/maroc/bam-de-nouvelles-dispositions-pour-les-comptes-a-distance http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5848 1 liquidity risk management in the islamic banking: portfolio of ijara and murabaha abdellatif mabrouk 1 phd-student laboratory of analysis and modeling systems for decision support (lamsad), ensa of berrechid, university of hassan 1settat, morocco. mabroukabdellatif@yahoo.fr lamyaa farah 2 phdsenior consultant proximab group, morocco. associate researcher in laboratory of analysis and modeling systems for decision support (lamsad), ensa of berrechid, university of hassan 1settat, morocco lamyaa_farah@yahoo.fr abstractliquidity risk management in finance has always been well known as a necessity for conventional finance and islamic finance. conventional financing addresses this risk through known means. unlike islamic financing, this has few instruments suitable for shari’a to manage this risk. if this risk accelerates, the islamic bank faces significant challenges in the face of their depositors and investment projects. the objective of this study is to show that holding an optimal level of liquidity is necessary for islamic banks to minimize the liquidity risk. in this paper, we also examine the relationship between profitability and liquidity. this importance is explained by the fact that these banks cannot always count on the support of the central bank, or on the islamic money market. we refer in particular to the work of ben jedidia et al. (2013).unlike ben jedidia et al. paper, our model of financial intermediation and liquidity risk management uses two factors: murabaha and ijara. two analysis were used, the first one is static and the second one is dynamic, to determine the optimal amount to be held by an islamic bank using the optimization method. the study reveals that the factors in the first analysis are: the anticipated penalty costs, the rate of return on financing, the sharing rate between the bank and the depositors. this study also reveals in a second dynamic analysis that the factors are: the expected marginal cost of penalty, the ratio of the change in deposits to the change in funding. keywords: ijara, islamic banking, liquidity, murabaha, risk management, profitability. i. introduction the islamic or participatory finance industry depends on how their banks manage their liquidity risks. islamic banks are exposed to liquidity risk in a context of structural weaknesses in their financial system that weighs on their solvency and liquidity [2], [3], [4], [5], and [6]. a severe liquidity crisis can lead to a devastating spiral leading to the bank’s insolvency and possibly bankruptcy. the possibility of an illiquidity crisis justifies the intervention of lenders at last resort. as a source of liquidity at last resort, central banks have an increased interest in liquidity risk. the nature and extent of the risks to islamic banks may differ significantly from conventional banks [7]. in view of the interest ban, islamic banks are deprived of conventional instruments for hedging risk on the basis of interest. asset-liability management of liquidity is also difficult because of the lack of access to fixed-income instruments [8], moreover, which shows that islamic banks have fewer instruments to hedge their liquidity risks, it is the prohibition of gharar and speculation that do not allow islamic banks to manage their exposure to these risks through derivatives. in general, compliance with shari'a guidelines has placed restrictions on their management of liquidity risk. however, the nature of the relationship between the two types of banks is not the same. the submitted may 2021, revised august 2021, accepted august 2021 mailto:lamyaa_farah@yahoo.fr ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5848 2 islamic bank, like the conventional bank plays the role of intermediation [9], and draws from the liquidity of its investment operations, collecting deposits from its depositors, however, in islamic finance, contracts must first of all be in perfect conformity with islamic, religion. the intermediation model of islamic banks is presented as a financial innovation that integrates ethics and social dimension into contemporary banking practices [10]. islamic financing mechanisms have different forms from the conventional financial institutions and must be sharia compliant. there are two alternative mechanisms of financing namely equity financing (mainly mudaraba and musharaka) and debt financing (mainly murabaha, ijara and istisnaa) [11]. our study focuses on the islamic bank using two products murabaha and ijara. on the one hand, it determines the optimal level of liquidity for an islamic bank by considering the two products. on the other hand, it shows the interaction between the assets and liabilities of an islamic bank. ii. literature review bank liquidity is the ability of the bank to finance the expansion of its assets and meet its commitments on time without incurring unacceptable losses [12].in this research; we will use the murabaha contract as it is considered the main mode of financing, which represents 66% of the financing offered by islamic banks [13]. each contract has different implications for liquidity risk [3]. the predominance of funding based on real assets only increases liquidity gaps [14]. due to religious constraints, the liquidity management of islamic banks faces significant challenges [15]. diversification helps reduce this risk. as matthews, [16] assume, islamic banks can minimize the risks they face by building a diversified portfolio of holdings in a meaningful way. this reduction is similar to that when banks contribute to pooling risks by pooling risk-free financial assets, such as the mutual fund or the investment company with variable capital, which reduces unit risk per asset [17]. in fact, the majority of islamic banks operate in a world where monetary markets are underdeveloped or inexistent [18]. in addition to the problem of the virtual absence of interbank and money markets, the majority of central bank loans and facilities do not face sharia law [19]. this poses a problem of maintaining a large volume of liquidity; moreover this operation will miss investment opportunities and generate other risks such as displaced business risk. [20], [21] and [22] study the determinants of liquidity risk in islamic banks. [7], [23] and [24] emphasize that islamic banks need to improve their liquidity risk management practices to strengthen their resilience. sukuk al ijara is one of the most popular instruments for managing islamic liquidity risk in the middle east [25]. liquidity risk and credit risk are serious risks for the banca d'italia [26]. compliance with the principles of sharia law changes banking intermediation [4], [27]. in addition, islamic banks have few risk hedging instruments and techniques [27]. note also the closest studies on our subject are the following: [28], [29], [30], [31], and [32]. consequently, the issue of liquidity and its management presents challenges for participatory banks. the problem of liquidity risk management is similar to a problem of determining the optimal liquidity stock that the islamic bank must hold. a. ijara ijara is defined as a medium-term financing method by which the bank purchases machinery and equipment and transfers the usufruct thereof to the addressee for a period during which it retains title to ownership of the goods. the ijara contract is characterized by flexibility, which makes this instrument particularly useful in the case of project financing. it is possible to determine the amount of each payment not in advance but on the date on which delivery of the underlying asset is expected. the ijara technique used to finance investments in real estate or movable property is presented in the following stages: the client expresses to the islamic bank the need to acquire real estate or equipment; the bank gives the customer the opportunity to choose the material that suits them; this equipment will be purchased by the bank, and will be rented with the customer using a rental contract; the duration of the rental, the payment deadline, the amount of the rent and the periodicity must be indicated and known at the signing of the contract. the customer will not start paying the rent until the goods are received; at the end of the rental contract, the goods will be assigned to the customer, according to a transfer contract, previously signed by both parties. in ijara, it is necessary to determine by a separate act the manner in which the tenant acquires ownership of the property. the movable and immovable property acquired for use in the operations of ijara and ijara muntahia betamlik are included among the fixed assets at their acquisition ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5848 3 cost, namely the purchase price plus acquisition costs. ijara and leasing the difference between ijara and leasing is that there is no penalty for not making a monthly payment in the event of a delay. given the penalties that would arise for these reasons would be considered interest, and islamic finance refutes this process. the sharia rejects any provision in a financial contract that penalizes a debtor in good faith who is already in difficulty. ijara is very similar, in form and spirit, to a rental-sale contract. however, it is necessary to announce the differences according to this table: difference between ijara and leasing in the case of the ijara, the bank continues to be responsible for the property and the two contracts are separate. but, in the case of leasing, the risk of loss of assets is borne by the client and the contract is the same. also, for the ijara, the payments begin as soon as the lessee has taken possession of the property in question. otherwise, for the leasing, it is calculated when the lessor buys the underlying asset. moreover, in the ijara, there is no change in rental price unless malicious or negligent, and the payments stop at the end of the payment periods, it’s the bank that bears the expenses. but, in leasing, when there is a late payment of interest, the customer adds additional payments and supports the related expenses. b. murabaha murabaha[33] is a commercial transaction. it can be noted that this transaction is known most often, a deferred payment with margin. in all cases, delivery is immediate. in other words the murabaha is a contract of sale at the cost price plus a profit margin known and agreed between the buyer and the seller. murabaha assumes that the bank buys a given asset at a price known to both parties on behalf of its client. then, the bank resolves this asset to the customer for payments staggered or not over a given period, at a price agreed in advance between the two parties in excess of the purchase price. the main mode of financing is the murabaha which represents 66% of the financing offered by islamic banks [13]. this financial product, although singularly very close to a classic debt contract, is distinguished from it, nevertheless, on a few essential points. indeed: the bank has become the effective owner of the underlying asset; the transaction is actually backed by a real asset. it is therefore not a loan but a sale on credit (cash purchase and forward sale). in this transaction, the bank therefore bears the risks associated with holding the asset and this is the main justification for its margin. on the other hand, there is no explicit reference to an interest rate the creditor pays himself by means of an increase in the purchase price of the property. the amount of the profit margin does not vary over time: it is fixed beforehand and does not vary during the duration of the financing[34]. term extension, delay and default the bank must stipulate that in case of refusal of the client to receive the property at the planned time after the conclusion of the contract of murabaha, it may sell the property by representation of the client and on its behalf and recover its rights from the selling price and turn against the client, if applicable, if the price is insufficient. the islamic bank may not receive remuneration for the extension of the term or for any delay, whether or not the delay is justified. any remuneration granted to postpone the date of payment of the debt (rescheduling of the debt), whether the client is creditworthy or not, is prohibited. the amount due to the bank in the event of default by the debtor of the sums due corresponds only to the amount of the debt. the bank cannot compel the customer to pay remuneration for his benefit[35]. iii. methodology this work examines the relationship between profitability and liquidity. the bank’s objective is to maximize its profit taking into consideration the uncertainty regarding the amount of the withdrawal and the adjustment or penalty charges. this will be done using a two-factor liquidity management model that links the right balance between liquidity risk and profitability [7]. this model takes into consideration: the liquidity level of the bank. of the ijara contract and the murabaha contract); the bank bears a refinancing cost. when these factors are not rationally handled, the investment ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5848 4 deposits allocated to the financing of murabaha and ijara are the subject of the intermediation model we have chosen, which is the most common for islamic banks. holding an optimal stock of liquidity for these banks plays an important role since islamic banks cannot always rely on the support of the central bank or the islamic money market. particularly, we refer to the work of [1]. two analyses were used, one static and the second dynamic, to determine the optimal amount to be held by an islamic bank using the optimization techniques. a. the purpose of the model the main objective of our model is to determine the optimal amount of reserves an islamic bank should hold in order to guarantee unexpected withdrawals. b. the assumptions  investment deposits (d) are assumed to be homogeneous and remunerated according to the result of the bank’s assets.  the assets of the bank (f) consist of financing offered to the economy according to the techniques of murabaha and ijara.  the funding (f) does not present a risk of capital loss.  reserves (t) are cash that does not yield.  𝑟𝑝 is an exogenous variable. let us first consider an islamic bank whose balance sheet is as follows: asset liability reserves funding deposits the balance sheet equilibrium relationship is given by: d = t + f with: f = 𝐹𝑀 + 𝐹𝐼 c. definition of variables  d: investment deposits allocated to murabaha and ijara.  note 𝑟𝛼 for murabaha and 𝑟𝛽 for ijara: profit-sharing rates between the bank and depositors.  𝑟𝑚 : the yield of murabaha  𝑟𝐼: the yield of ijara.  f: financing provided to the economy of murabaha and ijara.  t: the reserves.  𝑟𝑝 is the unit cost incurred by the bank in an illiquidity situation.  𝜋 the profit  ε𝐹 the elasticity  t does not produce yield.  a single time period is assumed (t = 1). supply and demand functions for murayama the deposit offer may be worded as follows: d = d (𝑟𝛼 ) with 𝜕𝐷 𝜕𝑟𝛼 > 0 the request for funding shall take the following form: f = f (𝑟𝑚 ) with: 𝜕𝐹 𝜕𝑟𝑚 < 0 for ibarra the deposit offer may be worded as follows: d = d (𝑟𝑚 ) f= f (𝑟𝑚 ) with ∂f 𝜕𝑟𝑚 < 0 f= f (𝑟𝐼) with ∂f 𝜕𝑟𝐼 < 0 random variables that represent net deposit withdrawals are continuously distributed in the interval [0; +1[according to a density function g (x). then, two situations can be considered: if the liquidity constraint is met, the bank does not need to be refinanced and no additional costs are incurred. the bank bears the unit costs 𝑟𝑝 to deal with unforeseen drawdowns in a situation of illiquidity, then the use of supplementary funds is equal to the difference between x and t. c (t): the cost of the liquidity requirement which is equal to: 𝐶 𝑇 = 0 if𝑥 ≤ 𝑇 and 𝐶 𝑇 = 𝑟 𝑝 𝑥 − 𝑇 𝑖𝑓𝑥 ≥ 𝑇 iv. results and discussions 1. liquidity management model in a static framework let us suppose that a bank which is at arm’s length from the risk receives at the beginning of the period an amount of investment deposit equal to d. it keeps a part in a liquid form t and invests the rest using ijara and murabaha contracts. the bank’s objective is to determine the amount t that maximizes the expected profit. the bank’s profit is written: ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5848 5 𝜋 = 𝑟𝑚 𝐹𝑀 + 𝑟𝐼𝐹𝐼 − 𝑟𝛼𝑟𝑚 𝐹𝑀 − 𝑟𝛽𝑟𝐼𝐹𝐼 − 𝑟𝑝𝐸[𝑀𝑎𝑥 0, 𝑋 − 𝑇 ] noting:  𝑟 𝛾 the average sharing rate.  𝑟 the average rate of return. with 𝑟 = 𝑟𝑚 𝐹𝑀 + 𝑟𝐼𝐹𝐼 𝐹𝑀 + 𝐹𝐼 𝑟 𝛾 = 𝑟𝛼𝑟𝑚 𝐹𝑀 + 𝑟𝛽 𝑟𝐼𝐹𝐼 𝐹𝑀 + 𝐹𝐼 let’s replace the rates in the profit equation: 𝜋 = 𝑟 𝛾𝐹 − 𝑟 𝛾𝑟 𝐹 − 𝑟𝑝𝐸[𝑀𝑎𝑥 0, 𝑋 − 𝑇 ] with f = 𝐹𝑀 + 𝐹𝐼 = d – t replace f = d t which gives us: 𝜋 = 𝑟 𝛾 𝐷 − 𝑇 − 𝑟 𝛾𝑟 𝐷 − 𝑇 − 𝑟𝑝 𝑋 − 𝑇 𝑔 𝑥 𝑑(𝑥) +∞ 𝑇 the profit in case of no overshoot is described by the equation: profit without penalty 𝜋 = 𝑟𝑚 𝐹𝑀 + 𝑟𝐼𝐹𝐼 − 𝑟𝛼𝑟𝑚 𝐹𝑀 − 𝑟𝛽𝑟𝐼𝐹𝐼 the profit f from ijara and murabaha, which the bank must share with the holders of the investment deposit account at rates of 𝑟𝛼 and 𝑟β. the second part of the equation: 𝑟𝑝 e[max (0, x -t)] relates to the expected amount of the penalties. for 𝑟𝑚 ,𝑟𝐼 ,𝑟𝛼 ,𝑟𝛽 , 𝑟𝑝 given,the bank’s reserve holding curve is then defined as the amount of reserves that maximizes the bank’s profit. it is obtained after optimality conditions: 𝜕𝜋 𝜕𝑇 = 0 𝜕𝜋 𝜕𝑇 = −𝑟 𝛾 + 𝑟 𝛾𝑟 + 𝑟𝑝 1 − 𝐺 𝑇 ∗ = 0 this results in: 𝑟𝑝 [1 − 𝐺(𝑇 ∗)] = 𝑟 𝛾 − 𝑟 𝛾𝑟 = 𝑟 𝛾(1 − 𝑟 ) 𝐺 𝑇∗ = 1 − 𝑟 𝛾(1 − 𝑟 ) 𝑟𝑝 replace 𝑟 and 𝑟 𝛾 we get: 𝑟 = 𝑟𝑚 𝐹𝑀 + 𝑟𝐼𝐹𝐼 𝐹𝑀 + 𝐹𝐼 𝑟 𝛾 = 𝑟𝛼𝑟𝑚 𝐹𝑀 + 𝑟𝛽 𝑟𝐼𝐹𝐼 𝐹𝑀 + 𝐹𝐼 𝐺 𝑇∗ = 1 − ( 𝑟𝛼 𝑟𝑚 𝐹𝑀 +𝑟𝛽 𝑟𝐼𝐹𝐼 𝐹 )(1 − 𝑟𝑚 𝐹𝑀 +𝑟𝐼𝐹𝐼 𝐹 ) 𝑟𝑝 second method of derivation the profit of the bank is: 𝜋 = 𝑟𝑚 𝐹𝑀 + 𝑟𝐼𝐹𝐼 − 𝑟𝛼𝑟𝑚 𝐹𝑀 − 𝑟𝛽𝑟𝐼𝐹𝐼 − 𝑟𝑝 e [max (0, 𝑋 -t)] 𝜋 = 𝑟𝑚 𝐷 − 𝑇 − 𝐹𝐼 + 𝑟𝐼 𝐷 − 𝑇 − 𝐹𝑀 − 𝑟𝛼𝑟𝑚 𝐷 − 𝑇 − 𝐹𝐼 − 𝑟𝛽𝑟𝐼 𝐷 − 𝑇 − 𝐹𝑀 − 𝑟𝑝𝐸[𝑀𝑎𝑥(0, 𝑋 − 𝑇)] 𝜋 = 𝑟𝑚 𝐷 − 𝑇 − 𝐹𝐼 + 𝑟𝐼 𝐷 − 𝑇 − 𝐹𝑀 − 𝑟𝛼𝑟𝑚 𝐷 − 𝑇 − 𝐹𝐼 − 𝑟𝛽 𝑟𝐼 𝐷 − 𝑇 − 𝐹𝑀 − 𝑟𝑝 𝑋 − 𝑇 𝑔 𝑥 𝑑(𝑥) +∞ 𝑇 𝜕𝜋 𝜕𝑇 = −𝑟𝑚 − 𝑟𝐼 + 𝑟𝛼𝑟𝑚 + 𝑟𝛽𝑟𝐼 + 𝑟𝑝 1 − 𝐺 𝑇 = 0 [1 − 𝐺( 𝑇∗)] = 𝑟𝑚 + 𝑟𝐼 − 𝑟𝛼𝑟𝑚 − 𝑟𝛽 𝑟𝐼 𝑟𝑝 [1 − 𝐺( 𝑇∗)] = 𝑟𝑚 1 − 𝑟𝛼 + 𝑟𝐼(1 − 𝑟𝛽 ) 𝑟𝑝 𝐺 𝑇∗ = 1 − 𝑟𝑚 1 − 𝑟𝛼 + 𝑟𝐼 (1 − 𝑟𝛽 ) 𝑟𝑝 the second derivative of profit: 𝜕2𝜋 𝜕2𝑇 = −𝑟𝑝𝐺 𝑇 ∗ ≤ 0 it is a maximum; it is a concave function. 2. discussion(1) the islamic bank is exposed to liquidity risk. this is mainly due to the different maturities of the assets and liabilities of the bank. like the conventional bank, the islamic bank tends to collect short-term deposits to refinance long-term investments and is therefore exposed to liquidity risk. liquidity is an essential factor in the viability of any financial institution. poor liquidity risk management can result in intensive financing costs and difficulties in liquidating assets at fair value. this risk can be increased if the bank reputation is damaged. in this case, liquidity risk could lead to massive withdrawals of deposits and thus threaten the solvency of the financial institution. ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5848 6 following an optimization, we have found an optimal expression for reserve that the bank must hold and which should be written as follows: 𝐺 𝑇∗ = 𝑃 𝑈 < 𝑇∗ = 𝑓 𝑥 𝑑𝑥 𝑇 0 = 1 − 𝑟𝑚 1 − 𝑟𝛼 + 𝑟𝐼 (1 − 𝑟𝛽 ) 𝑟𝑝 u~𝑁(0,1) 𝑓 𝑥 = 1 𝜎√2𝜋 𝑒𝑥𝑝 ( − 𝑥−𝜇 2𝜎 2 )2 we look for reciprocal functions 𝑇∗ = 𝐺−1 (𝑟𝛼 ) 𝑇∗ = 𝐺−1 (𝑟𝛽 ) 𝑇∗ = 𝐺−1 (𝑟𝐼 ) 𝑇∗ = 𝐺−1 (𝑟𝑚 ) 𝑇∗ = 𝐺−1 (𝑟𝑝 ) our objective was initially to find reciprocal functions for each variable; we have found for the property variables in relation to the rates the reciprocal functions are linear except in the case of rate 𝑟𝑝 we have found the form shown in the figure 2. the idea is to know how t reacts when varying the rates one by one. for each variable (rα, rβ, ri , rm , rp ), we found linear functions as shown in figure 1. but compared to (𝑟𝑝 ), we still found a relatively significant representation like this (figure 1). therefore, the level of illiquidity is determined by the expected penalty fee, the rate of return on funding, and the sharing rates between the bank and the depositors. 𝑟𝑚 (1𝑟𝛼 )+𝑟𝐼 (1𝑟𝛽 ) represents the opportunity cost of the reserves or the disadvantages of holding cash, which does not provide a return. it kills and gives the bank a bad reputation. each currency unit of reserves held costs, in terms of opportunity 𝑟𝑚 (1 𝑟𝛼 ) + 𝑟𝐼(1𝑟𝛽 ): the 𝑟𝑝 [1 -g (t*)] part represents the expected adjustment cost. the benefit of holding liquidity allows the bank to cope with withdrawals and avoid the need for refinancing through central currency loans which, for each currency unit, cost 𝑟𝑝 [1 g (t*)]. the following figure shows: figure 1: distribution function of g (t*) that the distribution function g (t *) is a linear function for each variable. this means that:  if the rate of return on the murabaha increases, the bank has no interest in retaining sufficient liquidity, so as not to miss a significant profit margin.  an increase in 𝑟𝛼 increases the remuneration of depositors and therefore the amount of deposits collected by the bank. the distribution function g (t *) is a growing function with the rate 𝑟𝛽 of profit-sharing between the bank and the depositors. the following figure shows: figure 2: the distribution function of g (t*) the allocation function g (t*) has a particular form in relation to the penalty rate 𝑟𝑝 which represents the unit cost incurred in an illiquidity situation. we observe that the bank sets its amount of reserves in reference to the ratio of the opportunity cost of reserves to the penalty rate. if 𝑟𝑝 is independent of 𝑟𝑚 and 𝑟𝛽 and it is the only adjustment variable allowing t to reach its optimal level. however, a bank with financial privilege in the market may ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5848 7 expect to dominate by increasing the penalty rate, which offsets the effect of the penalty rate on the demand for banks' reserves. t reacts by varying the rates one by one. for each variable. we found that only for the penalty rate that counts. this means that the level of illiquidity is determined by the penalty provided for an islamic bank. the penalty rate is considered for the islamic bank as the only adjustment variable allowing t to reach its optimal level. the decision to increase the rates of remuneration of depositors increases the amount of deposits collected by the bank. in the end, the amount of the reserves is modified not by a direct effect of the penalty rate but by a change in the conditions of funding remuneration. even if islamic and conventional banks are subject to the same conditions of optimality, nevertheless, the specificity of islamic banks is that they can use asset remuneration conditions as an instrument to solve their liquidity problem given the interdependence between assets and liabilities. the study reveals that the determinants of the first analysis are: the expected penalty costs, the rate of return on financing, the sharing rate between the bank and the depositors. 3. liquidity management in a dynamic environment suppose the reserve amount is a function of the number of deposits and funding. the deposit amount is a function of 𝑟𝑚 murabaha rate of return, 𝑟𝐼 the ijara rate of return, 𝑟𝛼 rate of murabaha profit sharing between bank and depositors, 𝑟𝛽 rate of ijara profit sharing between bank and depositors. let us also denote by 𝑋 the withdrawals of a random amount and 𝑟𝑝 the unit cost of refinancing in the event of bank illiquidity. we can write the reserve amount as follows: t(𝑟𝑚 , 𝑟𝐼 , 𝑟𝛼 , 𝑟𝛽 ) = d(𝑟𝑚 , 𝑟𝐼 , 𝑟𝛼 , 𝑟𝛽 ) f𝑟𝑚 , 𝑟𝐼 the profit function of a bank is expressed as follows: 𝜋 = 𝑟𝑚 𝐹𝑀 𝑟𝑚 + 𝑟𝐼𝐹𝐼 𝑟𝐼 − 𝑟𝛼𝑟𝑚 𝐹𝑀 𝑟𝑚 − 𝑟𝛽 𝑟𝐼𝐹𝐼 𝑟𝐼 − 𝑟𝑝𝐸[𝑀𝑎𝑥 0, 𝑋 − 𝑇 ] replace t by its value: 𝜋 = 𝑟𝑚 𝐹𝑀 𝑟𝑚 + 𝑟𝐼𝐹𝐼 𝑟𝐼 − 𝑟𝛼𝑟𝑚 𝐹𝑀 𝑟𝑚 − 𝑟𝛽 𝑟𝐼𝐹𝐼 𝑟𝐼 − 𝑟𝑝𝐸[𝑀𝑎𝑥 0, 𝑋 − 𝐷 + 𝐹𝑀 𝑟𝑚 + 𝐹𝐼(𝑟𝐼 ] the equation can be expressed differently: 𝜋 = 𝑟𝑚 𝐹𝑀 𝑟𝑚 + 𝑟𝐼𝐹𝐼 𝑟𝐼 − 𝑟𝛼𝑟𝑚 𝐹𝑀 𝑟𝑚 − 𝑟𝛽 𝑟𝐼𝐹𝐼 𝑟𝐼 − 𝑟𝑝 𝑋 − 𝐷 + 𝐹𝑀 𝑟𝑚 +∞ 𝑇 + 𝐹𝐼 𝑟𝐼 𝑔 𝑥 𝑑(𝑥) the bank then chooses two 𝑟𝑚 and 𝑟𝐼 rates that maximize its profit, which corresponds to the firstorder optimality. 𝜕𝜋 𝜕𝑟𝑚 = 𝐹𝑀 𝑟𝑚 + 𝑟𝑚 𝐹 ′ 𝑀 𝑟𝑚 − 𝑟𝛼𝐹𝑀 𝑟𝑚 − 𝑟𝛼𝑟𝑚 𝐹 ′ 𝑀 𝑟𝑚 + 𝑟𝑝𝑃𝑟𝑜𝑏 𝑋 ≥ 𝑇 𝐷 ′ 𝑟𝑚 − 𝑟𝑝𝑃𝑟𝑜𝑏 𝑋 ≥ 𝑇 𝐹 ′ 𝑟𝑚 = 0 𝜕𝜋 𝜕𝑟𝐼 = 𝐹𝐼 𝑟𝐼 + 𝑟𝐼𝐹 ′ 𝐼 𝑟𝐼 − 𝑟𝛽𝐹𝐼 𝑟𝐼 − 𝑟𝛽 𝑟𝐼𝐹 ′ 𝐼 𝑟𝐼 + 𝑟𝑝𝑃𝑟𝑜𝑏 𝑋 ≥ 𝑇 𝐷 ′ 𝑟𝐼 − 𝑟𝑝𝑃𝑟𝑜𝑏 𝑋 ≥ 𝑇 𝐹 ′ 𝑟𝐼 = 0 (1-𝑟𝛼 ) 𝑟𝑚 𝐹 ′ 𝑀 𝑟𝑚 + 𝐹𝑀 𝑟𝑚 = 𝑟𝑝𝑃𝑟𝑜𝑏 𝑋 ≥ 𝑇 𝐹′𝑀 𝑟𝑚 − 𝑟𝑝𝑃𝑟𝑜𝑏 𝑋 ≥ 𝑇 𝐷 ′(𝑟𝑚 ) (1-𝑟𝛼 ) 𝑟𝑚 𝐹 ′ 𝑀 𝑟𝑚 +𝐹𝑀 𝑟𝑚 𝐹′𝑀 (𝑟𝑚 ) = 𝑟𝑝𝑃𝑟𝑜𝑏 𝑋 ≥ 𝑇 − 𝑟𝑝𝑃𝑟𝑜𝑏 𝑋 ≥ 𝑇 𝐷′(𝑟𝑚 ) 𝐹′𝑀 (𝑟𝐼) (1-𝑟𝛽 ) 𝑟𝐼𝐹 ′ 𝐼 𝑟𝐼 +𝐹𝐼 𝑟𝐼 𝐹′𝐼(𝑟𝐼) = 𝑟𝑝𝑃𝑟𝑜𝑏 𝑋 ≥ 𝑇 − 𝑟𝑝𝑃𝑟𝑜𝑏 𝑋 ≥ 𝑇 𝐷′(𝑟𝐼) 𝐹′𝐼(𝑟𝐼) (1-𝑟𝛽 )[𝑟𝐼 + 𝐹𝐼 𝑟𝐼 𝐹′𝐼 𝑟𝐼 ] 1 𝑟𝐼 = 𝑟𝑝 prob (𝑋 ≥ 𝑇) 1 𝑟𝐼 – 𝑟𝑝 prob(x≥ 𝑇) 𝐷′(𝑟𝐼) 𝐹′ 𝑟𝐼 1 𝑟𝐼 consider ε𝐹 the elasticity of the funding request: ε𝐹𝑀 = −𝑟𝑚 𝐹′𝑚 (𝑟𝑚 ) 𝐹(𝑟𝑚 ) and ε𝐹𝐼 = −𝑟𝐼 𝐹′𝐼 (𝑟𝐼 ) 𝐹(𝑟𝐼 ) the condition of optimality is: (1 − 𝑟𝛼 )𝑟 ∗ 𝑚 = 𝑟𝑝𝑃𝑟𝑜𝑏 𝑋 ≥ 𝑇 (1 − 𝐷′ 𝐹′𝑀 ) 1 − 1 𝜀𝐹𝑀 (1 − 𝑟𝛽 )𝑟 ∗ 𝐼 = 𝑟𝑝𝑃𝑟𝑜𝑏 𝑋 ≥ 𝑇 (1 − 𝐷′ 𝐹′ 𝐼 ) 1 − 1 𝜀𝐹𝐼 4. discussion (2) the rate of return on the murabaha is fixed by reference to the expected marginal penalty cost, the ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5848 8 sharing rate between the bank and the depositors, the elasticity of the demand for financing, and the ratio of the variation of deposits to the variation of financing. the rate of return of the ijara shall be fixed by reference to the expected marginal penalty cost, the sharing rate between the bank and the depositors, the elasticity of the demand for financing, and the ratio of the variation of deposits to the variation of financing. the increase in the penalty rate leads the bank to increase its rate of return on financing operations to maintain its profit margin 1 . this result depends on the funding elasticity, the ability of𝑟𝑚 , and 𝑟𝐼to act on the supply of d' deposits. from the previous equation, it is easy to see that the derivative of verses is positive. the management of bank liquidity must be integrated into an overall asset-liability management framework. in the case of islamic banks, this notion can be demonstrated by rewriting the equation differently. (1 − 𝑟𝛼 )𝑟 ∗ 𝑚 = 𝑟𝑝𝑃𝑟𝑜𝑏 𝑋 ≥ 𝑇 1 − 1 𝜀𝐹𝑚 − 𝑟𝑝𝑃𝑟𝑜𝑏 𝑋 ≥ 𝑇 𝐷′ 𝐹′𝑚 1 − 1 𝜀𝐹𝑚 (1 − 𝑟𝛽 )𝑟 ∗ 𝐼 = 𝑟𝑝𝑃𝑟𝑜𝑏 𝑋 ≥ 𝑇 1 − 1 𝜀𝐹𝐼 − 𝑟𝑝𝑃𝑟𝑜𝑏 𝑋 ≥ 𝑇 𝐷′ 𝐹′𝐼 1 − 1 𝜀𝐹𝐼 the first term describes the optimality in the case of independence between the remuneration of assets and that of liabilities. the rate of return on assets depends only on the penalty rate and the elasticity of the funding. this is the same result found by [1] in the context of islamic banks, [36]and [37]in the context of conventional banks, where the increase in the penalty rate increases the optimal rate of return on assets and reduces the amount of loans. in the case of islamic banks, the resulting increase in reserves means, for the bank, a decrease in the anticipated penalty cost and an increase in its marginal profit. an increase of 𝑟𝑝 generates a smaller increase compared to the conventional case because the bank knows very 1 from the previous equation, it is easy to see that the derivative of𝑟𝑓 versus 𝑟𝑝 is positive. well that there will be a positive return effect of this increase on the supply of deposits and therefore on bank reserves. ultimately, according to our model, the optimal liquidity stock of the islamic bank depends on different factors: rates of remuneration of the asset: there is a special feature of liquidity risk management for the islamic bank when changes in the conditions of remuneration of the asset are transmitted directly to the liability. islamic banks can use asset remuneration conditions as an instrument to solve their liquidity problem. sharing rates: a significant remuneration of depositors and a remarkable collection of deposits leads to a risk of low liquidity scarcity. -penalty rates: increasing the cost of refinancing encourages banks to keep enough reserves to avoid high-cost overruns. the practice of interdependence between assets and liabilities allows the islamic bank to manage its reserves using a single instrument which is the rate of return on financing. conventional banks are obliged to use two instruments (lending rate and credit rate). it is said that the interdependence between assets and liabilities can be a source of competitiveness gain for these banks since they can finance the economy at a lower rate than their conventional competitors. bank liquidity risk management must be integrated into an overall asset-liability management framework. the interdependence between assets and liabilities can be a source of competitive gain for islamic banks as they can finance the economy at a lower rate than their conventional competitors. this study reveals in a second dynamic analysis that the determinants are: the expected marginal cost of the penalty, the ratio of the variation of deposits to the variation of funding that joins the study [1]. the results confirm the idea that banks' liquidity management must be integrated into an overall asset-liability management framework. v. conclusion liquidity risk is a real threat to islamic banking activities. islamic banks cannot always rely on the support of the central bank or the islamic money market. therefore, the holding of an optimal stock ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5848 9 of liquidity plays an efficient role for these banks. as a result, an effective mechanism for managing this type of risk is a prerequisite. the importance of liquidity risk, the specificities of islamic banks, and the challenges these banks face have motivated us to do this research on islamic banks and liquidity risk. an attempt has been made to study the links between the financial intermediation of islamic banks and liquidity risk. thus, we tried to study the arbitrage between liquidity and profitability through a formalization of the im 2 liquidity management model that uses two factors: murabaha and ijara. we tried to determine the optimal amount of reserves that an islamic bank should have to cover unplanned withdrawals. 1. according to the model developed, the optimal amount of reserves is set according to the anticipated penalty fees, from the rate of return of the financing to the sharing rates between the bank and the depositors. 2. we found that the ijara rate of return is set to the expected marginal cost of the penalty, the sharing rate between the bank and the depositors, the elasticity of the demand for financing, and the ratio of variation of funding and variation deposits. 3. islamic financial engineering faces a multitude of obstacles.[38] suggested that the adoption of new liquidity risk management products such as the “takaful liquidity risk fund” can contribute to better liquidity risk management. improving liquidity risk management requires a variety of measures. the islamic money market obligation becomes a requirement to offer sharia-adjusted interbank instruments. 4. it is recommended that the regulatory and supervisory mechanism recognize the specificities of islamic banks in the dual system where they coexist with conventional banks. to this end, the active use and incorporation of government financing instruments in money market operations and the sukuk contribute to the development of the islamic money market [19]. the limitations and implications of the research: islamic banks reveal a difficulty that relates to sharia compliance constraints, as well as the under exploitation of quantitative tools for liquidity risk management compared to conventional banks. thus, the difficulty of modeling contracts according to nature (legal, religious, etc.). 2 ijara and murabaha references [1]ben jedidia khoutem, jlassi mouldi, “le risque de liquidité pour une banque islamique enjeux et gestion”, etudes en economie islamique vol. 7, no. 1 (71-96), 2013. [2] v. sundararajan, l. errico, "islamic financial institutions and products in the global financial system: key issues in risk management and challenges ahead, imf working paper wp/02/192, international monetary fund, washington, dc, 2002. [3] s.a. salman, "islamic modes of finance and associated liquidity risks, paper presented at the conference on monetary sector in iran: structure, performance and challenging" issues, tehran – février, 2004. [4] d. el-hawary dahlia, w. grais, z. iqbal: “diversity in the regulation of islamic financial institutions”, the quarterly review of economics and finance, vol 46, n° 5, pp. 778-800, 2007. [5] i. akkizidis, s. k. khandelwal [2008]: financial risk management for islamic banking and finance, palgrave macmillan, hardback, 252 pages. [6] s. al-muharrami, d. c. hardy, cooperative and islamic banks: what can they learn from each other? international monetary fund, wp/13/184, 2013. [7] ben arab, m., &elmelki, a., “managing risks and liquidity in an interest free banking framework: the case of the islamic banks”, international journal of business and management, 3 (9), pp 80-95, 2008. [8] a.hassoune ,"les fonds propres des banques islamiques face aux exigences réglementaires", moody’s investors services, paris, janvier 2010. [9] k. ben jedidia"l'intermédiation financière participative des banques islamiques", etudes en economie islamique, vol 6, n°1, pp.17-31, 2012. [10] o. amrani and a. najab, l’évolution de la gouvernance bancaire : d’une approche classique vers une approche fondée sur la charia (revue de littérature),‖ revue du contrôle de la comptabilité et de l’audit, vol.4(3), pp. 822-847, 2020. [11] p.p. biancone and m. radwan, social finance and unconventional financing alternatives: an overview, european journal of islamic finance, (10), 2018. https://doi.org/10.13135/24212172/2818 ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5848 10 [12] comité de bâle, “liquidityrisk : management and supervisory challenges”, banque des règlements internationaux, février 2008. [13] al-jarhi et iqbal, “banques islamiques : réponses à des questions fréquemment posées”, document périodique n°4, institut islamique de recherches et de formation, bid, jeddah, 2002. [14] e. al monayea , "selecting the right business model in islamic banking, paper submitted to global islamic finance forum", kuala lumpur, du 18 au 20 septembre 2012. [15] a.r. abdul majid, "development of liquidity management instruments: challenges and opportunities", paper presented at theinternational conference on islamic banking: risk management, regulation and supervision, jakarta-indonesia, 30 septembre-3 octobre 2003. [16] matthews, robin, issamtlemsani, and aftab siddiqui. islamic finance. working paper, centre for international business policy, kingston business school, 2002. [17] daoud, khoutem ben. "l’intermédiation financière participative des banques islamiques." les cahiers de la finance islamique 5 (2013): 28-40. [18] h. hesse, andreas jobst, j. solé, "trends and challenges in islamic finance", world economics, vol. 9, no. 2, pp. 175-193, 2008. [19] islamic financial services board (ifsb) “technical note on issues in strengthening liquidity management of institutions offering islamic financial services: the development of islamic money markets”, 2008. [20] jedidia, k. b., & hamza. h, "determinants of liquidity risk in islamic banks: a panel study", vol 2, no.2 (special issue), pp 137-146, 2014. [21] ghenimi, a., & omri, m. a. b., “les déterminants du risque de liquidité dans les banques islamiques : cas de la région mena”. la revue gestion et organisation io, pp 127-136, 2018. [22] a. mabrouk, a. talibi, o.touri, b. achchab, "apport des techniques de sélection de modèles et de variables pour la modélisation du risque de liquidité en finance", recherches et applications en finance islamique, volume 4, numéro 1, pages : 36-57, 2020. [23] iqbal, a., “liquidity risk management: a comparative study between conventional and islamic of pakistan”, global journal of management and business research, 12(5), pp 5464, 2012. [24] gomes, t., & khan, n. strengthening bank management of liquidity risk: the basel iii liquidity standards. bank of canada financial system review, 5, 35-42, 2011. [25] reda, m. h. islamic commercial law: contemporariness, normativeness and competence. brill, 2017. [26] hussain, a. hameeda and al-ajmi, jasim, risk management practices of conventional and islamic banks in bahrain. bahrain: department of economics and finance, university of bahrain, sekheer. 2012. [27] greening, v., and h. iqbal. "risk analysis for islamic banks. herdon." 2007. [28] abdullah, a., & khan, a. q. , “liquidity risk management: a comparative study between domestic and foreign banks in pakistan”, journal of managerial sciences, 6(1), pp.61-72, 2012. [29] goodhart c., "la gestion du risque de liquidité", la revue de la stabilité financière, banque de france, 2008. [30] s.a. salman,“state of liquidity management in islamic financial institutions”, islamic economic studies, vol. 21, no. 1, pp.63-98, 2013. [31] tariqullah khan et habib ahmed, "la gestion des risques, analyse de certains aspects liés à l’industrie de la finance islamique", 2002. [32] a.el hamdi, m. benmahane, “ la gestion de la liquidité des banques islamiques quelles perspectives pour le cas de la banque participative marocaine ? ” research and applications in islamic finance. v3, n 2, pp 205-226, 2019. [33]t.m. youssef, the murabahah syndrome in islamic finance: laws, institutions and policies, in clement m. henry and rodney. wilson, eds. politics of islamic finance, edinburgh university press, edinburgh, 2004. [34] wadi mzid, "la finance islamique: principes fondamentaux et apports potentiels dans le financement de la croissance et du développement". economic agendas of islamic actors, papersie med, 2011. [35] hassen ben ouhiba, chartered public accountant, cpa. les banques islamiques étude de positionnement, spécificités réglementaires et particularités d’audit. 2015. ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5848 11 [36] e. z. prisman, b. slovin myron, e.m. sushka: “a general model of the banking firm under conditions of monopoly, uncertainty, and recourse”, journal of monetary economics, vol 17, n° 2, pp. 293-304, 1986. [37] x. freixas, j. rochet, "microeconomics of banking", mit press cambridge, 1997 [38] h. ahmed,“financial crisis: risks and lessons for islamic finance”, international journal of islamic finance, vol 1, n°1, pp. 7-32, 2009. ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5848 12 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4560 1 islamic countries and maqasid al-shariah towards the circular economy. the dubai case study. maura campra 1 , valerio brescia 2 , vahid jafari-sadeghi 3 and davide calandra 4 1 maura campra, full professor, department of economics and business studies, university of piemonte orientale “amedeo avogadro”, novara, italy 2 valerio brescia*, researcher, department of management, university of turin, turin, italy, e mail: valerio.brescia@unito.it 3 lecturer, coventry business school, coventry university, priory street, coventry cv1 5fb, uk 4 phd candidate, department of management, university of turin, turin, italy abstract— this paper aims to explore the economic, social, and environmental policies in gulf countries. despite the increased attention paid by scholars on circularity, there is no evidence about the relationship between the circular economy and islamic countries. using an explorative case study, this paper benefits from analyzing several information sources underlying the first link between circularity and islamic countries. after an in-depth literature review, the authors present a useful comparison between the linear and circular economy concepts. additionally, we emphasize a framework of policies and best practices adopted from dubai, which merges several approaches applied towards the circular economy. furthermore, this paper highlights the theoretical link between social entrepreneurs and islamic pillars based on the maqasid al-shariah business model. in conclusion, the article provides useful implications for researchers and practitioners, who in the future aim to investigate the relationship between islamic systems and the circular economy. keywords-component; maqasid al-shariah; circular economy, dubai, sdgs i. introduction some scholars state that the islamic entrepreneur can be considered a social entrepreneur, as his work is based on three interconnected pillars, the pursuit of opportunities, socioeconomic or ethical aspects, and religion-spiritual aspects [1], [2]. in islamic countries, quran and sunnah guide the entrepreneur's work by configuring him as a social entrepreneur [3]–[5] attentive to secular norms that influence and affect various aspects currently debated, such as the sustainable development goals (sdgs) [6], [7]. islamic countries often act as social enterprises at both micro and macro-level [1] with attention not only on economic development but also on social and environmental development where elements of the sdgs and maqasid alsharia coincide [8]. currently, many islamic states are based on a linear economy or a market economy, based on the extraction of raw materials, production and mass consumption, and the disposal of waste once the end of the product's life has been reached [9]. many sdgs are oriented towards a type of circular economy designed to regenerate itself [10]–[12]. therefore, the circular economy is an economic system planned to reuse materials in subsequent production cycles, reducing waste as much as possible [9], [13]–[15]. population growth and the increasing intensity of demand for renewable and non-renewable energy suppliers have led to a request for global resources higher than those available, which must be resolved through a new approach [16]–[18]. maqasid al-shariah includes ethical aspects, impact-based investments, and asset management that can accompany change strategies required by the sdgs and the new paradigm linked to a new economic and managerial system of public policy and resource management [8], [19]. although few gulf countries invest in a new economic model that takes account of circular supply-chain, recovery and recycling, product life-extension, sharing platform, and product as a service, something is changing. they are also starting to consider sustainable policies due to environmental change [20]–[22]. however, some studies show that the gulf countries have not yet adopted effective policies to obtain safe, inclusive, resilient, and sustainable cities[22]. the study we conducted submitted june 2020, revised april 2021, accepted april 2021 mailto:valerio.brescia@unito.it ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4560 2 demonstrates that explicit policies' effectiveness in the arab emirates is adopted and follows theoretical, cultural, and religious models that lead to real change and a tangible impact on the city context. despite the importance of this theme for all humankind [23], there are not many analyzes of the economic, social, and environmental policies adopted in the gulf countries in the literature. therefore, the study explores a significant and virtuous case study that applies the circular economy and maqasid al-shariah simultaneously, leading to the assumption of effective integration and union of the social, economic, and political aspects of an emirate. the study contributes to the two research streams by analyzing the micro and macro social, economic, and political level developed by the head of the uae study. although there are no studies on adopting the circular economy in dubai, several policies could be read as an ongoing change towards this new economic approach. different emirate strategies could be considered changes of attitude towards a circular economy; examples are the dubai plan 2021, which aligns with the uae vision 2021 and the green economic for sustainable development initiative, dubai clean energy strategy (dces) 2050[24] and dies 2030. after an in-depth literature review, the essay continues with the identification of the methodology framework used. then, the results and discussion sections are provided. the last paragraph concludes the paper and offers future implications in this field. ii. literature review a. the linear paradigm and impact, the changing paradigm the current economic system is called the linear system [25], [26]. this system developed in several countries is based on taking, making, and disposing of mechanisms [27]. this mechanism is based on the extraction of natural resources that are already scarce, producing manufactured products and products sold to the consumer. once consumed, they are transformed into waste. this leads to an increase in pollution and the suffering of resources and an inability to respond to global demand [17]. the paradigm of linear production is linked to satisfying the consumer’s needs, with greater company efficiency and higher profits [28]. however, the expansion of demand leads to identifying renewable resources to respond to needs [29], [30]. in addition to the scarcity of resources, the linear economy leads to waste intensive [31], which includes wasted resources, wasted life cycle, wasted capabilities, and wasted embedded values. wasted resources are not renewable and, therefore, are not kept for future generations. wasted lifecycle provides products that end their life cycle after the first use exiting the market. considering or wasted capabilities in the linear economy, products are not entirely used for the purpose. embedded wasted values relate to materials and energies that have not been recovered. the world population is increasing in cities, and by 2050 the number will be so high that it will not be able to sustain current production [17], [32]. the linear economy paradigm conflicts with the trend of the population and needs and requires new policies and alternatives. a first alternative to the linear economy was defined in 1849. the royal society of chemistry president mentioned that "[...] in an ideal chemical factory there is, strictly speaking, no waste but only products. the better a real factory makes use of its waste, the closer it gets to its ideal, the bigger is the profit" [33]. a first push is proposed to reuse waste. the change of the junction occurs with technological efficiency with a more sustainable approach linked to the waste cycle, and socio-economic contributions unities identify the main drivers in the circular economy new approach [17], [34]–[36]. the new method could intervene in the waste-intensive linear paradigm and the destructive effect that the linear economy has on our planet [37]. several countries globally, including dubai, are starting a circular economy process that considers the economic, social, and environmental limits of the linear economy [38]. to realize this aim is necessary to consider the difference between the linear economy and circular economy to map the countries' policies (table 1). table i. comparison between linear economy and circular economy linear economy circular economy the linear paradigm's attitude towards nature and its resources are more toward forcing nature to produce more. the circular paradigm focuses on making use of what nature is already producing. the production behavior in the linear economy is considerably base on taking, make and waste. the production behavior in the circular economy is significantly focused on reducing, reuse and recycle. the product life span is shorter in the linear economy, and they become outdated even when they are usable. extended product life span as new products can be used as useful raw material for other products. the linear economy's earning model is mainly the producers determining the price to be charged for each product. in the circular economy's earning model, producers are charge not for the cost of the product but charge for the use of the product. the primary business model in the linear economy is based on monetary benefit. the business model in the circular economy is a blend of financial, environmental, and societal benefit. the new economic approach generates five key elements to consider in developing a new business model based on the circular economy. the first element concerns the circular supply-chain focused on promoting fully renewable, biodegradable, and recyclable materials with a longer life cycle and future reuse to produce new products [39], [40]. the second key element considers the recovery and recycling phases, which require recovering value from end-oflife products during the production process [41]. it concerns creating zero waste facilities where waste is treated, recycled, and converted into energy [16]. ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4560 3 furthermore, more considerable attention to the product life-extension would allow the materials to be used for as long as possible, making it possible to consider waste only when it is no longer possible to upgrade, repair, re-sell or rework them as products [42]. the fourth key point linked to the circular economy model is the development of sharing platforms. communication between product owners with companies and individuals who intend to reuse them is guaranteed [43]. this development is connected to the diffusion and use of certain communicative technologies [44]. if we consider the long-life cycle of a product, it is not enough to sell the product a profit. still, we must also consider that as the fifth essential element of the model, even the quality and durability to allow reuse or rental of the product once finished its usefulness for a subject [45]. therefore, the new model considers environmental value, economic value, and business value based on the circular economy model to analyze the policy implemented. the new model can support the sdgs or guide some of the expected objectives [46], [47]. b. maqasid al-shariah and circular economy maqasid al-shariah is known as the basis of human needs related to islamic ideology and derives from the quran and sunnah. a response of needs through this ideology, according to chapra [48], guarantees a more sustainable society and overall well-being. al ghazali reforms maqasid al-shariah into categories into five objectives on which human needs and interests are based [19], [49], [50]. the five fundamental pillars are therefore identifiable in nafs (the human self), din (religion), aqal (intellect), nasl (posterity), and mal (wealth). religion guides the work of individuals according to islamic principles, empowering the work of individuals. the human self-increases individuals' ability to interpret more based on more excellent knowledge; what is adopted in the scriptures can be taken in daily life. posterity is the principle according to which it is necessary to respond to needs through civilization, this includes a moral development, respect for laws, of the family of peace, of health to have fallout from today's work on society in the long term. wealth is accentuated to increase individuals and community; with health, it is possible to reduce income inequalities through zakah. walth also leads to a potential acquisition of better education, technological knowledge, and research efficiency. therefore, the general objectives of sharia promote longterm well-being by establishing themselves as bases for human welfare [51]. the current linear economy paradigm focuses on short-term economic prosperity by maximizing growth. the other aspects of environmental protection and social development are not considered. therefore, the standards highlighted by the circular economy highlight how considering the islamic ideologies of maqasid al-shariah can guarantee above all in islamic countries the application of a complete approach if wealth is only one linked with the linear economy paradigm, religion, the human self, intellectual, posterity bind and support the circular economy paradigm. islamic banks are also able, through blended murabaha, to support the circular economy's development according to the principle that the banks themselves finance the institutions pay the need for funds and the markup or profit margin. nevertheless, in this contractual structure, the business or entrepreneur can receive qard hasan whereby the enterprise only needs to pay back the principal amount. at the same time, the institution of compassion covers the markup. therefore, maqasid al-shariah finds a capacity to respond to sustainable development goals (sdgs) more than in other european contexts where faith does not guide choices from an ethical point of view [8], [52]. iii. method maqasid al-shariah consists of five main elements: protection of life, faith, intellect, progeny, and wealth. these elements are compared with human prosperity measurement elements to understand the socio-economic values better [19]. nevertheless, the socio-economic well-being analyzed by the author is associated with the functional elements of a country. these elements deal with new approaches and processes linked to the limitation of available resources and the search for innovative strategies to reduce and regenerating resources based on consolidated social, cultural, and productive models [53], [54]. therefore, the two research streams find a practical link and an overlap that requires confirmation through the case study as adopted in biancone et al., 2019 [55]. the approach implemented envisages an integrated theory involving two theoretical perspectives that speak to different phenomena, but applying one theory to the domain of the other can lend novel insight [56]. the analysis to confirm the theory was conducted through a qualitative approach based on the case study [57] of dubai. the protocol adopted were analyzed through a triangulation of information, official documents, public interviews, and reports [58] collected between 2002 and 2018. the first action that involved the city of dubai with the practical policy is 2002. the study carries on elements highlighted in the literature and seeks through the dubai case study to highlight implementations, shortcomings, or any features not highlighted in the research [59]. the validation of the theoretical approach based on critical elements of the circular economy and maqasid al-shariah takes place by studying the policies adopted [60]. the dubai case study analysis is significant in that the dubai plan 2021 aligns with the uae vision 2021, dubai clean energy strategy (dces) 2050, and dies 2030. additionally, the emirate declares its desire to apply the circular economy model by respecting the maqasid al-shariah principles intrinsic to the policy adopted. the population of dubai is 3,217 million; the area that covers the emirate is 4114 km2. the country's economy is developed, and it is among countries with an advanced economy [61]. iv. result and discussion in the emirates, where ethical principles are intrinsic to public, economic, and environmental management involving ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4560 4 all macro and microeconomic levels [62], the theoretical model presented finds evidence and development. the dubai plan 2021 aligns with the uae vision 2021 and the green economy for sustainable development initiative, dubai clean energy strategy (dces) 2050 and dies 2030. it aims to create new markets for circular goods, services and revenue by surfacing, supporting and connecting entrepreneurs and innovations through nationally led challenges and partnerships. the intention to adopt policies of this type was made explicit for the first time during the eighth annual edition of the emirates green building council (emiratesgbc) congress gathered regional and international experts to discuss for the first time, the adoption of a circular economic model in the building industry and construction sector, in a bid to advance the uae's sustainable development goals of vision 2021. in 2014, the dubai government released dubai plan 2021 which aligns with the uae vision 2021 and the green economy for sustainable development initiative and aims to position dubai at the forefront with a primary focus on the happiness of residents, society, and economy, as well as smart and sustainable cities. along with dubai's plan to be the most sustainable city globally by 2020, the strategies above serve as tools to drive green buildings and sustainability in the emirate. additionally, dubai municipality applied the green building regulations and specifications (gbr&s) to governmentowned buildings in january 2011 and mandated it for all new buildings in dubai starting march 2014. based on the gbr&s, dubai municipality (dm) introduced the al sa'fat rating system in september 2016 with four certification levels to strengthen the city's sustainable built environment. etihad esco was established in 2013 to create a viable performance contracting market for energy service companies (escos) in dubai. along with other escos, they aim to retrofit about 30,000 buildings by 2030 and generate 1.68 twh energy savings and 5.64 big water savings by 2030. as of 2017, etihad esco and other rsb accredited escos have completed retrofitting 2,465 buildings. to support the retrofit market's growth, emirates green building council (emiratesgbc) commenced its building retrofit training (brt) program in august 2017, based on the emiratesgbc technical guidelines for retrofitting existing buildings. in october 2018, the advanced level brt program was launched, aimed at industry professionals to provide them with information on retrofit methods to support ongoing retrofit projects and streamline their technical capacity for more effective post-retrofit maintenance and preventive care. in january 2019, emiratesgbc, in partnership with dubai supreme council of energy (dsce), published a benchmarking report on (dies) 2030, issued by dubai supreme council of energy in 2011, is to reduce the emirate's energy and water consumption by 30% by 2030. additionally, it promotes diversification of fuel sources to include clean coal, solar and nuclear energy. dsce developed a demand side management strategy (dsm) to supports dubai's energy and efficiency plan, with taqati serving as the dedicated program management office. in 2018, dsce officially unveiled the 'my energy, my responsibility 'campaign to encourage responsible behavior to reduce dubai residents' energy and water use. emiratesgbc's commitment to advancing net-zero buildings in the uae was done through a first-of-its-kind report. defining nearly zero energy buildings in the uae – 2017, which provides a definition for nearly zero energy buildings in the uae and highlights the challenges and opportunities for the development of net-zero facilities in the uae. in 2018, emiratesgbc formally established the net zero centre of excellence, a think tank and accelerator that provides a platform for the public sector, academia, civil society, and the private sector to learn and share net-zero knowledge buildings. to support net zero buildings' uptake in the uae, emiratesgbc signed a partnership agreement with the international living future institute to offer zero energy and zero carbon buildings certifications in the uae. in 2018, dsce launched a government-backed campaign, e-sayyara, under the dubai green mobility strategy 2030 to increase the number of electric vehicles driven by the private sector and residents in dubai. dubai electricity and water authority (dewa), the roads and transport authority (rta) provide incentives from 1 september 2017 to 31 december 2019 to encourage electric vehicles' public use, including free open vehicle charging, free assigned parking, and renewal fees, among others. in october 2018, dewa announced that it had completed the second phase of the ev green charger initiative, increasing its number from 100 to 200, helping to achieve dubai's carbon abatement strategic target of a 16% carbon reduction by 2021. the rta is in the process of converting 50% of dubai taxicabs to hybrid vehicles by 2021. they are also developing 900 kilometres of cycle paths per the dubai bicycle master plan. additionally, the dubai metro's red line is currently being extended to the dubai expo 2020. in 2018, dubai signed the c40's advancing towards zero waste declaration to cut the amount of waste generated by each citizen by 15% by 2030, reduce the amount of waste sent to landfills incinerate 50% and increase the diversion rate to 70% by 2030. since 2002, the clean-up uae campaigns, launched by emirates environmental group (eeg), has brought together individuals, families, and organizations from both public and private sectors to participate in cleaning, waste segregating and recycling campaigns. in 2018, dubai signed the c40's advancing towards zero waste declaration to cut the amount of waste generated by each citizen by 15% by 2030, reduce the amount of waste sent to landfills and incineration by 50% and increase the diversion rate to 70% by 2030. since 2002, the clean-up uae campaigns, launched by emirates environmental group (eeg), has brought together individuals, families, and organizations from both public and private sectors to participate in cleaning, waste segregating and recycling campaigns. the report forms part of dubai's commitment under the building efficiency accelerator (bea) program of undertaking a demonstrable project to accelerate the uptake of energy efficiency in the emirate by assessing and benchmarking the performance of hotel, school, and shopping mall buildings. under dubai's commitment to the bea, rsb ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4560 5 dubai is also developing an energy labelling scheme for hotels, offices, and residential buildings. one of the main objectives of the dubai integrated energy strategy dubai clean energy strategy (dces) 2050, launched in 2016, aims to provide 75% of the emirate's energy through clean energy sources and strives to make dubai a global centre of a green economy with the smallest carbon footprint in the world by 2050. one of the main pillars of dces is mohammed bin rashid al maktoum solar park, one of the region's most ambitious renewable energy projects. it will have an installed capacity of 5,000mw by 2030. to encourage installing micro-solar systems, dewa also launched its shams project to promote installing photovoltaic solar panels on residential and commercial buildings and generate electricity on-site. the uae energy strategy 2050, a federal initiative announced in january 2017, also aims to increase clean energy contribution to 44% in the total uae's energy mix by 2050. added to this are specific and projects launched during the last world economic forum. scale 360 is the first project that the emirates supported through a partnership to cut the amount of waste produced. scale 360 is affiliated with the platform for accelerating the circular economy. it aims to create new markets for circular goods, services, and revenue by surfacing, supporting, and connecting entrepreneurs and innovations through nationally led challenges and partnerships. the idea is to help them scale up solutions in collaboration with government ministries, impact investors, experts, and companies. another project is launched in ras al khaimah, where camel manure is used to produce fuel in the emirate's cement factories. since the project started in 2018, over 100,000 used 6,000 camel manure has been hijacked per fuel product, contributing to the consumption of 18,000 fuel costs as well as reducing the cost of fuel needed for the cement factory. in the process of change towards the circular economy, islamic finance and the contractual (blended murabaha) and social [63] characteristic elements are also considered, which can modify the business model at the micro-level, making it consistent with the economic approach [64]–[66]. starting from the circular economy's assumptions on dubai's policies, it is possible to identify first the distinctive aspects of the model. a recovery and recycling system has been adopted to manage waste better. this aspect is also linked to the sdgs 12 objective to guarantee sustainable production and consumption models which identifies the implementation in point 12.3 halve per capita global food waste at the retail and consumer levels and reduce food losses along production and supply chains, including post-harvest losses. the use of sharing platform is applied through partnership and scale 360, although to date, there is still no evidence of the impact of its adoption. the durability of the products used is focused more on building construction material than on consumer goods. there is no trace in the circular supply-chain policy that could be fully introduced in the country in association with the other planned adoptions. the extension of the life of the products has also not been fully defined in the policies adopted unless we refer to the material and type of buildings produced. nevertheless, the circular economy's adoption finds support in the application of the maqasid al-shariah model, especially if we consider the energy plan. human resource development, the presence of professionals dedicated to developing the energy plan, 1935 leed credentialed professionals (uae), and the building retrofit training plan (brt) programs are based on prosperity principles that also push individuals towards the human self. a rich country's opportunities to invest in its professionals enrich the economic microsystem and lead to a wealth of resident inhabitants. self is identified as a public investment aimed at growth in the energy technology adopted. the use of clean energy made up of micro-solar systems on buildings and mohammed bin rashid al maktoum solar park with a reduction in consumption by hotels, schools, and shopping centers encourages the policy's effect. social development is guaranteed by an almost entirely islamic population who base their actions considering the future longterm impact. this also falls on the exploitation of energy and the use of resources, which finds its foundation already in religious work. the development of the individual and financial means in support of the individual and businesses allows, thanks to religious principles, to set up a good social support system and development, which also brings with it the principles of circular economy envisaged by the policies of the emirate. the country's economic growth based on wealth and posterity is guaranteed in turn by the attraction of funds and by the investment of new technologies such as hybrid vehicles in line with wealth. efficiency in the use of resources with a reduction of carbon dioxide and the use of clean energy is also based on the principles of wealth and posterity. the removal of dependence on hydrocarbons is one of the keys of the private sector. it pushes towards a further development from that promoted by the linear economy by implementing a change in entrepreneurship, economics, and innovation. intellect and posterity are the principles applicable to this type of change. let's consider the 17 goals divided into 169 targets, although muslims are reluctant to identify goals not defined by non-muslims [67]. it is possible to notice several applications related to the circular economy and the maqasid al-shariah. the first goal, end of poverty in all its firms everywhere, finds application in supporting the poorest through religion and charity with zakah, also guaranteeing the principle of prosperity. the circular economy supports the principle thanks to a reduction in resources and the release of economic value. the second goal "zero hunger" is based on the principle of prosperity and guides in reducing waste. as we have already said, the four-goal quality education objective also applies through dedicated training programs linked to sustainability and the implementation of policies. goal four is based on the principle of prosperity and self. goal six, clean water and sanitation and goal seven affordable and clean energy are the two that finds the most support from the policies and is based on the prosperity and possibility of guaranteeing water for the primary needs of the human need in the future and a reduction of waste generated by fossil oil energy. as also highlighted the goal nine industry, innovation, and infrastructure find the complete application based on wealth and prosperity. the ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4560 6 whole approach is evident in goal eleven, aimed precisely at supporting the goals eleven sustainable cities and communities, the circular economy, platforms, twelve responsible consumption and production, thirteen climate action with the reduction of resources is in line with the principle of prosperity. the new model is described in the table 2. table ii. model of circular economy based on maqasid alshariah circular economy maqasid alshariah final model resources use of resources present in nature today[29]. enhancement of resources with a medium-long term perspective [8]. actions capable of mitigating food waste, resources (i.e. water). new models of green innovation. production sustainable production in accordance with available resources [43]. increased productivity with less use of resources. waste minimization [8]. new innovative business models that include business development to human, social and economic development. garbage use of production, processing and domestic waste [33]. enhancement for medium / long term wellbeing[8]. sustainability in accordance with sdg 9 on the industry with the management of waste wealth. training training aimed at sustainability (i.e. waste of food or energy) [29]. human development on issues of challenge and interest in the well-being of the community[20, pag. 7]. creation of highly specialized professionals on the circular economy and bearers of wisdom. food use of waste, even with sustainable production methods [29]. help for environmental and human enhancement through exchange platforms between capital gaining entities [4]. "zero hunger" objective with enhancement and targeted enhancement programs. v. conclusion the analysis conducted highlights that the emirate of dubai can be considered a social entrepreneur, aimed in many respects at developing the circular economy through the three pillars of the islamic faith [1]. the policy adopted from an environment value perspective increases health by decreasing pollution, natural resources, the maximum consumption of water and other energies. the economic value generated by a sustainable approach linked to the circular economy foresees the world to generate $ 4.5 trillion in additional economic output by 2030 in the world. if supported by adequate financial instruments, it can support the country's work and economic growth. the case study identifies the overlap and integration of two theoretical strands that support each other within the context, justifying the proposed model. the business model based on maqasid al-shariah will be able to mitigate environmental risks by increasing efficiency and productivity, green innovation, and innovative business models to reducing waste by minimizing the use of value. the circular economy model based on maqasid al-shariah involves human, social, economic, and environmental development. the strengths of the policy implemented by dubai include economic growth, innovative business models, increased competitiveness between professionals and companies, reduction of operating costs related to a reduction in materials, future sustainability of resources, increase in environmental conditions associated with the issue of co2, more significant relationships linked to a circular economy market that brings together the players through platforms and the creation of new jobs and highly qualified and specialized professionals. the circular economy based on the principles of maqasid alshariah could guarantee the achievement of sdgs 1,2,4, 6,7,8, 9, 11,12, 13 and 14. the study provides emirs and public governors of the gulf countries with a first theoretical and practical model that can lead to social, economic, and ethical impact and well-being for the population. the professionals involved in macro and micro areas can orient the system more towards circular economy processes, although a commitment and first virtuous results are already evident. the change in the economic and social ecosystem will take several more years to allow for real change, although several sdgs are currently being achieved thanks to the new policies. despite this, barriers to the circular economy's complete development are still identified, identifiable in the absence of circular supply-chain product life-extension also linked to consumer goods and not only to infrastructures. currently, the islamic finance system is a necessary criterion in the development of the circular economy. however, policies do not consider it as an element within the model development system. the same theory-based analysis approach can be conducted to other islamic states to highlight strengths or weaknesses adopted to implement the circular economy and sdgs. future studies will have to investigate more on what criteria the circular economy's application could be increased in light of the scientific evidence of the model and the reported impact. references [1] a. a. gümüsay, «entrepreneurship from an islamic perspective», journal of business ethics, vol. 130, n. 1, pagg. 199–208, 2015. ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4560 7 [2] v. j. sadeghi e p. p. biancone, «shariah compliant international entrepreneurship: a study of islamic finance in europe», european journal of islamic finance, vol. 8, 2017. 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[67] m. shinwell e g. cohen, «measuring countries’ progress on the sustainable development goals: methodology and challenges», evolutionary and institutional economics review, vol. 17, n. 1, pagg. 167–182, 2020. ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4560 10 http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 demystifying the theoretical framework of research in islamic finance: a review of literature nanik kustiningsiha,soesilowati soema atmadjab,syed alamdar ali shahc a stie mahardhika, indonesia. nanik.kustiningsih001@gmail.com b stie mahardhika, indonesia. atiekatma@gmail.com c universitas airlangga, indonesia. alamdar2000pk@yahoo.com abstractthis research takes insights into the research on islamic finance before and after the occurrence of financial crisis to rediscover its linkages with islamic socialism and capitalism across international boundaries to establish grounds of islamic finance theoretical framework. it takes extensive review of literature on islamic socialism, capitalism and islamic capitalism taking into account differences in practices of islamic finance in islamic and non islamic countries. research in islamic finance has great linkages with islamic socialism, islamic capitalism and capitalism as affected by the occurrence of financial crisis during the period of research. the originality value of this research work lies in the novel selection of period of research literature, and the discovery of theoretical framework in islamic finance research, “islamic socialistic capitalism”. key words: islamic socialism, islamic capitalism, capitalism, islamic socialistic capitalism jel classification: p16, p19,p27,p29 i. introduction: modern islamic finance has seen a major hump in the global financial markets during the last decade [2,44]. its application in more than 70 countries of the world in general and particularly in usa during the crisis of 2008 has shown its ability to protect institutions during the period of crisis [21,24]. this can be considered as a major turnaround for islamic finance industry, because until 2004 islamic finance was not very well accepted by western world mainly because of the strong uphold of riba in their economies [8,13]. one of the causes for sluggish growth of islamic finance in western economies is the fact that islamic literature failed to prove its legitimacy to be accepted as a new science that can establish as a new direction to in-practice phenomenon of “riba” [12,49]. the concept of market economy, based on the concept of competition between buyers and sellers, that has been on boom during is against the concept of “tazkia e nafs” (meaning controlling your unislamic and beyond means wishes) [13,49]. comparing the economies of mena region and western world, the reasons for such unacceptability have been found to be the difference in “free trade” and in the allowance of private entrepreneurship between two regions [1,48]. the concept of islamic finance has gained importance just in the last century after having been discussed for ages [9,23]. to be very exact it started its modern application in 1963, when an egyptian bank generated its earnings solely based on profit & loss sharing basis [40]. a concerted effort in this direction can be regarded as starting from the year 1973 when muslim countries resolved to establish a bank for development of islamic finance in muslim countries based on the principles of shariah [46]. this is marked as the first major step officially taken by the muslim states for promotion of islamic finance. the purpose of establishing a mechanism for development of islamic finance is also to disintegrate the flow of funds of muslims from institutions functioning on the basis of riba [28,42]. with this broad objective in perspective islamic finance authorities started developing islamic finance products that can match the conventional finance products but at the same time can also match the shariah requirements [7,40]. in the initial era of islamic finance industry the islamic financial institutions relied on three modes of islamic finance; mufawada (based on musharika & mudarba), murabaha (based on cost plus selling), and ijarah (based on the principles of leasing) [14,42]. the research conducted in first decade of the twenty first century shows unprecedented challenges for the growth of islamic finance on a number of grounds. firstly, it has to enforce its acceptability as a science that has been denied earlier. secondly, it has to design and introduce products that can meet the demands of modern day customers; and lastly but most importantly it has to survive the era of global financial crisis that might have eroded the islamic financial institutions like other biggies! the concept of islamic socialism is based on the combination of religious principles, anti capitalism and anti-imperialist politics taking its roots somewhat from russian revolution. its existence is normally discussed within the realm of political economy and economic systems; however, the literature on islamic finance shows that researches in this area are also widely affected by “arab nationalism” due to its roots from arab regions. concurrently, as modern financial systems basically have their roots in capitalism [38] and the latest developments in islamic finance are primarily modifying the conventional financial system products into islamic products [10,51]. therefore there is a need to reassess the path of ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 modern islamic finance. to have a holistic view of the progress of islamic finance literature in twenty first century, there is a need to carry out a survey of literature of islamic finance research. this is important because, the era starting from the year 2003 sets the direction of modern research in islamic finance after being neglected by the west [15,34]. accordingly we set the following research objectives for the purpose of our research:  to locate the roots of modern islamic finance research from various economic systems.  to determine the difference in the progress of islamic finance between muslim and non muslim countries.  ultimately, to find any new hidden theoretical framework that the islamic finance research. apart from the point of view of islamic research, the era 2003 to 2006 is also critical because of the fact that the financial crisis started immediately after it. hence, it will be very crucial to gauge the progress of islamic finance research in this era which will also help identify what factors have caused success to islamic finance in various parts of the world, and who have benefitted from it to heal; who to heal and develop; and who to develop straight away. in order to meet our objectives we have taken reviews of literature on of islamic socialism, capitalism and islamic capitalism from the works of prominent researchers in respective areas, and further have conducted a survey of literature of islamic finance research in different parts of the world on the following issues:  progress on islamic finance in muslim and non muslim countries and regions;  progress on the issue of corporate governance in islamic finance  progress on the issue of analytical methods in islamic the research on above issues have been made on islamic finance literature to figure out the answers to our following research question based upon our research objectives:  whether the research in islamic finance is affected by islamic socialism, capitalism and islamic capitalism simultaneously? as this is a pioneering research in this area hence this main question will be further explored with the help of following sub research question:  whether non muslim countries are taking more benefit out of islamic finance research than muslim countries?  is there any the new theoretical framework apart from islamic capitalism, islamic socialism and capitalism, being followed in islamic research? ii. literature review a. islamic socialism [31] working on the roots of arab socialism terms it as a root cause of islamic socialism. in his work he points that islamic socialism has its roots stemmed in the essays of jamal ud din afghani’s essays written between 1892 to 1897. however, in modern age it got its roots from russian revolution’s antiimperialist politics as well. according to [17, 31] distinct from absolute socialism, afghani’s school of thought for islamic socialism involves the materialists and bigoted divines as well. summing up, in modern age islamic socialism refers to a socioeconomic system that takes its basic roots from the teachings of the holy quran, ahadith and gets its development roots from arab nationalism, anti-imperialism, and anti colonialism with shades of democracy of public mandates as well [5,16]. b. capitalism historically it is a system in which economic activities are controlled by the private owners with the objective to maximize their wealth [9,36]. over the years capitalism has taken many forms that include laissez-faire capitalism, welfare capitalism and state capitalism all of which have three common bases namely, public ownership, social policies and market freedom which are important functions of an islamic economy as well [53]. however, in recent times the supporters of capitalism have changed this term affected by the ideas of karl marx, into “free enterprise” or “private enterprise” and the term “capitalist” has been changed with “investors” or “rentiers” [55]. b. islamic finance a. literature on progress of islamic finance in various countries [48] who compares the economy of mena region with usa, european and central asian states opines that mena countries take more time to establish and close businesses, lack hr processes and have higher quantum of informal markets which mark them with low economic development. [5,54] points that adaptation of basel principles into islamic finance system is merely accounting based and therefore requires more improvement. [11,19] point that the progress made in uk even until 2004 was great while the germany was in infancy stages. they stressed the need of islamic finance research and development in financial engineering and credit products trading as well. conducting a qualitative study for implementation of islamic banking in south africa in the year 2005, [22] states that it is in very early stages of development. there was a lot required to be done for promotion of islamic finance education, islamic finance boards, islamic finance research institute and development of local standards. [45] while discussing the challenges of islamic finance in usa argues that it can prosper in the region rapidly if research can be made to work out terms and conditions to extend bank credit to non muslims. [35] narrates that islamic finance in turkey plays the role of political economics more than economic development. [11,47] argues that in bahrain and malaysia debt based products for instance, products based on murabaha and bay` bi al-thaman al-ajil dominates the application of islamic finance. ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 discussing applications of islamic finance in lebanon and comparing it with other countries in mena region [18] argues that islamic finance regulations have been introduced in the country in year 2004 however, until 2006 the country had not made significant progress because of some legal issues. for promotion of islamic finance he argues that the country authorities are required to offer incentives to investors to set up islamic financial institutions and islamic research bodies. also long terms islamic securities, primary and most importantly secondary markets are required to be established. [12,26] in his research for the period upto the year 2006 in usa states that islamic financial institutions are losing their moral ground to compete because most of their products are debt like instruments which are mostly based on conventional financial benchmarks. for this reason many conventional finance institutions have also started to adopt islamic finance because they see very few operational differences. [52] while conducting a research on islamic project finance in canada indicate that for its faster development government guarantees are required. [4] while discussing islamic finance in australia argue that although islamic finance is making progress yet it was not governed by the australian regulatory authority. in giving recommendations to promote islamic finance in australia, [6] suggest more government involvement, international connections and research & development. [3] argue that australian government need to enact through parliament to make islamic finance competitive to practice even in the uk model. b. literature review about analytical methods [33,50] in their research indicate that an attempt to converge islamic and western economics schools of thoughts on western methods and study references alone is not justifiable. using their approach based on set theory they opined that islamic economics mechanism is a vital distinctive approach of managing life based on the concept of quran and ahadith, therefore it has its own systematic mechanism to provide analysis and solution of economic problems. [49] opines that islamic economics is although a separate phenomenon yet it is far less than the standards to be considered as a science merely on the basis of not dealing in interest. discussing, the performance appraising of islamic and conventional banks [19,52] find that performance measurement of islamic banks is altogether different and hence should be measured on the basis of cost, technical, allocative, scale, and pure technical efficiency scores and not on the basis of conventional accounting ratios. also [32] finds that islamic financial institutions perform better in countries were the society is altogether islamic like, iran, saudi arabia, sudan. [6] in their ice breaking research on time value of money in islamic environment state that in islamic finance matters the adjustment of time value of money is purely dependent upon return on trade and/or business capital; and no addition in the value of money is allowed after it has been created once. c. literature review about corporate governance issues in islamic finance [37] discussing on the concept of governance argues that islamic finance has been proven to be a vehicle for the implementation of islamic economics principles, which is making its way to emerge as a power house to enforce shariah anywhere around the world wherever the islamic finance will be practiced. discussing about research and development [25,41] in their research about fundamentals of interest in islamic realm points that most of the islamic banking products are debt like instruments e.g., murabaha, which is not an ideal scenario even according to islamic ideology. [41] further argues that promulgation of islamic finance is in fact is based upon existence of islamic society until which no significant progress in shariah compliance can be witnessed. the crux of [41] research is to encourage research in islamic finance based on no exploitation and not on riba free. [4] while conducting a research on islamic banking sector find that islamic finance being practiced is almost like having conventional banking under islamic names. the products used are debt based like ijarah, and murabaha [39]. [51] acknowledged that muslim researchers lack appropriate contemporary skills to analyze complex macroeconomic situations. islamic economics primarily lead by islamic finance should be developed on altogether different lines with greater maqasid (objectives) of shariah in mind and not maximization of material benefits [20,51]. they not only advise a periodic review of islamic products, but going one step further they advise revision of global monetary system for a broader perspective of shariah compliance. realizing the growth potential of islamic finance in 2006 world bank issued three documents on corporate governance numbered [28,29,30] that deal with challenges faced by islamic financial institutions and protecting interests of their stakeholders. these documents focus that all countries practicing islamic finance should develop indigenous regulations to smooth shariah compliant operations competitive with the conventional counterparts both on financial and non financial basis. commenting on the issue of governance [43] argues that there exist huge differences in the practices of islamic finance all over the world which is also causing hindrances in its across the board acceptability and development of universal islamic financial markets. he suggested introduction of “group ijtihad”, which brings people all around the globe together to settle the issues in practices of islamic finance. c. islamic capitalism according to [22] this term may sound awkward for the practitioners of islamic finance in many islamic countries, however, the fact is that it exists and takes back its roots from the period of prophet (pbuh) and his caliphs (r.a.) afterwards. the prophet (pbuh) himself used to conduct business and the caliphs after him abu bakar (r.a) and usman(r.a) were both traders as well [22]. a critical close analysis of literature on islamic business practices during the early days of islam and its comparison with modern capitalism shows that both these economic systems have three major ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 concepts in common namely: good governance, enforcement of contracts and protection of property rights, upon the basis of which we can form further rules of islamic capitalism [22]. iii. conclusion the period of 2003 to 2006 seems to be a take off period for islamic finance. this is because islamic finance started to attract the world based on “interest based economies” [8]. a review of literature on various aspects shows that many economies of the world have started skewing towards islamic finance [7,27]. the concepts of corporate governance got strengthened and rules on it formulated even by the world bank. various non muslim countries like germany, australia, uk, and usa recognized its potential and made legislation for its smooth progress. even muslim countries realized the need of attending the call of time and started making appropriate adjustments in their economies to foster results for optimum utilization of islamic finance potential. discussing about the competitive performance environment of islamic and conventional financial institutions it has been observed that islamic financial institutions perform better in an islamic society than in conventional societies, therefore promotion of islamic values in daily practice are more important. keeping in view this phenomenon islamic financial institutions working in non muslim societies, or even to deal with non muslims, have to devise products which are suitable for their individual requirements and societies. the debate about the legitimacy of time value of money within the realm of islamic finance has also been clarified that its adjustment is allowed only in the case of trade transactions and not in the case of merely lending of money in which case it only becomes a matter of changing wealth from hand to hand without any real significant economic contribution. discussing about the role of state for promotion of islamic finance it is recommended that the governments should come forward to guarantee the provision of finance to investors to promote economic development in respective economies. in a nutshell we can opine that researchers of islamic finance are asking much bigger role of research bodies, states and global regulatory financial bodies like world bank and imf to promote the financial institutions working under the realm of islamic finance. however, as identified the islamic finance that emerged in practice in most of the countries is more following the path of conventional financial institutions by introducing a majority of debt based products. in this way in a sense islamic financial institutions have started to diverge from the realm of capitalism, with a cover of shariah compliance, towards “islamic capitalism” characterized by mixture of elements of capitalism and pure islamic thought [22]. the emergence of concept of government patronage and guarantees and extended role of islamic financial institutions is required for the betterment of society, and corporate governance. in this way the elements of islamic socialism have penetrated into islamic capitalism making the path towards “islamic socialistic capitalism”. accordingly, by virtue of being stemmed from arab regions and adopting the route of islamic capitalism, islamic finance research seems to have developed the theoretical framework as mentioned in the figure. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 figure : theoretical framework of islamic socialistic capitalism: socialism islamic system based on quran and ahadith capitalism islamic socialistic capitalism islamic capitalism antiimperialism arab nationalism , anti colonialism democracy islamic socialism ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 iv areas of further study in this research work we 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(2004). capital regulation on islamic banking online accessed: from http://fis.uii.ac.id/images/al-mawarid-edisi-xi-200401-suseno.pdf. ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 55]. williams, r. (1983). capitalism. keywords: a vocabulary of culture and society, revised edition. oxford university press. p. 51. isbn 0-19-520469-7. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 analysis of the transmission asymmetry of monetary policy in a dual banking system: econometric modelling (case of turkey) abstract—the purpose of this research is to analyze the transmission mechanism of monetary policy in a dual banking system, composed of both islamic banks and conventional banks, highlighting the factors that may influence behavior of banks on the impact of monetary stimuli on their rates. in this context, an econometric model that examines the effectiveness of transmission of monetary policy in a dual banking system by advocating the hypothesis of asymmetric transmission of monetary policy was developed and tested. to answer the research problem, the adopted methodology is based on the vectoriel autoregressive (var) model, which is not only explanatory but also predictive. the different results obtained through the empirical investigation carried out are discussed by exposing their methodological and theoretical implications. keywords-component:policy, transmission asymmetry, islamic bank, conventional bank, central bank. i. introduction islamic finance emerged a few decades ago as a new financial system whose conceptualization is built around the integration of the ethical dimension into financial dynamics. nevertheless, despite the development of islamic finance thanks to its financial transparency, it was not spared the flaws and limitations that compromise its success or at least weakens it. indeed, the implementation of a chariâa-compliant monetary policy is one of the major challenges to be met because of the scarcity of monetary policy instruments while remaining faithful to the principles of the shariâa, particularly for economies that have adopted a dual banking system such as pakistan, malaysia and indonesia where the central bank should conduct monetary policies influencing both conventional and islamic banking systems, in order to effectively influence the overall macroeconomic situation. in this context, the main objective of this research is to analyze the transmission of monetary policy in a dual banking system, composed of both conventional banks and islamic banks, through the bank loan, taking into account the impact of certain factors, notably bank liquidity and market structure, on the banks' behavior with regard to the transmission of monetary impulses on the interest rate. this study aims to test the validity of the transmission of monetary policy impulses to bank retail rates in a dual banking system by providing empirical evidence on this issue. to achieve this goal, this study compares the impact of monetary policy shocks, represented by interest rate shifts, to the major balance sheet positions of islamic banks vis-à-vis traditional banks. moreover, while most of the existing literature in this area focuses on the implementation of monetary policy through so-called conventional policy instruments, this research offers a new dimension in assessing the impact of policy shocks in a dual banking system. such perspectives would allow us to draw several conclusions about the stability and viability of islamic financial instruments for the implementation of monetary policy. another aspect of the novelty of this study is in terms of the methodology employed. in fact, this study adopts several econometric investigation techniques to come to conclusions about this issue. in this regard, the study contributes to enriching the empirical literature in the field of monetary policy transmission in a dual banking system. following the results obtained, our article will be developed as follows: the first and second sections will be dedicated to the presentation of general information concerning the development of the islamic banking sector in turkey by maha radwan (ph.d.) 1, salma drissi (ph.d.) 2 1 department of management, university of turin, italy. email: maha.radwan@unito.it 2 laboratory of research in performance management of public, private organizations and social economy, university ibn zohr, morocco. email: mailto:maha.radwan@unito.it ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 highlighting the historical aspect of the establishment of the islamic finance and reviewing the literature review related to the analysis of the transmission mechanism of monetary policy in a dual banking system. section 3 describes the nature of the data and the methodology used in this study. section 4 and 5 present the empirical results. finally, the last section will be dedicated to the presentation and discussion of the main results obtained through this study. ii. overview of the développement of islamic banking industry in turkey the last decades have been characterized by sustained economic growth, where the financial system has played a crucial role. banks have been at the center of this development and have undergone a profound change. nevertheless, this period was also characterized by the appearance of a higher number of financial crises [29], [8]. indeed, the recent global financial crisis is described as the most significant in the history of global finance for the simple reason that it has weakened the financial system to create a global economic crisis. in the wake of the crisis, new mechanisms have been introduced to rethink financial stability, such as: the introduction of new banking control standards, the limitation of excessive risk-taking, transparency, and the adoption of a new management discipline. it is in this context that islamic finance is imposed through its fundamentally moral character distinguished by its financing techniques, based on participation and its principle of sharing profile and loss, can help to establish financial discipline and stability [28] ,[15]. this industry in full expansion is growing surprisingly fast. since its inception thirty years ago, the number of islamic financial institutions in the world has grown from one in 1975 to more than 300 today in more than 75 countries [30]. moreover, where islamic banks operate, their field of activity varies greatly: in some countries, the sector is entirely islamic (iran and sudan); in others, the two systems coexist (united arab emirates, indonesia, malaysia and pakistan) [31]; and in still others, there is only one or a few islamic banks such are the case of turkey. indeed, so-called "contemporary" islamic finance has existed in turkey for more than 30 years. in reality, the ottoman empire has imposed funding in accordance with islamic law. however, the secular republic of turkey ended, from 1923, the islamic legislation in force (sharia) and banned any form of religious reference, especially islamic, movement which for decades resulted in restrictions to freedom of religion [6]. however, in recent years, the government has allowed the turks to draw inspiration from their "glorious" past. this return to the sources has given an increasingly solid legal basis for islamic financing. the history of the islamic banking in turkey started more precisely in 1983 when, in order to attract more capital from the middle east, the government created a new legal framework allowing islamic banks to operate in the country side by side with conventional banks [18]. in the beginning, islamic banking institutions were named in the banking legislation of the "special finance companies" that we quote: al baraka, kuveyt türk, faisal finans, anadolu finans, ihlas finans and asya finans. however, these banks did not enjoy the same status as conventional banks, as they were not allowed to invest in government securities and were not covered by the deposit guarantee scheme of the turkish central bank (hardy, 2012). this regulatory framework was subsequently improved in 1999 and again in 2001, and in 2004; the government extended its deposit guarantee to special financing companies. a year later, the publication of a new banking law marked a new turning point. indeed, special financial institutions are now referred to as "participatory banks". while this law does not at any time refer to islamic law or the prohibition of interest. participatory banks and conventional banks are therefore treated on an equal footing. moreover, this banking law defines certain islamic credit operations or the participatory account by referring to the principle of sharing of losses and profits. between 2014 and 2015, the islamic banking sector faced another internal difficulty. it was no secret that bank asya, the market leader, had a direct relationship with the gulenist movement and that a considerable number of deposits had been withdrawn by the public because of hostile actions of the gulenists against the government at the end of 2013. subsequently, bank asya refused to share information about its preferred shareholders and its control was transferred to the deposit insurance fund, which significantly disrupted the islamic banking sector and significantly reduced its total market share. while bank asya's disenchantment has had a negative effect on the upward trend, the entry of two large state-owned banks into the sector should put this trend on the right track. these are ziraat participation bank in 2015 and vakıf participation bank in 2016. the historical process of the participation bank in turkey is presented in table1. table i. : historical process of participation banks in turkey date process activity status 1983 issuance of the decree no. 83/7506 of the council of ministers for the establishment of special finance houses status of special finance houses was transferred into status of participation banks in 2006. 1985 establishment of albaraka türk special finance house it continues to operate as albaraka türk participation bank. 1985 establishment of faisal finans special finance house the name of the bank was changed as family finans special finance house in 2001. it merged with anadolu finans special finance house in 2005 and the name of the bank was changed as türkiye finans participation bank. it continues to operate under the same name. 1989 establishment of kuveyt türk special finance house it continues to operate as kuveyt türk participation bank. 1991 establishment of anadolu special finance house it merged with family finans special finance house in 2005. 1995 establishment of i̇hlas special finance house it was liquidated in 2001. 1996 establishment of asya finans participation bank it was transferred into saving deposits insurance fund in 29 may 2005 and liquidated in 22 ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 july 2016. 2005 establishment of türkiye finans participation bank it is established in 2005 with the merger of family finans special finance house and anadolu special finance house. 2015 establishment of ziraat participation bank it continues to operate. 2016 establishment of vakıf participation bank it continues to operate. source : (buğan, 2015) and (varsak, 2017) at present, only five participating banks have remained in turkey to coexist with 47 conventional banks and banks, namely the albaraka türk holding bank, the kuveyt türk holding bank, the turkish participation finans, vakıf holding bank and ziraat bank. figure 1. evolution of the number of banks by type in turkey source: banking regulation and supervision agency december 2018 iii. literature review before you begin to format your paper, first write and save the content as a separate text file. keep your text and graphic files separate until after the text has been formatted and styled. do not use hard tabs, and limit use of hard returns to only one return at the end of a paragraph. do not add any kind of pagination anywhere in the paper. do not number text headsthe template will do that for you. the analysis of the transmission mechanism of monetary policy in a dual banking system represents a new theme in academic research in monetary and banking economics. recent literature has revealed that the transmission mechanism of monetary policy in a dual banking system may have a different impact depending on the type of bank which may affect the effectiveness of monetary policy [21]; [7]; [2] and [25]. indeed, several authors have examined the conduct of monetary policy in a dual banking system by analyzing the contribution of the financial sector in the transmission of monetary policy found that the behavior of conventional banks in the pass-through of monetary impulses on their rates may be completely different from their islamic counterparts [17]; [23] [24]. according to (sukmana & kassim, 2010), the transmission of monetary impulses to the real economy can be carried out through several channels, such as interest rate, credit, asset price and exchange rate channels [25]. the relative importance of a particular channel in the transmission of monetary policy generally depends, inter alia, on the structural features of the economy. for example, a very open economy where the foreign trade sector plays a crucial role in the creation of economic activity could opt for the exchange rate channel. similarly, a country that relies heavily on the economic activity of the bank may find that the lending channel is the most appropriate for the transmission of monetary policy. moreover, for countries adopting a dual banking system, the bank loan channel occupies an important place in channeling the effects of monetary policy. several authors like [16] & [20] have supported the use of this transmission channel especially for economies with two banking systems. these authors used rigorous econometric techniques that yielded detailed and conclusive results about the role of the bank lending channel in the transmission of monetary policy among countries adopting a dual banking system. in addition, a good number of research studies show that the impact of a change in monetary policy on conventional banks is less intense than for islamic banks, which means that islamic banks are more sensitive in terms of pass-through monetary shocks on these financing rates [12]; [13] and [14]. although the nature of financial intermediation is one of the essential elements of this difference in response to the transmission of monetary policy in a dual banking system, the theoretical and empirical literature highlights the existence of other factors that may explain this resilience of the banking sector to monetary shocks, including bank liquidity, size, capitalization and / or market structure. the first work in this area is done by kashyap and stein (1995). by examining disaggregated balance sheet data, the two authors compare the sensitivity of the supply of credit following a monetary shock according to the size criterion. they deduced that smaller banks exhibit less rigidity in the face of a monetary policy shock [19]. in other works, kashyap and stein (1997) examine this time the impact of banks' liquidity in relation to the transmission process of monetary policy, they deduced, whereas the liquidity criterion is decisive in explaining the behavior of banks face a monetary shock so that less liquid banks are more sensitive to monetary policy shocks. by pressing, the results of kashyap and stein [22] authenticate the role of bank size and liquidity in the transmission of money. for studies on african countries, we find the work of [4] having examined the impact of monetary shocks on banking behavior for morocco, jordan, tunisia and egypt. they concluded that, at jordanian level, only size can affect the rate and magnitude of transmission. as for morocco, tunisia and egypt, the liquidity and the size of the banks impact respectively the transmission of monetary shocks. competition also affects the process of transmitting key rates at bank rates. in fact, the competitive intensity between banks impacts the adjustment of bank rates following changes in the monetary policy of bank rates following changes in monetary policy. indeed, by seeking to mitigate the repercussions of a monetary shock, banks adopt a credit control strategy to protect the quality of their portfolios. in the event of a monetary shock, the ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 banking institutions decide not to pass on the increase in the cost of refinancing on their rates which neutralizes the effect of the shock on the rates. on the other hand, they will deprive the volume of the credit granted to neutralize the increase of the cost of liquidity. competition can still influence the quality of the transmission of monetary policy. for [10], the degree of competition between banks leading to a more or less complete adjustment of rates of detail. differences in the nature of financial intermediation institutions may again be one of the factors explaining the asymmetry of transmission of monetary policy in a given economy. these are dual banking systems that consist of both conventional and islamic banks. over the last thirty years, islamic banks have been gradually introduced in several countries side by side with conventional banking institutions. that said, financial and monetary relations, in a dual financial system, must be organized and conducted in such a way as to take into account the distinct nature of this finance, in particular, in relation to the transmission of monetary policy [28], [11]. however, few studies have examined the transmission of monetary policy in a dual banking system by taking into account the previously cited factors to justify the asymmetry of transmission noted in systems encompassing both conventional banks. and islamic banks [1] & [9]. in this context, we seek, through the present work, to empirically explore the transmission of monetary policy in a dual banking system via the bank loan channel through a comparative analysis between the behaviors of conventional banks versus islamic banks visà-vis banks variability of monetary policy to justify the asymmetry of reactions to monetary shocks. this asymmetry will be examined using autoregressive models, in particular vecm's estimation of the behavior of islamic banks and conventional banking groups to estimate the responses of banks to monetary shocks. iv. data and methodology a. data define abbreviations and acronyms the first time they are used in the text, even after they have been defined in the abstract. do not use abbreviations in the title or heads unless they are unavoidable. as noted above, the econometric model under study relates the selected macroeconomic, financial and structural explanatory variables in order to assess the behavior of islamic and conventional banks in the context of a comparative study on the attribution of changes in money market rates to their borrowing rate. the monetary policy variable is represented by the interest rate, in this case the money market rate, henceforth designated by on. the choice of the on to represent the monetary policy variable in the case of turkey is justified by the fact that by examining the empirical studies analyzing the transmission of monetary policy in a dual banking system, the authors opt for the interbank market as a proxy for the monetary rate. at the same time, the objective variables include the balance sheet items of islamic banks and conventional banks, namely total islamic bank financing (cti) and total conventional bank borrowing (ctc), as well as total loans from the banking sector ( ct). other objective variables are the consumer price index (cpi) and the industrial production index (ipi). the impact of the structure of the banking industry on the transmission of the policy has often been examined through the effects of the monetary shock on interest rates and the quantity of credit. to measure bank concentration at the national level, the choice was made on the herfindhal-hirschman (hhi) indicator, which is often used to obtain complete information on the market shares of all banks in the sector. to measure the bank liquidity relative to the two types of islamic and conventional banks, two different indicators are taken into account. to measure the liquidity of conventional banks, the asset liquidity ratio option appears to be an indication of the liquidity available to deal with expected or unexpected requests from rated cash (ci). regarding the liquidity of islamic banks [27] have proposed a proxy for the calculation of short-term liquidity that can be used for islamic banks the short-term funding ratio (stfr) noted (il). we built a monthly database for the 2007-2015 period constructed from aggregated banking data, islamic banks as well as conventional banks in order to examine the differences in banks' responses to monetary shocks. the collection of banking sector data, monetary policy guidelines and macroeconomic variables are based on statistics and annual reports of central banks and reports of the international monetary fund. b. methodology the current research is part of a series of research studies aimed at studying the transmission of monetary policy through the bank loan in a dual banking system that assumes the cohabitation of islamic banks with conventional banks and banks. the impact of a monetary shock on the supply function of these last two by identifying the variables likely to influence the sensitivity of the banks in the face of a monetary shock. to this end, and to test the hypotheses of the research, it is advisable to opt for a modeling on data in time series relating to the banking sector of each country composing our sample. indeed, any econometric modeling work that is based on time series requires the examination of two basic conditions to avoid any fallacious regression; it is mainly, the verification of the assumption of normal distribution of the variables and that of their stationarities. thus, we used the enhanced dickey fuller test to check the stationarity of each variable by retaining the t-statistic of the test and its probability. the results of the test will be summarized in the table below where it appears that the cpi and ipi variables are stationary at level. the variables itc, cl, il, on, hhi are stationary at first difference and the stationary ct and ctc variables at the second difference at a threshold of 1%. ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 to test the normality of the variables, the jarque berat test and the "skewness" and "kurtosis" coefficients were recommended. the results of the normality test for turkey indicate that, apart from cl and cpi, the normality assumption is invalidated. according to the results of the normality test, it turns out that the majority of the series do not follow a normal distribution and that the series are not stationary with the same order. thus, we cannot resort to estimating the econometric model by ordinary least squares. at present, the objective is to examine the direction of evolution of the time series of the variables related to islamic banks and those of conventional banks. the examination of this evolution is to check if it is kept stable in the long term. from an empirical point of view, cointegration analysis makes it possible to identify the existence of a number of linear combinations that can be interpreted as possible long-term equilibrium relationships. in other words, the analysis of cointegration makes it possible to study non-stationary series, but of which a linear combination is stationary. it allows stable long-term relationships to be specified while simultaneously analyzing the short-term dynamics of the variables considered. the offset length of all the models is selected according to the information criteria akaike the akaike criterion (aic), the hannan-quin criterion (hq), the schwaz criterion (sc) and that of forecast prediction error (fep). the results of the test indicate that for the turkish conventional banks, the number of delays retained is 2, while the number of delays set for the turkish islamic banks is 4. v. estimation of econometric models of the turkish banking system a. estimation of econometric models for turkish conventional banks after specifying the different models and the number of cointegration relationships for each. now it is time to identify the long-term and short-term relationship between bank rates captured by both the interest rate for conventional banks and the financing rate for islamic banks as well as the investment tool. the monetary policy presented by the monetary rate, the balance sheet variables (bank liquidity ratio) and the market structure captured by the herfindahl-hirschman concentration index. the table below presents the results of the estimation of the coefficients: table ii. econometric estimation of the model of turkish conventional banks source: personal results deducted from eviews the equations are an exception to the prescribed specifications of this template. you will need to determine whether or not your equation should be typed using either the times new roman or the symbol font (please no other font). to create multileveled equations, it may be necessary to treat the equation as a graphic and insert it into the text after your paper is styled. the equation of the long-term relationship between the conventional interest rate and the different variables is thus: coefficient std. error t-statistic prob. c(1) -0.060703 0.045315 -1.339590 0.0183 c(2) 0.016146 0.023604 0.684045 0.4958 c(3) -2.75e-06 2.39e-06 -1.151388 0.2528 c(4) 0.187663 0.110306 1.701292 0.0925 c(5) 0.006451 0.101101 0.063808 0.9493 c(6) 0.441873 0.117170 3.771220 0.0003 c(7) 0.015671 0.127995 0.122434 0.0328 c(8) 1.99e-05 1.50e-05 1.330302 0.1870 c(9) -1.73e-06 8.91e-06 -0.194126 0.8465 c(10) -2.08e-05 1.81e-05 -1.152742 0.0252 c(11) -1.59e-05 2.55e-05 -0.623307 0.0348 c(12) 0.008865 0.035545 0.249404 0.0037 c(13) -0.007406 0.035722 -0.207318 0.0363 c(14) 9.61e-05 8.85e-05 1.086537 0.2803 c(15) 2.12e-05 6.20e-05 0.341446 0.7336 c(16) -0.052969 0.113770 -0.465582 0.6427 c(17) 0.008276 0.093305 0.088698 0.9295 c(18) 0.001731 0.001845 0.937929 0.0365 c(19) -0.000540 0.001406 -0.384089 0.0419 c(20) 0.032956 0.243197 0.135513 0.8925 r-squared 0.506163 mean dependent var -0.057314 adjusted r-squared 0.273423 s.d. dependent var 0.818167 s.e. of regression 0.697401 akaike info criterion 2.286732 sum squared resid 41.34133 schwarz criterion 2.792248 log likelihood -100.0534 hannan-quinn criter. 2.491577 f-statistic 3.059839 durbin-watson stat 1.994790 prob (fstatistic) 0.000221 ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6      the model is illustrated through this equation, which reveals the long-run relationship between the conventional interest rate and the model variables. statistically, the model is robust since the r-squared exceeds 50% bound by the verification of the assumptions of the normality of the residues, their autocorrelations and the hypothesis of heteroscedasticity which reveal that the model is valid statistically. b. analysis of results (review of short and long-term dynamics) error-correction relationships embody the joint combination of long-term and short-term relationships. in the middle of these two relations is the coefficient of return which is worth in equation 1 of the model (-0.060703). this value represents the rate of adjustment of the bank interest rate following a monetary shock. the restoring force a = (-0.060703) <0 also means that when a variable at time t deviates from the long-term equilibrium, the return speed after this difference (shock) is 0.060703. in a simpler way, if there is a shock on the long-term equilibrium, it would take exactly 16.47 months (1 / 0.060703) to return to the equilibrium situation. it should be noted that this gap period between the occurrence of a shock and the return to a stable long-term equilibrium is relatively shorter compared to conventional banks. with regard to the short-term dynamics, this one is established using the wald test to verify the existence or not of a short-term relation between each of the variables and ic. thus, according to the table displayed, the conventional interest rate holds a short-term relationship with the variables (monetary rate, total conventional credit, and liquidity of conventional banks and the concentration index of the banking market). in fact, the probability of acceptance of the null hypothesis is 5%. table iii. result of the wald test on the existence of a shortterm relationship between the conventional interest rate and the model variables. the variables ic conventional interest rate probability on (monetary rate) exists a short term relationship 0,0013 ctc (total conventional credit) exists a short term relationship 0,0476 cl (the liquidity of conventional banks) exists a short term relationship 0,0490 hhi (concentration of the banking market) exists a short term relationship 0,0116 ipi (index of industriel production) does not exist a short term relationship 0,5069 cpi (consumer price index) does not exist a short term relationship 0,8023 source: personal results deducted from eviews c. estimation of econometric models for turkish conventional banks the same approach is followed for the islamic banking pole where the model obtained is thus: table iv. econometrica estimation of the model of turkish islamic banks coefficient std. error t-statistic prob. c(1) -0.100368 0.098685 -2.618119 0.0110 c(2) -0.039055 0.037174 -1.050602 0.2973 c(3) 3.75e-06 1.38e-06 2.722601 0.0083 c(4) -0.042020 0.136756 -0.307260 0.7596 c(5) 0.300548 0.143418 2.095602 0.0400 c(6) 0.053376 0.164991 0.323508 0.7473 c(7) 0.169850 0.135963 1.249238 0.2160 c(8) -0.081898 0.084696 -0.966974 0.0371 c(9) 0.147252 0.089454 1.646113 0.0145 c(10) -0.089475 0.101003 -0.885860 0.0389 c(11) 0.258119 0.097428 2.649340 0.0101 c(12) 2.16e-05 8.69e-06 2.487610 0.0154 c(13) -1.58e-05 8.67e-06 -1.817792 0.0736 c(14) -1.55e-05 8.60e-06 -1.799333 0.0765 c(15) -2.84e-05 7.78e-06 -3.657613 0.0005 c(16) -2.46e-05 0.000122 -0.200685 0.0416 c(17) -0.000143 0.000131 -1.091542 0.0270 c(18) 5.02e-06 0.000127 0.039438 0.0187 c(19) 4.59e-05 0.000119 0.386952 0.0300 c(20) 0.002553 0.001797 1.420493 0.0196 c(21) 0.001965 0.001668 1.178242 0.0429 c(22) 0.003143 0.001420 2.213267 0.0303 c(23) 0.000869 0.001135 0.765710 0.0466 c(24) 0.128023 0.132766 0.964276 0.3384 c(25) 0.100278 0.111651 0.898138 0.3724 c(26) 0.109273 0.087645 1.246777 0.2169 c(27) 0.014934 0.072916 0.204813 0.8383 c(28) 4.58e-05 0.000114 0.400000 0.6904 c(29) -1.33e-05 8.74e-05 -0.152663 0.8791 c(30) -4.53e-05 7.43e-05 -0.610086 0.5439 c(31) -3.52e-05 4.95e-05 -0.711040 0.4796 c(32) -0.025609 0.067299 -0.380520 0.0048 c(33) -0.169599 0.083721 -2.025767 0.0468 c(34) -0.175791 0.080871 -2.173709 0.0333 c(35) -0.061805 0.073914 -0.836180 0.0401 c(36) 0.074716 0.144211 0.518104 0.6061 c(37) 0.008504 0.003020 2.816114 0.0064 rsquared 0.629259 mean dependent var 0.01494 4 adjusted rsquared 0.427037 s.d. dependent var 0.62314 6 s.e. of regressio n 0.471686 akaike info criterion 1.60836 6 sum squared resid 14.68419 schwarz criterion 2.55482 2 log likelihoo d -45.83086 hannan-quinn criter. 1.99171 3 f-statistic 3.111721 durbin-watson stat 2.04753 5 prob (fstatistic) 0.000032 source: personal results deducted from eviews ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 the equation of the long-term relationship between the islamic financing rate and the different variables is thus: (if) = -0.100368* ( if(-1) + 5.50519424415e-05 * itc(-1) + 0.0297623318507 * hhi(-1) + 6.47462623409 * cpi(-1) + 0.00109689185527 * ipi(-1) + 0.246522330064 * il(-1) 0.0747025810944 * @trend(07m01) 156.385106538 ) (2) statistical analysis of these results reveals that the model is statistically robust as r-squared exceeds 60% and verification of the hypotheses of normality of residues, their autocorrelations and the hypothesis of heteroscedasticity revealed the validity of the model. d. analysis of results (review of short and long-term dynamics) error-correction relationships embody the joint combination of long-term and short-term relationships. in the middle of these two relations is the coefficient of return which is worth in equation 2 of the model (-0.100368). this value represents the rate of adjustment of the bank interest rate following a monetary shock. the restoring force a = (-0.100368) <0 also means that when a variable at time t deviates from the long-term equilibrium, the return speed after this difference (shock) is 0.100368. in a simpler way, if there is a shock on the long-term equilibrium, it would take exactly 10 months (1 / 0.100368) to return to the equilibrium situation. note that this gap between the occurrence of a shock and the return to stable long-term equilibrium is relatively shorter compared to conventional banks that need 16.47 months. with regard to the short-term dynamics, this is also established using the wald test to check whether or not there is a short-term relationship between each variable and fi. thus, according to the table displayed, the islamic financing rate holds a short-term relationship with the variables (monetary rate, total credits of islamic banks, liquidity of islamic banks and the concentration index of the banking market). in fact, the probability of acceptance of the null hypothesis is 5%. table v. result of the wald test about the existence of a short-term relationship between the islamic financing rate and the variables of the model. the variables if islamic financing rate probability on (monetary rate) exists a short term relationship 0,0218 itc (total islamic credits) exists a short term relationship 0,0330 il (the liquidity of islamic banks) exists a short term relationship 0,0177 hhi (concentration of the banking market) exists a short term relationship 0,0124 ipi (index of industrial production) does not exist a short term relationship 0,7771 cpi (consumer price index) does not exist a short term relationship 0,7089 source: personal results deducted from eviews vi. variance decomposition and impulse analysis in the context of our work, it is important to know the impact of changes in the money market rate on lending rates, since in addition to the explanatory aspect of our model, it also has a predictive power. the most common methodology for analyzing the shortterm dynamic relationships between the monetary rate and the other variables, whether financial or real is through the examination of the dynamic response of the autoregressive vector following a simulation of the shock. it is a matter of simulating a monetary policy shock on the banking conditions of the countries that are the subject of our study. this simulation consists of comparing the impulse response of islamic banks as well as conventional ones following a monetary shock. the values of the impulse response functions provide information on the extent and delay of banks 'passthrough of central bank decisions, taking into account the amplifying or limiting factors of the banks' reaction process following a monetary policy shock. in the context of this study, the impulse response function (irf) reflects the magnitude and timing of responses of objective variables (ipi, if and ic) to a shock in the monetary policy variable (on). this allows a comparison of the extent of responses of objective variables to political shocks for both conventional and islamic banks. it is thus the simulation of a shock of monetary policy on the banking conditions that it is on the side of the islamic banks or conventional banks of the turkish banking system. to obtain the functions of impulse response, it was necessary to take again the model error correction already estimated for each bank. the vecm representation of the resulting model is used to compute the impulse response functions. figure 2. interest rate simulation of the turkish banking system -.20 -.16 -.12 -.08 -.04 .00 .04 .08 1 2 3 4 5 6 7 8 9 10 11 12 on hhi il re s pons e of if to chole s ky one s.d. innovations t a u x d e fi n a n ce m en t is la m iq u e -.3 -.2 -.1 .0 .1 .2 .3 .4 .5 .6 1 2 3 4 5 6 7 8 9 10 11 12 on cl hhi re s pons e of ic to chole s ky one s.d. innovations t au x d' in té rê t c on ve n ti on n el source: personal results deducted from eviews ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 the analysis of the impact of the monetary shock on the conventional interest rate reveals that the shock of the positive monetary interest rate causes a very sharp rise in the conventional interest rate which reaches a maximum value in the 4th month after the shock before it knows a slight downtrend and stability at the end of the period. for islamic banks, a notable difference in terms of the reaction of the financing interest rate to a monetary shock seems rather cyclical compared to conventional banks. indeed, there is a significant negative relationship between the islamic financing rate and the monetary rate, this finding suggests that islamic banks for example in turkey grant credit pro cyclically [3].one possible explanation for this relationship is that the demand for islamic loans is lower during periods of high interest rates because consumers do not want to lock in their loan commitment at high interest rates. for the effect of banking characteristics, namely liquidity and the power of the market, note that conventional banks proceed by increasing their interest rates by keeping their liquidity positions more or less stable. for islamic banks, the level of liquidity seems to be in a sharp downtrend showing a negative relationship with the financing rate. figure 3. simulation of reaction of the credit volume of the turkish banking system. -400 -300 -200 -100 0 100 200 300 400 1 2 3 4 5 6 7 8 9 10 11 12 on hhi il re s pons e of itc to chole s ky one s.d. innovations v o lu m e d u c ré d it i sl a m iq u e -1,500 -1,000 -500 0 500 1,000 1,500 1 2 3 4 5 6 7 8 9 10 11 12 on cl hhi re s pons e of ctc to chole s ky one s.d. innovations v o lu m e d u c ré d it c o n ve n ti o n n el source: personal results deducted from eviews the impulse response function of the credit volume reflects the negative response of the conventional credit supply following the shock of the monetary rate. however, islamic financing seems to be more impacted by the monetary shock since the fall in credit supply is simultaneous with the shock, whereas for conventional banks, the impact of the rate shock has had an impact on the supply of credit in a gradual way. the supply of credit also depends on the liquidity position and market power, which gives rise to different reactions on the banks. indeed, for conventional banks, the interest rate does not act in an immediate way on the credit offer until the fifth month following the shock. the combination of the level of liquidity with the uncompetitive and concentrated nature of the turkish banking system largely explains the credit behavior of credit institutions. on the side of islamic banks, the concentration of the banking market and the low level of liquidity amplify the reaction of the supply of credit to the shock of the monetary rate. in addition, liquidity and market power are among the structural factors behind this asymmetry in the transmission of monetary policy in a dual banking system. figure 4. simulation of reaction of the consumer price index (turkish banking system). -.15 -.10 -.05 .00 .05 .10 .15 .20 .25 1 2 3 4 5 6 7 8 9 10 11 12 on if itc re s pons e of cpi to chole s ky one s.d. innovations c h o c d es v a ri a b le s is la m iq u es -.12 -.08 -.04 .00 .04 .08 .12 1 2 3 4 5 6 7 8 9 10 11 12 on ic ctc re s pons e of cpi to chole s ky one s.d. innovations c h o c d es v a ri a b le s co n ve n ti o n n el le s source: personal results deducted from eviews in terms of the impact of a shock of conventional variables on inflation, the impulse function graph shows that the monetary shock triggered a rise in the interest rate, a process that explains the decline in interest rates inflation as measured by the consumer price index during the first quarter the movement of the debit interest rate following the monetary shock causes inflation to decrease persistently and then gradually returns to its long-term value. during the second quarter, the money market rate fell; however, the short-term bank rates materialize the expectation of a rise in the monetary rate and subsequently the resurgence of inflation from the end of the 4th month. as for the transmission of the monetary shock via the islamic loan channel, a rather weak reaction of islamic banks following a monetary shock. this weak effect is reflected more rapidly in the real economy is manifested by the fall in the financing of the volume of credit islamic from the first month after the shock. however, the impact of the monetary rate on inflation through the islamic financing rate seems to appear ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 later compared to conventional banks. moreover, the fact that islamic banks do not operate with a rate of interest may suggest they are not subject to interest rate risk. it should be noted that fluctuations in the interest rate can affect and endanger the revenues of islamic financial institutions that use a base rate to index and value financial instruments. figure 5. response simulation of the index of industrial production (turkish banking system) -400 -300 -200 -100 0 100 200 300 1 2 3 4 5 6 7 8 9 10 11 12 on if itc re s pons e of ipi to chole s ky one s.d. innovations c h o c d es v a ri a b le s is la m iq u es -500 -400 -300 -200 -100 0 100 200 1 2 3 4 5 6 7 8 9 10 11 12 on ic ctc re s pons e of ipi to chole s ky one s.d. innovations c h o c d es v a ri a b le s co n ve n ti o n n el le s source: personal results deducted from eviews in the same vein, consider the two impulse response functions of the index of industrial production following the shock of conventional variables as well as that of the islamic variables. indeed, at the level of the reaction of the index of industrial production, following the shock of conventional variables, the rise in the monetary interest rate leads to a fall in the supply of credit; therefore, industrial production falls after a delay of two months following the shock. after this phase, the impact of the monetary shock eases to begin its decline towards its equilibrium level after twelve months. on the side of islamic banks, the transmission of the impulses of the shock of the monetary rate registered a shift compared to the conventional banks so that a slight fall of the index of the industrial production registered 5 months after the monetary shock. as regards the impact of the supply of credit, it turns out that financing on the basis of the principle of sharing of losses and profits gives more importance to the profitability of projects, while that based on interest is only concerned with the creditworthiness of the debtors, which explains the maintenance of the stability of the economic activity until the 6th month before the offer of islamic financing falls with modest attempts to increase are not very significant from the 11th month. however, we can say that the monetary shock limits the ability of islamic banks to provide financing, resulting in a contraction of the real economy. vii. concluding lessons and discussion of the results at the level of this analysis, the study focused on the transmission mechanism of monetary policy in a dual banking system by highlighting the factors likely to impact this transmission process. to achieve this objective, it was necessary to conduct an analytical study by seeking to answer the main questions raised about the transmission efficiency of monetary policy and the potential effect of asymmetry in the transmission process. indeed, the results of the econometric study show that, indeed, monetary policy is transmitted to banking conditions via the bank loan channel in the case of a dual banking system, composed of both conventional banks and islamic banks. . these results seem consistent with those found by previous empirical investigations such as the work of (altunbas, fazylov and molyneux, 2002, gambacorta, 2005, kishan and opiela, 2000) for the conventional banking system and (cihák and hesse, 2010; al., 2013, abedifar et al., 2013, yousuf et al., 2014, sukmana and kassim, 2010, kassim et al., 2009) for a dual banking system. indeed, the bank lending channel highlights the impact of the variation in the bank financing offer on the behavior of economic agents following a monetary shock. this channel takes all its meaning in an environment where information is asymmetrical and imperfect substitutability characterizes credit / securities arbitrage. in this context, non-financial agents dependent on bank credit, such as households and new businesses, are directly affected by the rationing (increase) of borrowing possibilities linked to an increase (decrease) in banks' refinancing terms with the central bank. in addition, when a tightening of monetary policy is initiated, it is noted that the credits granted to economic activity diminish through two effects: that of price and that of volume. in the first case, the banks pass on the increase in their financing costs to their lending rates. this discourages some of the potential borrowers for whom the cost of capital appears too high. in the second, banks prefer to cap lending rates at a given level. monetary policy also impacts banking behavior in terms of credit distribution, which proves that bank intermediaries do play a central role in the transmission of monetary policy, since the effects of monetary policy depend on its impact on these banking institutions. the results of this study also support the impact of the banking market structure on the transmission process of monetary policy to banking conditions for a dual banking system. indeed, according to the structure-behaviorperformance (scp) model, the degree of competition and concentration of the banking sector impacts the behavior of banks in terms of the impact of changes in money market rates on their lending rates. indeed, banks with large market power can absorb monetary policy changes to protect their profitability. as a result, a monetary shock will have less impact on interest rates. in this context, the concentration levels of the different banking systems may explain, in part, differences in the ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 transmission patterns of monetary policy, particularly in the case of countries adopting a dual banking system. moreover, several studies confirm these results, for example, the works of cottarelli and kourelis, 1994; cottarelli et al. 1995; corvoisier and gropp, 2002; leuvensteijn et al. 2008; adams and amel, 2005; olivero, li and jeon, 2011; ali mirzaei, 2011, said that the structure of the banking market influences the sensitivity of banks to the transmission of monetary policy via the bank loan channel. bank liquidity may still be a source of alteration in the transmission of monetary policy. the results revealed that less liquid banks respond more strongly to a monetary shock than banks with a very high level of liquidity. in the case of a restrictive monetary policy, the most liquid banks manage to respond easily to loan requests without being forced to switch to a tightening of their credit supply. the impact of the monetary shock is greater on the less liquid loan function. in the case of this analysis, islamic banks are better able to pass on monetary shocks to their credit supply because of their low liquidity compared to conventional banks. the results reported here are confirmed by previous empirical studies that indicate that the level of bank liquidity alters the transmission of monetary policy like kashyap and stein, 2000; ehrmann et al, 2001; altunbas et al., 2010. finally, from the examination of the banks' reaction in the context of a comparative study between the behavior of conventional banks and that of islamic banks in a dual banking system in the face of a monetary shock, it turns out that the impact of monetary stimuli on their bank rates is asymmetrical, which can affect the effectiveness of monetary policy. in the context of the present study, this asymmetry can be amplified by the combination of several factors, in particular, the liquidity level and the structure of the banking market, which constitute a set of factors responsible for recurrent asymmetries of transmission of monetary policy. for the verification of such an assumption, it was necessary to seek, through this study, to analyze the relevance of the bank loan channel in a dual banking system in terms of channeling the effects of monetary policy towards the real economy. given that this field of study targets countries with a dual banking system, it is useful to consider whether islamic banks are also able to respond in the same way as their conventional counterparts once the central bank imposes some monetary policy. indeed, the results show that conventional banks can reduce the intensity and magnitude of monetary impulses compared to islamic banks that are more sensitive to monetary shocks. all in all, in a dual banking system that assumes the cohabitation of islamic banks with conventional banks, there may be the problem of asymmetric transmission of monetary policy related to the difference between financial intermediation among islamic banks by compared to their conventional counterparts. this asymmetry is amplified by several factors that determine the resilience of the banking sector to monetary shocks, including bank liquidity and the structure of the banking market. in this respect, this observation corroborates the conclusion of the work of zarqa, 1983; khan and mirakhor, 1990; errico and farahbaksh, 1998; rosly, 1999; kassim et al., 2009; abedifar et al., 2013; cihak and hesse, 2010; hasan and dridi, 2011; rajhi and hassairi, 2013; aysan, disli, ng, et al., 2016. conclusion islamic finance emerged a few decades ago as a new financial system whose conceptualization is built around the integration of the ethical dimension into financial dynamics. nevertheless, despite the development of islamic finance thanks to its financial transparency, it is not spared the flaws and limitations that compromise this success or at least weaken it. indeed, the implementation of a chariâa-compliant monetary policy is one of the major challenges to be met because of the scarcity of monetary policy instruments while remaining faithful to the principles of the shariâa, in particular for the economies having adopted a dual banking system such as turkey, malaysia and indonesia where the central bank should conduct monetary policies influencing both conventional and islamic banking systems, in order to effectively influence the overall macroeconomic situation. thus, the main objective of this research is the identification and analysis of the monetary policy transmission process via the bank loan channel in a dual banking system. in addition, this research examined the key factors that determine the resilience of the banking sector to monetary shocks, including liquidity and the structure of the banking market. indeed, these factors are advanced in the literature as potentially affecting the transmission channels by impacting the behavior of banks on the impact of monetary impulses on their rates. the results obtained also support the contribution of these factors in the difference in reaction of conventional banks compared to islamic banks in the face of a monetary shock, which made it possible to justify the asymmetry of transmission of monetary policy in a dual banking system. after having constructed a theoretical frame of reference based on the literature review, the empirical study focused on a sample of three countries having adopted a dual banking system, for the period between 2007 and 2015. in this which is the empirical method used, we used the autoregressive vector model, especially an estimate with the cointegration model. according to the results obtained at the level of the empirical study, the transmission of the monetary policy is confirmed for the case of a dual banking system via the bank loan channel. indeed, the long-term relationship assumptions and the dynamic adjustment of bank rates following a currency shock are confirmed. in addition, the asymmetry hypothesis of the transmission of monetary policy in a dual banking system is confirmed, since islamic banks show a greater degree of sensitivity than conventional banks in terms of the impact of changes in the money rate on their rates. this comparative analysis between the behavior of islamic banks and conventional banks on the transmission of monetary impulses through banking conditions seems to provide a more scientific and deeper insight into the transmission mechanism of monetary policy in a dual banking system as well. the main ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 11 factors that may affect banks' sensitivity to the rate of adjustment of their rate to a monetary shock. references [1] abedifar, p., molyneux, p., & tarazi, a. 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[28] radwan, m., (2019). adoption of unconventional financial institutions: a european perspective, giappichelli, torino, 2019. 1-128. [29] biancone, p. p., & radwan, m. (2019). social finance and financing social enterprises: an islamic finance prospective. european journal of islamic finance. [30] biancone, p. p., & radwan, m. (2018). sharia-compliant financing for public utility infrastructure. utilities policy, 52, 8894. [31] biancone, p. p., secinaro, s., & kamal, m. (2019). crowdfunding and fintech: business model sharia compliant. european journal of islamic finance, (12). ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. buerhan saiti, istanbul sabahattin zaim university, turkey prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4937 1 the role of islamic social finance in mitigating humanitarian crises; a multi-range strategy to mitigate covid-19 impacts mustafa m. hamed department of public administration, sadat academy, egypt, mostafa.hamed@sadatacademy.edu.eg abstract—the economic shutdown resulting from the covid-19 pandemic across countries has caused huge impacts on various industries which are cutting down production and jobs. this led to many socio-economic risks, such as high unemployment rates, low income rates, increasing risks of poverty and hunger. this study explores the validity of the proposition that the islamic social finance have an effective role in mitigating the humanitarian crises risks. so the paper tries to provide a multirange strategy for maximize the benefit from islamic social financing tools such as zakat, sadaqah, and waqf in short, medium and long range, and choosing the well-suited tool in each range of the strategy, in order to effective handling the social impacts of covid-19. this paper reviews the conceptual definitions of islamic social finance, and its various instruments. the study relied primarily on sources gathered from ongoing researches, news articles, reports, and information recorded by verified online sources of information. the results indicate that the multi-range strategy of islamic social finance providing an innovative way which can helps governments and policy makers for manage the crisis during and after the covid-19 pandemic keywords; humanitarian crises; covid-19 impacts; islamic social finance; islamic social finance tools i. introduction since the last five decades, the world has testify a dramatic increase in humanitarian crises as a result of wars, natural disasters, epidemic outbreaks, poverty, human right abuses, among others. based on the executive summary of the world humanitarian summit (whs) 2016, in the last two decades, 218 million people each year were affected by disasters at an annual cost to the global economy that now exceeds $300 billion [1]. the recent crisis covid-19 pandemic, which 13,378,853 cases has been infected; more than 580,045 people worldwide have already died [2]. and before the pandemic finishes, it could kill hundreds of thousands, even millions. but the final toll is destined to be far higher than just those who die of covid-19. experts warn that deaths from secondary impacts poverty, hunger, diseases, and violence exacerbated by the pandemic may dwarf the number of those who die of the novel coronavirus itself [3]. furthermore, governments and media are focusing attention on the domestic impacts of the virus and the medical and political responses. with over 126 million people in need of humanitarian assistance globally, including 70 million forcibly displaced, this critical questions looks at the potential impacts of the pandemic on existing humanitarian crises and the immediate impacts on vulnerable populations in affected settings [4]. these increments of poverty and unemployment, the emergence of several humanitarian problems have all called for an innovative strategy for overcoming such social problems. although, many governments have announced stimulus packages to channel the funds to people to fight the pandemic, providing money to spend even if they aren’t working. however, the easiness of interest-based loans may create a debt trap for households and business firms in the long run, which will have a negative impact on the economic system [5]-[6]. social and faith-based financing, such as islamic social finance, are important additional sources of financing that can be better leveraged to reduce vulnerability. there are strong evidences in islamic history for financing the social sector using islamic financial tools like zakat, sadaqa, qard hassan, takaful, sukuk, and waqf. these financial and social tools participated heavily in alleviating humanitarian risks and reducing the suffering of many societies affected by disasters, conflicts and epidemics [7]. every year, muslims worldwide donate generously to islamic social finance mechanisms to alleviate human suffering. given that the majority of people in need of aid are in muslim countries, the role of islamic social finance is particularly important. innovative investments in submitted july 2020, revised december 2020, accepted december 2020 mailto:mostafa.hamed@sadatacademy.edu.eg ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4937 2 humanitarian action, such as sukuk (bonds), will not only lead to long-term social improvements, but also to longterm resilience and to adaptive capacity-building for communities at risk. such investments will empower communities to recover more strongly from shocks as well as facilitate social and economic inclusion within their populations. what we seek here is to think about how to respond to humanitarian crises. when humanitarian crises strike the response determines whether those affected not only survive— but also have the chance to thrive—in the aftermath. efficiency and effectiveness of humanitarian responses are vital, as is managing the risk and impact of future emergencies with disaster preparedness. so the paper tries to provide a multirange strategy of using islamic social financing tools in short, medium and long range to handle the social impacts of covid-19. this paper is action/applied research in nature, that provides insights for governments, decision-makers, and practitioners of how could be humanitarian crises response strategically. this paper is organized as follows: section two starts with conceptual overview of islamic social financial tools. in section three we discuss the role of islamic social finance in mitigating humanitarian crises; the philosophy and opportunities. section four explores the humanitarian and socio-economic impacts of covid 19. section five provides a multi-range strategy of using islamic social financing tools in short, medium and long range to handle the social impacts of covid-19. finally section six concludes. ii. conceptual overview this section highlights the conceptual review on islamic social finance in related literature. it covers mainly the islamic social financial tools "zakah, waqf, sadaqah, qard hassan, sukuk, and takaful". a. social finance social finance is defined as provision of financial services to achieve social protection of the poor; reduction in their vulnerability through community, microfinance, social enterprise finance, outcome-based philanthropic grant-making and program-related investments [8]. b. islamic finance islamic finance defined as the provision of financial services in accordance with the islamic jurisprudence (shariah) [9]. others can see islamic finance as structuring financial instruments and financial transactions to satisfy traditional muslim structures against the payment of interest and engaging in gambling [10]. similarly, the farlex financial dictionary (2012) sees islamic finance as the range of financial transaction that conforms to the shariah or islamic law. [11] c. islamic social finance islamic social finance therefore refers to the provision of financial services to the vulnerable members of the society to achieve socio-economic welfare. it comprises three main sectors vis-à-vis zakah/sadaqah, waqf and islamic microfinance. the institutions are meant to serve as platforms for empowering and disbursing wealth and income in the society.[41] d. instruments of islamic social finance according to maiden islamic social finance report (2014) sector comprises the traditional islamic institutions based on philanthropy-zakat, sadaqah, and waqf; those on mutual cooperation such as qard (loan) and kafala (guarantee); and also, the contemporary islamic not-for-profit microfinance that use for profit modes to cover primarily their cost and sustain their operations. [12] e. zakah literally, zakat means to grow, to increase and to purify. technically, it refers to the determined share of wealth prescribed by god to be distributed among deserving categories. it is also used to mean the action of payment of this share. [13] zakat is one of the five pillars of islam and thus a compulsory levy on the excess wealth of an adult and sane muslim individual if the wealth remains in the ownership of the individual for one hijri calendar year (hawl) and has exceeded the minimum threshold (nisāb). zakat is a multidimensional measure in the sense that the sources of zakatable wealth vary across the major sectors of the economy and the same time, the recipients are derived from the different sections of needy members of the society. [13] zakat is a cornerstone of islamic social finance. a tax on wealth and income, zakat (arabic: azkāt, ―that which purifies‖) is a type of obligatory alms-giving. f. sadaqah or infaq fi sabilillah in the modern context, sadaqah means voluntary charity, given in addition to obligatory alms-giving, zakat [14]. sadaqah is very wide term and used in the qur’an to cover all kinds of charity and alms-giving: ―those who believe, and do deeds of righteousness, and establish regular prayers and regular charity, will have their reward with their lord: on them shall be no fear, nor shall they grieve‖ (qur’an: 2 : 277) [14] even a kind word and smile can be considered sadaqah. g. qard al hassan loan this is also called good loan, benevolent loan. it is considered as a type of loan whereby the lender does not charge any interest or additional amount over the money lent [41]. most of the existing micro credit (loan) availed to beneficiaries by the government via its micro finance banks are interest based. despite a reduction in its interest element to single digit in as far as it's not zero [15]. interest on loans as clearly spelt out in the quran is prohibited as stated 12 different verses of the quran. for instance q2:275, q 2:278 so also there ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4937 3 are different hadiths that prohibits interest in all its forms. therefore, noncompliance to allah’s command, make such funds to lacks his blessing. interest on loan has the following effects, it’s a repression of the needy, it further widens the gap of wealth, it creates inflationary tendencies, it's an unjust income, its markdown the future, it causes economic volatility. h. waqf waqf is generally defined as ―a type of islamic endowment that can take the form of cash, property or any form of private wealth which is donated in perpetuity for a charitable purpose set and directed by the endower‖. traditionally waqf has taken the form of real estate, particularly in the middle east where in the 19th century up to two thirds of all property in the ottoman empire was held as waqf assets [16]. most waqf is real estate assets that have been donated by an individual for the sole purpose of providing charity to a particular institution and that institution uses the returns from those assets in sustaining its activities. waqf is made up of different kinds [17]: religious waqf:this form of waqf serves as an addition to the social welfare of any society as it assist to satisfy the religious needs of the people and thus reduce the direct cost of providing religious services. philanthropic waqf: this form of waqf is targeted at supporting the poor in the society such as providing public utilities for the needy or poor such as libraries, education, health services etc. posterity or family waqf: in this form waqf the revenue must be given to the waqf founder and his or her descendants and only the surplus if any should be given to the poor [15]. i. sukuk sukuk in the context of money and capital markets refer to certificates or securities (bonds), representing financial rights arising from underlying trade and other commercial activities [16]. it evidences an undivided ownership right or interest, wholly or partially, in a shari’ah-compliant tangible asset, intangible asset, usufruct, commodity, or business as a going concern, or a participation right in any shari’ah-compliant profit-sharing venture, or a shari’ah-compliant financial asset, or any combination thereof through a mixed portfolio of various assets [18] j. takaful (co-operative insurance) mutual insurance systems such as takaful have existed in the islamic world for centuries. conventional insurance relies on interest-based investments – which are forbidden in islam – and is entirely rooted in un-islamic, speculative investments. the insurance provider gambles on receiving more income from the premiums, the payments it receives, than it has to pay out [19]. takaful does not aim to make a profit – its purpose is to ease the risk faced by contributors. it is a co-operative system of reimbursement or repayment in case of loss. people and companies make small contributions into a mutual pool of funds, from which they are compensated. iii. islamic social finance in mitigating humanitarian crises; the philosophy and opportunities: a. philosophy islamic religion calls for a comprehensive development of an economy and puts emphasis on social welfare and urges for maintaining social justice, equity, and poverty alleviation. its teachings stresses on the duties of muslims towards humanitarian and social welfare. the concept of the maqasid al sharia (purpose of sharia) upholds the principle of serving the public interest of maximizing benefit and reducing harm of the community. thus eradication of poverty, socio-economic justice are among the primary goals of islam [34]. that is based on adl (social justice) and ihsan (benevolence), which makes islamic finance attractive to the western countries is that this financial system operates in an ethical way similar to the socially responsible investments. in addition, islamic finance with it various financial products is not limited to muslims but on the contrary available to everyone, and this is confirmed by its diffusion and ability in attracting the attention of the investors, financial institutions and regulators as a valid alternative to conventional one [34]. the role of islamic social finance assumes great significance, especially in countries with high poverty levels among muslims. the main objective of islamic philanthropy such as zakat, sadaqat, waqf, etc, is to meet the needs of the poor and to curb ever-rising levels of relative poverty. to fulfill this objective, it is essential to know to what extent islamic social funds can meet the resource requirements for poverty alleviation, and whether the current distribution of islamic social funds to the poor have been effectively managed and distributed. as an islamic charity the instrument of waqf differs from zakah and other charity instrument such as sadaqah, fitrah, and lillah etc. following table shows the comparison of islamic charity instruments: table i. islamic charity instruments factors waqf zakah lillah nature voluntary compulsory voluntary rate any amount fixed rate any amount expense categories flexible expense categories. donor can decide 8 fixed expense categories as approved by shariah flexible expense categories. donor can decide spend generally capitalized generally spent with one year generally spent within one year investment s invested in social or economic asset generally not invested – needs to be discharged as soon as possible generally not invested – may be discharged according to need and mandate shariah governance : liability donor must be sane, of age, male or female liability for payment is governed by shariah any person can give ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4937 4 us$ 200 billion to us$1 trillion are spent annually in zakat and sadaqah across the muslim world, several times more than the conventional global humanitarian aid contributions (just over us$13 billion in 2011). • a minimum of us$600 billion of excess zakat from 40 oic countries is potentially distributable annually for humanitarian action. • however, contribution from the muslim world to the humanitarian system in recent years is only 5-7%. muslim countries’ contribution to the central emergency response fund of the united nations has been below 0.05% since 2006. this could be because muslims cannot give their zakat to non-islamic institutions as there are strict requirements on how the funds can be used and how they must be managed. • only 1% of the annual excess islamic social funds were sufficient to plug the humanitarian gap in 2014. mutawallee must appoint mutawallee (trustee) mutawallee not necessary mutawallee not necessary document no document necessary no document necessary no document necessary sadaqah jariyyah always a continuous charity and continuous reward generally not continuous generally not continuous capital base forms a capital base for sustainable community development not a capital base not a capital base beneficiari es may be applied to all irrespective of creed. applied only to muslims. may be applied to all irrespective of creed. time for payment can be paid at any time generally paid in ramadan can be paid at any time how payment is effected can take the form of any asset – cash, land, coins, jewellery generally paid in cash or stocks can take the form of any asset (foyasal khan, waqf: an islamic instrument of poverty alleviation– bangladesh perspective, thoughts on economics, 2015, vol. 22, no. 03, pp. 99-130) b. opportunities will you believe it if i tell you that the total amount of islamic social funds given yearly is so huge that there should be zero poor muslims? there is a great deal of wealth in the muslim world—at least usd600 billion in excess zakat from oic countries—that can potentially be distributed for humanitarian causes. for example, zakat, waqf and sadaqah can be used in a pilot project involving schools: zakat can provide daily meals to ensure that children get at least one meal a day for proper nutrition (which will also help keep them in school); waqf can be used to provide facilities for the schools; and sadaqah can be used to purchase school uniforms and stationary [35]. there are also efforts underway to establish an independent, autonomous shariah-compliant fund that can capture zakat, waqf and sadaqah from all over the world and channel the funds towards high-impact aid organizations, but challenges exist: islamic finance must reconcile the apparent contradiction between its commercial and social roles—it must serve the interests of its commercial stakeholders while fulfilling the goals of humanitarian assistance. yet the poorest communities and countries are muslim! according to the idb’s research institute, global zakat collections alone are estimated to come up to a total of at least us$500 billion a year. this is about 20 times more than total global humanitarian aid. the beautiful system of zakat alone should be sufficient to eradicate poverty, and we have not even touched on other forms of islamic social finance [36]. islamic social finance can help fill the current gap in the humanitarian funding through instruments such as sukuk as well as social financing mechanisms such as zakat, waqf and sadaqah, see figure n.1. figure 1. islamic social finance can potentially fill the humanitarian funding gap. zakat payment of zakat certainly has social and economic significance in the society. firstly, it plants loves and cooperation between the haves and haves not members of the society. through the payment of zakat, the poor is felt loved by the rich and the potential hatred is eliminated in the process replaced by caring and cooperation [41]. the poor then prays for the rich and the blessings continue to manifest in the society [37]. secondly, payment of zakat reduces the undesirable wealth concentration among the few riches in the society, thereby bridging the gap between the rich and the poor. this distributive justice coupled with the multiplier effect of private spending, trade and commerce will be advanced and economic prosperity will be resulted [37]. thirdly, there will be smoothening consumption and regulating, if not eliminating the cyclical effects of business cycle. this is more realizable where institutional zakat collection and distribution are advocated such as in the south east asian countries and recently sub-saharan african countries such as nigeria [38]. views that zakat can be used as a fiscal measure to control recession or to boost the economy. thus, expansionary zakat policy would be applied during recession while contractionary zakat policy would be adopted in the boom period. fourthly, zakat is a reliable means of reducing poverty eradication, which provides permanent mechanism from within the economy to continuously transfer income from the rich to the poor and that once correctly assessed, promptly collected and properly disbursed [39]. zakat system plays the role of ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4937 5 solving dangerous problems such as poverty, unemployment, catastrophe, indebtedness and ensures equitable income distribution in a muslim society. it is also a self-help measure adopted with full religious backing to support those‖. waqf the waqf industry is undeniably growing in importance as global muslim wealth increases. in many middle east countries, such as qatar, kuwait and saudi arabia, waqf structures are widely available and a favoured method of charitable giving; while the sector is also once more growing in popularity in countries such as lebanon, egypt and especially turkey; which has seen an explosion in charitable funding since the revision of its waqf regulations in 1981, with wealthy families competing to make endowments particularly in the education sector. the global size of waqf assets is estimated between us$105 billion to us$1 trillion [40]. in indonesia, the market value of registered land waqf is estimated to be us$ 60 billion. in malaysia there is 11,091 hectares of land under waqf valued at of us$ 384 million [12]. it has been shown that waqf projects in islamic countries are used as strategy for developing economic sector and alleviating poverty. traditionally, waqf had been used for providing clean water, building orphan houses and bridges, organizing funerals and financing the marriages. however, this trend has been changed with the advent of the industrial revolution. currently, waqf assets are financing education, health and social welfare to promote social development. in malaysia, the waqf funds are being used for establishment of cooperative housing, industrial companies, libraries, laboratories and research centers [16]. sukuk social impact sukuk has been gaining traction in recent years, as the new frontier for the islamic finance industry. in a recent article exploring the potential of social impact sukuk, michael bennett and akinchan jain the world bank suggest that a social impact sukuk appeals to investors from both the islamic and conventional ethical finance sectors as it combines ―true risk sharing and a focus on a specific social cause with a fully shari’ah compliant sukuk structure [18]. social impact sukuk promotes multi-stakeholder collaboration by aligning incentives among stakeholders and focusing on result-oriented objectives. social impact sukuk can offer an additional avenue of mobilizing sustainable funding for social projects and enhance the effectiveness of current funding. the use of private capital reduces fiscal pressure especially in countries where taxation is low and government funds are limited. the focus on paying for results rather than paying for activities allows the government to reallocate resources efficiently to where it is most needed and helps to reduce the need for international borrowing and overseas aid. by anticipating and addressing social issues before they arise, social impact [16]. iv. humanitarian and socio-economic impacts of covid 19 more than 580,045 people worldwide have already died of covid-19, 13,378,853 cases have been confirmed to who [2], and before the pandemic finishes, it could kill hundreds of thousands, even millions. but the final toll is destined to be far higher than just those who die of covid-19. experts warn that deaths from secondary impacts — poverty, hunger, diseases, and violence exacerbated by the pandemic — may dwarf the number of those who die of the novel coronavirus itself. with over 126 million people in need of humanitarian assistance globally, including 70 million forcibly displaced [4]. in this section we looks at the potential impacts of the pandemic on existing humanitarian crises and the immediate impacts on vulnerable populations in affected settings. the economic shutdown has created issues like demand and supply shocks that reverberate through the global economy. manufactories and companies were forced to cut down production; employees are losing jobs and facing cash flow constraints. governments are working to safeguard employment and livelihoods of the people to reduce the adverse impacts [20]. in brief, the following lines summarize the social and economic impacts of the coronavirus pandemic: poverty and hunger while world hunger levels have been rising since 2015 with over 820 million people going hungry on a daily basis and 135 million experienced acute food insecurity in 2019, covid-19 has arrived at a time of unprecedented global need, with a record 168 million people already requiring humanitarian assistance at the beginning of this year [21]. a new analysis by researchers from king’s college london and australian national university, under the aegis of the united nations university world institute for development economics research, for example, warns that the economic contraction caused by covid-19 could push an additional 500 million people — about 8 percent of the earth’s population — into poverty, reversing 30 years of economic improvement. ―we were surprised at the sheer scale of the potential poverty tsunami that could follow covid-19 in developing countries,‖ said andy sumner, one of the study’s authors [3]. income and jobs loss income losses as a result of covid-19 are expected to exceed $220 billion in developing countries. with an estimated 55% of the global population having no access to social protection, these losses will deeply affect the poorest and most vulnerable communities in particular [21]. according to united nation framework for socio-economic response to covid-19, about 1.6 billion informal workers lost 60% of their income, with little to no savings and no access to social protection [22]. according to the ilo now casting model, global working hours declined in the first quarter of 2020 by an estimated 4.5 per cent (equivalent to approximately 130 million full-time jobs, assuming a 48-hour working week), compared to the pre-crisis situation (fourth quarter of 2019) [23]. global working hours in the second quarter are expected to be 10.5 per ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4937 6 cent lower than in the last pre-crisis quarter [23]. this is equivalent to 305 million full-time jobs, which represents a significant deterioration on ilo’s previous estimate of 195 million for the second quarter [23]. this has been driven mainly by prolongation and extension of containment measures. taking together employers and own-account workers, around 436 million enterprises in the hardest-hit sectors worldwide are currently facing high risks of serious disruption [23]. gender equality on average, women make up to 70% of health care workers and social care sector in 104 countries. women already do three times as much unpaid care work as men. with covid-19 [3], unpaid care work has increased, with children out-ofschool, heightened care needs of older persons and overwhelmed health service. in developing countries, vast majority of women’s employment is in the informal economy – about 70% covid-19 quarantining has caused a spike in domestic violence levels [3]. increase in food insecurity covid-19 will double the number of people facing food crises. about 265 million people in low and middle-income countries at risk of acute food insecurity by the end of 2020 unless swift action is taken. most people suffering acute food insecurity in 2019 were in countries affected by conflict (77 million), climate change (34 million) and economic crises (24 million people) [22]. education; students out of school the covid-19 pandemic has affected educational systems worldwide, leading to the near-total closures of schools, universities and colleges. most governments around the world have temporarily closed educational institutions in an attempt to contain the spread of covid-19 [24]. as of 7 june 2020, approximately 1.725 billion learners are currently affected due to school closures in response to the pandemic. according to unicef monitoring, 134 countries are currently implementing nationwide closures and 38 are implementing local closures, impacting about 98.5 percent of the world's student population [25]. social protection; lack of adequate social protection 55% of the world’s population (as many as four billion people) is not covered by social insurance or social assistance. globally, only 20% of unemployed people are covered by unemployment benefits, and in some regions the coverage is much lower [22]. internally displaced people (idps) at risk many countries in the midst of armed conflict have seen substantial damage to critical health infrastructure. most conflict-affected states have the weakest health infrastructure, and displaced populations are vulnerable due to the environments they live in as a result of armed conflict [4]. in syria, for example, is well-documented as the prevailing impact of displacement on their overall health. consequently, the virus reaching syria or yemen would be ―impossible to manage,‖ and it could bring down entire medical systems in countries like south sudan and the democratic republic of the congo [4], [22]. trade and tourism decline in global trade the wto issued its annual trade outlook on 8 april, and as director-general roberto azevêdo said, the ―numbers are ugly.‖ world merchandise trade is set to plummet by between 13 and 32% in 2020 due to the covid-19 pandemic [26]. wto economists believe the decline will likely exceed the trade slump brought on by the global financial crisis of 200809. trade is likely to fall more steeply in sectors characterized by complex value chain linkages, particularly in electronics and automotive products. services trade will also be highly impacted due to the imposition of transport and travel restrictions and the closure of many retail and hospitality establishments. dramatic fall in tourism tourism is considered one of the hardest hits by the covid-19 outbreak. potential loss of 850 million to 1.1. billion international tourists. potential loss of $910 billion to $1.2 trillion in export revenues from tourism. estimated 100 and 120 million jobs at risk [22]. these increments of poverty and unemployment, the emergence of several humanitarian problems have all called for an innovative strategy for overcoming such social problems. although, many governments have announced stimulus packages to channel the funds to people to fight the pandemic, providing money to spend even if they aren’t working. however, the easiness of interest-based loans may create a debt trap for households and business firms in the long run, which will have a negative impact on the economic system [5]-[6]. this is what prompted us to consider islamic social financing as one of the innovative alternatives to mitigate the effects of the corona pandemic. v. multi-range strategy to mitigate covid-19 impacts dealing with a complex and fast-moving crisis like covid-19 can be extremely challenging. many countries are overwhelmed by the scale of information and the escalating risk and are focusing on immediate and operational incidents and challenges only. they fail to understand the impact and strategic consequences of the crisis in the long range [27]. organizations want to move quickly and demonstrate action to stakeholders. however, experience shows that organizations are most successful when identifying and assessing the strategic impacts of a crisis like covid-19 before planning their response. after carefully assessing the ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4937 7 impact of covid-19, a proportionate crisis and resilience strategy can be developed. in this section the paper tries to provide a multi-range strategy for maximize the benefit from islamic social financing tools such as zakat, sadaqah, and waqf in short, medium and long range, and choosing the well-suited tool in each range of the strategy, in order to make a guidance to policy makers to prepare, respond, and recover. the immediate priorities identified in the response include health systems support, inclusive and integrated crisis management and response, and social and economic impact needs assessment and response. the strategy outlines three components; tackling the fast and immediate impacts in the short term; focusing on social impact in the response and recovery in the medium term; and helping countries recover more sustainably for the long term. a. emergency support in the short term in the short term, the strategy aims to address risks with a rapid impacts faced by millions of low income people of the country are suffering great losses in their earnings since the enforcement of social distancing measures and lockdowns to fight novel covid-19 outbreak. zakat; food security donors typically require that zakat be disbursed within one year of being given. this focus on immediate benefit is well suited for crisis response. food assistance could be delivered quickly to the millions of households across the country suffering from acute food shortage. zakat can be an important component of food emergency support programs [28]. infāq; food security one of islamic social financing tools that can be utilized to achieve short-term and medium-term targets such as end hunger, food security and improved nutrition. however, since it is a voluntary action, the potential of infāq will not be at its maximum unless economically wealthy and luckiest societies could enhance their sense of togetherness and brotherhood (ukhuwah). one of the strengths of infāq or charity is that it may attract the non-muslims to jointly contribute in collecting the fund [29]. zakat; income and jobs lost issues zakat donors often give cash transfers, which can be especially important in emergencies. people who not enrolled in any social safety net programmes and so need proper delivery mechanisms to get cash aid emergency. zakat in the short term can be an effective tool for income and jobs loss issues. sadaqah or infaq fi sabilillah medical sector as until now there is no specific vaccine for covid-19, by sadaqah or infaq fi sabilillah tool could support the stakeholder of the health sector, both global and national level, to expand its role in conducting its researches and studies that are related to the covid-19 vaccine [30]. additionally, for health care assistance, the zakat institution can increase capacity or procure laboratory equipment that can detect patients that are infected with covid-19, such as the procurement of cdc covid-19 real-time reverse transcriptase kit. hospital medical providers are in urgent need of infection prevention supplies to deal with the many cases in hospitals. sadaqah or infaq fi sabilillah tool can bridge that deficit with a dilapidated infrastructure of health institutions in many developing countries. b. response and recovery in the medium term in the medium term, the strategy aims to improve living life, provide financing for trade and small enterprises, and improve education and health infrastructure. waqf sukuk, infrastructure waqf sukuk issuance is expected to put in a framework of covid-19 responses. in the context of unprecedented pandemics, waqf sukuk helps provide additional amount as part of front-loading strategy [31]. proceeds of the sukuk can be used for building additional infrastructure while the return can support relief operation and financial assistance, in particular provision of personal protective equipment, cash transfer or cash-for-work for those losing their jobs. islamic finance; livelihood and trade finance the financing of equipment, vehicles, and other sources of livelihood and trade finance are key mechanisms by which islamic banks and financial institutions can support recovery. aligning their financing activities with the sdgs is a significant opportunity for islamic banks [32]. impact investing – private investment prioritizing businesses with social impact – can play a central role in the recovery. undp’s global islamic finance and impact investing platform, launched in 2015 in partnership with the islamic development bank group, brings global impact investing expertise to islamic finance [32]. islamic development bank (isdb group) is setting up a special $730 million fund to mitigate the negative health and socioeconomic impact of the covid-19 pandemic [33]. income and jobs lost issues islamic microfinance (ismf) can offer takaful coverage, project financing and human resource development programs; human resource capacities acquired can subsequently complement proper project implementation. successful implementation of funded projects is expected to contribute towards poverty alleviation [16]. takaful coverage is expected to mitigate the financing and family risks of the poor. zakat; children and women support in medium-term, by 2025, the target is to end stunting and wasting in children less than 5 years of age, and address the nutritional needs of adolescent girls, pregnant and lactating ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4937 8 women and older persons. these threats are normally appearing within a community with lower level of income, higher level of poverty and difficult access to healthy and nutritious foods. obviously, they are categorized as the poor (al-fuqarā’) and the needy (al-masākin) and hence, eligible to receive zakāt. especially when there are cases of famine and malnutrition, zakāt fund must be disbursed immediately [29]. c. long-term recovery and resilience a in the long term the strategy aims to achieving strategic goals such as developing economic sector and alleviating poverty and aligning governmental sustainable development goals. sukuk sukuk (bond equivalents) can be an important source of long-term capital for governments and companies engaged in the covid-19 response and recovery. undp’s support of the government of indonesia’s green sukuk, including a us$1.25 billion issuance in 2018, is a prime example of how issuers can partner with undp to identity, track, and report on their sdg impact. they provide a decade of funding for indonesia’s national sdg plan [32]. undp has, through its green sukuk initiative, held workshops and other outreach with partners in malaysia, pakistan, and beyond. the pandemic has made long-term funding for development all the more crucial. waqf endowments can, in many contexts, be important contributors to long-term resilience. financial or non-financial assets such as land or buildings are permanently dedicated to social purposes. this can be an important way for stakeholders to contribute to social infrastructure that serves the sdgs and, in the words of the un secretary-general, help countries ―recover better‖ over the long term [32]. this is a time for new ways to help tackle the devastation of covid-19 and invest in sustainable development. islamic finance has the tools for each stage of the response. waqf could use as a part of strategy in the long term for developing economic sector and alleviating poverty. governments have to utilize waqf assets for financing strategic goals related to education, health and social welfare to promote social development. vi. conclusion at this critical policy making moment, while the rapid spread of the covid-19 pandemic has a serious economic and social impacts that led to a humanitarian crises. these emergences of these several humanitarian problems have all called for thinking about an innovative strategy for overcoming such social problems. the paper discussed the opportunities available from islamic social finance to mitigate the effects of humanitarian crises. we therefore recommend the multi-range strategy of utilizing the islamic social financing tools, such as waqf, zakat and sadaqah in short, medium and long range to handle the social impacts of covid-19. which can helps governments and policy makers for manage the crisis during and after the covid-19 pandemic. in the short term, the strategy introduce an way to utilize the tools of islamic social finance that could address risks with a rapid impacts faced by millions of low income people of the country are suffering great losses in their earnings since the enforcement of social distancing measures and lockdowns to fight novel covid-19 outbreak. while in the medium term, the strategy introduce solutions by choosing the tools of islamic social finance that could improve living life, providing financing for trade and small enterprises, and improving education and health infrastructure. in the long term the strategy aimed to achieve strategic goals such as developing economic sector and alleviating poverty and aligning governmental sustainable development goals. references [1] ocha, "global humanitarian overview", 2016. 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(12). ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4937 10 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5993 1 investment decision on government bonds and sukuk in indonesia department of economics, institute of tazkia, bogor, indonesia, ecoy13@gmail.com abstract— this research aims to find the factors that influence the decisions of institutional investors to invest in government bonds and sukuk, as well as to disclose the oversubscribes of state securities issued by indonesian government. the investment decisions of investors in this study use a proxy data approach from variables that affect investment decisions. the type of research used is quantitative research using an econometric approach with the auto regressive distributed lag (dynamic) model. the research data used is a time series for eleven periods from 2009 to 2020. data are analyzed using ardl (dynamic) model with determination of lag using the koyck model. the result of this research is that investment decisions with a rational approach to government bonds and sukuk are strongly influenced by macroeconomic and policy variables (inflation, exchange rates and the interest rate) and financial markets (financing interest rates, deposit rates, volumes and coupon rates). keywords-investment decision; dynamic model; government bonds; sukuk i. introduction one of the instruments that meet the financing of the state revenue and expenditure budget (apbn) is state securities (sbn). state of securities consists of government securities (sun) and state sharia securities (sbsn) or known as government sukuk. financing through government securities and sukuk is an important source of funds from external parties for the government. there is a fairly fundamental difference between sovereign sukuk where sukuk are supported by assets, while bonds or debt securities are supported by debt [1]. the issuance of a fairly large government sukuk is related to the fact that the sukuk allows the government to access a larger sharia liquidity market above the bond market in order to finance the country's debt [2]. based on the factual phenomenon of government securities auction data conducted by the government on the secondary market, where since 2008 the issuance of government sukuk until 2020, the government has always experienced oversubscribes on the auction offer. oversubscribes are excess liquidity that must be absorbed by investors, where oversubscribes are obtained from the indicative value of the auction target minus the bid value of the incoming investor minus the bid received by the government. research on investors' investment decisions in government bonds, government sukuk and oversubscribes on government securities are related to one another. in addition, historical time series data on investment also affect investment decisions, where exploration of the data shows patterns of behavior in investing and then the pattern is translated into a mathematical model [3]. investors try to maximize profits, they make decisions with a high level of satisfaction, so that the theory of maximum utility is in accordance with investor behavior. utility depends on (stock and market characteristics) and perceptions of decision makers [3]. investment decision-making behavior by investors is a rational and irrational decision [4]. previous research using a rational approach with a questionnaire approach to test the level of rationality of investors when they build investment portfolios or make decisions about financing, where the research results state that investment decisions in bonds are very sensitive to changes in interest rates, inflation and balance of risk and return[5]. then research on factors that influence investors' investment decisions in sukuk and bonds with a qualitative approach [6]. [1] the other research using dynamic model econometric techniques to test the grager causality between sukuk and bonds related to return behavior. [7]. the other research conducted a study on the determinants of factors that affect the sukuk market. although many efforts have been made by researchers, the main motivation for selecting the sukuk portfolio has not been determined [8]. there haven’t been many researches in the context of testing the investment decisions of institutional investors in government bonds and sukuk with investment value data as a proxy. therefore, this study discusses this knowledge gap to identify investors' decisions on government bonds and sukuk. in addition, based on the existing facts that until december 2020, the total outstanding government sukuk only reached . 934.118 trillion rupiahs, contributing 18.43% to the total government securities, still quite small when compared to government bonds. meanwhile, outstanding government bonds until december 2020 reached 4,134,620 trillion rupiahs eko suharti 1 submitted august 2021, revised august 2021, accepted august 2021 ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5993 2 contributing 81,57% of state securities. the existence of this inequality raises several questions related to factors or variables that affect investors' investment decisions in government bonds and sukuk. based on the gap analysis in the research above and the phenomena that occur, as well as the lack of research on investors' investment decisions in government bonds and sukuk with a rational approach, this is what motivates the author to conduct this research. this study focuses on aspects of the economic factors that influence investment decisions for institutional investors in government bonds and sukuk, as well as on oversubscribes to government securities. investors, in this case the actors and investors in the interbank market, can make purchases or sales, including the type of investment to be placed. this activity is determined by both macroeconomic factors such as domestic economic performance (especially economic growth), inflation, exchange rates, etc. as well as microeconomic factors such as indicators on financial markets, performance of securities issuing companies. then this research was conducted to solve the following problems : the decision of investors to invest in government bonds and sukuk is very sensitive to economic factors that affect the government's strategy for issuing government securities; the issuance of government securities is highly determined and depends on the decision of investors to invest in government securities and sukuk and the dynamics of current and previous economic conditions and developments will determine and influence investors' decisions to invest in government bonds and sukuk formatter will need to create these components, incorporating the applicable criteria that follow. ii. literature review investors have rational expectations that is, expectations formed with an awareness of the forces that determine market prices. in rational expectations, the forces that determine prices include decisions made by investors. rational expectations make sense in the context of pricing models, including assumptions about investors' preferences and the information they have [9]. rational investors can profit by investing in profitable securities and profitable opportunities that are not recognized by irrational investors. increased bond risk causes bond demand to fall and the demand curve shifts to the left [10]. an investor's decision to buy is a way to accept ownership of an existing debt, transferred from another person who may not be the original lender [11]. investors can be individuals or institutions. institutional investors consist of central banks, commercial banks, pension funds, life insurance companies, mutual funds, and investment companies. investors want to minimize risk and maximize profits [12]. investors are assumed to make their choices consistently, according to their preferences, taking into account their beliefs about the future and the constraints on their wealth. the implications of this analysis provide a decision rule for selecting a portfolio[9]. investors also do not make investment decisions every day, especially for long-term investments [3], [13]. prior gains increase an investor's risk taking, while prior losses reduce it. investor’s behavior is in line with standard utility theory with reduced risk aversion. in addition, investors perceive overall wealth and risk taking in financial markets to be affected by gains/losses in overall wealth, financial wealth and real estate wealth[14]. a. grand theory the key to the assumption that investors make investment decisions depends on the portfolio selection theory formulated by markowitz. the main purpose of portfolio selection is to maximize the expected return that is consistent with the level of risk that is accepted individually [14]. a portfolio that provides the highest possible expected return for a given level of risk is called an efficient portfolio. to build an efficient portfolio, it is necessary to make some assumptions about how investors behave when making investment decisions. modern portfolio theory explains how investors build efficient portfolios and select the best among all efficient portfolios. these parameters can be measured, which include the risk and expected return of an individual asset or a portfolio of assets. all of these parameters are estimated based on historical data and represent them in a statistical model. [15]. in general, the problem in portfolio selection is choosing a portfolio of assets to maximize the expected utility which is the subject of wealth [9]. b. capital asset pricing model(capm) rational investment decisions are models based on expected returns and risks associated with investments, and decisions using risk-based asset pricing models such as the capm and other similar frameworks [16]. the expected return on the capm is as follows [14] e(ri) = rf + βi[e(rm) – rf] (1) e(ri) is the expected return on the portfolio i is a measurement of the systematic risk of asset i relative to the portfolio. in the economic model, the model can be modified by relaxing one or more assumptions. some modifications constitute the capm. the only risk that rational investor value is systematic risk, because it cannot be eliminated by diversification and the only systematic risk is market risk. diversification of the portfolio refers to the selection of a portfolio of assets designed to reduce the variability of the returns on the entire portfolio compared to the variability (variance or standard deviation) of the return on assets [16]. the assumption in capm is that if the asset market is assumed to be in equilibrium (supply=demand), then investors choose based on the mean-variance objective and investors behave according to the general average value and variance of asset returns. capm predicts that all investors hold the same portfolio risk (if the portion of the asset portfolio is proportional to the market) [9]. the capital asset pricing models and its extend variants are widely used for evaluation of the performance of investment portfolio[17] ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5993 3 c. liquidity one of the actions to absorb liquidity is through the issuance of government bonds [18]. bonds vary in liquidity, for government bonds are very liquid, because bond dealers trade in large quantities every day. people can sell government bonds in that market at any time [12]. underdeveloped bond markets and government securities markets add to excess liquidity, lack of market due to government or central bank securities limits the ability of banks to reduce their holdings of excess liquidity by buying bonds [19]. in this context, excess liquidity is liquidity used by banks as a precaution and can be considered as optimization behavior by banks. other important factors include the volatility of deposit holders' cash preferences, bank lending rates and variations in return on loans. in the short term, the cost of illiquidity is found to have a positive impact on excess liquidity. excess liquidity may result from a decrease in demand for credit or underborrowing which may be caused by weak growth prospects and loss of confidence. in such cases, low interest rates prove ineffective to stimulate demand [18]. in addition, excess liquidity can reduce the effectiveness of monetary policy in controlling inflation [20]. d. islamic financial market the government seeks to maximize the development of islamic financial instruments and infrastructure; develop an investor and regulatory base; develop sharia liquidity management; establish cooperation both domestically and internationally in the deepening of the islamic financial market [21]. financial market deepening is a concept, (i) the banking sector and banking agents can use various financial instruments. for investment decisions, (ii) government intermediaries and market intermediaries can deploy a larger volume [22]. deep financial markets and high quality risksharing assets and instruments enable borrowers to equally absorb various financing and risk management instruments [23]. the financial market development strategy aims to optimize the role of the financial market as a source of development financing, by contributing to the formation of a market structure that can support financial system stability. this market structure is expected to make: (i) financial markets able to provide alternative sources of financing and investment for business actors and the public; (ii) efficient and secure financial markets; and (iii) financial markets that can facilitate risk mitigation for market participants. in the accelerated stage of 2020 to 2022, the expected results are strengthening of the domestic and foreign investor base on a wider scale, increasing transaction volume and enrichment of financial market instruments and their derivative products, as well as increasing the credibility of benchmark rates[21]. e. government sukuk sukuk is investment certificates that are asset-based rather than asset-backed securities, with the underlying asset being necessarily sharia compliance in both nature and use [24]. referring based on indonesian law no. 19 of 2008 state sharia securities (sbsn) or goverment sukuk are state securities issued based on sharia principles, as evidence of the share of participation in sbsn assets both in rupiah and foreign currencies. sbsn issuance requires assets as underlying. the assets are state property financing objects that have economic value, in the form of land and buildings as well as other than land and buildings. government sukuk was first issued by the government on august 26, 2008. after the enactment of law no.19 of 2008 on may 7, 2008, the government began issuing state sharia securities (sbsn / goverment sukuk) as an effort to diversify sources of apbn financing. through the issuance of sbsn, the government can provide safe and credible sharia-based financial instruments, which are needed by the islamic finance industry iii. methodology this research uses the auto regressive distributed lags (dynamic) model. because it wants to know the factors that influence investment decisions, the dynamic model can estimate the magnitude of the independent influence of the model variables by not only paying attention to the condition of the current variable but also the condition of the variable in the past. so that the dynamic model that best reflects investor behavior, investor behavior based on an economic approach is not only influenced by current economic conditions but is also influenced by past economic conditions [25] in this study, the research sample is institutional investors (banks, central bank of indonesia, pension fund and insurance). using a quantitative method approach where the data used is secondary data to analyze investor behavior in investing in government bonds and sukuk. the data used is the time series from 2009 to 2020. the data source is based on data from the official website of indonesian ministry of finance and other sources relevant to this research. market participants make financing and investment decisions in a dynamic financial environment. they must understand the role of government in the economy, and the financial markets and financial intermediaries operating within the financial system [3]. previous research on investment behavior model is to create a framework that models investor decisions in the stock market. investors take several sources of information in making decisions, namely based on information on the stock market which provides stock information and official data provided by each company, then the bank provides data related to indicators for these shares and each company. these indicators represent the state of the financial ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5993 4 market and the level of risk. five indicators as explanatory variables (x), quality, sentiment, value, technique and price. quality is measured by the fundamental quality of the company, seen from the company's financial data, sentiment is measured by a combination of estimates made by company analysts, technique is measured by a combination of indicators that analyze company activities by looking at the rhythm of prices, value is measured by price/earnings ratio. price characteristics shows the price of the shares related to the company. the equation for the variation of relative performance is [3]: per f ( c,t(k),th)= (1) long (( c,t(k),th)= c,l(k) (2) short (( c,t(k),th)=xc,t(k)long (( c,t(k),th ) (3) sigm (( c,t(k),th)= c,t(k)long (( c,t(k),th )) 2 ..(4) xc,t = {xc,t (k), per f ( c,t(k),th, long (( c,t(k),th), short (( c,t(k),th), sigm (( c,t(k),th)} th ϵh,..(5) yt ={vixt, per f ( t,th), long ( t,th), short ( t,th),sigm ( t,th) } th ϵh, k=1…kx..(6) a. auto regressive distributed lags (ardl) this study uses secondary data. the analysis method uses the ardl model, which combines the koyck method (dynamic model) in determining the lag. the reason for this research using ardl/dynamic model is as follows: (i) each variable in government bonds and sukuk, oversubscribes of state securities can also function as an independent variable (explaining other variables) or can be a dependent variable (explained by other variables) in the equation. (ii) in addition to the level, the time lag of the variables in the ardl model is also more precise and influential in explaining the dependent variable. (iii) generating multivariate equations (ardl model) has the potential to track causal relationships between variables and interconnections between variables. . the ardl model can comprehensively explain the three models in this study, namely the investment decision model on government bonds and government sukuk; oversubscribe state of securities model. lag on ardl model [26]: yt = + t + + t = + jxt-j +δ 1wt-l + 1ɛt-l (7) this determination is called the rational lag model. the lag coefficient of xt, xt-1 in the ardl model on individual polynomial ratios is seen in the distributed lag form, where the coefficient is α0,α1,α2,…= coefficient of 1, l, l 2 ,…at (8) the stability of the dynamic equation in the lag koyck model, determined that the value of λ < 1, is needed for the model to be good, as well as for autoregressive, the autocorrelation parameter ρ < 1. koyck transformation yt = + 0xt + yt-1 + v1 (9) where vt = ( λ𝓊t-1), moving average of 𝓊t dan 𝓊t-1 an advanced test of koyck's method is the durbin h test to detect autocorrelation in the dynamic autoregressive acceleration model of the investment model: it = (xtxt-1) > 0 (10) where it is the investment at t period, xt is the output at time t and xt-1 is the output at time (t-1) since the ardl (dynamic) model is a model with ols, a unit root test is performed to check for the stationary of each variable. two tests that can be used for this test are augmented dickey fuller (adf) and phillip & perron (pp) [27]. iv. result and discussion the important finding is about the factors that affect the investment value and the factors that affect the oversubscribes on state securities. the investment value reflected in the outstanding government bonds and sukuk, is a fundamental thing that distinguishes the behavior of investors in choosing investments based on rational decisions on government bonds and sukuk. likewise, the decision of the issuer, in this case the government, is reflected in the oversubscribed value of state securities issued by the government. there are several economic indicators used in measuring these rational decisions: a. macroeconomic indicators (inflation, changes in currency values, changes in interest rates) b. financial market indicators (financing rate, transaction volume, deposit rate, yield rate on government bonds and sukuk) ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5993 5 a. analysis of factors affecting investment value in government bonds dan sukuk econometric analysis begins with describing the variables and constructing a model, then testing the model whether it meets the classical assumption test and is in accordance with the blue standard, then explains the results of the interpretation of the model. variables that affect investment value in sukuk are divided into two, namely macroeconomic variables, namely interest rate, inflation, changes in exchange rates, then financial market variables, namely coupon rate and sukuk transaction volume. with the details of the variables as follows 1) investment decision model on government sukuk this model represents the investment decision model on government sukuk. in this model the dependent variable is the outstanding investment value in government sukuk, while the independent variable is described as follows: 1. changes in interest rates, one of the investment decision variables on government sukuk investment. 2. changes in currency exchange rates. for government sukuk investment, this is a macroeconomic indicator that affects investment 3. the yield or return from government sukuk stated in the coupon rate. coupon rate is an indicator of investors in making decisions whether to invest in sukuk or not. 4. government sukuk transaction volume. a) stationary test table i stationary test of government sukuk variable adf (augemented dickey fuller) level 1 st difference interest rate -1.041414 -7.498017*** coupon rate -2.348730 -14.33903*** exchange rates -0.568247 -7.664923*** volume -1.653775 -12.94155*** outstanding 4.255247 -9.890101*** notes:*** refers to 1% significance b) correlation and causality test to test the strength of the linear relationship between the independent variable and the dependent variable and the causal relationship, using the grager causality test, where the variable has a positive linear relationship if r = 1 and has a negative linear relationship if r = -1 and has no linear relationship if r = 0 table 2 value of correlation coefficient variable value of correlation coefficient interest rate coupon rate exchange rate volume sukuk -0.6905 -0.6628 0.8623 0.8544 the correlation coefficient of the investment decision variables on government sukuk, is more than 50%. for the volume variable and exchange rate changes, it shows a positive linear correlation. this shows that every time there is an increase in volume and a change in the exchange rate, it will increase the value of investment in government sukuk, while the interest rate and coupon rate coefficient variables have a strong linear relationship, but in opposite directions. when the interest rate decreases, where the government sets the interest rate for central bank of indonesia to fall, it will cause the investment value in government sukuk to increase. for government sukuk, coupon rates have a strong and negative linear relationship, this can be explained as follows figure i historical of interest rate and coupon rate of government sukuk 3 4 5 6 7 8 9 10 11 12 09 10 11 12 13 14 15 16 17 18 19 20 bi rate cprate coupon rate and interest rate if viewed from the trend from month to month during 2009 to 2020, the coupon rate was always above the interest rate, only in february 2015 the coupon rate was lower (6.75%) than the interest rate (7.5%). at that time there was a deflation of 0.36% where the price decline was for transportation, communication and financial services. the existence of a negative linear relationship indicates that the coupon rate is less attractive to investors and there are other needs that cause it to not be included in the investment in government sukuk. 2) investment decision model on government bonds this model represents the investment decision model on government bonds. in this model the dependent variable is the outstanding investment value in government bonds, while the independent variable is described as follows: 1. changes in interest rates, one of the investment decision variables on government bonds investment. 2. currency exchange rates. for government bonds investment, this is a macroeconomic indicator that affects investment 3. the yield or return from government bonds stated in the coupon rate. 4. government bonds transaction volume ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5993 6 a) stationary test table 3 stationary test of government bonds variable adf (augemented dickey fuller) level 1 st difference interest rate -1.041414 -7.498017*** coupon rate -1.787004 -13.82857*** exchange rate -0.568247 -7.664923*** volume -0.402051 -17.89821*** outstanding 1.210691 -11.42576*** notes:*** refers to 1% significance b) correlation and causality test table 4 value of correlation coefficient value of correlation coefficient interest rate coupon rate exchange rate volume bonds -0.6550 -0.5994 0.8893 0.8455 figure 2 historical of interest rate and coupon rate of government bonds 3 4 5 6 7 8 9 10 11 12 09 10 11 12 13 14 15 16 17 18 19 20 bi rate cprate coupon rate and interest rate in the graph above, it can be seen that the coupon rate also experienced the same thing in the july 2014 period where the coupon rate was lower (7.26%) compared to the interest rate (7.5%). indonesia's economic growth in 2014 experienced a slowdown, as for investment, although the global economy experienced a slowdown, in that year a new portfolio of idr 177.75 trillion was formed during january to november 2014 which was higher than the previous year. 3) investment decision model from the issuer side (government) this model represents the decision model of the issuer (government) which is seen in oversubscribes of state securities. in this model, the dependent variable is oversubscribes of state securities, the oversubscribes is obtained from the indicative target value of state securities minus the total incoming bids then subtracted the total offers received, while the independent variables are described as follows: 1. inflation, which is an independent variable in investment decisions from the issuer's perspective. 2. currency exchange rates. for state of securities oversubscribes, this is a macroeconomic indicator that affects investment. 3. yield or return from state securities. the value of the coupon rate is an indicator of investors in making decisions. 4. deposit rate, this is an indicator in seeing oversubscribes because institutional investors always pay attention to which investments are profitable on deposits, the indicator is on the deposit rate offered. 5. financing rate, this is one of the indicators in viewing state securities oversubscribes, because excess liquidity can be absorbed by channeling financing a) stationary test of oversubcribed state of securities table 5 stationary test variable adf (augemented dickey fuller) level 1 st difference inflation -10.32493*** -11.43421*** exchange rates -0.568247 -7.664923*** oversubcribed state securities -0.013404 -9.468222*** rate deposito -1.678019 -4.675500*** financing rate -1.121258 -5.896649*** coupon rate -1.977744 -11.41699*** notes:*** refers to 1% significance b) correlation and causality test table 6 value of correlation coefficient value of correlation coefficient inflation coupon rate exchange rate rate deposito financing rate state of securities 0.1994 0.51571 0.6087 0.3517 0.55961 the correlation coefficient value on government issued state securities oversubscribes can be conveyed as follows, the linear relationship between independent variables (inflation, coupon rate, exchange rate changes, deposit interest rates and financing rates) and the government issued state securities oversubscribes variable (dependent variable) is all linearly related which is positive, meaning that if all independent ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5993 7 variables increase, it will increase the value of oversubscribes on securities issued by the government. b. estimation of investment decision models in government bonds and sukuk, and oversubscribes the estimation model of investment decisions on government bonds, sukuk and from the government side (state of securities oversubscribes) uses classical assumptions such as autocorrelation tests, heteroscedasticity tests and multicollinearity tests. the coefficients of the individual variables and the overall variables must also follow the blue standard. 1. model of investor's investment decision on government sukuk. table 7 estimated investment decision model on government sukuk dependent variable (investment value in government sukuk) independent variable coefficient p-value constant 5629.867 0.0000 d (coupon rate(-2)) 0.105523 0.0113 d (interest rate(-6)) 0.129156 0.0181 d (exchange rate(-1)) -0.1031524 0.0005 d (exchange rate(-4)) 0.690870 0.0207 d (volume(-8)) -0.142366 0.0416 d (outstanding sukuk(-1)) 0.196766 0.0148 analysis diagnostic value p-value r-square 0.226667 residual sum square 1.64e+10 akaike info creation 21.55692 fstatistics 6.252877 0.000009 lm test 0.482572 0.7856 heteroskedasticity test 11.03445 0.0873 based on the model in table 7, it can be seen that: (i) any change in the coupon rate in the 2nd lag period will cause an increase in investment in government sukuk by 10.5%. (ii) every time there is a change in the percentage of the interest rate in the 6th lag period, it will cause an increase in investment in government sukuk by 12.9%. (iii) every time there is an increase in changes in currency exchange rates, it will increase investment by 58.7%. this shows that the interest rate has an effect on investors in deciding to invest in government sukuk. the interest rate has an influence on government sukuk investment decisions. every time central bank stipulates, an increase or decrease in the benchmark interest rate is ensured because there are conditions that must be balanced and stabilized, so that this interest rate has a broad impact on the economy, especially the financial market and will indirectly have an impact on other sectors. likewise for changes in exchange rates, every time there is an increase in the exchange rate, the investment value in government sukuk will increase. the overall independent variables are proven to be able to explain changes or movements in government sukuk investment by 22.66%, this shows that although the independent variables are sufficient to represent domestic and international instruments, in general there is still a shortage of variables or there are other variables that can explain the analysis of investors' decisions on investment. government sukuk (there are other variables that are not included), because this research focuses on this variable only. 2. estimated investment decision model on government bonds table 8 estimated investment decision model on government bonds dependent variable (investment value in government bonds) independent variable coefficient p-value constant 14666.14 0.0000 d (coupon rate) -0.462650 0.0001 d (interest rate (-10)) -0.252253 0.0414 d (exchange rate) 0.357707 0.0000 d (volume) 0.039975 0.0035 d (volume(-1)) 0.034734 0.0124 d (outstanding(-1)) 0.235881 0.0046 analysis diagnostic value p-value r-square 0.382145 residual sum square 8.99e+10 akaike info creation 23.27521 fstatistics 12.98858 0.000000 lm test 1.990181 0.1410 heteroskedasticity test 0.677293 0.6682 from table 8 it can be explained that every time there is a percentage increase in the interest rate in the 10th lag period, this causes a decrease in investment in government bonds by 25.2%, this happens because if the interest rate decreases, investors will invest in government bonds and if the interest rate increases, then investors will invest in central bank. for investment in government bonds, changes in the interest rate have an effect on investment in government bonds after 10 periods. this can be a concern, where the interest rate has a significant effect on the investment value after 10 periods. by looking at the model on the coupon rate variable, changes in the exchange rate and the volume of government bonds, it can be concluded that investors in government bonds tend to look at the coupon rate value of the government bonds so that the ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5993 8 size of the coupon rate greatly affects investor interest. then, because the nominal value of government bonds at each auction is quite large, changes in the exchange rate and volume have a fairly rapid impact on the value of investment in government bonds. all independent variables are proven to be able to explain changes or movements in the value of investment in government bonds by 38.21% this shows that although the independent variables are sufficient to represent domestic and international instruments in investment decisions in government bonds, in general there is still a lack of variables or there are other variables that can be used. 3. state of securities oversubscribes model estimation the last model is the state securities oversubscribe model issued by the government. the government-issued state securities oversubscribes model is shown in table 9, table 9 state securities oversubscribes model estimation dependent variable (state securities oversubcribed) independent variable coefficient p-value constant -9367175 0.1315 d (coupon rate(-1)) -0.8600919 0.0446 d (exchange rate) 0.905700 0.0000 d (inflation(-2)) -0.2106608 0.0626 d (rate deposito(-1)) -0.179224 0.0000 d (financing rate (-5)) 0.170269 0.0000 d (oversubcribed(-1)) -0.546266 0.0000 analysis diagnostic value p-value r-square 0.504887 residual sum square 6.35e+17 akaike info creation 39.00504 fstatistics 22.26436 0.00000 lm test 2.356273 0.0988 heteroskedasticity test 1.309931 0.2571 the government oversubscribes model issued by the government is influenced by various factors, including the coupon rate, changes in exchange rates, inflation, deposit rates, and financing rates. state securities oversubscribes are excess liquidity that must be channeled. coupon rates and deposit rates have an effect on the first lag period, while inflation in the second lag period and financing rates have an influence on the value of state securities oversubscribes in the 5th lag period. all independent variables are proven to be able to explain changes or movements in state securities oversubscribes by 50.4% c. output model investors' investment decisions in government bonds and sukuk are influenced by several factors where the influencing factor is the coupon rate listed on each issued government bonds and sukuk. each auction offers a different coupon rate and this value is usually above the interest rate, so investors are interested in investing in government bonds and sukuk. the coupon rate is used as a reference for investors who will buy or invest in government bonds and sukuk. then after the next coupon rate is the interest rate, this increase in interest rates becomes a reference for investors in investing in government bonds and sukuk. if central bank of indonesia takes action to increase the interest rates, investors will try to invest their funds in deposits. so that to be more competitive, the coupon rate must be higher than the interest rate, so that investors get the desired expected return. the third factor is the change in the currency exchange rate, the change in the exchange rate is a factor that affects the investment value in government bonds and sukuk. investors are very concerned about this factor, because if the exchange rate significantly, it will affect the value of their investment. this is because exchange rate can cause the price of sukuk in the market to change, so that the expected rate of return does not match expectations, or even losses. the fourth factor is the volume of transactions on government bonds and sukuk, seen from the trend that the volume of these transactions continues to increase so that the outstanding value of investments in government bonds and sukuk also increases. the last factor that affects the investment value in government bonds and sukuk is the change in the outstanding value of government bonds and sukuk where the investment value in previous government bonds and sukuk affects the current government bonds and sukuk value. for inflation, it is not included in the model because its value is not economically significant in time period. this inflation has been calculated in the interest rate, so investors refer to the interest rate. then there is this inflation which is surprising and temporary in nature, which will disappear by itself over time. this state securities oversubscribe is seen from the issuer's perspective, namely the government, to see how much excess liquidity the government has to distribute. judging from the historical point of view, every auction always oversubscribes the issued state securities, meaning that the number of interested parties (investors) bidding is far higher than the issued state securities. the factor that affects the oversubscribed value is the coupon rate, every coupon rate offered is above the interest rate (only in certain periods there are anomalies). this coupon rate becomes a reference for investors and the government in issuing state securities. second, changes in currency exchange rates, these exchange rate changes become macroeconomic factors that affect the overall model. this exchange rate change has a fairly broad impact, so the government always strives to keep the value stable, so that it does not cause a wide impact and is difficult to control. in the case of excess liquidity oversubscribed on state securities, changes in the exchange rate may cause excess liquidity to increase or lead to short liquidity. the third factor is inflation, the value of which fluctuates at any time has an influence on the value of state securities oversubscribes. the fourth factor is the yield on bank deposits, this factor affects the value of excess liquidity state securities oversubscribes because investors tend to invest in deposits with short periods of time (weekly, monthly, and 3-month periods) so that they tend liquid, but they can be withdrawn at any time and moved to other places. in line with this, the next factor is financing ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5993 9 interest rates, state securities oversubscribes which can cause excess liquidity to be absorbed, one of which is through bank financing, so that excess liquidity can be absorbed v. conclusion . investment decisions in government bonds and sukuk are strongly influenced by the prevailing macroeconomic and financial market conditions. the state securities yield value stated in the state securities coupon rate is a very crucial factor for investors who will invest in state securities. the value of this coupon rate, with the increasing number of investment alternatives, the value is contrary to investment decisions because there is a tendency for the value of investment in state securities to increase even though the value of the coupon rate is decreasing. macroeconomic conditions that influence investment decisions are changes in currency exchange rates. the currency exchange rate is a crucial macroeconomic factor for investors in their decision to invest in government bonds and sukuk. the next crucial factor in terms of macroeconomic policy, which affects investment decisions is the interest rate, if further examined changes in the interest rate affect the coupon rate so that it has an impact on investors' investment decisions. when the interest rate decreases, there is a tendency for the coupon rate to also decrease, so if the interest rate increases, the coupon rate value also increases. however, the value of investment in state securities continues to increase in the value. investment decisions between investors in government bonds and sukuk are influenced by the same variables, namely coupon rate, exchange rate changes, interest rate and transaction volume, but the crucial difference is in the lag period for the interest rate, government sukuk tends to be affected more quickly by the interest rate value, namely at short-term period in the middle of the year (at lag 6) meanwhile, investment in government bonds value is affected by changes in the interest rate in the long term, namely the 10th lag period. then next is the transaction volume for government sukuk, the transaction volume has a long-term impact, namely the 8th lag period, because the value of government sukuk transaction volume is indeed quite far when compared to investment in government bonds. for changes in exchange rates and coupon rates, these two variables affect investment in government bonds and sukuk in the short term. state securities oversubscribes, seen from the issuer's investment decision is influenced by the coupon rate variable, exchange rate , inflation, deposit rate, financing rate and all of these variables have an impact on the short-term state securities oversubscribed value. state securities oversubscribes which are excess liquidity must be channeled immediately so that they can be absorbed properly, so that it is in line with the model that all of these factors have an impact in the short term. from the results of the analysis and discussion above, the things that researchers can recommend are as follows 1. the government as the issuer of state securities should pay attention to the value of the coupon rate, although the interest (investors) is still quite high, but the tendency of investors is to continue to look at the value of the yield (coupon rate) obtained by investors. 2. policy formulation regarding the structure of state securities ownership should still be conditioned so that institutional investors (banking, central bank, pension funds and insurance) are still dominant in sbn ownership). 3. policies related to state securities oversubscribe, in which the government can absorb oversubscribes so that in development it can open wider access to alternative islamic investments. 4. facilities and infrastructure that support investor investment in state securities so that it can be improved such as strengthening electronic-based systems, management of state assets that become the underlying government sukuk, documentation so that it is more well integrated this study only focuses on macroeconomic and policy variables (inflation, exchange rates and interest rate) and financial markets (financing interest rates, deposit rates, volumes and coupon rates). however, based on the model that has been generated and analyzed, there are still other variables that greatly determine the analysis of investment decisions on government bonds and sukuk such as internal management decisions, government regulations related to the islamic capital market and general economic conditions (crisis or normal). for further researchers, it is hoped that they can conduct more in-depth research on investment decisions in government bonds and sukuk because there are still many shortcomings in this study. it is also expected to add psychological factors, social factors, environmental factors and other matters such as foreign investors' 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[27] r. ismal. “the management of liquidity risk in islamic banks” : the case of indonesia. durham e-theses, unpublished.2010 http://www.bi.go.id/ https://doi.org/10.1016/j.jup.2018.03.006 ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5993 11 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6202published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 11/08/2021 accepted for publication: 20/07/2022 published: 29/07/2022 35 a deep learning approach to risk management modeling for islamic microfinance klemens katterbauer1, philippe moschetta2 1,2 euclid university, central africa republic corresponding author 1*: katterbauer@euclidfaculty.net contact author 2: philippe.1@euclidfaculty.net abstract— islamic microfinance rides two recent growing trends: conventional microfinance and islamic banking. it offers financial flexibility to the poorest strata of the population in different muslim countries by borrowing and mixing techniques from these two sources. in particular, risk management and loan qualifications tend to be similar to those operating inside conventional and islamic financial institutions. the loan approval process heavily relies on scoring applicants mostly on their financial criteria. this paper aims to demonstrate that an alternative framework based on artificial intelligence improves traditional financial techniques. this framework also resonates more with the fundamental and specific values of islamic microfinance as it captures some non-financial attributes of the applicant that are informationally rich. we first present the critical components of this novel approach. then, we apply it to a business case (approximately 30,000 applications to a microfinancing institution in the central african republic) to demonstrate its usefulness. keywords-component; islamic microfinancing, artificial intelligence, risk management, shariah law, data-driven study i. introduction a. the islamic microfinance context microfinancing has been a growth area of modern finance in developing countries. it provides individuals with modest financing options. it allows them to escape poverty and overcome some of the restrictions encountered in conventional banking based on strict demand for collateral and strong credit history. deprivation continues to be a significant challenge in many muslim communities: more than 500 million individuals live on less than 2 us dollars per day in indonesia, pakistan, india, bangladesh, egypt, and nigeria. these individuals struggle given the lack of sufficient liquidity, savings management, and ability to transfer and receive money [1]. islamic microfinance has been posited as an innovative instrument for poverty alleviation. in contrast with traditional microloans, shariah-compliant financing options offer a more suitable answer for muslim borrowers [2]. we often see a recourse to a blend between conventional high-interest microfinancing and their islamic version, but both rely on the existence of collateral. the first advantage of the islamic option with collateral (e.g., jewelry or gold) is the continual roll-forward of the loan with a flexible repayment schedule that allows the monetization of the collateral by following the cash inflow/outflow borrower’s profile. this option is open without the need to re-enter a loan application process every time the borrowing re-starts [3]. the second advantage of the islamic microfinancing option is the safekeeping of the collateral by the lender at a very low cost [4]. finally, the overall cost to the lender tends to be more competitive than the conventional option. the limitation of this islamic financing option is two folds. first, the lender usually restricts these loans to the acquisition of an asset and prohibits discretionary spending. second, the absence of financial interest on the microloan prevents the significant growth of the loan book for the lender, particularly when the financial interest is computed to cover the risk of late payment or even of a write-off. due to the importance of managing late payment and default risk in the context of riba-free loans (i.e., absence of financial interest), assessing the overall financial risk associated with islamic microfinance is paramount for the sustainability of this market. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6202published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 11/08/2021 accepted for publication: 20/07/2022 published: 29/07/2022 36 b. financial risk in islamic finance risk management for financial institutions includes several broad risk categories: market risk, credit risk, operational risk, and liquidity risk. market risk arises from changes in market prices (e.g., interest rates, commodity prices). credit risk derives from the possibility that the debtor does not repay the debt in total, and the recovery on the net value of the pledged asset does not cover the unpaid balance. operational risk covers negative situations caused by failed internal processes, fraud, collusion with the debtor, mere incompetence of the credit officer, or inadequate collection processes. another critical risk is the liquidity risk, which implies that there is not sufficient liquidity in the market to buy or sell assets. these risks are present in islamic finance, so conventional risk techniques used to manage them are also relevant. a difference with conventional risk analysis arises with the quantum of risk that the institution should allow: “it [gharar] is not as well defined as riba, and a ruling of permissibility based on gharar could take into account a cost-benefit analysis.” [5]. it explains why the level of risk acceptable in islamic finance can differ from one institution to another. on the one hand, one could consider risk as intrinsic to any financial transaction, hence not a reason to exclude from a pure loan a risk element. on the other hand, one could be willing to eliminate any trace of this notion on a loan. the risk is then transferred to an ancillary islamic transaction that takes place simultaneously as the loan transaction. we observe an analogous islamic debate about the degree of risk inclusion with the concept of ‘haram’ food. for example, the shafie school seeks to eliminate any najis-components in ‘halal’ food to avoid potential contamination. in contrast, other schools may accept a minute percentage of non-halal ingredients. similarly, uncertainty related to the price is equally prohibited in islamic finance [6]. therefore, risk modeling techniques in islamic finance institutions should filter only permissible risks. consequently, risk modeling should specify whether the variation in asset quality or reimbursement price is part of the risk model. these techniques are particularly relevant for regulators. their importance has been generally increased with each financial crisis. the basel accords, set up in the 1980s, tried to establish for financial institutions an international standard for minimal capital requirements with a particular focus on credit risk. the basel ii agreement (viz. the revised capital framework) broadened these terms in the aftermath of the 200708 financial crisis and incorporated, besides minimal capital requirements standards related to supervision and discipline in financial markets [7]. similar to the basel accords, in case an islamic financial institution faces unexpected losses, partners /shareholders are required to forgo a portion of the profit or, in the worst case, provide additional equity. for islamic microfinance institutions, these remedies are more difficult to implement. these institutions are not usually run for profit. they cannot absorb through their gains the credit losses. in addition, the lack of future profitability limits the recourse to fresh funds charitable sources. hence the heightened need to control for risk to minimize the amount of risk that the institution's management can take [8]. in this paper, we will first review the current practice that conventional financial institutions use to assess the borrower's suitability. then, we will present a novel framework based on artificial intelligence (ai) techniques that will extract from the borrower’s profile an informational advantage compared to conventional techniques. we will show that this advantage optimizes the risk/reward equilibrium of the financial institution and also chimes with the islamic values that are the cornerstones of these institutions. finally, we will test this possibility through a business case of approximately 30,000 applications to a microfinancing institution in the central african republic. ii. three levels of financial risk models a. conventional risk model to manage the overall risk of a financial institution, the basel regulations impose a minimum coverage ratio of 8% defined by: regulatory capital risk-weighted sum ≥ 8 % the denominator in this model is computed by multiplying a pre-defined risk factor (specific to each class of loans) by the nominal value of the loan. the main advantage of this model is its simplicity. the regulator can easily audit the computation and track the evolution from one reporting period to the other. the main drawback is the absence of the covariance effect between loans. this absence can work in two different directions. for example, the benefit of a diversification strategy with negatively correlated loans is not reflected in this ratio. the potential negative impact of having correlated loans in different classes is not translated either. furthermore, the effectiveness of this ratio is heavily dependent on the methodology used to determine the risk factor associated with each class of loans. a different approach is the utilization of a factor sensitivity measure. this measure can be expressed for the value of a portfolio 𝑉! = 𝑓(𝑡!,𝑍!) at time n, as 𝑓"!(𝑡!,𝑍!) = 𝜕𝑓 𝜕𝑧# (𝑡!,𝑍!) the factor sensitivity approach is important to analyze the portfolio's robustness with respect to a change in risk-factor. however, it is difficult to aggregate all sensitivities together to determine the overall riskiness of the loan portfolio [9]. the most conventional approach to risk modeling is utilizing a loss distribution approach. the main objective is to estimate the loss 𝐿!$% given a probability distribution 𝐹& that is estimated european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6202published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 11/08/2021 accepted for publication: 20/07/2022 published: 29/07/2022 37 from historical data. the challenge that arises from this is to determine the distribution and its parameters [10]. a widely used parameter used for risk assessment is the standard deviation. however, this depends on the context, and the standard deviation may be inadequate for several applications. specifically, the standard deviation is only defined for distributions that fulfill 𝐸(𝐿') < ∞. probability distributions with fat tails (i.e., kurtosis > 3) do not fulfill this criterion. additionally, the standard deviation does not distinguish between positive and negative events as it sums the absolute deviation from the mean equally. a critical alternative measurement criterion is the value-atrisk (var) quantifier. the var is defined as 𝑉𝑎𝑅((𝐿) = inf {𝑙 ∈ ℝ:𝑃(𝐿 > 𝑙) ≤ 1 − 𝛼} which implies that for each confidence level 𝛼 ∈ ([0,1]) the probability that the loss l exceeds l is less than 1 − 𝛼. while the var is an important measurement criterion and has attracted the attention of regulators, it has considerable limitations [7]. specifically, it does not provide any information on the magnitude of the expected loss. the shape of the loss curve after the var point does not impact the var calculation. the computation of the expected loss is necessary. it is defined as 𝐸𝑆((𝐿) = 𝐸(𝐿|𝐿 ≥ 𝑉𝑎𝑅((𝐿)) these computations present a statistical challenge due both to their limited number of degrees of freedom and to specific probability distribution assumptions on the data that underlie them [9]. in summary, most regulators prefer the ethical transparency and auditability of such established statistical models primarily based on a limited number of frequently used statistical assumptions. therefore, understanding the model becomes more important than understanding the data. financial institutions are then tempted to make the data fit the statistical model they use, or that has been prescribed by the regulator rather than developing a fit-for-purpose alternative [11]. the great financial crisis of 2008-2009 has amply demonstrated that most risk models did not sufficiently capture capital risks. they were not comprehensive enough to include extreme events and underestimated their true frequency, particularly the sharp increase of covariance between loans at times of general financial stress. nevertheless, we posit it is possible to reconcile regulators’ needs and improved outcomes in risk management. we hypothesize that techniques derived from ai offer an efficacious alternative in building an adequate risk model. these models will support better decision-making for financial institutions while allowing regulators to monitor risk policies. b. artificial intelligence risk model ai has gained considerable traction in a variety of different industrial and business applications. it allows novel insights from semi-structured data. it facilitates automatized decisions at a lower cost compared to a human-only process. in the islamic microfinance context, it considers a variety of different quantitative and qualitative factors germane to the specificity and originality of that industry. we can identify at least four areas of relevance: 1) the loan decisions in microfinance are numerous and repetitive, 2) the islamic finance construct of these pure loans put pressure on the cost structure of the financial institutions and requires a high level of automation, 3) shariah law promotes the avoidance of specific types of uncertainties 4) the tracking of the coverage ratio collateral/loan must be done frequently to minimize the default risk. [12]. at the same time, ai can draw inferences from a large and evolving database of user data. it can be optimized continuously. therefore, it can train itself in adequate conditions. nevertheless, as it is frequent with ai-driven decision processes, machine learning models provide little explainability. it may cause uncertainty in the final go/no go result [13]. so, financial institutions may be at a loss to explain to loan applicants why they have rejected the loan request. it may also require constant monitoring to avoid embedded biases that could run contrary to the notion of fair and equal treatment, a value highly promoted by islamic finance for the umma at large. if we examine now the steps followed by conventional machine learning models, they start out with a pre-processing step to analyze and filter the data. the first step comprises data filtering and data imputation, as well as the management of data outliers. this phase is critical for ensuring that the machine learning model is robust and extracts the core features in the data [14]. the second step is the choice between regression and classification, representing a significant differentiation between ai models. whether to utilize a classifier or regression model depends on whether one wants to estimate the potential loss or value depreciation or aims at classifying the risk incurred. concerning classifiers, one can distinguish either 1) heterogeneous, 2) individual or 3) homogeneous classifiers. heterogeneous classifiers combine the predictions from various types of models and involve stacking, averaging, and hill-climbing algorithms. individual classifiers conventionally incorporate logistic regression, support vector machines, neural networks and decision trees. finally, homogeneous classifiers combine the predictions from multiple similar models and achieve diversity through sampling. such models are called bagging, random forest and boosting. researchers can also use these algorithms similarly for regression purposes. they also exploit hyperparameter optimization to optimize model performance [15]. in the third step, data scientists, when faced with a large number of parameters, follow a nonlinear optimization approach to achieve adequate optimization results. they determine a globally optimal set of hyperparameters via genetic optimization. the optimization relies on the principles of natural selection to find a globally optimal solution. a critical aspect of european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6202published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 11/08/2021 accepted for publication: 20/07/2022 published: 29/07/2022 38 genetic programming is the importance of the initial solution and the evolution of the population to find the most optimal solution. while the framework's performance depends on the measurement criterion used, a considerable improvement may be achieved from intelligent optimization [15]. after that step, they face the challenge of explainability. transparency about the factors influencing decision-making is crucial in islamic finance, given that risk sharing is a crucial feature of islamic finance instruments. most machine learning models have an inherent but rudimentary form of explainability. while this may not be in the form of a single equation with a few parameters, the impact of the various input data on the model may be conventionally determined by a feature analysis. treebased models enable with relative ease to measure the impact of each model feature and how these features interact with each other. quantified as feature importance, the impact on the model evaluation metric is determined via changing a single variable in the tree. this subsequently allows the determination of the model quality. to test the importance of a variable, data scientists perform a sensitivity analysis on the quality of the model. the most relevant variables generate the most important changes in quality. therefore, they can address from these most influential variables the explainability challenge [9] and provide in layman’s terms a simplified causal explanation to loan applicants. a final consideration generally absent from the classic risk management model for financial institutions flows from a compulsory environmental, social and governance (esg) assessment. certain elements of the esg schema have been included ab initio in the islamic finance conceptual framework. for example, environmental sustainability is a crucial component of islamic finance as shariah law stipulates that financing projects detrimental to the environment are forbidden [7]. islamic finance forbids other sectors detrimental to a safe environment for humankind like pornography, gambling, or the military industry. in terms of governance, equality between the financial partners is another component of islamic finance. given these esg concerns, ai is particularly well-suited to comprehensive risk modeling that promotes an inclusive approach by combining numerical with non-numerical data. while the conventional models focus on the financial profitability of the loan, islamic microfinance must incorporate other ethical considerations that are often more difficult to measure in a purely numerical way. c. islamic microfinance ai risk model we have developed a novel ai islamic risk management framework for assessing credit risk for islamic microfinancing institutions. the framework determines both individual and overall credit risk for the islamic microfinancing market. furthermore, the framework incorporates a recommendation engine that enables individuals without formal financial qualifications to review islamic microloans. it also contains the value risk of the underlying asset [7]. to develop the framework, we have utilized a random forest approach. random forest methods belong to the class of ensemble learning techniques [16]. in these techniques, the random forest consists of multiple decision trees where the trees are trained by either bagging or bootstrapping. bagging is an advantageous ensemble technique for enhancing accuracy. individual decision trees are combined into different bags. from these bags, we select the bag with the highest accuracy to be further branched out. then, increasing the number of trees that are incorporated leads to an increase in the precision of the estimates or classification. a critical benefit of random forest trees is the reduction of the limitations of the decision trees, specifically when it comes to overfitting [17]. our framework benefits from the effective way that random forest algorithms handle missing data. in addition, they do not need excessive hyperparameter tuning to achieve reasonable predictions. we illustrate in figure 1 the various types of nodes are encountered in a random forest algorithm [17]. we start with the root node, followed by the decision nodes and then the leaf nodes. each decision node may have multiple leaves or decision nodes. a decision node with multiple leaves represents a subtree. information theory provides insights into the way decision trees and random forests operate. specifically, the critical objective for a decision tree is to maximize its entropy or information gain, which is a measure of uncertainty [18]. given a set of independent variables, entropy increases when the uncertainty is reduced. higher entropy means that a higher degree of uncertainty has been removed during the training of the decision trees. the main advantage of the random forest method is that the segregation of the nodes is performed randomly through bagging. this process allows the use of different samplings for the training phase. figure 1:graphical illustration of random forest algorithm. our framework separates the risk management model into three sub-models: 1) the estimation of the individual credit risk, 2) the classification of risk and, 3) the maximum acceptable loan amount. furthermore, the sub-models also estimate the expected value at risk for the entire islamic microfinance institution. it also offers alternative recommendations for loan applicants in case they do not qualify for a conventional microloan. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6202published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 11/08/2021 accepted for publication: 20/07/2022 published: 29/07/2022 39 iii. case study a. data sources and structure to evaluate the ai-driven islamic risk model for microfinancing, we collected from an islamic microfinancing institution a dataset of approximately 30,000 loan takers and applicants in the central african republic. the dataset was augmented with data based on general demographic, income, and societal norms when the data was not complete. the reference data were taken from a variety of sources, such as the european country of origin information network, the world bank, the international monetary fund, and the united nations statistics [19, 20]. table 1: dataset parameters categorized according to personal data, islamic values, and financial data. data columns type gender p ersonal d ata age job marital status number children wife is working number of mobile phones number of children studying zakat amount paid per year islam ic value s participates in islamic volunteering committed crimes number of crimes committed went to an islamic school monthly salary f inancial d ata monthly overall income monthly loan repayment monthly expenditure number successfully repaid loans number defaulted loans value of collateral for the risk modeling framework, we analyzed initially the dataset to discern potential correlations and relationships within the data. the structure of the collected data for each individual loan applicant is outlined in table 1. the collected data were categorized into three different types: personal data, data related to islamic values, and financial data. b. data visualisation in this section, we describe the data distributions and composition of the initial dataset. in figure 2, we outline the dataset's age distribution and marital status. the histogram values are all indicated in per cent. the distribution shows that most of the applicants were married, with a few being single (less than 5 % for each age group) and a lesser number (less than 2 %) being divorced or widowed. figure 2: histogram of the age distribution and marital status. the data outline that almost 38 per cent of the women are married, while around 17 per cent are single. the overall statistics outline that the dataset contains more women as compared to men in the dataset. given that the average income of men is typically higher than women's, with many islamic microfinance businesses primarily being run by women, this is mirrored in the dataset. this situation is outlined in figure 3 that clearly outlines that men have a shifted and flatter salary distribution as, which clearly outlines than men have a gone and flatter salary distribution compared to women. another interesting statistic is the comparison between overall monthly income and the attendance of an islamic school. figure 4 outlines the statistics, which do not seem to significantly impact. to understand gender-induced effects on marital status, we visualise the distribution of the data in figure 5 their distribution and colour each by their marital status. 60 per cent of the dataset is made up of women. in comparison, the remaining 40 per cent constitute men. most of the individuals are married, with a further 33 per cent being single. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6202published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 11/08/2021 accepted for publication: 20/07/2022 published: 29/07/2022 40 figure 3: histogram of the salary distribution for different genders. figure 4: histogram comparison of overall monthly income versus attendance of islamic school. figure 5: comparison of the distribution of males and females according to their marital status. c. data interpretation to analyze the data in greater detail, we performed hypothesis testing to ascertain visually observed trends. the first visual observation is that the salary levels of the male is considerably higher than those of women. to analyze this, we performed a statistical 2-sampled z-test. the t-test is an inferential statistical test to assess whether two groups exhibit a significant difference in their respective means. given that we know from the dataset the two groups' population variances and a large sample size, the z-test is more adequate to determine the difference. to statistically prove that the distributions for men and women are not equal, we utilise the null hypothesis that the means of the two groups are identical and aim to reject the null hypothesis. performing the analysis and calculating the p-value, we could easily reject the null hypothesis that the two means are identical. analysing the histograms in figure 3, we can observe that the earnings for males are considerably higher as compared to women. furthermore, we perform statistical analysis with the null hypothesis that the income shall be independent for women whether they operate a business or not. this hypothesis could be rejected, indicating our previous results. finally, we evaluated whether the attendance of an islamic school affects the income level. the null hypothesis is that there is a difference in income level between those who attended and those who did not participate in. the idea was rejected, implying that there is no difference. d. ai-driven loan application model having analysed the data and its validity, we then aimed to develop an islamic ai-driven risk model to determine whether an individual qualifies for an islamic microfinancing loan. in addition, the model utilises a risk rating approach driven by deep learning to indicate a maximum loan amount. that maximum corresponds to a high probability of repayment. to evaluate the performance of the framework for the loan qualification of individuals, we performed a confusion matrix comparison. the framework performs on the training and testing dataset well, achieving perfect accuracy scores ( figure 6). this strong estimation performance is due to a variety of reasons. first, there is a strong correlation between the monthly income and collateral value in determining an individual's qualification for a loan. higher-income individuals with sufficient collateral easily qualify for an islamic microfinance loan due to the increased probability of repayment. furthermore, the criminality score of the individual may also impact the estimates significantly. figure 6: confusion matrix plot for the qualification of individuals for an islamic microfinance loan. to evaluate which features have the most substantial impact on the estimation, we determined the feature importance based on: 1) the mean decrease in impurity and 2) feature permutation. the former calculates the mean and standard deviation of the accumulation of the impurity decrease within each tree. then, the mean and the standard deviation are used to measure the impact. for the latter, the features are computed based on a leftout test set. their advantage is that they are less susceptible to a bias towards high cardinality features. to ensure robust calculation of the feature importance, we compared the results for both versions and displayed the results in figure 7. the results indicate that the number of crimes and european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6202published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 11/08/2021 accepted for publication: 20/07/2022 published: 29/07/2022 41 whether a crime was committed are the essential features determining whether someone qualifies for a loan in addition to their islamic credentials, such as the amount of zakat they pay per year. the amount of zakat plays a critical role as it is an implicit factor correlated to honesty and commitment to the well-being of others. following religious prescriptions and being a law-abiding citizen fits well with the objectives of islamic finance. this would contrast with conventional risk management models that primarily focus on income levels to assess the qualification for a loan. the amount zakat paid is a handy parameter as more significant amounts of zakat paid also implies that the individual aims to benefit society to support those less well-off. figure 7: feature importance for both mean decrease in impurity and feature permutation for the qualification of individuals for an islamic microfinance loan. once completing the loan qualification step, we turned to the evaluation of the credit default risk of the applicant. we created five risk categories, from shallow risk (a) to severe (e). figure 8 the confusion matrix for both the training and testing dataset. the credit default risks are consistent with a high classification score for both the training and testing dataset. figure 8: confusion matrix plot for the credit default risk of individuals for an islamic microfinance loan. to evaluate the feature importance impact on the various risk categories (figure 9), we can observe that the value of zakat is the most important before the value of the collateral. these islamic results are aligned with conventional microfinance data that utilise islamic values and contribution to society as a critical parameter for evaluating creditworthiness and risk. mdi feature permutation figure 9: feature importance for both mean decrease in impurity and feature permutation for the credit default risk for an islamic microfinance loan. as a final step, we estimate the maximum loan an individual can support for a low level of risk. we developed a random forest framework to estimate the maximum loan amount. the estimation results for the training and testing dataset are presented in figure 10. for the maximum loan amount, it outlines the target vs predicted result. both summarise strong estimation results with a coefficient of determination of 0.9 and 0.85, respectively. the main objective of the model is to take into account islamic factors such as zakat payments and the number of committed crimes. while the number of committed crimes and the attendance of an islamic school only marginally affects the maximum overall amount, the amount of zakat paid represents a key parameter in determining the ability to pay back the funds. figure 10: regression plot for the maximum number of individuals for an islamic microfinance loan. in summary, the most important parameters to the model are the amount of zakat paid, number of committed crimes and the value of collateral. interestingly, by using the difference between the mdi and feature importance based on permutation, the amount of zakat paid as well as value of collateral, in addition to the number of crimes committed are the most critical parameters. comparing this to conventional risk management, the model outlines the stronger focus on islamic values and behavioral parameters as compared to solely numerical and income derived parameters. while these parameters are taken into account, contributions to the society in the form of zakat are utilized as benchmarks in order to assess the qualification. thereby, the financial institution aims to correlate factors such as honesty and high charity contributions with a better credit rating and likelihood of repayment. this has been observed in multiple european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6202published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 11/08/2021 accepted for publication: 20/07/2022 published: 29/07/2022 42 instances where individuals tried to take advantage of situations and lacked honesty, and in the end aimed to severe and take advantage of the business environment [21]. while treachery may pay off for the loan taker that may gain an unfair advantage from dishonesty, the microfinance institution may experience considerable losses. hence, a stronger focus on social parameters, such as charity contributions and faith may be key parameters to enhance microfinance efficiency and overcome the challenges of conventional risk management models. mdi feature permutation figure 11: feature importance for both mean decrease in impurity, and feature permutation for the maximum loan value for an islamic microfinance loan. iv. conclusion we have presented in this paper a novel ai-driven approach to financial risk management for islamic microfinancing. the data-driven framework overcomes a key challenge in incorporating islamic values in the provisioning of islamic microfinancing for determining eligibility for loans, credit risk, and the maximum overall amount. the results from the framework represent a critical step towards strengthening loan governance and evaluating loan applicants fairly. a distinctive feature is to capture the loan applicant’s attitude vis-à-vis islamic values. this value element is generally absent from conventional microfinance that primarily focuses on income levels and collateral. an additional benefit of this model is the absence of a loan officer’s personal views on the individual who applies for a loan, reducing biases against the most disadvantaged and processing costs. this approach represents a positive step toward enhancing access to islamic microfinancing. v. references [1] b. kustin, "islamic (micro)finance culture, context, promise and challenges," bill & melinda gates foundation, 2015. [2] m. uddin, "determinants of loan default of lowincome borrowers in urban informal credit markets: evidence from dhaka city.," european journal of business and management, vol. 11, no. 26, pp. 105-114, 2019. [3] m. el-komi and r. croson, "experiments in islamic microfinance," journal of economic behavior & organization, vol. 95, pp. 252-269, 2013. [4] h. begum, m. r. alam, a. s. a. alam and a. h. awang, "islamic microfinance as an instrument for poverty alleviation.," advanced science letters, vol. 21, no. 6, pp. 1708-1711, 2015. [5] b. shanmugam and z. r. zahari, a primer on islamic finance, new york: research foundation of cfa institute, 2009. [6] c. paldi, "understanding riba and gharar in islamic finance.," journal of islamic banking and finance, vol. 2, no. 1, pp. 249-259, 2014. [7] n. al rahahleh, m. i. bhatti and f. n. misman, "developments in risk management in islamic finance: a review.," journal of risk and financial management, vol. 12, no. 1, p. 37, 2019. [8] m. k. hassan and r. n. kayed, "the global financial crisis, risk management and social justice in islamic finance.," risk management and social justice in islamic finance, 2009. [9] p. christoffersen, elements of financial risk management., academic press, 2011. [10] s. byoun, j. kim and s. s. yoo, "risk management with leverage: evidence from project finance.," journal of financial and quantitative analysis, vol. 48, no. 2, pp. 549-577, 2013. [11] h. gazali, j. jumadi, n. ramlan, n. rahmat, s. uzair and a. mohid, "application of artificial intelligence european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6202published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 11/08/2021 accepted for publication: 20/07/2022 published: 29/07/2022 43 (ai) in islamic investments," journal of islamic finance, pp. 70-78, 2020. [12] t. lin, "artificial intelligence, finance, and the law," fordham law review, p. 531, 2019. [13] m. nasri, "application of artificial neural networks (anns) in prediction models in risk management.," world applied sciences journal, vol. 10, no. 12, pp. 1493-1500, 2010. [14] p. giudici, "fintech risk management: a research challenge for artificial intelligence in finance.," frontiers in artificial intelligence, vol. 1, p. 1, 2018. [15] n. bussmann, p. giudici, d. marinelli and j. papenbrock, "explainable ai in fintech risk management.," frontiers in artificial intelligence , vol. 3, p. 26, 2020. [16] l. tang, f. cai and y. ouyang, "applying a nonparametric random forest algorithm to assess the credit risk of the energy industry in china.," technological forecasting and social change , vol. 144, pp. 563-572, 2019. [17] m. schonlau and r. y. zou, "the random forest algorithm for statistical learning.," the stata journal , vol. 20, no. 1, pp. 3-29, 2020. [18] n. ghatasheh, "business analytics using random forest trees for credit risk prediction: a comparison study.," international journal of advanced science and technology, vol. 72, pp. 19-30, 2014. [19] austrian red cross, "central african republic ssptw 2019," european country of origin information network, vienna, 2019. [20] w. a. k. kouame, h. t. edjigu, n. ouattara and s. tomi, "central african republic economic update : the central african republic in times of covid-19 diversifying the economy to build resilience and foster growth," world bank group, washington, 2020. [21] a. bhide and h. stevenson, "why be honest if honesty doesn’t pay," harvard business review, 1 october 1990. [online]. available: https://hbr.org/1990/09/whybe-honest-if-honesty-doesnt-pay. [accessed 11 december 2021]. paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 islamic finance and the new technology challenges department of international economic relations, university of economics, varna, bulgaria, kamdzhalov@ue-varna.bg abstract— islamic finance, as a new economic paradigm based on ancient principles and rules, needs to embrace the new it opportunities in order to be up to date with the contemporary financial industry. this process will become a “bridge” between the past and the future of socially responsible financing. the world’s financial and economic environment in our days is marked with immense inequality and imbalance. with the emergence of the global capital structures, solely ruled by the principles of the financial markets, the main focus of the economy shifted from real entrepreneurship to a form of capital bureaucracy. the financialization of the economy is a crucial phenomenon of contemporary capitalism, which could lead the world economy nowhere. structures such as hedge funds, venture capitals and private equities create no real value. the main objective of such financial management firms is short term profits. by cutting costs (firing workers, reducing investments etc.) they have harmful impact on the companies they invest in. in order to evade deleterious effects on the economy, caused by the financialization, an interest free environment and financial technology (fintech) development need to be implemented. islamic finance as a no-interest based intermediary can be fully embedded in such processes. by nature the islamic mode of financing excludes the dealing with debt and purely monetary activity. the digital disruption can bring independence, shrink costs, and improve services as a whole. blockchain is the technology which provides the contemporary base for development of the fintech. on one hand it enables maximum security of transactions and on the other it energizes crowdfunding. in the islamic finance context of the profit and loss sharing paradigm, the new disruptive technology has the potential to reduce the risk and to increase productivity. in the end by increasing trust, blockchain and islamic finance can mitigate debt-based financing. keywordsislamic finance, blockchain, financialization, fintech, crowdfunding. i. introduction inequality is a major concern in society. from social and economic perspective inequality is a wide researched area of study. this topic has attracted the attention of many scholars, scientists and writers. since the time of david ricardo and after that karl marx many bright minds (and others not so prominent) have touched upon the theme. inequality is a fact which is so important that it needs to be discussed in depth and observed not only by philosophers, economists, sociologists etc. but from all who can share their thoughts on it. politics are deeply influenced by the same phenomenon. if the members of the society exploit the natural and production goods unfairly, this will lead to uncertainty and unsustainable growth. there is always conflict between different social classes on how to distribute wealth. in our day, in the era of widespread information, disruptive information technology provides a significant opportunity to enhance the discussion and take action towards solving the problem. we need calm observations and analyses of all statements and facts related to the economic, political and social mechanisms that might answer the question of wealth distribution and social justice. without a doubt inequality is a matter of perception. there are no scientific clues as to what its ideal state should be. it is more or less a philosophical category. nevertheless, to achieve such a state in which the economy is growing and wealth distribution is fair, we need a well balanced mix of policies and institutions. the contemporary world’s financial and economic environment is marked with immense inequality and imbalance. with the emergence of the global capital structures, solely ruled by the principals of the financial markets, the main focus of the economy shifted from real entrepreneurship to a form of capital bureaucracy. the financialization of the economy is a crucial phenomenon of the contemporary capitalism, which could lead the world economy nowhere. structures such as hedge funds, venture capitals and private equities create no real value. the main objective of such financial management firms is the short term profits. by cutting costs (firing workers, reducing investments etc.) they have harmful impact on the companies they invest in. islamic finance has principles that makes it very close to social finance like risk sharing and calls for social justice and welfare. there are solid and undeniable evidences in islamic history for financing the social sector using islamic financial tools like zakat (obligatory charity) sadaqa (voluntary charity) and waqf (perpetual endowment) [1]. the aim of this research is to elaborate probable opportunities of the islamic finance, combined with the latest information technologies, to mitigate the harmful effects on the economy, caused by financialization. islamic finance as a socially responsible activity could be used to shrink such negative economic effects. the core principles of asset-based financing, combined with disruptive technologies such as blockchain present new challenges to contemporary financing. ii. financialization and islamic finance the phenomenon “financialization” arises after the collapse of the bretton woods agreement. according to noam chomsky in the mid 1970s, after years (1945 – 1975) of miroslav kamdzhalov mailto:kamdzhalov@ue-varna.bg ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 unprecedented economic growth in the developed capitalist counties, the economic situation changed. the financial system prevailed over production and sustainable development. the finance was freed, speculation boomed, huge amounts of capital started going into speculation against currencies and other paper manipulations, and the entire economy became financialized [2]. chomsky was probably the first voice to signal the problem that was the immense power of the financial institutions. after the financial crisis in the usa from 20072008, the consequences of the financialization became apparent and many economists started to address this issue. what exactly is the phenomenon financialization? why is it so important? gerald epstein defines financialization as: “the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of the domestic and international economies” [6]. the financial sector is vital to any economy. without investment there is no development. but the devil is in the details. here we do not deal with the normal banking activity where a financial institution lends money on purpose to create value. structures such as hedge funds, venture capitals and private equities create no real value. the main objective of such financial management firms is the short term profits. by cutting costs (firing workers, reducing investments etc.) they have harmful impact on the companies they invest in. the capitalist economy is considered a structure which comprises different spheres of activity – namely production, circulation, and distribution – among which production is dominant [7]. production creates value. finance as a part of circulation does not create value. the effects of financialization increased after the appearance of a global spread of financial markets. bank behavior is derived from market-related financial transactions. speaking of value we should mention mariana mazzucato and her term “value creation – value extraction”. even big multi-national companies, which create value in a similar way, extract value. with different, mainly financial techniques such as tax-evasion, share buy-back, they feed the financialization of the economy. rather than reinvest they transfer capital to the closest group or individual shareholders. the social, economic and political impact of value extraction is huge. prior to the 2007 financial crisis, the income share of the top 1 per cent in the us rose from 9.4 per cent in 1980 to a staggering 22.6 per cent in 2007. since 2009 inequality has been increasing even more rapidly than before the 2008 financial crash. in 2015 the combined wealth of the planet’s sixty-two richest individuals was estimated to be about the same as that of the bottom half of the world’s population – 3.5 billion people [8]. we can see a similar process depicted in figure 1. inequality is rising almost everywhere, but at a different pace: 0 10 20 30 40 50 60 1 9 8 5 1 9 9 0 1 9 9 5 2 0 0 0 2 0 0 5 2 0 1 0 2 0 1 5 india russia europe china us-kanada figure 1: top 10% income shares across the world, 1985– 2015. source: world inequality report 2018 this inequality is born from debt one whose burden is carried by the middle class. the working people are encouraged to experience more and more debt. this, no doubt, will lead to a financial bubble which was the cause for the last world financial crisis. the governments rescued the financial institutions responsible for this economic crash with public resources. financialization as a phenomenon of the advanced capitalist economies has enormous influence on banks, nonfinancial enterprises and households. more and more nonfinancial enterprises are involved in pure financial activity. we observe a huge increase of the financialization of the productive sector. there are many examples of that. in the 2000s, the us arm of ford made more money by selling loans for cars than by selling the cars themselves. over the same period ge capital, the finance arm of the enormous general electric group, made around half of the whole group’s earnings [8]. let us remember what islamic finance means. definitions vary from very narrow (interest-free banking) to very broad (financial operations carried out by muslims). here we deal with the type of financial operations governed by the sharia. from here the following definition of ‘islamic financial institutions performing islamic financial operations’ can be derived: islamic financial institutions are those, whose objectives and operations are firmly based on the principles of the quran and the sunnah. in this way they differ from the conventional institutions (be they muslim as well), which do not have such considerations or concerns. this definition exceeds the mere equalization of islamic financing with ‘interest-free’ banking. it allows for operations which can or cannot be interest-free, but are still influenced by certain islamic principles to be taken into account. such principles include the avoidance of riba (usury) and gharar (uncertainty, risk, and speculation), the focus on halal (religiously permissible) activities, as well as in general the search for equity and other moral and religious purposes. there are two aspects of islamic finance that must be clearly distinguished: ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 • the first is the philosophy of risk sharing – the lender must share the risk with the borrower. the fixed interest rates determined in advance (in the case of conventional banking) guarantee return on investment to the lender and that they are taken up by the party receiving the loan. from islamic point of view these interest rates are seen as exploitative and socially unproductive. the preferred financing method is sharing both the profit and the loss (pls). • the second is the encouragement of economic and social development by means of specific business practices and through zakat (alms). most of but not all islamic institutions have a board of religious advisors, whose opinion regarding the acceptability of new methods is highly sought after. essentially their function is carrying out a religious audit of the activities of the bank. the islamic financial principles ensure the preservation of the contractual agreement and the balance between the borrower and the lender for the sake of mutual benefit. every islamic financial transaction suggests direct involvement in asset efficiency (in some cases this can be realized with a special purpose vehicle spv). the investors have clearly defined rights and obligations specified in the financial agreement’s predetermined parameters, which ensure return on investment proportionate to the amount of money invested by each party. the sharia law forbids the trade with debt as a means to acquire interest (riba), the use and transfer of economically inactive assets without ramification, as well as contractual uncertainty. interest-free forms of financing are deemed acceptable only if they do not involve pork, alcohol, gambling or pornography. according to the sharia, profiting from and paying to use a particular asset is permissible if both parties adhere to the pls principles. the very same principles stipulate that returns are not guaranteed but are realized if there is income. to sum up, the main difference between both methods of financing is that while conventional financing usually only aims at maximizing profit, within the confines of a given regulatory frame, islamic financing is also governed by particular social and moral tenets. there is a plenty of space for social impact financing in order to diminish poverty and inequality in the world economy. in this context, the islamic financial instruments can be considered in line with the same objectives and requirements social impact investments that generate social and economic benefits. biancone and radwan [9] considered that unconventional financing alternatives provided by islamic finance can be used in impact investing. impact investing and islamic finance are highly complementary as both of them upholding rigorous moral and social criteria for investments and emphasize on inclusiveness. some authors [4] see a correlation between economic growth, islamic finance and financialization. unlike financial capitalism or financialization, islamic financing is purely a real goods financing. no financing can find its way to the islamic system without passing through the production and exchange of real goods and services. such asset-based activity is fundamental for economic growth and real value creation. islamic financing is essentially connected with the goods and commodities market and it is limited by the volume of finance required by actual transactions that take place in this market. islamic financing is limited by the size of the transaction in the goods and services market whether it is done by means of sharing, sale or lease contracts. this makes islamic modes of financing direct and strongly linked to real physical transactions. sharing modes are only possible for productive enterprises that involve real-life businesses that increase quantity or improve quality or enhance usability of real goods and services. such businesses generate a return that can be distributed between the entrepreneur and the financier. even the sale-based modes are those that involve actual physical exchange of commodities from one hand to another whereby financing is measured only by real sale of commodities and can only be provided to the extent of the real value of the goods exchanged. the same thing also applies to leasing where leased assets are the pivotal thing around which financing is built. iii. blockchain and islamic finance the revolutionary uniqueness of blockchain technology is the reliability and trustiness of information transferring. with its self-controlling peer-to-peer algorithms users can be sure that the system would reject any malicious attempt. the other key feature of this technology is its decentralization, which can change the world in a disruptive way, much like the internet and smart phones are capable of doing. the intermediation of a third party is gone which automatically shrinks security risks. the blockchain became popular with the development of cryptocurrencies such as bitcoin. this is only a single feature of the technology. except currency, blockchain enables contracts and applications. this provides an opportunity for wide application in the social, economic, health, art, etc. areas of society. with this technology immediate digital currency payments as well as more complicated financial contracts are possible. any currency, financial contract, or hard or soft asset may be transacted with a system like the blockchain. furthermore, the blockchain may be used not just for transactions, but also as a registry and inventory system for the recording, tracking, monitoring, and transacting of all assets. a blockchain is quite literally like a giant spreadsheet or ledger for registering all assets, and an accounting system for transacting them on a global scale that can include all forms of assets held by all parties worldwide. thus, the blockchain can be used for any form of asset registry, inventory, and exchange, including every area of finance, economics, and money; tangible and intangible assets [10]. many authors [12] depict blockchain as a genealogical tree. but at the same time they clarify that genealogy is not sufficient to explain all the features of the technology. blockchain uses cryptography and hashes extensively for data protection and deterring hackers. the key concepts of blockchain are bitcoin, peer-to-peer network, cryptography and hash functions, and ledger. encryption is the process of converting plaintext into incomprehensible text, called ciphertext. decryption is the ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 reverse process of turning back the incomprehensible ciphertext in to plaintext. the encryption algorithms used by bitcoin mining are hash functions. a hash function is a function that maps data of any size to data of a fixed size. the values returned by a hash function are called hash values or simply hashes. a cryptographic hash function allows one to verify easily that some input data maps to a given hash value. however, the reverse – when the input data is unknown is practically infeasible as it requires reconstructing the input plaintext from a hash value. in other words, hashing is a one-way operation. another notable attribute of a hashing function is that a minor change in the input plaintext will result in a completely different hash value. this feature is desirable for safeguarding information as any tiny change to the original data by a hacker results in a visibly different hash. that is why blockchain is such a reliable technological tool. there are three categories (generations) of blockchain: • blockchain 1.0 cryptocurrencies • blockchain 2.0 – smart contracts • blockchain 3.0 applications blockchain 1.0 stands for the decentralization of money and payments. blockchain 2.0 stands more generally for the decentralization of markets. it is concerned with the transfer of many other kinds of assets beyond currency using the blockchain; from the creation of a unit of value through every time it is transferred or divided. the information (bitcoin or else) transferred trough blockchain is not saved somewhere in a folder. the transactions are recorded in a ledger, which uses the resources of a large peer-to-peer network to verify and approve each transaction. the operations run on computers provided by volunteers around the world, hence there is no central database to hack. this type of distribution together with public appearance (anyone can view it because it resides on the network) and the above-mentioned encryption guarantees the security, decentralization and efficiency of the blockchain. in the context of efficiency we should point out the relatively low number of transaction per second. but this is the cost paid for the balance between decentralization, security, and scalability. islamic finance is a socially responsible and ethical financing method. is there compatibility between islamic finance and blockchain? the answer is not unambiguous. if we take into consideration bitcoin or any other criptocurrency, the answer should be negative on the forgoing question. the islamic scholars still have not come to a decision on this issue. if we take into consideration asset-based principles in islamic finance, then probably, according to sharia, criptocurency is not permissible. but the focus here should be on the potential of the blockchain technology to fund start-up projects on peerto-peer basis. with its decentralization, security and scalability it brings value and encourages entrepreneurship. the key word in both islamic finance and blockchain is “trust”. the sharia prohibits contractual uncertainty and deceiving methods. the global ledger of the blockchain works under a similar direction: it keeps information truthful thus creating an environment of trustworthiness. in the preblockchain world trust in transactions came from individuals, intermediaries, or other organizations acting with integrity. because we often cannot know our counterparties, let alone whether they have a reputation for integrity, we have come to rely on third parties not only to vouch for strangers, but also to maintain transaction records and perform the business logic and transaction logic that powers commerce online. these powerful intermediaries—banks, governments, paypal, visa, uber, apple, google, and other digital conglomerates—harvest much of the value [11]. one possible way to embed blockchain in islamic financial activity is by using smart contracts. smart contracts are a complex suite of software codes with components designed to automate execution and settlement of contractual agreements. they are programmable contracts which self-execute the stipulations of an agreement when predetermined conditions are achieved. once two or more parties consent to all of the terms within the contract, they cryptographically sign the smart contract and deploy it to a distributed ledger. when a condition specified in the code is met, the program automatically triggers a corresponding action. by lack of any direct human involvement, a deployed smart contract on a distributed ledger could make contractual relationships more efficient and economical with potentially fewer opportunities for error, misunderstanding, delay or dispute [5]. following the principles of islamic financial contracts, we would compare them to the aforementioned smart ones. in the case of mudaraba or musharaka contracts there is a reliable and trustworthy opportunity for crowdfunding. in general, crowdfunding is used to finance start-ups, small and medium enterprises, expansion projects and capital increase. it is also used to finance all works, creative ideas and works of art such as films and charity projects such as relief campaigns and others. it is based on the principle of social solidarity to serve an idea or a project, and the redistribution and better utilization of financial resources. this is in line with the essence of islamic finance, which is considered a revolution in the financing methods in the islamic world if properly invested [13]. when a mudarib for instance needs funding for his startup or already functioning business, blockchain technology could provide such support. sukuk as a main contemporary method of fundraising for infrastructure projects and business development in islamic financing is possible to be integrated in smart sukuk contracts. hussein elasrad [5] stated that, the smart sukuk structure has strived to use the blockchain and boost efficiency, transparency, reduce the cost and make it possible for small and medium enterprises, social impact projects, groups and associations to issue their own sukuk using the new technology. the world’s first innovation in smart sukuk was introduced by blossom finance. the facility endeavored to change the conventional ways of sukuk issuances using the blockchain. blossom’s smart sukuk uses ethereum blockchain smart contracts in order to strengthen the efficiency and make it a ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 globally acceptable sukuk. the most significant feature of smart sukuk is standardizing and automating the accounting. legal and overhead payments of conventional sukuk offerings are all fully backed by a licensed legal entity in the issuing country [5]. we could emphasize too on shrinking of the financialization effects, as an addendum of such assertion. the conventional sukuk issuance is delivered by powerful institutions and government agencies and despite the core principles of the islamic finance there is a possibility for short term profit striving and rising of the inequality. as is visible on the following chart (figure 2), income inequality is highest in the middle east. 0 20 40 60 80 figure 2: top 10% national income share across the world, 2016 source: world inequality report 2018 good application of the blockchain could also be observed in zakat administering. zakat is one of the main pillars of the islamic economy and the basic principle of distribution of social goods. it relies on both approaches voluntary in the form of alms and obligatory, to tackle poverty and social inequality. here there is a divergence with conventional, secular-type economies, where the issue of social well-being is a matter of a government-run macro-economic approach through the collection of population taxes. the islamic approach to taxation policy involves taking social policy management out of the government's reach. this lack of government regulation, relative to decentralization in the blockchain technology, leads us to the conclusion that blockchain can be used successfully in zakat practice. according to some authors [5] there is already obligation for muslims linked to cryptocurrency. the amount of zakat is calculated at 2.5% of liquid assets held for at least a full year: gold, silver, cash, savings, investments, rent income, business merchandise or profits, shares, securities, and bonds all qualify as part of the calculation. since cryptocurrency like bitcoin qualifies as a liquid asset, muslims must take care to include their cryptocurrency assets in the calculation for their zakat obligation, as well as to keep track of how much cryptocurrency they’ve held for a full year, since assets held for less than one year need not be included in this calculation. iv. conclusion as set out herein, we can conclude that there is an extensive interconnection between financialization of the economy, blockchain and islamic finance. based on common principles the last two can work in symbiosis in order to mitigate the negative effects on the economy and so to all society. the implementation of the new information technology in islamic financing is not only vital for the future of socially responsible financing. the advantage is that it will bring more trust and business prosperity, especially in the middle class. blockchain as a new disruptive technology is a tool for relieving the economy of financial “illnesses”. blockchain has a potential to return the entrepreneurship back to life. on the other hand, islamic finance, based on its own fundamental principles (real asset-based activity, money is not asset, they are just means), could support the process of sustainable economic development. the institution of profit-loss sharing by definition excludes speculative motives in an investment so that the interests of borrowers and lenders in a common project are met. crowdfunding supported by blockchain could thrive and thus develop sustainable growth. references [1] p. p. biancone, and m. radwan, “social finance and financing social enterprises: an islamic finance prospective”. european journal of islamic finance, 2019. [2] n. chomsky, “chomsky: understanding the crisis markets, the state and hypocrisy”. foreign policy in focus, 2009. (available at https://fpif.org/chomsky_understanding_the_crisis_markets_the_state_a nd_hypocrisy/). [3] f. alvaredo, l. chancel, t. piketty, e. saez and g. zucman, “world inequality report”. world inequality lab, 2018. [4] a. el-galfy and k.a. khiyar, “islamic banking and economic growth: a review”. the journal of applied business research – volume 28, number 5, 2012. [5] h. elasrad, “blockchains for islamic finance: obstacles & challenges”. mpra paper no. 92676, 2019. (online at https://mpra.ub.unimuenchen.de/92676/) [6] g. epstein, “financialization and the world economy”. northampton, ma: edward elgar publishers, 2005. [7] c. lapavitsas, “profiting without producing: how finance exploits us all”. verso, 2013. [8] m. mazzucato, “the value of everything making and taking in the global economy”. penguin publishing, 2018. [9] p. p. biancone and m. radwan, “social finance and unconventional financing alternatives: an overview”. european journal of islamic finance, (10). 2018. [10] m. swan, “blockchain: blueprint for a new economy”. o’reilly media, inc., 2015. [11] d. tapscott and a. tapscott, “blockchain revolution: how the technology behind bitcoin is changing money, business, and the world”. penguin publishing, 2016. [12] x. wu and w. sun, “blockchain quick start guide”. packt publishing, 2018. [13] p. p. biancone, s. secinaro and m. kamal, “crowdfunding and fintech: business model sharia compliant”. european journal of slamic finance, (12). 2019. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. buerhan saiti, istanbul sabahattin zaim university, turkey prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 35 analysis of factors affecting community interest in bengkalis regency riau province indonesia in using sharia banking 1 department of islamic banking and centre for research and community service at stain bengkalis riau (indonesia) contact author: zulfikarhasan61@gmail.com abstract— this study aims to find what are the biggest factors that make the people of the bengkalis regency choose islamic banking to conduct financial transactions. the research was made using sem amos quantitative data analysis to see in more detail and more detail what are the biggest factors in choosing islamic banking in bengkalis regency. this research is also assisted by the theory of planned behavior (tpb) from ajzen which explains the four main variables in analyzing the data, the four variables are (1) attitudes, (2) subjective norms, (3) perceived behavioral control, and (4) interests. each variable has several questionnaire questions, where all of them are 17 questions. from the results of the study using the sem amos, it was found that all the questionnaire questions used had a value above 50 percent, of which the highest value was 90%, the people of bengkalis regency chose islamic banking to transact because of suggestions from relatives. hopefully, in the future, there will be other researchers who research islamic banking in bengkalis regency, riau province. keywords: the theory of planned behavior, sem amos, islamic banking, factors i. introduction the development of islamic banking in indonesia has become a benchmark for the success of the existence of the islamic economy. bank muamalat indonesia as the first islamic bank and a pioneer for other islamic banks, has already implemented this system amid the proliferation of conventional banks. the monetary crisis that occurred in 1998 had drowned conventional banks and many were liquidated due to the failure of the interest system. meanwhile, banks that implement the sharia system can exist and survive [5] [1] [36]. not only that, amid the global financial crisis that hit the world at the end of 2008, islamic financial institutions have again proven their resilience from the crisis. islamic financial institutions remain stable and provide benefits, comfort, and security for their shareholders, securities holders, financing customers, and customers depositing funds in islamic banks [12] [2]. besides the success of bank muamalat indonesia into the crisis that occurred in 1998 through giving the improved appearance and not receiving some support from the government and in the 2008 financial year crisis, bank muamalat indonesia was even able to make income profit rp. 300 billion more [35]. based on law no. 12 of 1956 (state gazette no. 25 of 1956), bengkalis regency with its capital city bengkalis is led by a district head of level ii. bengkalis regency is the number one largest district in riau province (statistik, 2021). riau province itself is one of the richest provinces in indonesia. his wealth includes the results of mining oil, coal, forests, plantation products such as oil palm, rubber, marine, and river products, and so on. meanwhile, the contribution of riau province to the center every year is almost 59.6 trillion [7] [8] [9]. riau province is one of the mainstay provinces for state treasury income. one of them, for oil alone riau contributes about 50% of national production. riau is among the three richest provinces in indonesia with an income of 3.7 trillion, behind west java (5.2 trillion) and east java (4.3 trillion) [33]. bengkalis in the past played an important role in history. based on existing folklore, starting in 1645, bengkalis was only a fishing village. based on historical sources, in 1678, this area became a meeting place for malay, javanese, arab traders who brought their wares along with traders from palembang, jambi, indragiri, aceh, kedah, perak, kelong, johor, penang, farmers. , siam, cambodia, kocin, chinese and minangkabau people inhabit sumatra and come there to take salt, rice, and also fish (terubuk) which is mostly caught by the straits people [16] [23]. based on a report from the central statistics agency, the islamic banking industry in bengkalis regency is still quite low when compared to other sectors. from the data above, it can be explained that mining and quarrying are still the main sector in bengkalis regency wherein 2020 it will reach 9,280,895. meanwhile, the financial services sector (including banking) was only 36,333. zulfikar hasan1 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 36 seeing the development of islamic banking, which is getting better from year to year, the riau provincial government has made a good enough master plan so that the literacy and inclusion index of the people of riau province increases from the previous year. so, in 2020 the riau kepri regional development bank (bpd) has planned to convert the riau kepri bank into a sharia riau kepri raiu bank. bank riau kepri (brk) is ready to convert into a sharia commercial bank. several processes are being carried out in collaboration with the riau province financial services authority before officially submitting to the directorate of sharia bank licensing and regulation (dpps) ojk head office in jakarta. the conversion of brk into a sharia bank is the decision of the brk shareholders [25]. however, ojk asked the board of directors to conduct studies and surveys to ensure that the converted brk can later grow and develop properly. the conversion must also be supported, especially by the people of riau and riau kepri. including support from existing customers, both funding customers and financing customers. brk as the host in riau and the riau archipelago is expected to do well to be able to become an accelerator in encouraging the acceleration of economic growth in the two provinces which have slumped as a result of the covid-19 pandemic. as of january 2021, brk recorded total assets of rp 26.6 trillion. profit was recorded at rp 7.6 billion. as of the third quarter of 2020, brk's core capital was recorded at rp 2.8 trillion and the return on equity ratio of 19.21 percent, and the loan to deposit ratio (ldr) of 83.75 percent [3]. according to the financial report of uus bpd riau kepri, the total assets of uus as of june 2020 were idr 3.3 trillion with a profit of idr 41 billion. gross non-performing financing (npf) was 2.78 percent and financing to deposit ratio (fdr) was 98.05 percent [3] [20]. seeing the development of bank riau kepri in riau province, this research it will easily have an impact on bengkalis regency because bengkalis is one of the districts with the largest shareholder in this regional bank. hither the author tries to see and examine whence the people from bengkalis regency prefer islamic banking to direct activities. besides needing to see what factors increase the bengkalis community to accomplish at islamic bank. table 1. bengkalis regency economic structure chart data 2015 2016 2017 2018 2019 2020 agriculture, forestry and fisheries 5 7 8 9 8 1332568 mining and excavation 80 73 69 66 68 9280895 processing industry 8 10 11 12 11 1865822 electricity and gas supply 0 0 0 0 0 3742 water supply, waste management, waste and recycling 0 0 0 0 0 1491 construction 2 2 2 2 2 425380 wholesale and retail trade 3 5 5 5 5 923580 transportation and warehousing 0 0 0 0 0 37024 provision of accommodation and food and drink 0 0 0 0 0 38229 information and communication 0 0 0 0 0 48784 financial services and insurance 0 0 0 0 0 36333 real estate 0 0 0 0 0 40037 company services 0 0 0 0 0 532 corporate administration, defense and social security mandatory 1 0 0 0 0 117986 education services 0 0 0 0 0 43104 health services and social activities 0 0 0 0 0 12231 other services 0 0 0 0 0 37333 source: central bureau of statistics of bengkalis regency european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 37 ii. literature review theory of planned behavior or tpb is a further development of the theory of reasoned action. tpb is a conceptual framework that aims to explain the determinants of certain behavior. according to ajzen (1991), the central factor of individual behavior is that behavior is influenced by individual intentions (behavior intention) towards that particular behavior. intention to behave is influenced by three components, namely (1) attitude, (2) subjective norm, and (3) perceived behavior control [10] [11]. a person may have various kinds of beliefs about behavior, but when faced with a particular event, only a few of these beliefs arise to influence behavior. it is these few beliefs that stand out in influencing individual behavior [16] [10]. these prominent beliefs can be divided into first, behavior beliefs, namely individual beliefs about the results of behavior and evaluation of these results. behavioral beliefs will affect attitudes toward behavior [4]. the second is normative belief, namely the individual's belief in the normative expectations of others who become his reference such as family, friends, and tax consultants, as well as the motivation to achieve these expectations. this normative expectation forms the subjective norm variable for a behavior [16]. the third is control belief, namely the individual's belief about the existence of things that support or hinder his behavior and his perception of how strongly these things affect his behavior [29]. control belief forms the perceived behavior control variable [16]. in tpb, attitudes, subjective norms, and perceptions of behavioral control are determined through key beliefs. the determinant of a behavior is the result of an assessment of the beliefs of the individual, either positively or negatively. theory of planned behavior or tpb is based on the assumption that humans are rational beings and use the information that is possible for them systematically [10]. people think about the implications of their actions before they decide whether or not to perform certain behaviors. according to [3], there is a basic assumption that has been misunderstood so far, namely, that the majority of the muslim community has so far been possessed by the usury virus and at the same time deeply appreciates secularism, especially in the financial aspect [27]. as a result, there are always excuses raised to evade the invitation to return to islamic teachings purely and consistently. this does not only happen among the relatively ordinary people but also among those who are quite familiar with the provisions of fiqh and sharia. from there it can be understood that the preferences and orientation of society, in general, is profit (profitoriented), regardless of the source of income, halal or haram. they will be happy and feel lucky if their wealth increases, even if it is a vanity way, whether they realize it or not. regarding the picture of the public's reluctance to access islamic banking products and services, it can be seen from the view of [13] [30]. he explained that the rapid development of the islamic economy does not mean a happy development. this is evidenced by the emergence of understandings and expressions from several groups, such as islamic banks are no different from conventional banks, borrowing from islamic banks or baitul mal wat tamwil (bmt) is more expensive than conventional banks or financial institutions. issues that tend to be negative like that should not be responded to with words that are counter-attacking. however, it should be used as a trigger to prove that islamic banks will become an alternative financial institution for the people [37]. because, according to [22], people do not understand what islamic banks or islamic banks are. they think that islamic banks are only interest-free banks, but that's not all. islamic banks are banks built on justice. and, among the ideals of establishing a sharia bank is to create justice, prosperity, welfare, and benefit for the entire indonesian nation, this was conveyed by [32]. about the benefit (maslahah) itself, from a legal perspective its existence is very decisive in addition to carrying values, benefits, uses, for humans in their lives, it also means that it will prevent humans from all forms of harm, misguidance, and freezing [39] [14]. islamic banks exist other than as commercial financial institutions, the purpose of which is to uphold justice, prosper, prosper, and create benefits for the people should be manifested from the vision and mission that have been formulated. the social welfare aspect must be a priority compared to profit-oriented goals. for the sake of creating justice, prosperity, welfare, and benefit for the people that we need islamic banks that are light-handed and generous in terms of sharing with people who are not so lucky in navigating life, such as the poor. so that the pure ideals of the establishment of islamic banks are realized and have a special place in the hearts of the people [22] [28]. the operations of islamic banks (islamic banks) are not much different from conventional banks (commercial/general banks), namely as intermediary institutions. islamic banks act as intermediary institutions between units of community groups or economic units that experience excess funds and other units that experience shortages of funds. through the bank, the excess funds can be channeled to parties in need and provide benefits to both parties [5] [9] [24] [31]. interest-based banks carry out this role through their activities as borrowers and lenders. fund owners are interested in depositing funds in the bank based on the promised interest rate [26]. similarly, banks provide loans to parties who need funds based on their ability to pay a certain interest rate. the relationship between a bank and its customers is the relationship between creditors and debtors [15]. in contrast to conventional banks, the relationship between islamic banks and their customers is not a relationship between debtors and creditors, but a partnership relationship between funders and fund managers. therefore, the profit level of european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 38 islamic banks not only affects the level of profit-sharing for shareholders but also affects the profit-sharing that can be given to customers who deposit funds [34] [18]. thus, the ability of management to carry out its function as a treasurer, a good entrepreneur, and an investment manager will greatly determine the quality of his business as an intermediary institution and its ability to generate profits [17]. iii. methodology the research area covers bengkalis regency, riau province, indonesia with the criteria that islamic banks are operating. the sample of this study consisted of four clusters: namely conventional bank customers, sharia bank customers, conventional and sharia bank customers, and non-customers. the population of the bengkalis regency is 543,987 people [8] [6]. sampling in this study with probability sampling technique using the slovin formula produced 100 respondents. the design of the research questionnaire includes aspects of demographics, banking service usage activities, and consumer behavior. the demographic aspect consists of [19]: (1) gender; (2) age; (3) religion; (4) education; (5) job. the activity of using banking services uses the theory of planned behavior (tpb) from ajzen [10]: (1) attitudes; (2) subjective norms; (3) perceived behavioral control; (4) interest. indicators of consumer behavior aspects are measured using 5 point likert scale: 1 = strongly disagree; 2 = disagree; 3 = neutral; 4 = agree; 5 = strongly agree. analysis of people's attitudes and behavior in choosing islamic banks, used descriptive statistical analysis in the form of cross tabulations, graphs, averages, and frequencies, while behavioral aspects consumers and perceived quality were analyzed using factor analysis. structural equation model models (sem) are statistical techniques that allow the simultaneous testing of a relatively complex series of relationships (barbara, 2016). complex relationships can be built between one or several dependent variables with one or more independent variables. there may also be a variable that has a dual role, namely as an independent variable in a relationship, but becomes a dependent variable in another relationship given the existence of a tiered causality relationship. the questionnaires that have been collected were analyzed using amos which has a structured problem and is used to test the hypothesis model. this is due to the ability to estimate known coefficients from structural linear equations, accommodating the model as latent variables, accommodate measurement errors in the dependent and independent variables, accommodate simultaneous reciprocal warnings and interdependencies. according to imam [21] sem has several stages, including: (1) collect all information from the literature review; (2) scientific reports, results of previous research; (3) and reports related to research to formulate theories of causality table 2. list of research variables construct indicator code attitudes interested x1 sure x2 guaranteed and reliable x3 the right choice x4 subjective norms parent's advice x5 sibling advice x6 relatives advice x7 friend's suggestion x8 perceived behavioral control peace of mind y1 according to islam y2 safety in the afterlife y3 get blessings and rewards y4 get the best service y5 interest possibility y6 planned y7 committed y8 affordable location y9 source: author elaboration european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 39 iv. results from the results of data analysis that the researchers did use sem amos, it can be explained in general that the four variables used by the researchers have one of the largest loading factors of the four variables. the variables used by the researchers used the theory of planned behavior (tpb) from ajzen. the variables in question are presented in table 3. table 3. variables used in research no variables code 1 attitudes x1, x2, x3, x4 e 2 subject x5, x6, x7, x8 d 3 perceived y1, y2, y3, y4, y5 f 4 interest y6, y7, y8, y9 g source: author elaboration from the table above, it can be explained that the four variables can be further divided into various kinds of questions, where 17 questions have been made by researchers which are distributed through microsoft form. table 4. profile of respondents classification basis sub-classification total percentage gender men woman 35 55 35 % 55 % age under 18 18-24 25-34 35-44 45-54 55-64 65+ 2 46 34 9 5 2 2 2 % 46 % 34 % 9 % 5 % 2 % 2 % education sma/smk diploma s1 s2/s3 others 43 9 32 16 0 43 % 9 % 32 % 16 % 0 profession government employees private employees lecturer student entrepreneur others 11 5 13 45 9 17 11 % 5 % 13 % 45 % 9 % 17 % source: author elaboration figure 1. convergent validity testing source: author elaboration a. validity test validity testing can be seen from the loading factor value. based on the amos output, this value can be seen in the path diagram or amos output at estimates scalars > standardized regression weights. an indicator is said to be valid if the loading factor is greater than 0.5. based on table 4, the subject <---attitudes indicator is declared invalid because its value is less than 0.5, so it must be re-estimated by eliminating subject <---attitudes. table 5. regression weights: (group number 1 – default model) estimate perceived <--attitudes .869 interest <--perceived .469 subject <--attitudes -.070 subject <--interest .511 x1 <--attitudes 1.000 x2 <--attitudes 1.204 x3 <--attitudes 1.186 x4 <--attitudes 1.270 y5 <--perceived 1.000 y4 <--perceived 1.544 y3 <--perceived 1.517 y2 <--perceived 1.509 y1 <--perceived 1.428 x5 <--subject 1.000 x6 <--subject 1.382 x7 <--subject 1.370 x8 <--subject 1.148 y9 <--interest 1.000 y8 <--interest 1.458 y7 <--interest 1.623 y6 <--interest 1.337 source: author elaboration european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 40 based on the re-estimation results as shown in table 4, it turns out that the loading factor of all indicators is not smaller than 0.50. thus, all indicators are declared valid, and the model evaluation process can be continued b. sem assumption test testing the normality of the data is carried out using the criteria for the critical ratio skewness value of ± 2.58 at a significance of 10%. the data is said to be normally distributed if the critical ratio skewness value kurtosis value is below the absolute value of 2.58 and can be rounded up to 3. in general, the value of c.r. skew and c.r. kurtosis is in the range of -3 to 3 so it can be stated that this data has met the assumption of normality. table 6. normality test variable min max skew c.r. kurtosis c.r. y6 1.000 5.000 -.499 2.038 .106 .217 y7 1.000 5.000 -.462 1.884 -.039 -.080 y8 1.000 5.000 -.468 1.910 -.054 -.111 y9 1.000 5.000 -.695 2.837 .400 .817 x8 1.000 5.000 -.198 -.809 -.509 -1.039 x7 1.000 5.000 .146 .595 -.367 -.750 x6 1.000 5.000 .117 .478 -.497 -1.014 x5 1.000 5.000 -.120 -.489 -.593 -1.211 y1 2.000 5.000 -.927 3.786 .066 .135 y2 2.000 5.000 -.974 3.976 .068 .138 y3 1.000 5.000 -.960 3.920 .593 1.211 y4 2.000 5.000 -.601 2.455 -.499 -1.018 y5 2.000 5.000 -.482 1.967 .195 .398 x4 2.000 5.000 -.469 1.915 -.188 -.383 x3 2.000 5.000 -.376 1.537 -.498 -1.017 x2 2.000 5.000 -.143 -.585 -1.031 -2.105 x1 3.000 5.000 -.241 -.982 -.925 -1.888 multivariate 78.611 15.464 source: author elaboration from the research results in figure 1, it can be explained that: 1. the greatest attitude is x4, meaning that the people of the bengkalis regency choose islamic banks because they are one of the right choices. where there are 60% who choose x4 as the biggest factor of the attitudes of the bengkalis community respondents. 2. the largest subject is x7, meaning that the people of bengkalis regency choose islamic banks because of the advice of relatives (uncles, aunts, cousins). where there are 90% who choose x7 as the biggest factor of the respondents of the bengkalis community. 3. the largest perceived is y4, meaning that the people of bengkalis regency choose sharia banks because of getting blessings and rewards. where there are 71% who choose y4 as the biggest factor of the bengkalis regency community's perceived respondents. 4. the greatest interest is y7, meaning that the people of bengkalis regency choose islamic banks because they are planned. where there is 86% plan to start using islamic financial institutions within the next 1 year. statistical test of processing results with sem is carried out by looking at the significant level of the relationship between variables is shown through the critical ratio (c.r) and the significance probability value of each relationship between variables. the following is the output of the research hypothesis testing table using the amos test tool in the form of regression weights output as shown in the following table: european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 41 table 7. regression weights estimate s.e. c.r. p label perceived <--attitudes .869 .194 4.485 *** par_15 interest <--perceived .469 .152 3.091 .002 par_16 subject <--attitudes -.070 .194 -.362 .717 par_14 subject <--interest .511 .169 3.016 .003 par_17 x1 <--attitudes 1.000 x2 <--attitudes 1.204 .237 5.082 *** par_1 x3 <--attitudes 1.186 .224 5.290 *** par_2 x4 <--attitudes 1.270 .222 5.718 *** par_3 y5 <--perceived 1.000 y4 <--perceived 1.544 .233 6.614 *** par_4 y3 <--perceived 1.517 .245 6.180 *** par_5 y2 <--perceived 1.509 .231 6.528 *** par_6 y1 <--perceived 1.428 .216 6.605 *** par_7 x5 <--subject 1.000 x6 <--subject 1.382 .178 7.751 *** par_8 x7 <--subject 1.370 .172 7.943 *** par_9 x8 <--subject 1.148 .169 6.808 *** par_10 y9 <--interest 1.000 y8 <--interest 1.458 .211 6.910 *** par_11 y7 <--interest 1.623 .234 6.922 *** par_12 y6 <--interest 1.337 .213 6.288 *** par_13 source: author elaboration from the table, whether the effect of significance or whether or not is known from the p-value. the significance (alpha = = α) used is 0.05. if the p-value is less than 0.05. the estimated parameter value of the standardized regression weight coefficient between attitude and perceived is 0.869, testing the relationship between the two variables shows a probability value of 0.000 (p <0.05) from the estimated value of 0.00, thus h1 is supported because there is a significant positive relationship between attitude and perceived. this is reinforced by the results data processing that shows a probability value of 0.00 has met the requirements <0.05 and the positive direction is seen from the estimate 0.869, so it can be concluded that attitude has a significant positive effect on the perceived, so that the higher the attitude of the community, the higher the perceived. table 8. notes for model number of distinct sample moments 153 number of distinct parameters to be estimated 38 degrees of freedom (153 38) 115 minimum was achieved chi-square = 218.561 degrees of freedom = 115 probability level = .000 with the number of samples n = 100, the total number of covariant data is 153 while the number of parameters to be estimated is 38. from these results, the resulting degrees of freedom are then the hypothesis is accepted. the results of the hypothesis of the influence between variables can be seen in the following table: table 9. hypothesis test results no hypothesis p limit information 1 the influence of attitude on perceived *** <0.05 there is influence 2 perceived influence on interest .002 <0.05 there is influence 3 influence of attitude on subject .717 >0.05 no influence 4 effect of interset on subject .003 <0.05 there is influence 5 effect of attitude on interest 6 the influence of attitude on sure *** <0.05 there is influence 7 effect of attitude on guaranteed and reliable *** <0.05 there is influence 8 influence of attitude on the right choice *** <0.05 there is influence 9 influence of subject on parents advice 10 influence of subject on sibling advice *** <0.05 there is influence 11 influence of subject on relatives advice *** <0.05 there is influence 12 influence of subject on friends suggestion *** <0.05 there is influence 13 influence of perceived on peace of mind *** <0.05 there is influence 14 perceived influence on according to islam 15 perceived influence on safety in the afterlife *** <0.05 there is influence 16 effect of perceived on get blessings and rewards *** <0.05 there is influence 17 perceived influence on get the best service *** <0.05 there is influence 18 effect of interest on the possibility 19 effect of interest on planned *** <0.05 there is influence 20 effect of interest on committed *** <0.05 there is influence 21 the effect of interest on affordable *** <0.05 there is influence source: author elaboration european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 42 153 38 = 115, because 115 > 0 (positive df) and the sentence "minimum was archived”, then the process of testing the maximum likelihood estimation has been carried out and the estimation is identified with the data results normally distributed. table 10. model fit test criteria goodness of fit index expected value results in models information chi-square expected small 0.000 fulfill probability ≥ 0.05 gfi ≥ 0.90 1 fulfill agfi ≥ 0.90 0.222 not fulfill ncp expected small 0.000 fulfill cfi ≥ 0.90 1 fulfill rmsea ≤ 0.08 0.095 not fulfill rmr < 0.05 0.000 fulfill source: author elaboration v. conclusion from the results of the analysis using the amos sem above, it can be concluded that: 1. this study uses the theory of planned behavior (tpb) from ajzen, which explains that there are four variables with 17 questionnaire questions. the four variables are (1) attitudes, (2) subjective norms, (3) perceived behavioral control, and (4) interest. 2. the attitude variable has the greatest value, which is 60 % of the question "i believe using the services of a sharia financial institution is the right choice". 3. the subject variable that has the greatest value is 90% of the question "usually i use the services of islamic financial institutions because i follow the advice of relatives (uncle, aunt, cousin)". 4. the perceived behavioral control variable has the greatest value, which is 71% of the question "i believe using islamic financial institutions will get blessings and rewards". 5. the variable interest that has the largest value is 86% of the question "i plan to start using islamic financial institutions within the next one year". references [1] a, & mursid, a. 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(2021). management ownership and the performance of islamic microfinance institutions: a panel data analysis european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 43 of indonesian islamic rural banks. international journal of islamic and middle eastern finance and management, 0. [14] gait, a., & worthington, a. c. (2015). attitudes of libyan retail consumers toward islamic methods of finance. international journal of islamic and middle eastern finance and management, 439-454. [15] hardianto, d. s., & wulandari, p. (2916). islamic bank vs conventional bank: intermediation, fee based service activity and efficiency. international journal of islamic and middle eastern finance and management, 296311. 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(2021). the strategy of islamic economic colleges to prepare their graduates to work in islamic banks. higher education, skills and work-based learning, 0. paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 the concept, structure and epistemological development: musharakah tijariah cross-border financing abstract — musharakah tijariah cross-border financing (“product”) is the product to enable the bank to undertake projects and contract cross-border financing activities or other identified business ventures on “pure” joint venture basis, using the underlying islamic financing contract, structure and epistemological development that are expected to inject greater musharakah concept, structure and epistemological development and also that is expected to inject greater prosper to the bank’s overall performance and ultimately able to assist small time landowners in a big way through business risk sharing. this paper also provides the link of financial access for muslim small medium entrepreneurs to islamic venture capital as alternative financing business innovation with blockchain strategies. keywords – islamic finance; musharakah; qard; wakalah; crross-border financing; project and contract financing; joint venture; blockchain. i. introduction islamic financing does not only focus on banking products which are deposit and financing but also extended to any investment related tools. malaysia islamic banking sector has initiated islamic financial and services act 2013 (“ifsa2013”) to reflect the new arm under banking institution, which distinct itself from conventional practices. the idea of introducing partnership contracts such as mudharabah and musharakah have created new dimension in banking. even though they could increase the risk of banking and do not comply with basel ii and basel iii requirement, but they seem feasible in certain situation especially related to development sector. of course, they have to be comprehensively modelled as to ensure any increase in risk could be minimized. this paper purposely explores the potential of practicing musharakah tijaria, an underlying contract to accommodate business venture, especially between financier and entrepreneur. ii. musharakah tijariah musharakah tijariah cross-border financing uses the underlying shariah contract of musharakah. musharakah literally means sharing. it is the modern term for shirkah alamwal, one type of islamic partnership. the capital raised shall be used to finance identified business ventures that generates revenue. the profits generated shall be shared between the bank and customer in a pre-agreed profit-sharing ratio. for example, bank a as the financier through bank a special purpose vehicle and customer will contribute capital in the project / business venture which customer has earlier requested for funding. for example, bank a as the financier will contribute capital in the projects / business ventures which requested by customer earlier for funding through bank a special purpose vehicle and customer. this joint venture can be done through musharakah joint venture (jv partners) and joint-venture agreement. the capital raised shall be used to finance property development projects and contract financing or other identified business (“the project”) that generate revenue with the objective of making profit. the simple product arrangement is shown in diagram 1 capital contribution to the joint venture (“jv”) is subjected to negotiation, feasibility study, internal policies, board of directors’ approval and project meetings the relevant credit risk’s requirements. bank a via bank a spv and customer shall regulate their relationship as the shareholders of musharakah jv in the jv agreement. both jv partners shall be represented in the jv’s joint management committee (“jmc”). this arrangement will entail both parties jointly sharullizuannizam salehuddin, (universiti sains islam malaysia, affin islamic bank berhad); azrul azlan iskandar mirza (universiti sains islam malaysia); and ahmad saufe nawi (export-import bank of malaysia) ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 contributing capital in the jv agreement. bank a, through its bank a spv, will take up majority / controlling stake in musharakah jv, with the balance to be contributed by the customer. the purpose of this financing is to channel the funding direct to the project or business undertaking with bank a spv via jmc having the rights to observe and monitor regarding the business and non-business aspects of the jv. based on the simple product arrangement, which have been identified from this product are as follows: a. possibility of having higher net margin the return from musharakah based products is higher than those provided under the normal debt financing arrangement due to the inherent higher risk involved. the bank shall share control over the management of the project via representative in jmc. b. high return the bank has opportunities to earn higher return through sharing of the profits as high risk and high return. c. minimization of capital leakage compared to the current financing arrangement where financing is extended to the owners of the business venture/projects, direct project/business financing can minimize capital leakage through active participation in the project management. d. more acceptable proposition to investors from middle east musharakah provides an alternative investment, which will cater for islamic investors and partners, especially from the gulf cooperation country (gcc), who might be reluctant to invest in conventional or current debt-based financing schemes. musharakah concept is the most preferred and globally accepted islamic financing structure. the bank can attract these investors to participate in similar risk sharing arrangements through the creation of islamic syndication to support the financing made into jvs. since the product requires a degree of sophistication from the investors, it is intended for the product to initially, be marked to targeted groups of customers as per matrix below: iii. risk analysis a. market risk the most challenging issues faced in the process of the implementation islamic financial system is the development of musharakah instrument that can provide the investors a sufficient degree of liquidity, security and profitability to encourage their holding. generally, musharakah represents a position in real assets and having risk bearing characteristics whose rate of return is variable and tied to the performance of the asset is considered acceptable in the islamic system.  risk mitigation o pre-emptive the financing (credit) paper submitted by bank a’s personnel to its internal financing approving authorities (i.e. board of directors) should include the project cash-flow evaluation using corporate finance approach (using net present value (npv), internal rate of return (irr), discounted cash flow (dcf) valuation) to investigate its viability breakeven analysis and possible default. o post-monitoring measures: hedging instruments in the form of currency markets should be put place. b. credit risk in musharakah financing, banks restrict their role in the monitoring of a company’s performance without interfering too much both its partner’s both management and confidentiality that do not relate to the specific joint venture project. the finance provided by banks too is also not a part of the permanent capital of a company, though there is no legal restriction for banks to finance the working capital needs of a company in the form of equity or capital participation if it is manually agreed between them. the decision whether to involve in a musharakah arrangement with a company is based on time-honoured and prudent practices observed by banks all over the world. efficient management, commitment worthiness and a good performance record are some of the most important criteria where a decision is normally taken. however, in cases of new companies, banks have to exercise their good judgement. banks may adopt different techniques in evaluating a musharakah financing proposal. to evaluate the profitability of a proposal with objectivity, the under noted exercise will be found helpful in quantifying the profit performance of a company wishing to enter into a profit and loss sharing arrangement with a bank. profit sharing ratios are determined on the basis of project projections made by company in line with its previous performance or in the light of its justifiable future plans and the economic climate in general. in musharakah, the bank only provide funds, whereas a company or its directors besides ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 provide capital use their enterprise, energies, skills, expertise and connections in running the business and its affairs. this aspect is given due to its consideration in deciding the profitsharing ratios. the drawback is that projects for funding through musharakah are expected to be selected primarily on the basis of both anticipated profitability and the creditworthiness of the partner. the bank’s possible exposure to credit risk is also another main reason why banks are hesitant to push musharakah. credit risk arises when the counterparty fails to meet its obligations on time and fully in accordance with the agreed terms. in cases of defaults in debt contracts, the bank can easily liquidate the collateral to recover its principles, whereas in equity or capital financing of the assets and recovering returns is through the sale of its share in the project at the appropriate time. unfortunately, to dispose the asset at a fair price is not easy. then, even with strong monitoring and control, the return of the financier will suffer. while the banks can sell its share either to the entrepreneur or other interested parties, one way in which the value of a firm can be enhanced by launching it in the stock market by issuing initial public offering (ipo). the latter would be possible if a well-functioning and efficient stock market exists. c. operational risk musharakah structure is document intensive compared to conventional, tedious documentation procedures for financing disbursement, and more shariah audits, time consuming and costlier for issuer. musharakah in particular requires more commitments and effort from the bank in the aspect of monitoring and supervision as the bank assumes business as well as credit risks. given the fact that musharakah is equity or capital financing in character, collateral is not prerequisite. this inability to secure a lien on the assets of the business partner would require careful evaluation of the prospects of the business. as the entire business is based on confidentiality, the client entering into musharakah may put a condition that the bank will not disclose any information about the business to any person without prior permission of the client. however, the extent to which bank’s board representative may have the access to primary and sensitive information of the invested entity would depend on whether such financing does not rank the same as a debt holder (i.e. first claimant). if the financing does not rank the same as a debt holder, given the higher capital risk exposure, the board representative should be allowed to access to primary and sensitive information of the invested entity, including discussion on the company’s exposures with other banks. the information system used for any cross-border financing is also major concern. the integrity and security of all data are very crucial to protect the stakeholders especially investor. this is to prevent any leak and manipulation that will create harm among contracting parties. heading into sophisticated technology and fintech era, providing a strong operation information system is a must. therefore, any process needs to be digitalized and protected by a strong operation system. d. liquidity risk in an islamic bank, the security is not only needed to protect the respective customers from their inability to repay to the bank if they unsuccessfully run their business with the funds provided by the bank. if this happens and the security is held by the bank, the customer’s account payable could be settled through the selling security. mismatch between the amount of money withdrawn and the completed work could happen which may lead to over spending at the end, especially if the contractor is either not using all the money for the specific project or not managing their spending properly as should, in either case the bank must step in to rectify the situation as soon as it notices any indication of such mismatch. the best solution for the bank is by executing a workable drawdown mechanism that can avoid capital leakage. it is imperative that the bank releases cash orders and direct payments to certain identified beneficiaries. also, progressive monitoring of assets and liabilities in the jv for construction projects under jv can be done stringently by using the general formula as per below: return to the bank are more uncertain as they depend on the performance of the business; in other words, there are no guaranteed annual profits. it is risky to finance medium and long-term projects out of short-term funds. the root of these problems lies in the improper matching between the maturities of assets and liabilities in the bank’s balance sheet. when there is a mismatch between the two, liquidity risks arise.  risk mitigation o to finance assets using equity or capital financing, the liabilities need to be of longterm maturity to avoid exposure to liquidate risks. if the financial institutions can invest in assets for longer terms (i.e. equities) that are financed by long term liabilities, then the riskadjusted profit for the bank increases. o as the banks deal mainly with deposits that are short term, complementarities between assets and liabilities indicate that it is just optimum (in terms of risks adjusted profits) to be use assets that have liabilities are scarce in many islamic financial markets, most banks would prefer engaging in short-term fixed income instruments like murabahah and ijarah to avoid liquidity mismatch. o under aaoifi 3/1/5/14, it is permissible, based on the association or a decision of the ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 partners, not to distribute profit of the company from the creation of sinking fund. it is also permissible to set aside periodically a certain ratio of profit as solvency reserve or as a reserve for meeting losses of capital (investment risk reserve or as a profit equalization reserve). e. legal risk various regulatory requirements will need to be met when investing directly in a business. the spv structure will perceive benefits for bank in terms of “ring-fenced” and insolvency-remoteness (such as from of the extraneous risk associated with the ownership of the asset, for example environmental liability). the bank’s liability is up to extent of its financing in the specific jv, extended via the spv if there are liabilities arising, it would clawback to the spv only if the spv has given a shareholder’s guarantee, and otherwise, liability will stop at the jv level. the legal documents must clearly stipulate:  purpose of musharakah venture.  contractual relationship between parties.  rights, roles and responsibilities of parties to the musharakah venture.  capital contributed by partners.  profit sharing ratio.  loss shall be borne proportionate to the capital contribution.  calculation methodologies and timing for profit distribution.  tenure of venture.  pricing or valuation method of underlying asset or shares.  reporting obligation of the musharakah performance which include the timing and the information to be reported.  collateral and guarantees including rights over assets, if any.  terms and dissolution, termination, redemption or withdrawal of musharakah venture.  fees and charges to be borne by the relevant contracting parties. the jv agreement should entail the rights and exclusively of each partner. it is also more important to be involved in the day-to-day management as stated in the agreement. the bank should be watertight in governing the business, and should not just be a jmc nominee. thus, jv agreement should also focus on the legal perspective in civil law, necessary undertaking and pre-determination of default / negligence. f. currency risk it is known that musharakah venture has to be denominated in a single currency. since it is a cross border financing and involved at least two types of currency, any significant movement in a currency will lead to the unmatched expectation and therefore could breach the objectives. therefore, we need to ensure the political and financial stability of any nation involved, as to ensure the uncertain expectation will be minimized. moreover, this musharakah venture somehow involves in long term contract. it is good to introduce a single accepted currency or even digital currency to standardize the transaction and minimize the impact stakeholders. iv. potential innovation the industry revolution 4.0 has been a theme and foundation for any future development including finance. fintech has already been a base for financial innovation. either financial and non-financial institution has invested extensively to mark themselves to market. big data analytics, artificial intelligence, smart contract, block chain and distributed ledger technology are those among new dimension to be explored. the concept of musharakah tijariah could benefit all these technologies to mitigate or minimize any risk associated to the product. for example, the use of block chain technology could improve the transparency of the venture, which could trace any fraud or wrongdoing. block chain technology could also create a “special purpose currency” or “universal currency” like crypto currency to mitigate risk associated to uncertain rate of denominated currency in the venture. this could also improve the reliability of the venture, without only focusing on the conventional risk mitigation tools. the simulation of the risk in the venture could be traced extensively using big data analytics and artificial intelligence. any potential loss could be traced earlier than expected and any mitigation plan can take place. these could be new dimension to mitigate risk under venture business and make proposed musharakah venture looks viable and reliable. ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 conclusion this product encourages mobilization of idle capital or cash entities within cross-border financing activities and thus provides a basis for economic cooperation between these organizations in the society. this product also is expected to inject greater prosper to the bank’s overall performance. premised on the above, musharakah tijariah cross-border financing provided the bank wider customer experience for markets that are still largely untapped. it also provides opportunities to expand the investment choices and opportunities available to the bank clients and allow them to execute alternative investment strategies. customer also may leverage on market reputation as a jv partner to the bank especially small medium entrepreneurs. references accounting and auditing organization for islamic financial institution. “accounting standard fas 3 musharakah financing”. bank negara malaysia, “capital adequacy framework for islamic banks (capital components)”, november 2012. bank negara malaysia, “guidelines on musharakah and mudharabah contracts for islamic banking institution”, june 2010. bank negara malaysia, “guidelines on property development and property investment activities by islamic banks”, january 2019 biancone, p.p., & radwan, m. (2019). social finance and financing social enterprises: an islamic finance perspective. european journal of islamic finance. biancone, p.p., & radwan, m. (2018). social finance and unconventional financing alternatives: an overview. european journal of islamic finance,(10). biancone, p.p., & radwan, m. (2018). sharia-compliant financing for public utility infrastructure. utilities policy,52, 89-94. biancone, p.p., secinaro, s., & kamal, m. (2019). crowdfunding and fintech : business model sharia-compliant . european journal of islamic finance,(12). lembaga piawaian perakaunan malaysia, “shariah compliant profit-sharing contracts”, march 2012. malaysian institute of accountants (mia), “tax treament on islamic finance in malaysia”, november 2012. ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 islamic view towards bitcoin abstract this paper proposes to analyze the agent behavior by means of big data extracted from the search engine « google trends » and twitter api to visualize the emotions and the manner of thinking about « bitcoin » in the islamic context. two kinds of sentiment measures are constructed. the first is based on search query of the word « bitcoin » with religious connotation in all over the world from 14/04/2017 to 14/04/2018 in weekly frequency. the second is built on twitter data from 03/04/2018 to 13/04/2018, by using a bayesian machine learning device exploiting deep natural language processing modules to assign emotions and sentiment orientations. in the next step, the granger causality analysis is used to investigate the hypothesis that this sentiment causes the volatility and the returns of « bitcoin ». the results show that, at a first-level that twitter users of the word « islamic bitcoin » improve positive sentiment. secondly, the twitter sentiment measure has a significant effect on lagged bitcoin returns and volatility. furthermore, this sentimental variable granger causes bitcoin returns and volatility. this study contributes to the literature by studying the influence of the doctrinal view towards bitcoin on his prices dynamics. knowing that bitcoin is a new financial asset and there is a large debate on his compliance with shariah keywords-component; bitcoin, microblogging, sentiment analysis, text minig, islamic finance. i. introduction the development of information technology over the past two decades has changed the ways of generating, processing and transmitting information and thus profoundly influenced the asset prices in capital markets. a huge volume of searches, news, comments and recommendations are generated daily on social media, from which behavioral economics researchers extract proxies reflecting investor sentiment. in particular, bitcoin gained increasing media attention in social networks. bitcoin is a form of cryptocurrency introduced by nakamoto (2008). it is a payment system based on blockchain. muslim people occupy an important space from the world. they present over than 23,4% from all the world in 2011. some of them which are looking for satisfying their religious needs are focusing on the sharia compatible degree of the bitcoin [1]. many studies have focused on studying the muslim psychology [2] and the islamic market [3][4] [5]. in order to measure investor sentiment, empiricists use sentiment analysis approach which is a process of detecting the contextual polarity of the text. it determines whether a given text is positive, negative or neutral. in this analysis, the opinions about «bitcoin» combined to «islam » are collected from the users of different social media and classified by their polarity. furthermore, behavioural science uses search query data to analyze the degree of users’ attention towards these terms. in fact, it constitutes a mean of sentiment analysis. in this paper, we propose a semantic approach to discover user attitude and business insights from social media and web users. for this purpose, we will first give brief literature in section1. then, in the second section, we will try to visualize the attention of internet users of the word «bitcoin» in the context of religions and beliefs by means of « google trends ». in the third section, we will focus on the twitter user’s emotion and polarity who interact around the subject « bitcoin » in islamic doctrine. a measure of sentiment will be associated with this category of twitter users. this sentiment will be used to test our hypothesis of the existence effect caused by this sentiment. this methodology will be explained in section 4. the results will be discussed in section 5. finally, we will conclude by some remarks. ii. literature review and hypothesis development actually, many studies using google trends have demonstrated several examples of how the search volume for keywords coincides with as many patterns showing how these kinds of correlation hold for many local phenomena. for instance, it seems that media providers and policymakers are interested in looking at google trends in order to determine the hot topics for their editorial content. as an example, we can take a look on the case of a popular political site which could benefit by looking at the current hot queries and, consequently, writing down a post on the site containing focused keywords so that google can quickly index the post. these examples are just some of the many strategies adopted by seo practitioners (yun et al.). the high penetration rate of the internet [6] is not sufficient to be representative of the entire population. in our case, we are interested especially on the effect on financial markets, traders and policy maker’s decisions. furthermore, we mnif emna, jarboui anis ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 consider the fact that active users issue more queries than less active ones, with the consequence of blinding the weight carried by each user in creating the aggregated queries. accordingly, many other researchers focused on the validity of search queries as potential indicators of public opinion [7]. more optimistically, others have argued for predictive models based on search query data (varian and hal, 2015) and social media sentiments data (ruths et al., 2014) and (asur, 2010). as for [7] the views expressed in polls are solicited because search users are volunteers; while survey pollsters, under the pressure of survey staff, select respondents. the discretionary nature of search behaviors loans verisimilitude to the query data, which are not altered by search engines [7]. [8] suggest that the data genrated by « google teends » has an influence on the market movements. by analyzing changes in query volumes on google for terms related to finance, they found patterns that can be interpreted as '' early warning signs '' of shares to market movements. milas and c. panagiotidis th. (2014) attempted to explain the influence degree of the information contained in social media (twitter and facebook) and web search queries (google) on financial markets. using a multivariate system and focusing on the peripheral countries of the euro area, the giips (greece, ireland, italy, portugal and spain), they showed that the discussion of social media and search queries related to greek debt crisis provide significant information in the short term mainly to the bond yield differential of greekgerman state, even when other financial control variables (default risk, liquidity risk, and international risk) are recognized and to a much lesser extent, portuguese and italian yield spreads. d'avanzo et al (2017) led an experimental framework allowing the integration of google search query data and twitter social data. they built a pipeline interrogating twitter to track, geographically, the feelings and emotions of twitter users about new trends. the core of the pipeline is represented by a sentiment analysis framework using a bayesian machine learning device exploiting deep natural language processing modules to assign emotions and sentiment by twitter data.they employed the pipeline for consumer electronics, healthcare and politics. their results show that the proposed approach in order to measure social media sentiments, and emotions concerning the trends emerged on google searches is plausible. [9] introduced the concept of divergence of sentiment to the behavioral finance literature. they measured the distance between people with the positive and negative sentiment on a daily basis for 20 countries by using data from status updates on facebook. their results showed that the divergence of sentiment is positively related to trading volume. they further predicted and found a positive relation between the divergence of sentiment and stock price volatility. they also compared the effect of the specific country measures to a global measure of divergence of sentiment. they found that the separate effects of specific country and global divergence measures depend on a country’s level of market integration. [10] examined the relationship between investor attention and bitcoin fundamentals. he found that realized volatility and volume have significant effect on the bitcoin attention. [11] used a dual process diffusion model to assess the impact of twitter and google trends on bitcoin. they showed in their results that bitcoin prices are partially influenced by the web and twitter information. unfortunately, empirical studies focusing on the use of big data to visualize the islamic view are very rare. as we know our work is the first empirical framework focusing on the influence of the agent’s psychological component on the bitcoin by means of big data. for this purpose, we propose the following hypothesis. hypothesis: the twitter sentiment has an effect on the contemporaneous and lagged bitcoin return and volatility. iii. search query sentiment in this section, we will present the search query tool generated by google trends in order to build a measure of investor sentiment based on the search query of the word « bitcoin » in the islamic context. a. search query presentation the service of google trends offers a curve representing an indicator of the number of a term of research given in function of time. the time scale goes back to january 1, 2004, and is up to about two days before the current date, the updates are very fast. in addition, the user also has access to news related to the curve, allowing him to draw conclusions about the impact of such an event on the user’s interest. in the end, the service details the most often related to term research and a map seeing areas where the expression is the most sought at the global, national and regional levels, as well as cities. it is possible to enter up to five terms and compare their developments. in our methodology, the proposed measure is based implicitly on the fact that people collect information on the internet using search engines. furthermore, search-based sentiment measures are available in real time; as economic fundamentals change over time, a high frequency sentiment measure can carry out more precise empirical tests. second, such a measure reveals attitudes rather than inquire about them [12]. while surveys lack cross-verified data on actual behavior, search behavior proves to be this objective external verification [13]. this framework exploits google trends, which summarizes queries through the analysis of web users search behaviors in order to find the most relevant queries related to « bitcoin » in the context of « religions and beliefs ». google trends is a tool designed for tracking the popularity of any given search term over time [14]. we start then by introducing the ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 word « bitcoin » since 2004 in monthly frequencies with religious connotation as shown in figure1. figure 1. interest search evolution for the term “bitcoin”, source « google trends » figure 1 represents the behaviour of the search query of the word “bitcoin” with religion and belief’s connotation from the period between 14/04/2017 and 14/04/2018. in figure 1, we can observe that the frequency of the term « bitcoin » is very high in the period between 17/11/2017 and 23/11/2017. this period is marked by the remarkable evolution of the “bitcoin”. figure 2. geographical search query figure 2 shows that the word “bitcoin” in the mentioned context is very frequent in slovenia, south africa, malaysia, united arab emirates, turkey, croatia, singapour, australia, and pakistan. b. search query sentiment: as we have previously reported, the investor sentiment is a much-debated topic in behavioral finance. the researchers were very interested in how to measure investor sentiment. some empiricists use indirect measures based on market sentiment indices. we may mention for example the approach of baker and wurgler (2006) offering an indirect measure of investor confidence by using six "inputs". other empiricists use direct measurements with indices based on surveys, such as the consumer confidence index or "consumenten conjunctuur onderzoek (cco)" cbs netherlands 1 while this approach shows a clear theoretical link of investor confidence, it has the disadvantage of taking time in the polls and creating an offset [15]. in addition, respondents are often biased by answering questionnaires ; it is proving to be a difficult task to obtain sincere and prudent responses by respondents [16]. thus we will consider the series given by google trends as a measure of the sentiment involving the degree of attention paid by internet users for the word « bitcoin » in the context of « religion and beliefs ». iv. twitter sentiment this framework is planned on the basis of two kinds of analysis. the first aim at measuring the sentiment, while the second one is oriented at estimating the emotions expressed in posts broadcasted on social networks. tweets are retrieved by using twitter apis, exploiting the default access level. by using a special account, twitter apis can also provide two other levels of access, the firehose and the gardenhose, returning, respectively, 100% and 10% of all public tweets. the retrieved data of the tweet, contain other features, such as date, source, type, profile, location, number of favorited friends, followers, url, hashtag, and so forth. relevant tweets were searched and extracted from twitter programmatically by using twitter package, written in r programming language. this comprehensive tweet search was conducted between 03/04/2018 to 13/04/2018. consequently, the collection of related tweets was retrieved and saved in csv files. the data in this file contained the tweet information along with user information posting the tweet. posting dates were also substantial for the analyses. however, not all the tweets had the posting date information. the analyses in this study performed using the tweets with no missing values. 1 www.cbs.nl ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 during data cleaning, the retweets were also omitted as the aim of this study is to specify the sentiments or opinions of individuals and the retweets were not considered to reflect a new personal opinion. therefore, we removed retweets from our analyses. the language of each tweet is automatically detected and, if it is different from english, an online translation service is invoked, so as to translate in the best possible way the currently examined tweet using only english. in fact, according to [17], [18] and [19] in some cases a translation procedure can be useful for detecting sentiment in language other than english. at this point of the development of the entire framework, this allows us to refine as much as possible the modules as a function of only one language. all tweets so obtained are, then, pre-processed as in the following: stop words are filtered out, links and hashtag are removed, and words of length less than three characters were discarded before processing the text because they often hide off-topic posts or even spam. the tweets containing mainly abnormal sequences of characters were discarded [20]. the processing step just described, culminates in the intervention of the two modules of sentiment and emotion analysis. in particular, the sentiment detection module estimates the predominant orientation, i.e. positive or negative, of each tweet. simultaneously, the emotion detection module identifies the emotions expressed by the current tweet, giving as a result the predominant feeling among one of the following: anger, disgust, fear, joy, sadness, and surprise [21]. the choice of these six emotions comes from the psychological evidence of human nonverbally expressed emotions proposed by ekman (1992). therefore, we introduce some details about both the sentiment and emotion detection modules that, at this stage of overall development of the framework, cover the most important experimental role. furthermore, some aspects of the visualization module are also introduced. a. sentiment detection module sentiment detection module exploits different sentiment detection tools, constituting a submodule, which can be plugged or unplugged, at will. in particular, at present the sentiment detection module exploits naive bayes detection algorithm as sentiment analysis tool. the dataset contains 941 terms, each of which is associated to a sentiment which can be “positive” na¨ıve bayes detection algorithm has been trained on wiebe’s subjectivity lexicon [22]; overall, or “negative”. the learning module analyzes a given text and for each polarity returns its absolute log likelihood expressing that sentiment; results are then evaluated, resulting in the most likely polarity b. emotion detection module as well known, tweets can express also emotions and, as such, this module estimates the most appropriate one for each tweet among the six basic emotions: anger, disgust, fear, joy, sadness, surprise proposed by ekman (1992). the emotion detection module can exploit different emotion detection tools, embedded as sub-modules, which can be plugged or unplugged at will. in particular, two submodules, a naive bayes learning algorithm and a voter algorithm have been at present plugged in the emotion detection module. each of them is briefly summarized below: • the simple voter algorithm uses the above-mentioned lexicon by counting the number of occurrences of the anger, disgust, fear, joy, sadness and surprise words contained in the text. the majority of counts give the prevalent emotion associated to the text message. if the text does not contain a prevalent number of words expressing a given emotion, the text message is labeled as carrying “no emotion”. the outcome of each sub-module is the percentage of retrieved tweets classified as expressing an emotion among the aforementioned six or classified as “no emotion”. finally, the results coming from all the submodules on the retrieved tweets are averaged, obtaining an “emotion” distribution, obtaining: disgust, fear, joy, sadness, surprise and anger, whereas the overall sum must be equal to 1. as is the case for the sentiment module, results obtained from all the retrieved tweets are averaged, and the averaged distribution is the outcome of the module. c. visualization module an overall result is therefore presented to the user in a graphical manner, in order to help us in her decisional process (dhar, 2003). data visualization offers to decisionmakers a way to make sense of large dataset, allowing the discovering of patterns for decision support (white and colin, 2011). the user can decide also to plot and compare the analysis results regarding different queries in order to get an idea on the general feelings that arise from twitter social network regarding specific themes or features of interest. this feature can be helpful also for the comparison of sentiments and emotions arising from tweets retrieved by using different queries. this approach simplifies the decisional process and allows overcoming the information overload by quickly having an idea about the general sentiment or emotions raised by news goods or aspects. d. experiments we have implemented and tested the prototype employing « islamic » combined by « bitcoin». the tweets retrieved in this context are represented in table 1. in fact, as we have said, the framework proposed represents for us an experimental laboratory where we can test hypotheses and models on different social phenomena, using social behavioral data. we analyzed the word frequencies for english tweets about “islamic bitcoin » using word clouds. their visualisation figures of emotions, polarity in figure 3. ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 table i. bitcoin tweets in islamic context text favorited truncated screenname retweet count isret weet retwee ted 1 rt @apompliano: an important islamic scholar has deemed bitcoin to be compliant with sharia law. this means 1.6 billion muslims are now pe… 13/04/2018 20:28:57 <a href="http://twitter.com/do wnload/iphone" rel="nofollow">twitter for iphone</a> probabl ysaif 218 true 2 rt @apompliano: an important islamic scholar has deemed bitcoin to be compliant with sharia law. this means 1.6 billion muslims are now pe… 13/04/2018 20:28:45 <a href="http://twitter.com/do wnload/iphone" rel="nofollow">twitter for iphone</a> therea lvherus 218 true 3 rt @cryptobanger: @jack "islamic scholar declares bitcoin sharia law compliant, potentially opening market to 1.6 billion muslims" 13/04/2018 20:28:35 <a href="http://twitter.com/do wnload/android" rel="nofollow">twitter for android</a> adi014 9 21 true 4 rt @apompliano: an important islamic scholar has deemed bitcoin to be compliant with sharia law. this means 1.6 billion muslims are now pe… 20:27:38 13/04/2018 <a href="http://twitter.com/do wnload/android" rel="nofollow">twitter for android</a> colinc allahan 46 218 true 5 rt @apompliano: an important islamic scholar has deemed bitcoin to be compliant with sharia law. 20:27:25 13/04/2018 <a href="http://twitter.com/do wnload/iphone" rel="nofollow">twitter for pupsric s 218 true this means 1.6 billion muslims are now pe… iphone</a> 6 #cryptocurrency #bitcoin #halal (declared permissible) under sharia law 1.6 billion muslims can now enter crypto… https://t.co/bq0skds6sy 20:27:12 13/04/2018 <a href="http://twitter.com" rel="nofollow">twitter web client</a> larrya llhands 0 false the wordcloud is presented figure 4. these figures adress the thinking style of twitter users. in fact, twitter users have a global positive view towards “islamic + bitcoin”. their emotion of “joy” towards the two cited words is dominant. https://t.co/bq0skds6sy https://t.co/bq0skds6sy ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 figure 3. sentiment analysis of tweets about bitcoin (emotion and polarity) figure 4. wordcloud of the term « islamic bitcoin » e. twitter sentiment indicator in the next step we try to define a twitter sentiment indicator of « islamic » and « bitcoin » using the number of tweets. after retrieving the positive words and the negative ones we build our twitter measure as tws: tws= v. empirical investigation a. data and methodology time-series data have been used to examine the sentiment-return and the sentiment volatility relationship at the aggregate market level by considering bitcoin. to maintain consistency in our analysis, we computed the corresponding return and volatility proxies for the bitcoin. for instance, islamic faith sentiment is measured by two different methods and extracted from different data. we have then different sources of data described as follow.  financial data: our financial data are composed by bitcoin prices extracted from the thomson reuters and datastream database.  social media data: we collect our social media data from twitter api database in order to measure our corresponding sentimental variable. this data is a microblogging database which is grouped from twitter api from 03/04/2018 to 13/04/2018 in instantaneous frequencies reduced in daily frequencies by means of moving average (f. corea, 2016). b. methodology in this section, we provide a detail discussion on the methodology used to show the link and effect of our sentimental variable on the daily returns and volatilities of the bitcoin. the obtained measures of twitter sentiment (twm) are averaged in each day. in other words, the daily twitter sentiment (twd) follows this formula: twdi in order to be able to apply the var model and granger causality tests, we need to verify the stationary of our variables. adf test results show that all our variables are stationary. in our work we use the vector "var" proposed by sims (1980) to predict the relationship between sentiment and returns in a multivariate time series. the var model is a flexible model that allows us to accurately describe the dynamic behavior of the economic and financial time series, and can be used as a correct prediction tool. however, before building a var model, we need to check the stationary of the studied series, which is already done previously. similarly, we need to determine the optimal number of lags for our var. *lag length selection: ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 when running the var-models it is important to include the right lag lenght of the dependent variable as well as the independent variables. the lag length for the var (p) can be determined using selection criteria model. the lag length for the var (p) model can be determined using model selection criteria. the basic idea is to fit var (p) models with orders p=0, 1….pmax and choose the appropriate value of p which minimizes the model selection criteria (lütkepohl, 1991). in our work we use the sc criteria and additional criteria of hannan-quinn information hq formally stated: hqc = 2k + -2lmax log log n where: lmax represents the log likelihood probability data into a model, k is the number of parameters, n: is the number of observations. using these models, we can identify if the tested variable is persistent, and if its value in the past still weighing on today's values; and therefore the integration time offsets is necessary and obvious. according to the fpe "final prediction error", the number of significant lags to use is 5 lags, while lr, hannan-quinn information criteria hqic and sbic and aic “akaike information criterion”, suggest eleven lags. in this work we use five lags in order to simplify the calculations. * the "granger"causality test granger causality test, proposed in 1969, is a statistical hypothesis test to determine whether a time series is useful in forecasting another. normally, regressions reflect the "simple" correlations, but clive granger argued that the economy causality could be tested by measuring the ability to predict future values of time series with past values of another series time. since the question of the "real causality" is deeply philosophical and guess that something before another can be used as proof of causation, econometricians argue that the test of granger believes "predictive causality". hence, if we control the information contained in past y, we can say then that x “granger cause” y (datta et al., 2006). formally, the possible granger causal links between stock and bond outcome (returns and volatility noted by r) and sentiment (s) is formulated as follow: rt ԑt c. empirical results: in this section we try to give the results of testing our hypotheses. therefore, we use the regression with neweywest standard errors in order to avoid any autocorrelation and heteroscedasticity of the errors. table 2 provides the results of this regression. in this table we clearly show that most of the coefficients of twitter, and google trends measures statistically significant in their relation with the return of bitcoin. these results conduct us to confirm our first hypothesis. the second part of this table shows that sentimental proxies are statistically significant. this result confirms our second hypothesis. table ii newey-west standard errors regression results twitter sentiment bitcoin return 0.3282316 bitcoin volatility 0.0329292 when we apply the var model, we find that the twitter sentiment has a delayed effect on the return and the volatility of bitcoin. table 3 details the results of the var model. table iii var model results for our last hypothesis, table 4 expresses the results of granger causality test with five lags. in this table 4 most of the p values are under 5% which show that our sentimental proxies granger causes the bitcoin return and volatility. table iv granger causality results for bitcoin conclusion: the compliance of bitcoin to shariah has created great debate between muslim people. this work visualizes the attention and the emotions towards bitcoin with regard to its conformity with sharia law. for this purpose, a measure of sentiment is constructed based on twitter and google trends data. then the top methods are proposed to investigate whether these sensations and emotions have an impact on the market sentiment and the price fluctuations. bitcoin twitter sentiment bitcoin return lag 1 0.0479795 lag 2 -0.0010292 lag 3 -0.0957978 lag 4 -0.1831325*** lag 5 0.0619689 bitcoin volatility lag 1 1.850196 lag 2 1.583181 lag 3 -0.7420697 lag 4 1.212408 lag 5 -2.880991*** granger causality test chi2 freedom degree p value twitter →bitcoin return 7.1305 5 0.211 twitter→bitcoin volatility 12.488 5 0.029** twitter→bitcoin return and volatility 23.511 10 0.009* ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 bayesian machine learning device exploiting deep natural language processing modules has been used to assign emotions and sentiment orientations. the contemporaneous effect deduced by newey-west regression, the delayed influences tested by var model, and granger causality analysis are used to investigate the hypothesis that the constructed measure of sentiment has an impact on the volatility and the returns of islamic assets. these metrics prove that this sentimental index has a significant effect on the bitcoin variables. both positive and negative sentiment are expressed by twitter users’. bitcoin is not totally accepted by muslim people who seek to satisfy their religious needs. we let future research to develop new islamic cryptocurrencies satisfying sharia requirements. references [1] p. p. biancone and m. radwan, “social finance and financing social enterprises: an islamic finance prospective,” eur. j. islam. finance, 2019. [2] e. mnif, b. salhi, and a. jarboui, “herding behaviour and islamic market efficiency assessment: case of dow jones and sukuk market,” int. j. islam. middle east. finance manag., 2019, doi: 10.1108/imefm-10-2018-0354. [3] p. p. biancone and m. radwan, “sharia-compliant financing for public utility infrastructure,” util. policy, 2018. [4] p. p. biancone, s. secinaro, and m. kamal, “crowdfunding and fintech: business model sharia compliant,” eur. j. islam. finance, vol. 0, no. 12, apr. 2019, doi: 10.13135/2421-2172/3260. [5] p. p. biancone and s. secinaro, “the equity crowdfunding italy: a model sharia compliant,” eur. j. islam. finance, no. 5, 2016. [6] e. d’avanzo and g. pilato, “mining social network users opinions’ to aid buyers’ shopping decisions,” comput. hum. behav., 2015, doi: 10.1016/j.chb.2014.11.081. 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[18] h. j. do, c. g. lim, y. j. kim, and h. j. choi, “analyzing emotions in twitter during a crisis: a case study of the 2015 middle east respiratory syndrome outbreak in korea,” in 2016 international conference on big data and smart computing, bigcomp 2016, 2016, doi: 10.1109/bigcomp.2016.7425960. [19] p. sangiorgi, a. augello, and g. pilato, “an unsupervised data-driven cross-lingual method for building high precision sentiment lexicons,” in proceedings 2013 ieee 7th international conference on semantic computing, icsc 2013, 2013, doi: 10.1109/icsc.2013.40. [20] d. terrana, a. augello, and g. pilato, “automatic unsupervised polarity detection on a twitter data stream,” in proceedings 2014 ieee international conference on semantic computing, icsc 2014, 2014, doi: 10.1109/icsc.2014.17. [21] c. strapparava, c. strapparava, a. valitutti, a. valitutti, o. stock, and o. stock, “the affective weight of lexicon,” proc. fifth int. conf. lang. resour. eval., 2006, doi: 10.1080/08839510590887450. [22] t. wilson, j. wiebe, and p. hoffmann, “recognizing contextual polarity: an exploration of features for phraselevel sentiment analysis,” comput. linguist., 2009, doi: 10.1162/coli.08-012-r1-06-90. ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5323 1 can fintech progress the real estate sector? the disruptive role of crowdfunding & blockchain: a systematic literature review fabio creta 1* , jelena mazaj 2 1* department of management, university of turin – corresponding author 2 department of economics, business and statistics, university of palermo abstract— the aim of this article is to examine the literature on the role of two dominant players within the fintech world in recent years: on the one hand, crowdfunding and on the other, blockchain. our focus will be on the traditionally static and noninnovative real estate sector, trying to analyse how the latter can benefit from the use and interaction between these two new actors. through a systematic literature review (slr), 143 scientific articles based on current literature have been identified to better understand the topic. the information collected from the selected articles is presented and summarised in specific tables and graphs for a more immediate understanding. the qualitative research software nvivo was also used. this research found 43 out of 143 articles analyse the phenomenon of crowdfunding based on blockchain technology from an economic point of view. after the descriptive results through qualitative analysis, the evidence that emerged is that none of the articles analysed deals with the issue in terms of real estate to understand possible practical implications and further theoretical contributions. this research work suggests to investors who intend to invest in real estate, how new investment methodologies could bring enormous benefits to a sector that is less prone to innovation and traditionally static, considering how the use of new technologies applied to alternative financing instruments would make real estate investments much more attractive and accessible. this study contributes to advancing knowledge of the fintech world, specifically of new alternative financing instruments such as crowdfunding and new emerging technologies such as blockchain, from a theoretical point of view. as far as the authors are aware, this is the first study that systematises the international literature on the subject, highlighting the main contributions written on the subject, always keeping a focus on real estate. keywords: fintech, crowdfunding, blockchain, real estate, systematic literature review i. introduction the term fintech, composed of the words financial and technology, is a term to describe the use of technology applied to finance and everything that revolves around it. as highlighted in the literature (hochstein, 2015), the term was coined in the early 1990s but has only recently come to the fore with its main subsets that at present appear to be crowdfunding and blockchain. another definition of fintech is that given by pricewaterhousecoopers (pwc) in its 2019 global fintech report: fintech is a combination of technology and financial services that's transforming the way financial businesses operate, collaborate, and transact with their customers, their regulators, and others in the industry. all types of companies, from start-ups to tech companies to established firms, are using fintech (pwc, 2019, p.3). specifically, we can say that fintech concerns the digitisation of the financial system, in particular the banking system, to make it more effective and efficient (e.g., freedman, 2006; ferrari, 2017). not only do we hear about crowdfunding and blockchain but often also about peer-to-peer lending, payment systems and crypto currencies. 2018 was a record year for fintech investments, with figures approaching $40 billion. the results showed an exponential increase in investment compared to the previous year of 120% worldwide. among the countries that have distinguished themselves for innovation and artificial intelligence (ai) technologies in the financial field, the united states has played a key role, but it is above all the new emerging giants, such as china and the asia pacific, that have gained significant market shares. in this context, europe, albeit slowly compared to other countries, is continuing its run of allocating from 10% to 15% of investments to the international market. the new players born in this evolutionary context can be grouped into two macro-areas: financial pure, which includes all the companies involved in payment, money management, lending, wealth and asset management, capital market and trading, and crowdfunding; and other companies that operate outside the strict banking value chain but enter the market with an innovative offer and which are of great interest to the financial world, such as insurtech, regtech, tech enabler and cybersecurity (cb insights, 2019). the interaction between crowdfunding and blockchain is a relatively young topic in terms of scientific discussion. there have been several contributions regarding the application of crowdfunding to the real estate sector (e.g., brzeski, 2014; montgomery et al., 2018; garcia-teruel, 2019; politecnico of milan, 2019). multiple contributions have existed for some submitted december 2020, revised april 2021, accepted april 2021 ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5323 2 years now in the literature regarding blockchain (e.g., fanning and centers, 2016; guo and liang, 2016; cai, 2018), but to our knowledge, there are no contributions in literature dealing with the application of blockchain-based crowdfunding in the real estate sector. our review is therefore based on the following research questions: rq1: could crowdfunding, through interaction with and the help of blockchain technology, be a valid alternative in real estate, a traditionally cyclical, static and non-innovative sector, to make this sector more attractive and innovative? rq2: what direction is being taken with regard to the development and use of blockchain as applied to crowdfunding? can it be applied to the real estate sector and, if so, how? can the use of tokens be a valid opportunity? rq3: can blockchain applied to crowdfunding play a key role in the real estate sector in the future? the purpose of this paper is twofold: 1) to highlight whether there are any contributions in the literature dealing with blockchain-based crowdfunding and whether they specifically concern the real estate sector; and 2) to understand the direction in which the studies on crowdfunding are going and if there are more connections with new technologies, in particular blockchain. from a methodological point of view, a systematic review of the scientific literature has considered crowdfunding and blockchain as a subset of fintech in real estate. slr is a method that allows the collection of a sample of publications to be systematically examined (petticrew and roberts, 2006) in different areas of research (e.g., pittaway et al., 2004; gligor and holcomb, 2012; kumar and goyal, 2015; tian et al., 2018). the use of the slr method can be beneficial for locating, evaluating and synthesising most of the information and recent contributions on blockchain-based crowdfunding. using the scopus database, 143 papers were identified and analysed to better understand the approaches and methodologies adopted in recent studies in the fintech field. more specifically, 42 out of 143 of the analysed articles were in the economic, financial or business and management areas. the rest of the article is structured as follows. in the next section, the theoretical frameworks for crowdfunding, blockchain and an overview of real estate, with a focus on italy, are summarised. section 3 examines the methodology adopted to collect the relevant documents for the review, while section 4 provides the descriptive results and section 5 addresses the gaps in the literature and the direction to be taken for future research lines. ii. theoretical background a. crowdfunding concept and definition the concept of crowdfunding is in an evolutionary state that arbitrarily limits definitions (e.g., de buysere et al., 2012; pais et al., 2014; quaranta, 2016; tencalla, 2017; european commission, 2018). de buysere et al. (2012, p.9) defined crowdfunding as ‘a collective effort of many individuals who network and pool their resources to support efforts initiated by other people or organizations’. pais et al. (2014, p.10) defined it as ‘a form of participation (financial, but not only) of the (social) network and through the network (internet) to a project that is characterized by: forward planning; freedom of choice of the project and of the designer, conveyed through reputational mechanisms; transparency of the funds collected’. quaranta circumscribed the term crowdfunding as: a particular type of collective funding that, exploiting the potential of the internet, allows those who have ideas or needs, but—respectively—not all the funds to realize or satisfy them, to try to access third-party financial resources, starting from those of relatives and friends (family and friends) in the hope of attracting those—much larger—of the crowd (crowd) that populates the online world, which, trusting the feedback mechanisms which are generated among users is willing to finance an increasing number of ideas (needs), as the tendency is to sell more and more units of products and/or services specific to small niches. in this way, anyone can potentially access a real ‘crowd funding’ (quaranta 2016, p.241). for tencalla (2017) crowdfunding can be defined as ‘the process by which more people give money to finance a project using websites and sometimes receive a reward in return’. finally, the european commission (2018) highlighted that ‘the basic function of crowdfunding can be described as an open call via the internet for the provision of small fundraisers. in order to compensate for the financial risk (tangible reward)’. crowdfunding can therefore be seen as a subset of fintech, which in the literature (belleflamme et al., 2015) is divided into 2 distinct groups: • investment-based crowdfunding • rewardand donation-based crowdfunding there are currently five standard crowdfunding models: donation-based crowdfunding, equity-based crowdfunding, reward-based crowdfunding, royalty-based crowdfunding and lending-based crowdfunding. equity involves the purchase of an investor's stake in the company; lending consists of a loan from private individuals or institutional intermediaries that will be repaid with consideration of an interest over a set period of time; reward involves a non-monetary reward, a product or service based on what is invested in the financial campaign; royalty involves a monetary reward in terms of shares of the future income of the project for which financing is requested; and donation involves a donation to finance projects with social implications (belleflamme et al., 2014). b. blockchain origin and definition everything started in the literature in 2008 with satoshi nakamoto's famous white paper which proposed his concept of decentralised digital payment: an electronic payment system based on cryptographic evidence [...] that allows any two counterparts to negotiate directly with each other without the need for a trusted third party [...] using a distributed peer-to-peer time stamp server to generate computational evidence of the chronological order of transactions (satoshi, 2008, p.1). as a result of this paper, the first block, called genesis block, was created in january 2009, within which the first bitcoins were mined. it is interesting to note that the word blockchain never appears in the white paper; in fact, the potential of the underlying technology for the bitcoin protocol only began to be taken into account a few years later. ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5323 3 it is important to pay attention to how the word ‘blockchain’ is written; with a capital letter, we refer to the technology underlying the bitcoin protocol, while with the lowercase letter, we refer to the underlying technology that has other cryptoassets and not necessarily bitcoin (garavaglia, 2018). literally, the term means a chain of blocks; it is a large, decentralised digital register in which entries are grouped in concatenated blocks in chronological order. we can think of blockchain as a huge shared database in which every 10 minutes, more or less, a new block is undermined whose security is guaranteed by asymmetric encryption. nakamoto's revolutionary idea included a type of data storage in which everyone can see what is inside and make sure it is real. not a single bit can be changed, and once something is on the network, it stays there forever (collins, 2016). blockchain technology is based on a few basic principles: • decentralisation and distribution because every single node that makes up the network has access to the whole blockchain and the whole history since the genesis block. • peer-to-peer communication, that is, communication passes through individual nodes without passing through a centralised server. • transparency because each transaction has an identifier and is visible by anyone; and pseudo-anonymity because each user has its own alphanumeric ‘address’ between which transactions occur, and each user can decide whether or not to show proof of identity. • irreversibility because once transactions are entered in a block and validated, that particular block is linked to the previous block without the possibility of modifying the history of the whole blockchain. • computational logic because the transactions within the blockchain are linked to computational power derived from the entire network. users themselves can set the rules and the algorithm that will automatically undermine the next bloc with the transactions between nodes inside (boucher et al., 2017; iansiti and lakhani, 2017; zheng et al., 2018). at the present time, there is no real regulation. however, we can say that some countries, such as the united arab emirates with its ‘uae strategy for artificial intelligence (ai) 2031’, have defined a new model of ‘smart government’ based on blockchain technology (http://www.uaeai.ae). in the united states, some states, such as illinois, have approved the ‘blockchain technology act’ within which smart contracts on blockchain are protected by law and given a clear definition as ‘a contract filed as an electronic record which is verified through the use of a blockchain’ (www.ilga.gov). at the italian level, on the other hand, an initial definition of blockchain has begun to be given with article 8ter of decree law 135/18, which establishes: technologies based on distributed registers as the it technologies and protocols that use a shared, distributed, replicable, simultaneously accessible, architecturally decentralised register on cryptographic bases, such as to allow the recording, validation, updating and archiving of data both in clear text and further protected by encryption that each participant can verify, cannot be altered or modified (official gazette of italian republic, 2019). smart contract, on the other hand, means ‘a computer program that operates on technologies based on distributed registers and whose execution automatically binds two or more parts on the basis of predefined effects by the same’ (official gazette of italian republic, 2019). c. overview of the real estate in italy real estate showed significant growth until the first years of the 21st century thanks to the new opportunities related to the possible achievement of a good yield and the high expectations related to achieving capital gains by developing new financial tools. nevertheless, starting in 2008, the conditions that supported real estate development have come to a screeching halt due to a negative economic situation that has strongly influenced market events of the past few years (tardivo et al., 2015). however, the real estate sector in italy is constantly recovering, and 2017 was an important first year of relaunch for italian real estate. the total amount invested was over 11 billion euros, 23% more than in the previous year. the technological change that has been taking place means that the real estate sectors in which investments occur are changing: the office sector remains unchanged (36% of total volume), retail is falling (21% of total volume), while the logistics sector is growing (11% of total volume) as is hotels (12% of total volume). this trend was confirmed in 2018, even assuming an increase in volume due to macroeconomic growth, new investors' appearance, and new investment methods (cbre research, 2018). international capital continued to be the main component of investments (around 65%), but domestic investor activity (35%) was up compared to 2017; the compression of prime yields continued, with office transactions closed below 3.5%, a sign of a healthy market in which interest continued to be strong; and, finally, the confirmation of attention to real estate development, whether it be for large urban regeneration projects or the enhancement of individual properties (business people, 2018). in italy, the real estate market continues to express a rather low potential in reference to its size, which is only 4% of european volume compared to an economy worth 12% of the total gdp (cbre research, 2018). iii. review method the literature review in this paper is based on the methodology of systematic literature review (e.g., tranfield et al., 2003; petticrew and roberts, 2006; macpherson and holt, 2007; littell et al., 2008). in general term, a literature review can be seen as a ‘mapping of knowledge’ of a given topic, intended to investigate and explore everything that has been written and summarise it all (frank and hatak, 2014). a slr can be divided into phases, which typically are: 1. definition of search and selection keywords in the database; 2. search for articles (papers) in the database; 3. reading and selection of titles and abstracts; ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5323 4 4. reading and selection of articles (papers); 5. analysis of articles (papers) for the purpose of research (thorpe et al., 2005). to build the sample to be analysed, the scopus database was used. through the boolean operators, and and or, it was decided to use the following terms as a search field in the title, abstracts and keywords: ‘fintech*’ with the asterisk in order not to overlook variations of the term since it is a new and compound term, ‘real estate’, ‘crowdfunding’ and ‘blockchain’. with the addition of the boolean operators and and or as the final search string, the following was used: ‘fintech*’ and ‘real estate’ or ‘crowdfunding’ or ‘blockchain’ it was decided to use this research string after appropriate evaluation because changing the boolean operator from or to and between the terms ‘real estate’ and ‘crowdfunding’ produced a sample with only one result, which was not reliable to give rise to our literature review. the search string gave 143 results, which were then filtered so that only those belonging to the area business/management/accounting and economic/econometrics/finance were taken into account. we chose to consider as a type of document only those articles that were already published and were in english. it was decided not to apply a time horizon because the topic in question is new; in fact, as shown by the research, there are no contributions before 2016. after applying these appropriate filters, the end result for the sample is 42. of these 42 articles, at the time of our review, it was impossible to locate three; thus, the total of those available is 39. the articles not available and for which no trace could be found are: kasthuri (2018), katyayani and varalakshmi (2019) and kursh and schnure (2016). following dada (2018) and endres and weibler (2017), we then manually searched the reference lists of all selected studies. this added step resulted in the retrieval of four more papers, thus increasing the selected studies to 43. the papers added are the following: schweizer and zhou (2017), montgomery et al. (2018), mochkabadi and volkmann (2018) and garcia-teruel (2019). the objective of this review is limited to two subsets of fintech—crowdfunding and blockchain in the real estate sector. for this reason, only papers that could make an in-depth contribution to the analysis of the chosen topic were selected. from the final sample obtained, we can say with certainty that there are no contributions in the literature that interface in the real estate sector with both these innovative tools. most of the articles deal with these two new tools that can be used together, but none are in the field of real estate. this was determined by following the slr principles proposed by tranfield et al. (2003) and littell et al. (2008). slr can be considered an analytical review scheme necessary to effectively evaluate the contributions of a given subject in the literature as it involves the adoption of a set of clear and reproducible steps that allow scholars to improve the overall quality of the review process (tranfield et al., 2003). table 1 shows in detail the various phases used to arrive at the final sample. table 1 slr process of this research research phase details selection of databases scopus selection of document types scholarly peer-reviewed journals terms used with boolean operator ‘fintech*’and ‘real estate’ or ‘crowdfunding’ or ‘blockchain’ elements subject area: business/management/accounting economics/econometrics/finance document type: article publication stage: final language: english outcomes selection of 143 papers; after the application of the filters, it dropped to 42 papers. three of these are not available. the sample then drops to 39. another 4 papers were added manually to the final sample. the final sample is then composed of 43 papers iv. analysis of results a. bibliographic map vosviewer software was used to analyse and display in bibliographic map mode the final sample that was used. by entering the sample of papers we exported from scopus, we obtained 103 items that corresponded to the authors of the papers in the sample. of these 103 items, many have no connection to each other, as can be seen in figure 1 below, but the largest cluster of items obtained as a result of the bibliographic map is six. in our opinion, this means that it is undoubtedly a new topic which many scholars have approached in recent years, but there is not yet a sufficient ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5323 5 number of interactions between the various actors to create a dense network of co-citations. figure 1 vosviewer process of bibliographic map b. final dataset table 2 below shows the articles that are part of the final sample used for our research, sorted by year of publication. the first thing that stands out is that there are no documents prior to 2016. this is because the interaction between crowdfunding and blockchain is a topical issue that has developed in recent years. table 2 list of articles used as samples ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5323 6 c. overview of publications by year and abs ranking by subdividing the number of publications by year, it can be seen that there are three in 2016, six in 2017, twenty-eight in 2018, which is the year with the highest number of publications of this type, and nine in 2019. this can be observed in more detail in figure 2. figure 2 – publications about interaction crowdfunding and blockchain broken down by year in figure 3 below, we can see the sample of analysed articles separated by the journal in detail. it emerges that the most represented journal is electronic commerce research and applications with five papers, followed by the european business organization law review with four published papers. with two published papers each, we find cutter business technology journal, european research studies journal, journal of management information systems, quality – access to success and investment management and financial innovations, while twenty-seven journals have published only one paper. figure 3 breakdown of journals by number of publications as shown in table 3, it is interesting to see the subdivision of these journals, taking into account the ranking for the top abs journals. although it is now a very topical subject, only three articles have been published since 2016 in journals classified 4 in the abs list. the following two articles have been published in the journal of management information system: ‘the role of provision points in online crowdfunding’ by burtch et al. (2018) and ‘on the fintech revolution: interpreting the forces of innovation, disruption, and transformation in financial services’ by gomber et al. (2018). production and operations management has published ‘research in operations management and information systems interface’ by kumar et al. (2018). the reasons for only three contributions in journals classified 4 in the abs list are that the topic is new and current, is undergoing great expansion and there are no contributions related to the interaction between crowdfunding and blockchain prior to 2016. table 3 also shows that our topic has been dealt with not only by newspapers that deal purely with computer science and technology but also by a wide variety of disciplines, such as management, marketing and finance. ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5323 7 table 3 journals included in the sample name of journal abs ranking no. of paper weight journal of management information systems 4 2 5% production and operations management 4 1 2% journal of strategic information systems 3 1 2% quantitative marketing and economics 3 1 2% small business economics 3 1 2% technological forecasting and social change 3 1 2% electronic commerce research and applications 2 5 12% accounting and finance 2 1 2% business horizons 2 1 2% emerging markets finance and trade 2 1 2% journal of retailing and consumer services 2 1 2% strategic change 2 1 2% venture capital 2 1 2% international entrepreneurship and management journal 1 1 2% journal of economics and business 1 1 2% journal of risk finance 1 1 2% property management 1 1 2% review of international business and strategy 1 1 2% european business organization law review no rank 4 9% european research studies journal no rank 2 5% quality access to success no rank 2 5% investment management and financial innovations no rank 2 5% computer law & security review no rank 1 2% financial innovation no rank 1 2% international journal of economics and business administration no rank 1 2% journal of money laundering control no rank 1 2% journal of private equity no rank 1 2% journal of reviews on global economics no rank 1 2% journal of risk management in financial institutions no rank 1 2% law and economics yearly review no rank 1 2% new economic windows no rank 1 2% the journal of portfolio management no rank 1 2% 43 100% ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5323 8 d. creating word cloud and cluster analysis through the nvivo software, we created what is called ‘word cloud’, in which the recurring words are inserted in the papers of our sample. it is interesting to note that the most frequently used words that appear in a larger and more central size are ‘crowdfunding’, ‘financial’, ‘blockchain’ and ‘fintech’. this means that within our specific case of the crowdfunding subset of the fintech world, the interest in possible interactions with a new technology like blockchain is growing stronger and stronger. figure 4 – word cloud a cluster analysis was then carried out on the paper sample, taking as reference the previously created word cloud. in figure 5 below, we can see how the sample was catalogued through the nvivo software which divided it into clusters using the ‘word similarity’ criterion. figure 5 – sample data clustered by word similarity through the cluster analysis of our sample, we were able to establish 11 leading labels, which the nvivo software calls ‘nodes’; that is, the most significant labels that have a redundancy in most of the papers in the sample. in alphabetical order, the nodes we have arrived at are the following: • blockchain • campaign • crowdfunding • equity • fintech • innovation • investors • lending • platform • regulation • technology e. autocoding nvivo as shown in table 4, we identified by means of autocoding using nvivo how many times these ‘main words’ or ‘nodes’ are repeated in the sample papers. ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5323 9 table 4 – autocoding results we then proceeded to analyse these ‘nodes’ found through cluster analysis to determine how many times the single nodes or main themes were mentioned within each journal within our sample as shown in figure 6 below. figure 6 – number themes/article f. a possible integrative practical–conceptual framework the grounded theory that underlies the qualitative research software nvivo, develops around the concept that theory is discovered through data analysis; it starts from data to build the theory and not the opposite, that is, starting from a theory already known to confirm research data (strass and corbin, 1990). grounded theory can be defined as a theory that is able to represent the reality to which it refers; it is applicable to various contexts inherent in the research that is being conducted, using both concepts and relationships between concepts (strass and corbin, 1990), as the software nvivo precisely does through the creation of what we previously called ‘nodes’. in our systematic literature review, we aimed to define, through the results obtained from the qualitative analysis of data, a possible future integrative conceptual framework because, in our opinion, there is no link in the literature that contains the three macro categories of crowdfunding, blockchain and real estate. the practical-conceptual framework proposed is the result of the analyzes previously carried out with the nvivo software. the analyzes provide a concrete indication of which topics can be cited individually within the observed sample. the data show an overview of the macrocategories described above, whose interaction can create benefits for the real estate sector. as shown in figure 7, an integrative framework can help to better understand the different parts of the existing literature and address future lines of research. above all, it can provide a new input of practical implications that has been missing until now. ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5323 10 figure 7 practical-conceptual framework source: own processing v. discussion and conclusion this review of the literature aims to advance the knowledge of the possible interaction between crowdfunding and blockchain and highlights that there are currently no studies in the literature concerning their possible joint use in the field of real estate. as far as we know, this is the first article that systematises the international literature on this subject, giving an overview on the use of blockchain technology applied to the alternative method for finance of crowdfunding. in particular, the world of real estate crowdfunding is a subset of crowdinvesting that allows widespread investors to participate in financing a real estate project in a residential or commercial environment in exchange for a return on capital. the project typically relates to the purchase of a property, so that it is put to income, rather than the restructuring of a real estate property (which will also be put to income or sold by earning a capital gain) or the development of a greenfield project (politecnico of milan, 2019). from this point of view, we have used an slr and are able to answer the three main research questions proposed in the introduction. rq1: could crowdfunding, through interaction with and the help of blockchain technology, be a valid alternative in real estate, a traditionally cyclical, static and non-innovative sector, to make this sector more attractive and innovative? blockchain methodology has many advantages over existing methods of transaction exchange and validation: there is no need for a centralised body to store and maintain transaction data and apply a commission; blockchain data is extremely difficult to create or modify inappropriately as all transactions need to be approved by consensus rather than unilaterally from a single source; there is a high degree of redundancy as common data is stored on multiple network computers and, therefore, a catastrophic loss of information is unlikely; as there is no central third party in a blockchain network, it is not possible to charge taxes or transaction costs on individual blockchain transactions. rq2: what direction is being taken with regard to the development and use of blockchain as applied to crowdfunding? can it be applied to the real estate sector and, if so, how? can the use of tokens be a valid opportunity? in crowdfunding, particularly in real estate crowdfunding, one of the dominant trends will certainly be the opportunity to use new blockchain technologies in the service of data collection; the use of blockchain technology not only optimises sale transactions because it effectively records the financial history of a property but also ensures greater stability to the market and effectively eliminates intermediaries. thanks to the collection of valuable information related to everything on buildings affected by real estate trading actions, which comes from the application of the system of big data, it will be possible to create increasingly intelligent structures (savina, 2019). the use of blockchain as a tokenisation of assets gives creators and entrepreneurs more freedom; they can raise more funds by issuing more fractional shares of their companies and then use these funds to expand. rq3: can blockchain applied to crowdfunding play a key role in the real estate sector in the future? the implications of using blockchain technology within the real estate industry through crowdfunding could be multiple and include: eliminating the need for centralised registries which would be replaced by a distributed registry of real estate holdings using digital property titles; timely and secure transfer of funds using blockchain technology; reduction or removal of unnecessary fees due to the peer-to-peer nature of blockchain transactions; and reduced fraud potential arising from the blockchain ‘consent’ verification and approval methodology. our literature review, conducted via a systematic approach, aims to provide a starting point for further advanced research on crowdfunding based on blockchain technology, especially in the real estate sector, which has always tended to be a sector where real estate investments have been accessible only to a limited part of the population. this is because investments in real estate require immobilising substantial capital resources and, at a later stage, an active management of the property because an investment property is characterised by low liquidity and a limited possibility for diversification. as so, the results presented underline the fact, that the study on the fintech and read state is just starting and this work can be a pioneer in guiding scholars on which future research directions can be taken further. practical implications consist in the birth of the first platforms operating in real estate crowdfunding based on blockchain technology, to certify data relating to investments in performing non-loans (npls). it is a sector typically not accessible to retail investors. national and international regulators (e.g. the european commission) should consider that the use of digital tokens in the crowdfunding sector, and more specifically in real estate crowdfunding, could provide the impulse for the creation of a secondary market, making the whole sector liquid. to the best of our knowledge, this is the first systematic literature review on the interaction between crowdfunding and blockchain within a specific sector such as real estate. scholars could support regulators and industry ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5323 11 because fintech, new support technologies and alternative finance tools will be among the most investigated topics. with regard to future avenues the focus can be on the organizations that manage real estate crowdfunding platforms. qualitative and quantitative studies can afford to analyze individual crowdfunding campaigns with the aim of observing how blockchain technology is used or how digital tokens are created to accompany each project. references [1] adhami, s., giudici, g. and martinazzi, s., 2018. why do businesses go crypto? an empirical analysis of initial coin offerings. journal of economics and business. vol. 100, pp. 64–75. available from: https://doi.org/10.1016/j.jeconbus.2018.04.001 [2] alabi, k., 2017. digital blockchain networks appear to be following metcalfe’s law. electronic commerce research and applications. vol. 24, pp. 23–29. available from: https://doi.org/10.1016/j.elerap.2017.06.003 [3] ashta, a. and biot-paquerot, g., 2018. fintech evolution: strategic value management issues in a fast-changing industry. strategic change. vol. 27, pp. 301–311. available from: https://doi.org/10.1002/jsc.2203 [4] azarenkova, g., shkodina, i., samorodov, b., babenko, m. and onishchenko, i., 2018. the influence of financial technologies on the global financial system stability. investment management and financial innovations. vol. 15, pp. 229–238. available from: https://doi.org/10.21511/imfi.15(4).2018.19 [5] belleflamme, p., lambert, t. and schwienbacher, a., 2014. crowdfunding: tapping the right crowd. journal of business venturing. vol. 29, no. 5, pp. 585–609. 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https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/09/2021 accepted for publication: 20/03/2022 published: 22/04/2022 1 understanding volatility dependence between mena sukuk, gcc sukuk and nifty shariah index during covid-19: a c-vine copula approach 1 centre for management studies, jamia millia islamia (a central university), new delhi contact the author: ssiddiqui1@jmi.ac.in abstract— the study aims to identify the dependence between mena sukuk, gcc sukuk, and nifty 50 shariah indices. further, it finds out volatility patterns among the same indices before and during the covid-19 pandemic. daily data (april 2017 to november 2020) of the indices are analyzed using the garch model and c-vine copula approach. it is done by modelling the returns of the indices. the outcomes may provide a prodigious advantage for portfolio makers and stockholders towards investment policies throughout financial catastrophes like the covid19 pandemic. in the pre-covid periodc vine copula shows that the sukuk have strong dependence while the shariah index has rather weak dependence, for mena sukuk and nifty shariah 50 it increased by a great margin in duringcovid 19 periods. gcc sukuk and nifty shariah indices are positively correlated to each other in comparison to the returns of mena sukuk. the results of the garch model show asymmetrical co movements for losses and gains. moreover, conditioned on mena sukuk, the gcc sukuk and nifty shariah 50 had a higher negative degree of dependence within and throughout the covid-19 period. the findings show substantial high and low tail dependency among the sukuk and shariah markets before covid19. gcc sukuk and nifty shariah 50 indices are highly positively correlated to each other in returns of mena sukuk. we also find negative dependency among the gcc sukuk and nifty shariah 50 during covid19 with mena sukuk. the outcomes are varied due to the time variation copulas that shows dependency diverges over time for all variables. furthermore, this study would be helpful to find out the significance of ethical finance functions safe havens for world investors by using the copula model. keywords: covid-19, dependency, volatility, sukuk, index, copula, garch i. introduction the outbreak of the pandemic of coronavirus (covid-19) is a widespread economic challenge and a major influencing factor in the current time. the novel disease has unfolded quickly athwart boundaries with quite 5,049, 497 individuals confirmed the infection and therefore the deaths of 367,230 people in more than 195 countries around the world, carrying an average death rate of 6.07% below 1% mortality from flu (gormsen & koijen, 2020; sherif, 2020), which has affected the islamic finance market too. the major contributor to the recent growth of the islamic finance market is sukuk, the islamic bond. these are structured to generate returns for investors without violating shariah. the sukuk market has shown remarkable growth in the first half of 2017. it has developed from just $ 200bn in 2003 to projected $ 4 trillion by the year 2030 (alam & seifzadeh, 2020). such exceptional development has been grown up in non-muslim nations in asia and europe (alam, 2019). this is because of the cultural diversity with enormous numbers of muslim immigrants (alam & seifzadeh, 2020). empowered by the above contentions and the possible effect of the current flare-up of the covid-19 pandemic, this study looks at and gives new proof on the impact of covid-19 on the s&p dow jones mena sukuk and gcc sukuk disparity with the nifty shariah 50 record and examines the volatility pattern of the s&p middle east and north africa (mena) sukuk, gulf cooperation council (gcc) and nifty shariah 50 indices. the key motivation for this research study is to analyze the volatility and dependency structure for shariah and sukuk index before and during the covid-19 pandemic. shariah market, including sukuk, is inclined by the situation of financial market circumstances specifically the volatility and returns. the statistic recounts the unrivalled volatility in sukuk and shariah indices throughout covid-19. saif siddiqui1, ziya batool rizvi1 https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6067 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/09/2021 accepted for publication: 20/03/2022 published: 22/04/2022 2 this paper also focuses on the factors of coupling and decoupling of sukuk and shariah index before and during the pandemic in association with globally perilous issues given joint dependency of return disseminations together in tails (extremes) and the focus. additionally, we enhance contribution and originality via associating the volatility of two sukuk and a shariah market, which gives a good insight of their comparative upended before and during the pandemic period. these findings provide better perceptions in understanding the volatilities. the outcomes may provide a prodigious advantage for portfolio makers and stockholders towards investment policies throughout financial catastrophes like to covid19 pandemic. apart from this, there is a dearth of studies on the s&p middle east and north africa (mena) sukuk, gcc sukuk and nifty shariah 50 indices together. this study adopts a copula approach that offers great flexibility in separating the marginal distributions from the dependence structure and in modeling these distributions independently to provide information on average dependence as well as on the probability that two variables jointly experience extreme upwards or downwards movements. this paper is organized as follows. section 2 reviews the documents available in the same way and/or related to islamic funds. section 3 describes the data source and method used for the current study. section 4 shows the strong results of the analysis and finally, section 5 concludes the paper by giving the real and strategy suggestions and delineation for future study. ii. literature review the studies that have examined sukuk indices are few. the empirical studies based on islamic indices, conducted around the world, collected from various sources, are presented in appendix 1. from the review of literature, it can be interpreted that the co-integration model is the widely used tool for analyzing shariah indices, followed by multivariate garch, capm and t-test. there are a few articles that have used other tests like copula, wavelet analysis and gmm. there are a few articles that have used other tests like wavelet analysis and gmm. this paper subsides the existing literature by investigating the dependency structure among sukuk and nifty shariah. so, we used various copulas which help to find out any variations in dependency structure over time variations. it is notified that most of the outcomes imply that the relationship between sukuk and shariah index counterpart by pretentious a continuous and symmetrical collaboration among them, most of the studies reflect the strong dependency between sukuk and shariah stocks. in our best information and considering the research gap, there is no research on gcc, mena sukuk and nifty shariah 50 index based on copula approach. the study intends to find out the modelled return in indexed based investments, primarily in sukuk before and during covid-19. iii. methodology 3.1 data and hypotheses as stated earlier, the data consists of daily returns of three indices, namely, dow jones mena sukuk (ms), s&p gcc sukuk (gs) and nifty shariah 50 index (nf). the empirical analysis is conducted on daily data obtained for the period 1st april 2017 to 30th november 2020 for benchmark indices. to examine the link between sukuk and nifty shariah, we consider the daily closing prices of the nearest contract to maturity on the sukuk and shariah. we choose data from 2017 to 2020 to analyze the pre and during covid-19 pandemic situation as it was earlier observed that there was the highest issuance of sukuk after financial crises. the dow jones mena sukuk consists of us dollardenominated investment-grade sukuk (islamic bonds) issued in the mena region, which are shariah-compliant. the s&p gcc sukuk consists of us dollar-denominated investmentgrade sukuk from gcc countries of risk. the nifty shariah 50 consists of investors with shariah-compliant investment solutions. the data is taken from the official websites of s&p dow jones indicesand nifty indices (www.spindices.com and www.niftyindices.com). (see appendix 1) null hypotheses for this purpose, two null hypotheses are put as follows: h01: there is no significant difference in dependency structure among gcc, mena sukuk and nifty shariah 50 before and during the covid-19 pandemic is not the same. h02: there is no significant difference in the volatility in sukuk and nifty shariah 50 before and during covid-19 pandemic. this includes various copulas with different tail dependency structures like student-t (symmetric dependency), rotated gumbel 180(lower and upper tail dependency), gaussian (upper tail dependency) and frank (symmetric tail dependency). intended for a better understanding, we analyze two global sukuk indexes namely, mena and gcc sukuk and nifty shariah 50 index by considering the data from 1st april’17 to 30th november’20. outcomes represent that both sukuk and nifty shariah50 indices are highly affected by the pandemic. additionally, results proposed that sukuk and shariah index are sturdily related and inclined to co-move during the covid19 crisis, which proves the coupling hypothesis of sukuk from shariah. our outcomes have several significant consequences and proposed some prominent contributions to the existing literature by examining the co-movements of the dependency structure of shariah and sukuk market through the copula approach before and during the covid-19 pandemic. for explaining the associations among sukuk and shariah index we build a dynamic and static dependency structure through copula. to our best knowledge, this research is the original one that examines the volatility and dependency among sukuk (mena and gcc sukuk) and shariah (nifty 50) index before and throughout the covid-19 crisis. https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6067 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/09/2021 accepted for publication: 20/03/2022 published: 22/04/2022 3 table i. data summary index launch date first date countri es conside red symb ols used at levels symbol s used at first differen ce s&p mena sukuk index september 20, 2013 july 31, 2013 the middle east and north africa ms rms gcc sukuk march 22, 2018 december 31, 2012 bahrain, kuwait, oman, katar, saudi arabia, and uae gs rgs nifty shariah 50 february 19, 2008 december 26, 2008 india ns rnf source: authors’ elaboration all the data series are considered after computing their log returns using the formula for calculating return: rt= ln (pt / p(t-1)). here, rt and pt addresses the everyday return at the business day t individually. all data series are retrieved from bloomberg, s&p dow jones and nifty shariah. the explanation behind using the dow jones list is for normalization in the total of indices value. next, the s&p mena is used for global islamic fixed income. the s&p index measures the performance of mena sukuk around the world which is involved in the middle east and african market. then, the bloomberg index is used to reflect the gcc sukuk. gcc sukuktracks the performance of 6 countries sovereign sukuk that are globally traded. lastly, nifty shariah 50 indices are used for reflecting the uncertainty in sukuk. this study has divided the observation into the before-covid 19 and the during-covid 19 period to examine the difference between pre and during covid-19. world health organization (who) issued the first disease outbreak news reporting 2019 globally. hence, we took the beginning of the covid-19 from november 2019 as global and defined the 1st november 2019 30th november 2020 as during the covid-19 period. the period from 1st april 2017 to 31st october 2019 is defined as the before covid-19 period. in the methodology part, first, we provided a brief introduction of the models used for the distribution of the margins. then, a brief description of the approach used for dependence. figure 1a-c presents pre covid-19 and 2a-c during covid-19-time plots of the price series and figure 3a-c presents pre covid-19 and 4a-c during covid-19 presents the time plot of return series for the three sample indices. figure 1a: price series from 1st april 2017 to 31st october 2019. source: authors’ elaboration figure 1b: price series from 1st april 2017 to 31st october 2019. source: authors’ elaboration figure 1c: price series from 1st april 2017 to 31st october 2019. source: authors’ elaboration figures 1a, 1b and 1c (pre covid-19 period) show that nf was at the level of 2150 as of april 1st, 2017, as it was initiated way before the other two indices. it rose and fell due to america’s trade war with china and again rose and finished at the rose level from starting (at increasing rate up to 50 per cent) https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6067 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/09/2021 accepted for publication: 20/03/2022 published: 22/04/2022 4 after 2.5 years. while, the other two were initiated on april 1st, 2017, at the level of 117.5 and 115. both gs and ms show a rising trend. price series during covid-19 figure 2a: price series from 1st november 2019 to 30th. source: authors’ elaboration figure 2b: price series from 1st november 2019 to 30th november 2020. source: authors’ elaboration figure 2c: price series from 1st november 2019 to 30th november 2020. source: authors’ elaboration figures 2a, 2b and 2c show that nf was at the level of 2500 as of november 1st, 2019, as it was initiated way before the other two indices. it rose and fell due to the covid-19 pandemic and lockdown situation in the world. investors do not have the funds to invest in the stock market which affect the global economy but once the lockdown was lifted from the economy and things normalize then again investors invest into the stock market so the price rose and finished more it's starting (increased 20 per cent) level. the other two were initiated i.e., ms and gs on november 1st, 2019, at the level of 128 and 133. both ms and gs show a rising trend (increase 7.81 and 6.76 per cent). figure 3: return series from 1st april 2017 to 31st october 2019. source: authors’ elaboration return series during covid-19 figure 4a: return series from 1st november 2019 to 30th november 2020. source: authors’ elaboration figure 3 & 4 shows the return series for the three indices and it can be observed that the return of during covid-19 of ms (rms), gs (rgs) and ns (rnf) having higher fluctuations as compared to returns of pre covid-19 period of ms (rms), gs (rgs) and ns (rnf) while, rms and rgs are leaping around the same path. this was due to the spread of the corona virus pandemic from china into the rest of the world, and the economic shutdown and investors were worried about the impact of the covid-19. hence, it can be observed from the graph that ns is the most volatile out of the three indices. outliers are also visible. https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6067 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/09/2021 accepted for publication: 20/03/2022 published: 22/04/2022 5 tables 3 & 4 reports summary statistics for the daily returns of the indices considered as well as statistics testing for normality and independence. 3.2 preliminary results preliminary analysis and results are presented as follows: descriptive statistics before covid-19 descriptive statistics of before covid-19 period are presented in table 2. table ii. descriptive statistics before covid period (3rd april 2017 – 31st october 2019) ms gs nf mean 0.000173 0.000177 0.000215 median 0.000171 0.000166 0.000146 minimum -0.00403 -0.004 -0.05156 maximum 0.004697 0.004318 0.027081 std.deviation 0.001011 0.000998 0.008275 skewness 0.153036 0.149481 -0.63146 kurtosis 4.247265 4.153168 6.588454 jarque-bera 46.0444 39.61861 404.0084 probability 0.000000 0.000000 0.000000 observation 670 670 670 source: authors’ elaboration table 2 premises the descriptive properties before the covid-19 period. the sample means are positive for ms, gs, and nf in the pre covid-19 period, whereas the standard deviation is lowest for gs (00.09 per cent) and highest for ms (00.10 per cent). thus, ms is found to be the most volatile index followed by gs and ns. skewness and kurtosis indicate that all series are completely skewed except nifty shariah 50 it skewed negatively and extremely leptokurtic. the values of skewness and kurtosis reveal that all indices follow the traditional distribution that is other verified by the value of jarque-bera datum and prospect value. as higher kurtosis relates to the extremity of outliers, which is highest for nf distribution followed by ms and gs, respectively. descriptive statistics for during covid-19 descriptive statistics of during covid-19 period are presented in table 3. table iii. descriptive statistics during covid period (1st november 2019 – 30th november 2020) ms gs nf mean 0.000251 0.000244 0.000683 median 0.000375 0.000372 0.001353 minimum -0.01172 -0.011702 -0.10902 maximum 0.006651 0.006697 0.089551 std.deviation 0.001935 0.001937 0.018286 skewness -1.99655 -1.98831 -0.8989 kurtosis 13.6984 13.67204 13.90106 jarque-bera 1515.907 1507.83 1195.223 probability 0.000000 0.000000 0.000000 observation 279 279 235 source: authors’ elaboration table 3 summarizes the descriptive properties of the variables during the covid-19 period. the sample means are positive for ms, gs, and nf during the covid-19 period, whereas the standard deviation is lowest for ms (00.19 per cent) and highest for ns (01.82 per cent). thus, nf is found to be the most volatile index followed by gs and ms. the values of skewness and kurtosis reveal that all indices don't follow the normal distribution. the same is given by jarque-bera test. as higher kurtosis relates to the extremity of outliers, which is highest for ns distribution followed by ms and gs, respectively. after the comparison of before covid-19 and during the covid-19 period, all variables, except ms have a positive return. the volatility of each variable has increased in both periods under study. ns has shown a higher mean return in the covid-19 period. the maximum and minimum returns during and after the covid period show the highest peak. standard deviation is highly volatile during the covid-19 period in comparison to pre-covid-19 period. all variables are somewhat asymmetric as shown by their non-zero skewness coefficients. https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6067 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/09/2021 accepted for publication: 20/03/2022 published: 22/04/2022 6 iv. results 4.1 garch modelling to comprehend the impulsiveness of the securities market, we will in general allow exponential garch models that area unit broadly utilized in learning the variability of the financial market in money writing have depended on uneven garch model developed by admiral nelson (1991) recommending the following work of arma garch model for volatilities (d’ecclesia & clementi, 2019). the arma approach created by box and jenkins (1976) may be a class of random models needed to investigate measurement information considering the ensuing autoregressive moving normal model meant as arma (p,q). + + (1) where may be a constant term, the ith autoregressive constant, θj the jth moving average constant, and error term at time t. p and q are known as the sets of autoregressive and moving normal terms, severally. when the backshift administrator b is applied, eq. (1) are regularly composed as: (1) ( ) = ) (2) where b(yt−μ) =yt−1−μ and b = −1. it is used to explore what proportion of sukuk influenced the market volatility pre and during the covid-19 crisis. in this study, the arma-garch method is used to assess the parameters of the marginal. the best-fitting model was selected among completely different lag orders (arma (0, 0), arma (0,1), arma (1,0), arma (1,1)) with the error term following the traditional, student’s t or generalized error distribution (ged). the estimated parameters for the select models are reported in tables 4 & 5. table iv. estimates of marginal distributions – before covid19 ms gs nf ged ged ged μ 0.00014*** 0.00178** * 0.000237 (0.000046) (0.0000) (0.32956) λ -0.146645 *** -0.149879 *** 0.053997 (0.000054) (0.000136) (0.21395) δ ms gs nf ω 0.000000 0.000000 0.000004 *** (0.958645) (0.845614) (0.00000) α 0.025792 *** 0.033352 *** 0.048261 *** (0.002054) (0.001945) (0.00000) β 0.961937 *** 0.950449 *** 0.896015 *** (0.00000) (0.00000) (0.00000) shape 1.378927 *** 1.387345 1.238533 *** (0.00000) (0.518705) (0.00000) source: authors’ elaboration * the table gives the constraint estimations of marginal distribution function along with standard error and p-value of garch test for the suitability of distribution function. the constraints of peripheral distribution function are given in eq. (1&2). for garch testing, p-values which are lesser than 0.05 shows that null hypothesis is rejected. ⁎, ⁎⁎, ⁎⁎⁎ shows statistical consequence at 10%, 5% and 1% level correspondingly. table v. estimates of marginal distributions – during covid19 ms gs nf std std std μ 0.000329 *** 0.000313 *** 0.001102 *** (0.002897) (0.004982) (0.0000) λ 0.856217 *** 0.856441 *** 0.397966 *** (0.00000) (0.00000) (0.00000) δ 0.730880 *** -0.730492 *** -0.343426 *** (0.00000) (0.0000) (0.0000) ω 0.000000 0.000000 0.000007 (0.955101) (0.958515) (0.513746) α 0.140091 ** 0.138502 ** 0.147472 * (0.015616) (0.018440) (0.077205) β 0.829632 *** 0.833673 *** 0.818538 *** 0.00000) (0.00000) (0.00000) https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6067 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/09/2021 accepted for publication: 20/03/2022 published: 22/04/2022 7 ms gs nf shape 8.602566 ** 8.456019 ** 0.988159 *** 0.023592) (0.021254) (0.00000) source: authors’ elaboration * the table gives the constraint estimations of marginal distribution function along with standard error and p-value of garch test for the suitability of distribution function. the constraints of peripheral distribution function are given in eq. (1&2). for garch testing, p-values which are lesser than 0.05 shows that null hypothesis is rejected. ⁎, ⁎⁎, ⁎⁎⁎ shows statistical consequence at 10%, 5% and 1% level correspondingly. as shown in the above tables, all the return series are best captured either by the ged or student t distribution based on aic. the autoregressive and moving average (arma) terms are statistically significant for the selected variables. the arch coefficients represented by α, exhibits the influence of past squared residuals. on the other hand, the garch coefficient represented by β shows the impact of lagged forecasted variance. all coefficients are statistically significant at 1% for all series. further, the sum of arch and garch coefficients is closer to unity which showing that the shocks are persistent. shape parameters are statistically significant indicating that the return series was asymmetric. lastly, the diagnostic tests could not reject the null hypothesis of no arch effect and no serial correlation. 4.2 c-vine copula approach a copula is a variable accumulative distribution operate of which marginal distribution is uniform on the interval [0,1] and it captures the dependence structure of a variable distribution. (rüschendorf, 2009). multi-data distribution methods have high flexibility as a result of it permits scholars to shape the marginal cdfs aboard a dependable structure expressed in copula's work. in alternative words, through copula, we will split the combined allocation operation fxy into a phase that explains the reciprocity among the random variables x and y and also the classes solely describe a marginal behaviour. according to sklar’s theorem, there exists a copula perform c (.) such for all x,y : (3) where fx (x) and fy(y) denote the marginal distribution functions the theory additionally states that joint distribution is given fxy performance; copula is exclusive for fx × range fy range, which may be a set of the ranges of the marginal cdfs. this suggests that the verb is going to be distinctive on the off chance that the marginal fx and fy are persistent. depending on the formulation, copula could be used to connect marginal to a multivariate of distribution functions, which could also deteriorate into its univariate minimal appropriation and copula catches the reliance structure. on account of bivariate appropriation incorporates a thickness fxy (x,y), and this is accessible, further: (4) where c(.) is the depth of the copula. a necessary property of the copula is that it provides important details associated with the mean dependence referenced and tail dependence (excessive dependence), that tests the chance of the two markets can collectively together expertise extreme top or drawback worth movements. unsurprisingly, the higher tail dependence suggests the relative quantity of size inside the higher (lower) portion of the quartile distribution. attained from copula, higher and smaller tail dependency processes area unit given as: (u) = (5) (u) = (6) where 0 ≤ u ≤ 1, 0 ≤ , ≤ 1. if >0 ( > 0), then variables x and y will in general be lower (upper) tail subordinate. this suggests a non-zero likelihood of noticing a tiny (huge) esteem for one arrangement with a minuscule (enormous) esteem for another arrangement (mensi, hammoudeh, shahzad, & shahbaz, 2017). further, different copula families are used to study the dependence between the variables. therefore, standard residuals from the garch models are transformed into uniform distribution using ecdf. 4.2.1 copula functions this paper uses a varied family of copula functions that have exceptional dependency structures. it includes student-t (symmetric dependency), rotated gumbel 180(lower and upper tail dependency), gaussian (upper tail dependency) and frank (symmetric tail dependency). the characteristics of these copulas are specified below: the rotated gumbel copula has an only a lower tail dependency. crg(u1, u2; δ) = u1+ u2 − 1 + cg(1 – u1, 1 – u2; δ). (7) student t-copula shows only symmetric tail dependency. cn.p (u,v) = dsdt (8) https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6067 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/09/2021 accepted for publication: 20/03/2022 published: 22/04/2022 8 λl= λu = 2+ [1 − 𝑡𝑛−1√ (𝑛 + 1) (1 + 𝑝, (1 − 𝑃))] (9) gaussian copula has only upper tail dependency. (10) frank copula has only symmetric tail dependency. (11) another phase is to identify a sequence of the variables in the c-vine copula structure. here, ms is placed in the first place in the order of the variables. for the rest of the variables, this study has used the method proposed by (panagiotelis, czado, & joe, 2012)for identifying the maximal tree spanning by arranging the variables following their sum of absolute pairwise estimated kendall’s tau │the variable with the highest dependency is placed at the next sequence and so on. by this method, the order of the variable is decided as ms, gs, and nf. this sequence applies to the pre and during covid 19 periods datasets both. figure 5: pairwise scatter plot (before covid 19). source: authors’ elaboration figure 6: pairwise scatter plot (during covid 19). source: authors’ elaboration figures 5 and 6 show kendall’s τ (above the diagonal) and pairwise scatter plot (below the diagonal) of the copula data. from the graph, it is evident that ms has strong dependence while nf has rather weak dependence on other indices. from the estimated kendall’s τ, ms is the highest dependent variable with the rest of the variables as it has the greatest sum of kendall’s tau, which labels it as the second variable. the next step involves choosing a suitable copula family for each pair and estimating their parameters accordingly. tables 7 and 8 summarize the results of parameters estimated for the ged copula structure. the first tree reflects the degree and structure of dependence between ms and two other indicesgs and nf. the estimated kendall’s tau evidenced that the degree of dependence has increased between ms and the other two indices the covid-19 period. this implies that gs and ns are more positively correlated with the movements in the returns of ms. the dependence structure between gs and nf is shifted from rotated gumbel 180 degrees to frank copula. though, both the copulas measure the lower tail dependence suggesting the downward movements in the index’s returns are more correlated than upward movements. in the view of symmetric tail dependency student-t, gaussian, rotated gumbel and frank copulas shows the dependency among sukuk and nifty shariah index is optimistic and substantial, opposing the view towards the sukuk as to be used as hedger and instrument of risk diversification in the risky market situation also. additionally, the proof of optimistic symmetric upper and lower tail dependency given by studentt copula suggests that sukuk and nifty shariah index markets change collectively but at different periods before and during covid19. for gcc and mena sukuk, there is a sign of optimistic dependency, even the tail dependency is lower, which shows the optimistic collective response towards the before covid19 situation. for gs and nf, the symmetric copulas offer the sign of optimistic dependency by supportive sign of upper and lower tail dependency. though, for gs and nf, we discover a sign of negative lower tail dependency with ms. so, with the features of oblique copulas, it gives the benefit for the diversified portfolio and managing the risk before the crisis. next, in the second tree, we tend to explore the dependence between gs and nf conditional on ms. given the returns of ms, the worth of kendall’s tau between ms and ns increased by a positive margin duringcovid-19 period. also, the dependence degree of ms and nf is highest among all the pairs. it is to be noticed that there are asymmetrical comovements as extreme losses are more correlated than extreme gains depicted through lower tail dependence. furthermore, conditioned on ms,gs and nf had a higher negative degree of dependence during the covid-19 period. the increased negative dependence could be due to high volatility in the index (during the covid period). https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6067 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/09/2021 accepted for publication: 20/03/2022 published: 22/04/2022 9 for gs and ms, there is a sign of optimistic dependency, with symmetric upper and lower tail dependency, that shows the optimistic collective response towards the during covid19 situation. for ms and nf, the symmetric copulas offer the sign of optimistic dependency by supportive sign of high lower tail dependency. though, for gs and nf, the symmetric copula gives the sign of negative dependence with a higher and lower tail dependency with ms. it illustrates that dependency with globally risky issues changed but asymmetrical due to covid19. v. conclusions the prodigious possible development and low apparently susceptibility of nifty shariah index as compared to sukuk throughout the strained financial situation. it attracts the curiosity of muslims, conventional stockholders as well as portfolio managers globally. due to the covid19 pandemic, the relationship between sukuk and shariah index is analysed and concurrence rises on the basis of literature related to the dependency among islamic finance and another index market, specifically in the risky market situation. we examine the volatility and dependency among the gcc and mena sukuk, and nifty shariah 50 index market by using the varied family of copula methods having different dependency structures with different periods i.e., 1st april’17 to 31st oct’19 as before covid19 and 1st nov’19 to 30th nov’20, the practical outcomes show substantial high and low tail dependency among the sukuk and shariah market before covid19. gs and nf indices are highly positively correlated to each other in returns of ms. we also find negative dependency among the gs and ns during covid19 with ms. the outcomes are varied due to the time variation copulas that shows dependency diverges over time for all variables. we find that sukuk has consistent tail reliance as bahrain, oman, and abu dhabi; these discoveries counsel that these gulf markets area unit getting constant direction and the same magnitude throughout the covid-19 era additionally as these three also. there are asymmetrical co movements for losses and gains. moreover, conditioned on ms, the gs and nf had a higher negative degree of dependence within and throughout the covid-19 period. the enhanced negative dependence may be because of high volatility in the index (throughout the covid period). hereafter, h01 was rejected because there is higher and lower tail dependency shown in sukuk and nifty shariah 50 before covid-19 and during covid-19 but gs and nf indices are highly positively correlated and dependent to each other in returns of ms during covid-19. h02 was rejected because before covid-19 sukuk and nifty shariah 50 indices are less volatile due to the news effect but highly volatile during covid-19. sukuk and nifty shariah 50 stock market are conditioned on ms, the gs and nf show high volatility in index. lastly, the outcome indicates some consequences and implications for portfolio managers and global stakeholders seeking interest to invest in the ethical stock market. meanwhile, the ethical stock market is pessimistically impacted by discriminating dread, tension and concern in the conventional stock market, the hedging assets and hedging strategies seem to be safe in the ethical stock market. furthermore, this study would be helpful to find out the significance of ethical finance functions safe havens for world investors by using the copula model. table 7 pre covid-19 period (3rd april 2017-31st oct 2019) pairs copula par1 par2 kendall’s tau tree 1 ms-gs student t 0.992768 2.0001 0.923475 0.923475 0.9233846 ms-nf rotated gumbel 180 1.045677 0.0596446 0 0.043679 tree 2 gs-nf│ ms gaussian -0.03402 0 0 -0.021667 source: authors’ elaboration table 8. during covid-19 period (1st nov 2019 -30th nov 2020) pairs copula par1 par2 kendall’s tau tree 1 ms-gs student t 0.9979992 2.83224 0.9536992 0.9536992 0.9597219 ms-nf rotated gumbel 180 1.161558 0.1838131 0 0.1390873 tree 2 gs-nf│ ms frank -0.101906 0 0 -0.0113283 source: authors’ elaboration https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6067 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/09/2021 accepted for publication: 20/03/2022 published: 22/04/2022 10 references [1] abadi, r. t., & silva, f. 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(2019). sukuk in islamic finance: a comparative study between s&p mena sukuk and s&p mena bond index. european journal of economic and financial research. [22] kumar, k. k., & sahu, b. (2017). dynamic linkages between macroeconomic factors and islamic stock indices in a non-islamic country india. the journal of developing areas, 51(1), 193-205. [23] mansor, f., & bhatti, m. i. (2011). risk and return analysis on performance of the islamic mutual funds: evidence from malaysia. global economy and finance journal, 4(1), 19-31. [24] mensi, w., hammoudeh, s., shahzad, s. j. h., & shahbaz, m. (2017). modeling systemic risk and dependence structure between oil and stock markets using a variational mode decomposition-based copula method. journal of banking & finance, 75, 258-279. [25] munusamy, d., & natarajan, p. (2011). seasonal anomalies between s&p cnx nifty shariah index and s&p cnx nifty index in india. journal of social and development sciences (jsds), 1(3), 101-108. [26] natarajan, p., & dharani, m. (2012). shariah compliant stocks in india: a viable and ethical investment vehicle\oman chapter of arabian journal of business and management review.-2012, vol. 1, no. 6, pp. 50-62: sohar university. [27] panagiotelis, a., czado, c., & joe, h. (2012). pair copula constructions for multivariate discrete data. journal of the american statistical association, 107(499), 1063-1072. [28] reddy, k., & fu, m. (2014). does shariah compliant stocks perform better than the conventional stocks? a comparative study of stocks listed on the australian stock exchange. asian journal of finance & accounting, 6(2), 155-170. [29] rüschendorf, l. (2009). on the distributional transform, sklar's theorem, and the empirical copula process. journal of statistical planning and inference, 139(11), 3921-3927. [30] sadeghi, m. (2008). financial performance of shariah-compliant investment: evidence from malaysian stock market. international research journal of finance and economics, 20(8), 15-24. [31] sherif, m. (2020). the impact of coronavirus (covid-19) outbreak on faith-based investments: an original analysis. journal of behavioral and experimental finance, 28, 100403. [32] siddiqui, s., & sheikh, s. (2016). modelling the return of shariah with underlying indices of national stock exchange of india: a case of 3sls and gmm estimation. journal of emerging economies and islamic research, 4(2), 1-15. [33] tyagi, a., & rizwan, m. (2012). a study of the movement of bsetasis shariah 50 index in accordance with sensex. international journal of emerging research in management & technology, 5-13. followed appendix a. https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6067 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/09/2021 accepted for publication: 20/03/2022 published: 22/04/2022 11 appendix a. review of the literature s. no authors (year) conceptual/ data (index and time period) methodology findings 1 irfan (2020) sensex, nifty (2010-2012) beta (capm), cagr, correlation, t-test there is no difference between shariah index and benchmark indices return and conjointly in shariah index and customary index. it found that equity primarily based shariah index is social accountable to invest in investors especially small and private investors. 2 sherif (2020) uk dow jones index, ftse100 index. time period is from january’20 to may 20. regression a well-structured and important statistical correlation among the covid-19 epidemic and the performance of a general stock market indices. it has shown a negative impact compared to the market indicator of complaints. it has co-examined the effect of covid19 on the performing of uk 10 sector clusters. the it revenues of the it sector have done much better than the market. return of shares in the field of consumer understanding, 3 grassa & miniaoui (2018) 88 sukuk and 287 conventional bonds of gcc countries were taken. the time period is from 2000 to 2015 (15 years) correlation, gmm prefer sukuk in the issuance of large debt and long tenor, because it gives negative correlation in terms of credit rating. 4 aloui, hammoudeh, & hamida, (2015) gcc shariah stocks and sukuk. the time period is from 2008-2013 (6 years) markov, univariate and multivariate egarch it propounds changes in sukuk price index having a considerable impact on chance of transmission across regime. it has many economic and managerial implications for islamic portfolio managers, islamic hedge funds, stock market regulators, and policy makers 5 bhuiyan, rahman, saiti, & ghani (2019) bond index (us, uk, australia, canada, germany and japan) and malaysia sukuk index. the time period is from 2010 to 2015 (5 years) wavelet coherence, multivariate garch developed market shown lower co movement of returns between bond and malaysian sukuk. malaysian sukuk shown negative correlation with bond market, good sign of diversification. it divulges alluring opportunity with credit quality to invest in fixed securities. 6 dharani, narayanamo orthy, & natarajan( 2011) nifty shariah index, nifty index 2007 to 2010 (4 years) sharpe, treynor, jensen and ttest it was found that nifty shariah underperformed throughout sample period. each were underperforming and consistent with respect to risk free return. nifty shariah is less volatile as compared to nifty index. https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6067 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/09/2021 accepted for publication: 20/03/2022 published: 22/04/2022 12 7 aloui, hammoudeh, & hamida, (2015a) gcc sukuk indices and shariah stocks. daily data of 240 days. wavelet, var it was found that there is strong dependency between shariah stocks and sukuk index. portfolio diversifications also vary with frequencies and time. 8 bhuiyan, puspa, saiti, & ghani, (2020) sukuk and bond indices. the time period is from 2010-2015 (6years) var it analyses that var amount of sukuk indices is way under var of bond indices. sukuk index with bond indices can cut back the var portfolio by 30-50% 9 abadi & silva, (2020) mena region 2007-2015 (8 years) sharpe ratio, multifactor model performance measure and period of analysis affects the performance of islamic and non-islamic portfolios. each portfolio found to be underperforming against the benchmark. islamic portfolios underperformed in global financial crisis. non-islamic counterparts throughout the arab spring their performance was at par 10 jawad & faris, (2019) mena region, s &p sukuk and bond index garch, egarch, arch-lm it founds that sukuk reacts lesser to shocks in comparison to bond. sukuk are more stable and have less risk. 11 ali, (2020) mena sukuk, mena bond adrl, dcc garch, copula it founds that mena sukuk is correlated with mena equity and mena bond in short run and in long run it is correlated only with mena. 12 boujlil, hassan, & grassa, (2020) 143 sukuk and 602 conventional sovereign bonds of 16 oic countries were taken. the time period is from 2000 to the year 2015 (15 years) correlation and logit model national, financial, and macroeconomic indicators decide about the governments’ choice of sovereign debt. countries with developed financial markets, could issue sovereign sukuk than sovereign bonds, to diversify their monetary markets with new debt products. 13 kumar & sahu, (2017) india region shariah indices and stock market. the time period is from 2006 to 2015. (9.5 years) vecm, granger, var, johansen’s long run equilibrium relation between dow jones index and macroeconomic indicators. in short run, unidirectional causality between dow jones index and money supply. indian islamic capital market is inefficient due to co-integration between stock return and macroeconomic indicators. 14 el-khatib & samet, (2020) 45 emerging countries stock market index garch it shows harshly struck and sharp decrease in stock market indices. it causes a growth in volatility levels on sovereign credit default. 15 ashraf & marashdeh, (2018) shariah indices from kuwait, oman, qatar, bahrain, saudi arabia and the united arab emirates, 5 years 6 months breusch godfrey lm test, kpss test and gph (geweke porter hudak) test it was noticed in this study that during the study period, the returns of all gcc equity shariah were not informationally economical however fractionally integrated. 16 siddiqui & nifty 50 shariah, correlation test, it was seen from the analysis that the returns of https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6067 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/09/2021 accepted for publication: 20/03/2022 published: 22/04/2022 13 sheikh, (2016) nifty 500 shariah, nifty 50 and nifty 500, 9 years cointegration test, granger causality test, gmm and 3sls shariah indices are better, and it is less risky as compared to underlying indices. 19 reddy & fu (2014) shariah and conventional stocks for companies listed on the australian stock exchange (asx), 13 years risk adjusted. return, sharpe rating, treynor rating, jensen alpha rating, and multiple reduction test the study shows that shariah based indices are better investment options while both indexes have a tendency towards act in the same way. 20 el khamlichi, sarkar, arouri, & teulon, (2014) islamic indices and conventional benchmarks of dow jones (12 years 2 months), financial times (3 years 4 months), standard & poor’s (4 years 2 months) and morgan stanley (3 years 2 months) cointegration test and variance ratio test the study concluded that shariah guidelines work other than in the case of msci and ftse. whereas the islamic indices and conventional indices of dow jones and s&p are found to be integrated and hence, provide opportunity of investment diversification. 21 akguc & al rahahleh, (2018) standard and poor compustat global database of gcc region. the time period is from 2000 to 2014 multi variate regression analysis shariah firms are more profitable than non shariah firms 24 al-khazali, lean, & samet, (2014) nine dow jones indices, 17 years correlation, capital asset pricing model (capm) statistic and davidson– duclos (dd) tests the results indicate that traditional indexes overshadow shariah index all markets with the exception of european market. whereas islamic indices for world, european and us markets overlook their traditional equivalents. 26 tyagi & rizwan, (2012) bse tasis shariah and sensex, 1 year 6 months graphical method the study revealed that sensex and tasis shariah behaved similarly for the period under study. 27 natarajan & dharani, (2012) nifty shariah index, nifty index and bse sensex index, 5 years t-test, capm to estimate beta, and correlation matrix it was determined that the median yields of the sharia compliant stocks and benchmark index were comparable. the returns from the sharia index were just like the returns attained from the common index. thus, sharia compliant investment is taken into account a viable and ethical investment opportunity. 28 munusamy & natarajan, (2011) nifty shariah index and nifty index, 4 years t-test no difference was found between average day-wise returns of the nifty shariah index and nifty index during the period of study. the effect of ramazan was also observed in the indian stock market. also, seasonal variation exists in the shariah index. https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6067 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/09/2021 accepted for publication: 20/03/2022 published: 22/04/2022 14 29 mansor & bhatti, (2011) malayasian shariah mutual fund and traditional portfolios, 13 years 4 months t-test and correlation analysis the results revealed that shariah portfolio earns less returns in regard of traditional equivalents and riskier than conventional one. 30 hassan & girard, (2011) dow jones islamic market index (djim) and their non-islamic counterparts, 10 years sharpe, treynor, jensen and fama’s selectivity, fourfactor pricing models and cointegration test no distinction was found among islamic and nonislamic files. the dow jones islamic lists surpass their ordinary partners from 1996 to 2000 and fail to meet expectations them from 2001 to 2005. generally, comparable award to hazard and enhancement edges exists for each the islamic and regular lists. 31 sadeghi, (2008) daily stock prices, bid ask to spread and volume of trade for 188 publicly traded companies on shariah index of bursa malaysia, 7 years event study methodology the results showed that the introduction of shariah index had a positive impact on the performance of financial performances of stock included in the study. https://www.ojs.unito.it/index.php/ejif/index paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4479 1 impact of covid19 on the islamic cryptocurrencies abstract— cryptocurrency is a new form of digital asset based on a network distributed across a large number of computers. the main objective of this work is to investigate the impact of covid-19 on the islamic cryptocurrency markets returns. in this methodology, we identify a group of islamic cryptocurrencies consisting of the x8x, hellogold and onegram. this paper uses the newey-west standard errors regression to estimate the effect of the covid-19 pandemic on the islamic cryptocurrencies returns. the empirical results show that covid-19 total deaths have a negative effect on respectively the x8x cryptocurrency, hellogold, and onegram cryptocurrencies. in the same way, the covid-19 total confirmed cases growth has a negative effect on respectively the x8x cryptocurrency, and onegram cryptocurrencies. this study contributes to the literature by identifying the impact of covid-19 on the islamic cryptocurrency markets. keywords-component; islamic cryptocurrency, covid-19, cryptocurrency market returns. i. introduction the number of muslims in 2015 is estimated at 1.8 billion worldwide, or 24.1% of the world population [1]. thus, they have more than $800 billion to invest [2]. this capital is currently increasing by about 15% per year [3]. the recent build‐ up of liquidity in muslim countries is attracting the attention of researchers to satisfy their demand for cryptocurrencies. scientists have created innovative technological applications exploiting existent blockchain to meet the religious needs of some investors such as the onegram, the x8x, and the hellogold. the onegram is the first cryptocurrency that has been certified in compliance with the ancient islamic rules. each onegram coin is backed by at least one gram of physical gold which provides a stable floor price. the x8x, hellogold, and the onegram are the most popular cryptocurrencies compatible with islamic laws. in fact, the x8x currency offers an alternative to value preservation assets. it trades 8 currencies and gold in its basket to fight inflation whilst remaining fully liquid and cash-backed. the hellogold, the x8x and the onegram have some common characteristics than bitcoin. they are considered speculative because they generally offer no cash flow underlying their valuations [4]. their prices‟ fluctuations are depending on the occurrence and lasting of some events or crises. some events like disasters or epidemic diseases such as covid-19 may incite this behaviour [5]. covid-19 is part of a large family of viruses that may cause illness ranging from the common cold to more severe diseases [6]. nowadays, this coronavirus has provoked fear and anxiety among people and investors [7]. major events may significantly affect cryptocurrency market returns [8]. the covid-19 outbreak has affected the investment and business environment in the world. several investigations have focused on stock market response [9] and conventional cryptocurrency reactions [10]. however, to the best of our knowledge, the response of islamic cryptocurrencies has not been investigated. for this reason, this paper attempts to answer the question of how is the reaction of islamic cryptocurrencies to this pandemic. the outbreak started on 31 december 2019, and since then, the number of infected cases has been published on a daily basis. to investigate the effect of this epidemic on stock returns, we employ the newey-west standard errors regression using four measurements: the daily growth in total confirmed cases, the daily confirmed cases, the daily growth in total deaths caused by covid-19, and the daily deaths caused by covid-19. our results provide evidence of a significant negative effect of all measurements on cryptocurrency returns over the period of 10 january to 10 april 2020. our further tests suggest that some cryptocurrencies performed better than others during the outbreak of the covid-19. we also find that the x8x cryptocurrency faces a significantly higher negative effect on the returns in comparison with onegram and hellogold cryptocurrencies. the implications of our study are important for cryptocurrency market main players to understand and predict the behaviour of islamic cryptocurrency returns during epidemic diseases. the principal novelty of the present study is the examination of the effect of contagious infectious mnif emna, jarboui anis submitted may 2020, revised december 2020, accepted december 2020 ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4479 2 diseases, specifically the covid-19 virus, on islamic cryptocurrency market returns. the rest of this paper is organized as follows: the next section provides the literature review. section 3 presents the data research methodology. section 4 develops the empirical results and section 5 concludes the paper. ii. literature review covid-19 is a severe respiratory illness with pneumonia-like symptoms, received worldwide attention in 2020. covid19 originated in wuhan. in december 2019, the wuhan municipal health commission in wuhan city, hubei province, china, reported a cluster of 27 pneumonia cases (including seven severe cases) of unknown aetiology, with a commonly reported link to wuhan's huanan seafood wholesale market, a wholesale fish and live animal market [11] the infected people carried the disease to thailand, japan and south korea. several studies have paid their attention to study the event consequence of sars and covid19 on financial markets. as the recent coronavirus is belonging to the sars virus family, we start our investigation by examining the previous studies on these issues. chen, jang, & kim (2007) examined the effect of the sars epidemic on taiwanese hotel stock prices movements using an event-study approach. seven publicly traded hotel companies experienced steep declines in earnings and stock price during the sars outbreak period. on and after the day of the sars outbreak, taiwanese hotel stocks showed significantly negative cumulative mean abnormal returns, indicating a significant impact of the sars outbreak on hotel stock performance. wells et al. (2020) estimate the impact of control measures and investigate the role of the airport travel network on the global spread of the covid-19 outbreak. their results show that the daily risk of exporting at least a single sars cov-2 case from mainland china via international travel exceeded 95% on january 13, 2020. they found that 779 cases (95% ci: 632 to 967) would have been exported by february 15 2020, without any border or travel restrictions and that the travel lockdowns enforced by the chinese government averted 70.5% (95% ci: 68.8 to 72.0%) of these cases. in addition, during the first three and a half weeks of implementation, the travel restrictions decreased the daily rate of exportation by 81.3% (95% ci: 80.5 to 82.1%), on average. arshad ali, baloch, ahmed, arshad ali, & iqbal (2020) reviewed the diligent measures that have been used to constrain the propagation of the covid19. hence, the public health emergency of international concern (pheic) has been established by the world health organization (who) with strategic objectives for public health to curtail its impact on global health and economy. several studies have focused on the disturbance caused by the covid19 pandemic on financial markets. the impact of the covid19 pandemic on stock markets was investigated by okorie & lin (2020) who examined the fractal contagion effect of this pandemic using the detrended moving crosscorrelation analysis (dmca) and detrended crosscorrelation analysis (dcca) techniques. the results confirm a fractal contagion effect of the covid-19 pandemic on the stock markets which fizzles out over time (in the middle and long run) for both the stock markets return and volatility. therefore, they provide pieces of evidence for the covid-19 fractal contagion effect on the stock markets. the impact of this pandemic on cryptocurrencies was also explored by mnif, jarboui, & mouakhar (2020) who justified a positive effect of the pandemic on the cryptocurrency market using multifractal detrended fluctuation analysis. in this paper, we paid our attention to study the impact of covid-19 on islamic cryptocurrencies. iii. data and methodology a. data unlike traditional equities and commodities, digital assets are traded on a number of exchanges. data is obtained from www.coinmarketcap.com, where closing prices are constructed using a weighted combination of closing prices from all exchanges on which the asset is traded. the sample consists of three types of islamic cryptocurrency namely x8x 29 from 06 august 2018 to 24 march 2020 and the onegram from 22 january 2019 to 23 february 2020 to and the hellogold from 12 october 2017 to 24 march 2020, extracted in daily frequency according to their availability. we also retrieved the number of daily active confirmed cases and daily cases of death from covid-19 in all over the world from worldmeter for the period between january 10 to 10 april, 2020. the continuously compounded daily returns of islamic cryptocurrencies is computed by taking the difference in the natural logarithm of two consecutive daily cryptocurrency prices defined as: rt = log(pt)-log(pt-1) where r t is the cryptocurrency return at date t, and pt is the cryptocurrency price at date t. figure 1depicts the evolution of daily cryptocurrencies‟ prices and returns. as shown in this figure, the cryptocurrencies‟ prices show high instabilities. the impact of covid-19 is observed for all cryptocurrency markets. the time variations of stock returns display stylized fact tails and volatility clustering in the x8x, hellogold and onegram return series. http://www.coinmarketcap.com/ ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4479 3 b. methodology this paper does not follow classical event study methodology because the peak of the event is not the start date and that this lasts for several days. we employ the regression with newey west standard errors to reduce estimation bias and multicolin earity. in fact, this estimator is used to overcome autocorrelati on (also called serial correlation), and heteroskedasticity in the error terms in the models, often for regressions applied to tim e series data. therefore, we estimate cryptocurrency returns as: ri,t = 𝛼0 + 𝛼1 cov19i,t-1+𝜀i,t cri,t the return of the cryptocurrency i at day t regressed on th e lagged previous daily values of cov19i,t-1, which is either daily growth in total confirmed cases or daily growth in total cases of covid19 deaths; 𝜀i,t is the error term. iv. empirical results ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4479 4 figure 1: onegram, hellogold and x8x prices’ and returns’ after representing the prices‟ and returns‟ plots of the three islamic cryptocurrencies (figure1), this work tests the impact of covid-19 predictors on the islamic cryptocurrency returns. table 1 illustrates the results of our regression, in which we analysed the islamic cryptocurrency market during the outbreak of the covid-19. the results suggest that islamic cryptocurrency returns are significantly negatively related to both the daily growth in total confirmed cases and the daily growth in total cases of deaths caused by covid19. several studies have proved a negative impact of the covid 19 pandemic on the stock markets [17]. other researches have justified a positive effect on cryptocurrencies (mnif et al., 2020a ). however, others demonstrated an effect of instability during this pandemic (lahmiri & bekiros, 2020). this empirical study shows a negative impact on islamic cryptocurrencies. table i. onegram cryptocurrency returns and covid19 panel a onegram cryptocurrency estimate pr(>|t|) std. error t value intercept 9.1900e-03 0.47692 1.2855e-02 0.7149 number of confirmed cases -4.383e-07 0.25603 3.8290e-07 -1.1447 increase in confirmed cases -1.363e-06 0.51800 2.0983e-06 -0.6495 deaths -1.269e-06 0.80410 5.0978e-06 -0.2489 deaths‟ growth 1.2796e-04 0.01097* 4.9035e-05 2.6095 signif. codes: 0 „***‟ 0.001 „**‟ 0.01 „*‟ 0.05 „.‟ 0.1 „ ‟ 1 table ii. hellogold cryptocurrency returns and covid19 panel a hellogold cryptocurrency estimate pr(>|t|) std. error t value intercept -2.184e-02 0.14247 1.4731e-02 -1.4824 number of confirmed cases 2.4998e-07 0.55507 4.2164e-07 0.5929 increase in confirmed cases 4.0090e-06 0.11344 2.5027e-06 1.6019 deaths -1.551e-06 6.0386e-06 5.0978e-06 -0.2569 deaths‟ growth 3.7493e-05 -8.96e-05 * -2.3911 0.01934 signif. codes: 0 „***‟ 0.001 „**‟ 0.01 „*‟ 0.05 „.‟ 0.1 „ ‟ 1 table iii. x8x cryptocurrency returns and covid19 panel a x8x cryptocurrency estimate pr(>|t|) std. error t value intercept -7.4818e03 0.3561487 8.0576e-03 -0.9285 number of confirmed cases 3.0207e-07 0.1478790 2.0656e-07 1.4624 increase in confirmed cases -1.8887e06 0.0008727 *** 5.4436e-07 -3.4697 deaths -5.832e-06 0.03775 * 2.7571e-06 -2.1154 deaths‟ growth 2.9706e-05 0.012492 * 1.1602e-05 2.5605 signif. codes: 0 „***‟ 0.001 „**‟ 0.01 „*‟ 0.05 „.‟ 0.1 „ ‟ 1 conclusion: this paper tests the impact of the covid19 on the outcomes of three islamic cryptocurrencies. the results clearly show that the covid-19 cases‟ growth, covid-19 death growth have a significant negative impact on the islamic cryptocurrencies returns. in other words, the empirical results show that covid-19 total deaths have a negative effect on respectively the x8x cryptocurrency, hellogold, and onegram cryptocurrencies. in the same way, the covid-19 total confirmed cases growth has a negative effect on respectively the x8x cryptocurrency and onegram cryptocurrencies. our findings are adequate for the general expectation about these markets and in line with empirical findings obtained elsewhere [19] [18] [20]. nevertheless, this research presents some challenges due to the data and market capitalization as islamic cryptocurrencies are very recent and they are less traded on the financial markets. the results in this study provide valuable information for policymakers, help them making policies. this paper is, therefore, useful in building trading strategies. more attention should be paid to the impact of covid-19 on financial markets as it could offer a better experience in market management models. ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4479 5 references [1] b. y. m. lipka and c. hackett, “why muslims are the world‟s fastest-growing religious group,” pew res. cent., 2017. 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[8] h. guo, e. meamari, and c. c. shen, “blockchaininspired event recording system for autonomous vehicles,” in proceedings of 2018 1st ieee international conference on hot information-centric networking, hoticn 2018, 2019. [9] d. zhang, m. hu, and q. ji, “financial markets under the global pandemic of covid-19,” financ. res. lett., 2020. [10] e. mnif, a. jarboui, and k. mouakhar, “how the cryptocurrency market has performed during covid 19? a multifractal analysis,” financ. res. lett., 2020. [11] z. liu, p. magal, o. seydi, and g. webb, “understanding unreported cases in the covid-19 epidemic outbreak in wuhan, china, and the importance of major public health interventions,” biology (basel)., 2020. [12] m. h. chen, s. c. (shawn) jang, and w. g. kim, “the impact of the sars outbreak on taiwanese hotel stock performance: an event-study approach,” int. j. hosp. manag., 2007. [13] c. r. wells et al., “impact of international travel and border control measures on the global spread of the novel 2019 coronavirus outbreak,” proc. natl. acad. sci. u. s. a., 2020. [14] s. arshad ali, m. baloch, n. ahmed, a. arshad ali, and a. iqbal, “the outbreak of coronavirus disease 2019 (covid-19)—an emerging global health threat,” j. infect. public health, 2020. [15] d. i. okorie and b. lin, “stock markets and the covid-19 fractal contagion effects,” financ. res. lett., 2020. [16] e. mnif, a. jarboui, and k. mouakhar, “how the cryptocurrency market has performed during covid 19? a multifractal analysis,” financ. res. lett., 2020. [17] b. n. ashraf, “stock markets‟ reaction to covid-19: cases or fatalities?,” res. int. bus. financ., 2020. [18] s. lahmiri and s. bekiros, “the impact of covid-19 pandemic upon stability and sequential irregularity of equity and cryptocurrency markets,” chaos, solitons and fractals, 2020. [19] j. cohen, “the united states badly bungled coronavirus testing—but things may soon improve,” science (80-. )., 2020. [20] q. ji, d. zhang, and y. zhao, “searching for safehaven assets during the covid-19 pandemic,” int. rev. financ. anal., 2020. ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4479 6 paper title (use style: paper title) 56 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6260 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/11/2021 accepted for publication: 03/03/2022 published: 22/04/2022 recent trend of deposits in islamic banks 1. senior economist, research department, intesa sanpaolo and aiaf analyst and research fellow at the catholic university of milan, italy corresponding author: davidia.zucchelli@intesasanpaolo.com abstract— bank deposits increased sharply in 2020, continuing in 2021, in countries with advanced economies and emerging countries alike. the pandemic caused savings to increase for precautionary reasons. at the same time, the lockdown compressed spending, but deposits are now a financial resource that could be used to boost the recovery of consumption and investments. there was an increase in deposits in islamic countries, but this was less marked. the fall in gdp in 2020 in all of the islamic countries considered, with the sole exception of bangladesh (+5%), was met with an increase in deposits, but not such as to be thought of exceptional magnitude. an acceleration was recorded in indonesia, bangladesh and saudi arabia, with increases only moderately higher than in the previous year. several drivers can explain this trend, some of which are attributable to islamic principles. in assessing the role of islamic finance and bank deposits, financial inclusion is also critical. despite gradually increasing, the level of financial inclusion, which is high in countries with the highest income (the gulf countries), shows a large margin for potential growth. especially in the less rich islamic countries, there exists a problem of mobilising resources and providing a custody function for the financial resources of households and businesses. the proliferation of fintech channels, primarily through mobile phones, can contribute significantly to financial inclusion, particularly among young people. prospects are positive thanks to the confluence of some factors (such as the strong demand for both sharia-compliant and esg products). keywords: bank deposit, islamic finance, islamic banks. i. sharp increase in savings in advanced and emerging economies in 2020 during 2020, there was a sharp increase in savings in countries with advanced economies and emerging countries alike, as deeply analysed by the imf (2021) [1]. a large part of savings was banked, this being the most immediate way that businesses and households allocate excess liquid funds, while waiting to define their use more clearly. the main drivers supporting deposits were primarily the impossibility of making purchases due to the lockdown, as well as uncertainty about the evolution of the pandemic and therefore the effects of the pandemic on the economy, labour, wages and salaries. these liquid funds are expected to be used for the consumption of goods and services and investments, which are expected to gradually recover in 2021, as well as for financial products (government bonds, funds, etc.) or for house purchases, including, to some extent, in emerging countries. the deposits in islamic finance have some distinctive features that substantially differentiate them from the deposits collected by conventional banks. after considering the continued presence and weight of islamic finance in the world, this paper outlines the technical peculiarities of the deposits and their objectives. an analysis of the financial statement data of a significant sample of islamic banks in countries where islamic finance is applied to a considerable extent, shows their recent dynamics and allows for assessment of the effects of covid-19 in the sector. lastly, the examination of the level of financial inclusion makes it possible to assess the spread of bank accounts and the ability of these systems to attract deposits and capture the development opportunities and the main evolutionary trends. ii. the muslim presence in the world and islamic finance various factors have contributed to the strengthening of the muslim presence in many countries in recent decades. the first and foremost among these are globalisation and immigration, which has led many muslims to settle in various western countries. according to the indications on the cia website [2], islam is the second most practiced religion globally (by approximately 24% of the population), after christianity which, in its main denominations (roman catholic church, protestant church and orthodox church), covers more than 30% of the population. in the emerging europe, there is significant muslim presence in albania and bosnia herzegovina (over 50% of the population). in the countries of the former yugoslavia, north davidia zucchelli1 https://www.ojs.unito.it/index.php/ejif/index 57 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6260 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/11/2021 accepted for publication: 03/03/2022 published: 22/04/2022 macedonia and kosovo are also predominantly muslim. a minority is present in bulgaria. a significant minority is present in russia, estimated to be between 10 and 15%. again, according to cia's figures, is growing due to the greater birth rate of the muslim minorities (such as the chechens) compared to the orthodox population. in the world, the main countries with the largest muslim populations are the gulf countries, with iran and iraq, as well as in asia, pakistan, bangladesh, indonesia and malaysia. the spread of islamic finance defined as the activity of financial institutions that base their objectives and operations on the principles of the koran reflects the spread of the religion, but with significant particularities. 235 banks that cover this area are operating worldwide (according to the bankfocus moody’s bvd database), 9 of which are in the european union (27 countries). the gulf countries account for the highest share of the total assets of the world's islamic banks (45.4% at the end of 2019) according to the islamic financial services industry stability report (2020) published by the islamic financial services board [3]. the middle east and south asia (mesa) area covered a share close to 26% on the same date, while the south east asia region accounted for 23.5%. even when adding north africa and sub-saharan countries, the african region's share of the world total is marginal (1.6%). breaking down the individual countries further, iran’s share is the highest (about 29% of the total), followed by saudi arabia, which has a slightly lower share (25%). figure 1. islamic finance (breakdown of ta between geographical areas, 2019). note: mesa includes afghanistan, bangladesh, iran, iraq, jordan, lebanon, the maldives, palestine, pakistan and sri lanka. source: our calculations based on ifsb figures. it is important to consider the regional distinction. this is because islam differs among geographical areas and countries (first of foremost with the distinction between shiites and sunnis), with a different interpretation of the provisions of the sharia, the islamic law [4]. figure 2. islamic finance (breakdown of ta, 2019). source: our calculations based on ifsb figures. the share that islamic finance has compared to traditional finance in the individual countries is very significant. as highlighted by hrh prince m. al-faisal al-saud (2000) [5] in providing a wide and in-depth examination of islamic economic principles, the gradual spread of islamic finance is part of the process defined in muslim circles as 'islamic resurgence', aimed at creating a new, united islamic society that avoids 'fundamentalism' and extremist positions. in iran and sudan, where the state has islamised the financial sector, this share is 100%. among the other countries, there is no perfect correspondence between the size of the sector (in usd bn) and the share covered by islamic banks. saudi arabia has a significant share of over 60% and high volumes of around usd 450bn. on the other hand, in kuwait the share of the total financial system is close to 50%, with a smaller volume (usd 100bn). other countries, such as turkey and indonesia, with volumes falling within the ranking of the major islamic countries in the world, have modest shares compared to the conventional system (around 6%). figure 3. islamic banks (ta and % share of the total assets of the country's banking system, 2019). source: our calculations based on ifsb figures. egypt is a very important exception. with an almost total sunni muslim presence (with the copts accounting for about 10%) of the population, the weight of islamic finance in egypt is still negligible (with a share of total world assets that fails to reach 1%), and the level of financial depth calculated using the main indicators referring to traditional finance also remains modest. a few sharia-compliant banks were involved in foreign currency speculative transactions in the 1980s, which led to their closing. subsequently, public banks have assumed a predominant role within the system, and they have held on to https://www.ojs.unito.it/index.php/ejif/index 58 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6260 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/11/2021 accepted for publication: 03/03/2022 published: 22/04/2022 this role to date. in the country, only 3 islamic banks are active, controlled by banks based in the gulf, out of a total of 38 institutions. the structural loan/gdp ratio also remains very low (just over 20% at the end of 2020) compared to peers, despite the presence of numerous international operators, while the ratio for deposits is higher (over 60% at the end of 2020). islamic banks in bosnia accounted for a share of the country's total assets equal to about 3% at the end of 2019. among other countries close to europe, such as russia, the muslim presence is not reflected in a corresponding proliferation of islamic financial instruments, as this presence consists of ethnic minorities whose role in the country's economy remains modest. iii. deposits in islamic banks: technical characteristics there are numerous differences between the principles of european/western and islamic finance. these differences pertain to the objectives that can be pursued and therefore their technical characteristics. article 14 of the italian consolidated law on banking (and the european directive 2006/48, article 4) provides authorisation to carry out banking activities which, in a "traditional" sense, is focused on the dual function of collecting deposits and loan granting, and article 11 states "for the purposes of this legislative decree, the acquisition of funds with the obligation to repay...". m. fahim khan and m. porzio (2010) [6], especially in the introduction, explain the way islamic banks are incorporated into european regulations. like conventional banks, islamic banks receive deposits and finance customers, businesses and households, though with significant specific characteristics. in almost all cases, the collection and financing scheme of islamic banks does not entail the obligation to repay. the operations of these financial institutions are therefore more complex and this has made it necessary to develop specific international standards to be followed for the preparation of the financial statements of these institutions (p. biancone, 2014) [7]. the islamic finance model is based on a different type of financial intermediation activity of banks based on the principle of profit and loss sharing (pls), i.e. participation in profits and losses deriving from its customers' investments. income from the interest typical of western financial systems is replaced by income from assets compatible with sharia requirements. it is interesting to note in this regard that the bank must adequately distinguish the proceeds obtained from projects financed with its customers' resources, from the profits obtained from its own capital, as explained by z. ahmad khan (2000) [8]. like all traditional banks, the islamic bank transfers financial resources from sectors with financial surplus to sectors with a deficit, but it also participates in business projects and may also promote business initiatives and actively partner with corporate customers. the assets and liabilities of an islamic bank differ significantly from those of a traditional bank. in addition to working capital, the bank’s assets include also equity investments in companies that entail the sharing of profits and losses, in accordance with sharia principles (especially mudarabah, musharaka and murabaha contracts). in liabilities, among funding instruments, g.m. piccinelli illustrates (in khan, porzio, 2010) [9], islamic banks offer three main categories of accounts, which essentially differ for the repayment method and the allocation of the amounts collected: • non-remunerated on-demand deposits in current accounts, in turn concern three types of deposit accounts (current accounts): the amanah or trust deposit, in which the bank acts as trustee and the qard hassan or good loan, where the bank shall return only the principal; the wadiah, or safe deposit, is a custody contract whereby the bank returns the money at the customer's request. in all three cases, the bank obtains authorisation to invest the money deposited in shariacompliant assets and does not pay out any form of interest or shares the profits with depositors. it only reserves the right to distribute gifts (hiba) in cash or in kind at its discretion, in order to render these deposits more attractive and competitive. they are mainly used by customers to manage current payments. due to its nature, this type of account must be backed by reserves of a value equivalent to the deposit (100%), and represent about 10% of liabilities, an average that is, however, only indicative in a highly diverse context; • investment accounts concern deposits for which the bank does not ensure reimbursement. funds collected in these types of accounts are invested in risky activities managed by the bank, which acts as an entrepreneur (rabb-ul-mal) or as investor on the stock market. depending on the degree of freedom the bank has insofar as the investment activity, the investment accounts may be divided into: o restricted investment accounts; o unrestricted investment accounts. banks have the highest investment freedom with the first category for which customers are only provided with the general information concerning the investment of their funds, while in the latter category the bank is bound by the depositor to invest only in some types of activities or to observe specific investment methods. in any case, the customers’ return is based on the results achieved and therefore they become a sort of shareholder in some projects. they represent about 70% of the bank's total funds. • special investment accounts or profit-sharing investment accounts, i.e. non-guaranteed term deposits. these generally set a minimum initial amount and allow the customer to withdraw only periodically following adequate notice to the bank. they can guarantee an ex-post return through profit and loss sharing, i.e. the equitable sharing of profits and losses of the financial asset. the main profit and loss sharing include the aforementioned mudarabah and musharaka. https://www.ojs.unito.it/index.php/ejif/index 59 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6260 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/11/2021 accepted for publication: 03/03/2022 published: 22/04/2022 these three types of deposits are recognised in the financial statements under liabilities together with reserves and share capital. iv. performance of deposits in islamic banks the analysis of data referring to islamic banks as highlighted by numerous scholars, as in particular i. warde (2000) [10] and the central authorities requires a number of important prerequisites. the relative "youth" of financial institutions and the products they offer, and therefore the uncertainties inherent in the interpretation of their technical and legal characteristics, also give rise to several accounting problems. first of all, operations have been ongoing only over several decades and they are handled differently by the various countries, which renders any analysis and comparison between them difficult. there are quite a few differences in the interpretation concerning the use and accounting of certain transactions. moreover, when interpreting the data, the financial and religious aspects are not always perfectly aligned. regardless of whether or not they evaluate opportunities, muslims concurrently rely on islamic banks and conventional banks, and non-muslims can bank with islamic banks, to diversify their investments and financial operators that have specific skills and professionalism. that said, the analysis of the financial statement data of a significant sample of islamic banks, in countries with an islamic majority, shows an acceleration in deposits during 2020. however, there is no real surge as was the case in many western countries. in fact, the fall in gdp in 2020 in all of the islamic countries considered, with the sole exception of bangladesh (+5%), was met with an increase in deposits, but not such as to be considered of exceptional magnitude. an acceleration was recorded in indonesia, bangladesh and saudi arabia, with increases only moderately higher than in the previous year. on the other hand, oman, kuwait and qatar slowed down. also, in the three other significant countries contained in the following table, the trend in deposits (over the entire banking system) does not appear to be particularly high, given a decline in gdp. the figures for egypt are unique, with the resilience of real gdp (3.6%) and a significant increase in deposits, but in line with previous years (in nominal terms). the comparison with the 2009 crisis is not helpful insofar as the interpretation, also due to the lack of data. as is known, the subprime mortgages storm had limited direct effects on islamic banks, as they had no exposure to that segment. in 2009, deposits accelerated, especially in malaysia and egypt, and held up in saudi arabia. this seems to be in line with the data for the last two years, which may help to exclude the assumption of an abnormal trend in deposits in 2020. the examination of some technical characteristics and functions of the deposits can help explain their growth, despite the decline in gdp. in western countries, one of the drivers underlying time deposit dynamics are interest rates. however, this is a factor that did not play a significant role in 2020, since interest rates were very low and decreasing. on the other hand, the precautionary reasons for saving money and the forcedly postponed consumption due to the lockdown measures adopted by governments were decisive in supporting bank deposits in the context of the crisis. de p. l oc.cu rr. re al gdp de p. l oc.cu rr. re al gdp de p. l oc.cu rr. re al gdp de p. l oc.cu rr. re al gdp indonesia 5.9 7.4 40.4 4.7 9.45 5 12.66 -2 bangladesh nd 6 n.d. 5 9.1 8.2 13.5 5.2 malaysia 4 4.8 16.8 -1.5 12.2 4.3 6.2 -5.6 s. arabia 24.7 6.2 22.5 -2.1 8.2 0.3 20.6 -4.1 uae 27.4 3.2 7.7 -5.2 -2.7 1.7 13.2 -5.5 oman nd 8.2 nd 6.1 21.4 -0.8 15.7 -6.2 kuwait nd 2.5 nd -7.1 15.5 0.4 11.7 -5 qat ar nd 17.7 nd 12 16.1 0.8 10.1 -3 egypt 6.3* 7.1 13.1* 4.7 17.01* 5.6 16.1** 3.6 albania 2.6* 7.5 6.8* 3.3 3.8* 2.2 8.1* -3.3 bosnia h. 5.5* 3.5 3.8* -2.3 8.4* 2.91 6.5* -5.5 2008 2009 2019 2020 table 1. deposits in islamic banks and real gdp in the major islamic countries (yoy % change). note: (*) central banks’ database referring to the entire banking system; (**) source: eiu; na= not available. source: our calculations on eiu and bankfocus bvd data. in islamic countries, the fact that the payment of interest is not permitted, though customers can participate in the bank's results may have prompted deposits by customers, households and businesses, on the basis of the results expected by the bank (according to the participatory model described in the previous paragraph). an empirical analysis regarding malaysia and turkey and elaborated by s. cevik and j. charap (2011) [11] revealed namely a high degree of correlation between conventional deposit rates and the rate of return islamic profitand-loss sharing accounts. at the same time, very low interest rates from conventional banks also in islamic countries may have limited the diversion of at least a part of the deposits to these banks by muslims who do not fully follow sharia rules, with the aim of a return. as highlighted by b. akhtar, w. akhter, m. shahbaz (2017) [12] with regards to pakistan, it is observed that any changes in the rate of interest or in the rate of profit of islamic bank significantly affect the level of deposit in conventional as well as that of islamic banks. consequently, customers of islamic banks appear to be motivated by profit. the conventional bank interest rate has an impact on the customers of both conventional and islamic systems. a boost in the interest rate of the conventional banks will increase the level of deposits at conventional banks and decrease the deposits of islamic banks. the fact that non-muslim customers can use of the services of an islamic bank, which in turn can offer its products to nonmuslim customers, is still up for discussion. far from expressing an assessment of muslim consistency, it represents a critical issue that is openly pondered by muslim scholars. that many issues and doubts regarding the admissibility of certain behaviours in the light of sharia remain open is actually part of the gradual process of understanding their islamic identity. it is therefore not possible to determine how many customers of islamic banks are actually muslim. in e. smolo, m. šeho and m. kabir hassan (2020), among others, we read: "the term ‘islamic finance’ may persuade that it is just for muslim countries with greater number of muslim populations. https://www.ojs.unito.it/index.php/ejif/index 60 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6260 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/11/2021 accepted for publication: 03/03/2022 published: 22/04/2022 nevertheless, it is been contended that larger part of islamic fund clients are really non-muslims." [13] a further factor that can explain the trend of deposits, which is strengthening, but to a rather modest extent, may be the need to avoid an excessive amassment or accumulation of financial resources, which is explicitly not permitted by islamic law. in other words, money is only valuable as a useful tool for development and growth, and should circulate rather than being set aside. due to the crisis generated by covid-19, a high level of liquidity has been created in western countries. on the other hand, the need to implement strategies to mobilise financial resources persists in islamic countries, especially the less rich ones. in the current context of strong liquidity, western banks are able to dispose of funds that are in excess of credit demand. the first consequence, which is rapidly spreading among banks, is the application of negative interest on deposits of a high amount (above 100,000 euro). but cases where the banks diverge their customers towards other forms of investment (to assets under management) also abound, as highlighted in i. moise (2021) for example [14]. they also do this to reduce the effect of this excessive liquidity on their capital requirements and the charges into the deposit guarantee scheme. in islamic countries, these terms do not seem to apply. especially in the less rich islamic countries, there exists a problem of mobilising resources and providing a custody function for the financial resources of households and businesses. both of these functions are of considerable importance in emerging countries, which are still working towards implementing their industrial and production structure. it is worth remembering that in italy, it was deemed necessary to provide constitutional protection to savings. article 47 reads "the republic encourages and protects saving in all its forms. it regulates, coordinates and oversees the operation of credit”. in fact, the incentive to attract savings measured by the level of financial inclusion is a primary objective pursued by the central authorities, since this is an indispensable tool for the development of a country, as analysed by k.b. jedidia and f. boubakri (2018) [15] with particular regards to tunisia. the gulf countries also need financial resources for the creation of a growing diversification of the local production system, one that is not only based on oil revenues, but also on renewable energy. although it is not useful to explain the dynamics of deposits, it should also be remembered that in islamic countries, particular attention is paid to the origin of the sums deposited, as the activities that gave rise to those amounts must be sharia-compliant. if the sums held for deposit originate from activities that are not sharia-compliant, the banks cannot withdraw and use them [16]. v. liquidity (is not) actively sought islamic banks often find themselves holding excessive liquidity due to the numerous restrictions limiting the granting of credit (linked to the technical forms allowed and the risks taken). they route these funds to the interbank market, and often even to conventional banks, generating quite a bit of criticism from the most devout muslims. in fact, the world bank and idbg (2018) [17], among international institutions, point out that funds originating in islamic countries are mainly sent to banks in oecd countries, with estimates for sovereign funds equal to usd 3trn. by contrast, islamic capital markets include an outstanding amount of sukuks and wealth management funds totalling usd 671bn. however, liquidity management is structurally complex in islamic banks, including because they cannot use funds from interest bearing accounts to subscribe for government bonds or hold reserves at central banks. these provisions were particularly binding especially with the application of basel iii provisions on liquidity. furthermore, the possibility of using sukuks was allowed under certain conditions for refinancing purposes at central banks (eligibility). vi. neither interest (riba) nor debt the main prohibitions concerning the islamic economy and finance, as mentioned above, include prohibition of the interest (riba). this is an aspect worthy of further analysis. the term "riba" literally means "increase", "excess" and "growth" in arabic. the notion of riba has been widely studied and discussed among islamic schools of jurisprudence and a variety of interpretations and explanations have been attached to it. moreover, all monotheistic religions have historically condemned usury. the creation of riba responds to the objective of achieving conditions of fairness and economic and social justice by preventing every form of privilege, through the earning of financial returns, without participation in the work effort involved. r. hamaui, m. mauri (2009) [18] offer an in-depth analysis on the interpretation of this ban and on certain related problems (in terms of operations, accounting, etc.). islamic reflection notes that the main reason for prohibiting interest is to protect the poor. since money and assets generate interest, the poor cannot obtain interest and accumulate wealth, while the rich can generate wealth from wealth, through interest. however, this position too was not accepted without criticism and reservations. iibi (1993) [19] raised several – still open questions. some aspects are still under discussion today. in particular, the question arises of whether for personal funds only the compound interest must be considered, thereby allowing simple interest, and whether the ban also applies to muslims living in non-islamic countries. islamic banks have actually sought to diversify deposits, providing modest amounts with insurance as well. in addition, according to islamic thinking, earning interest discourages donations, as those who obtain interest are less motivated and encouraged to create value and therefore less motivated to build a cohesive society, for the benefit of everyone. it is also believed that interest-based finance leads to many inefficiencies, i.e. high debt and hazardous risks linked to trading on financial markets, which expose economies to instability. on the other hand, sharing risks and results allows the parties involved to minimise the risk and obtain a common benefit. the assumption is that all participate in the risk of https://www.ojs.unito.it/index.php/ejif/index 61 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6260 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/11/2021 accepted for publication: 03/03/2022 published: 22/04/2022 default and are therefore encouraged to work together toward a common objective. the parties and therefore society as a whole are therefore protected from fraudulent activities and social tensions. the prohibition of riba prohibits all forms of risk-free "increases" set beforehand, which western thinking believes to be more "damaging" to investors. in fact, this view is opposite to the typical western economic thinking, according to which participation in profits entails the assumption of risks that are higher than the interest rate applied, even if it is variable. also strictly related to the riba prohibition is the prohibition against using debt. while the level of debt currently plagues many western countries, companies and states that have undertaken substantial measures to support the economy due to covid-19, debt is absent from the islamic system. as is known, debt is favoured over equity investments in western countries because it allows issuers to deduct interest paid for tax purposes, as they are costs, but also due to asymmetric information which discourages many investors from assuming capital risks. leverage obviously mitigates this situation, but if it is too high, it may generate instability risks. financial theory has dealt with this issue widely. here we will examine only some aspects that can explain at least part of the aversion to debt, compared to a partnership relationship with the investor. first of all, collateral guarantees which are prohibited by islamic law are required by conventional banks, but can lead to a less than optimal allocation of resources in the case of small and medium-sized businesses, even though they do pave the way for interesting projects. the debt is also unsuitable for financing businesses, especially when the results are highly uncertain, or if the company is in the start-up phase. the debt finally weighs heavily on the economic return and therefore on the project's success. similarly, although a model for sharing profits and losses may lead to greater monitoring costs, including on account of the presence of the bank's representatives in the board of directors, it is considered important in islamic countries for the purpose of the proper functioning of the capital market as it favours social cohesion. when the relationship between entrepreneur and investors is direct and of an ongoing nature, it leads to better risk control and thus to better relations and financial results. in order to finance themselves, in recent years islamic banks have increasingly made use of sukuk, which is a form of securitisation of their loans, including on international markets. the peculiarities of this market segment do not fall within the objectives of this sheet. vii. financial inclusion in islamic countries paints a composite picture an aspect that is fundamental in assessing the role played by islamic finance and bank deposits as in western financial systems is the level of financial inclusion. in other words, an essential requirement is the examination of the spread of current accounts, which are at the basis of both time deposits and loans, as highlighted by s.b. naceur, a. barajas, and a. massara (2015) [20]. financial inclusion measured by the share of people and businesses that use the financial products offered by banks and other intermediaries is the essential indicator of the proliferation and use of these financial products. various international institutions in particular the world bank, imf, oecd, iif are exploring this issue. the following analysis is based on the global financial inclusion database (global findex) published by the world bank on the basis of surveys conducted in 148 countries over several years (2011, 2014, 2017) [21]. a further update was expected in 2020, but it was postponed due to the covid-19 crisis. the latest survey in 2017 involved over 150,000 people over 15 years of age. availability and access to these products are not synonymous, since they may be available but not accessible due to various barriers (such as high costs, complexity of procedures, distance, required documents, etc.). as shown in figure no. 4 , the world bank data confirms a gradual growth in the spread of bank current accounts on the three reporting dates, 2011, 2014 and 2017, in the major islamic countries. inclusion is very high in the gulf countries, involving more than 80% of the adult population in the united arab emirates and kuwait. also in malaysia, the spread in percentage terms is very high (85%), but in the other asian countries the percentages appear to be much more modest, though they are rising (around 50% in bangladesh and indonesia, and stable at 21% in pakistan), mainly on account of the more limited income levels. the countries with the highest shares are high income countries, as well as iran among the upper middleincome countries, while the other countries that have lower shares belong to the lower middle-income category. it should be noted that in all the countries listed in the chart those where islamic finance plays a significant role or prevails the level of inclusion appears to be lower than the international average of the relevant income category, defined considering all financial intermediaries, mainly western/conventional. iran is a significant exception, since with a system wholly made up of islamic banks, it covers about a third of the total assets of the world’s entire islamic sector while showing a very high level of inclusion. https://www.ojs.unito.it/index.php/ejif/index 62 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6260 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/11/2021 accepted for publication: 03/03/2022 published: 22/04/2022 figure 4. adults with a bank current account (in some islamic countries, % of adults, over 15 years of age). notes: lmi=lower middle income, umi=upper middle income, hi=high income. (*) average of the country income category. source: our calculations based on world bank and global findex database figures. various studies in particular a. demirguc-kunt, k. leora, r. douglas (2013) [22] showed that, in general, in islamic countries the degree of proliferation of savings instruments is lower than that of loans. this can be explained, on the one hand, by the special ability islamic finance has insofar supporting small and medium-sized businesses. the demand for financial resources, especially in this category of businesses, may be encouraged when risk sharing is concerned, which is typical of operators in islamic countries, where private equity and venture capital are extremely widespread. this result is significant. according to a study by the world bank (2014) [23], the higher the number of islamic banks per 100,000 inhabitants, the lower the share of companies that find it difficult to access credit. in western countries, where financial systems have always been criticised for credit access by smes, the presence of adequate guarantees and the credit history of the borrower is a major consideration. in terms of deposits, the reduced proliferation may be partly due to the fact that savers may be less incentivised to deposit their money (due to the lack of returns and forms of deposit insurance), but also because of a lower level of disposable income, as mentioned previously. moreover, even if income is significant, as in the gulf countries, the income concentration is very high and therefore the level of distribution of financial products (measured by the number of people) may be lower than that recorded in western countries. egypt has additional peculiarities. despite modest financial inclusion, the deposits/gdp ratio is high (around 60%), but the loans/gdp ratio is just over 20%. the role of public banks is crucial, both during the deposit-taking phase, by offering reinsurance to depositors, and in terms of assets due to the significant weight of subscribed government bonds, with the public system therefore engaged in incisive crowding-out action. the breakdown by gender shows that it has been reasonable to expect a lower level of financial inclusion of women compared to men. however, it should be noted that also among women, financial inclusion has strengthened significantly in recent years, across all countries, especially in egypt (from 7% in 2011 to 27% in 2017). the gender gap remained high in bangladesh and pakistan (both approximately 30pp in 2017). surprisingly, these 2017 figures indicate that the gender gap was still equal to about 30pp in turkey. figure 5. women with a bank current account (in some islamic countries, % of adults, over 15 years of age). notes: lmi=lower middle income, umi=upper middle income, hi=high income. (*) average of the country income category. source: our calculations based on world bank and global findex database figures. the main reasons why adults do not open a current account include a lack of money or the necessary documents, as well as the (physical) distance from financial institutions. as highlighted in many studies (as in world bank, 2020) [24], the proliferation of fintech channels can contribute significantly to financial inclusion. the islamic population is also very young and includes half of the global population under the age of 34. young people are not only it proficient, they are also potential customers. among the various channels that can be used, the spread of fintech, especially through mobile phones, is expected in islamic countries too, especially for payments. the world bank estimates that two thirds of adults remain unbanked (around 1.7 billion), yet own a mobile phone that can be used to make payments. most islamic countries fall within the 50 countries with the highest penetration of mobile phones. figure no 6 shows the degree of smartphone penetration in a significant sample of islamic countries. indonesia has the highest share, accounting for 66% of the population, followed by malaysia at 57.5% and pakistan at 43% in 2018. egypt has stopped at 28%. these percentages are high, but still far from the 96% average in advanced economies. figure 6. smartphone penetration in some islamic countries (2018). source: newzoo global mobile market report, september 2018. https://www.ojs.unito.it/index.php/ejif/index 63 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6260 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/11/2021 accepted for publication: 03/03/2022 published: 22/04/2022 viii. concluding remarks bank deposits increased sharply in 2020 and in 2021 in islamic countries but not so strongly as in advanced economies. nevertheless, some structural factors (such as financial inclusion) may support a furher increase in the next decade. the numerous constraints that regulate the operations of islamic banks may affect their capacity to expand. on this topic, the world bank (2016) [25] offers a broad assessment of the role played by islamic banks in the economies of their countries. in 2020, muslim countries were affected by the pandemic as well, with effects that weighed heavily on their economies, falling gdp, as mentioned above, with even the oil prices dropping. now, as highlighted by rating agencies and international observers (as moody’s, 2021 [26], and a. hauser, 2020) [27] prospects are still positive thanks to the confluence of some factors. first of all, demand for sharia-compliant products is expected to remain strong, throughout the long term. the fact that sharia-compliant products will also be able to benefit from the growing focus on esg products and sustainability, both of which have been historically safeguarded by islamic principles, is important. k. long (2020) [28] argues that the affinity between "sharia-compliant" and "sustainability-compliant" finance is such that it has been proposed in the islamic sphere to steer islamic banks in a particularly determined manner towards this way of banking, which is highly appreciated by the community. the support measures implemented by the central authorities also in these countries in response to covid-19 will provide further support to "islamic" activities. moreover, in recent years numerous mergers have been carried out in the gulf countries, with islamic banks acquiring conventional banks, incorporating their business and expanding intermediated volumes represented by them, in many cases. all the mergers carried out in the gulf in 2020 involved at least one islamic bank. as shown in figure no 7 covering total assets, the islamic financial sector has posted an average increase of 6% over the last 5 years as compared to an average annual reduction of 1% in assets of conventional banks in saudi arabia. figure 7. total assets (cagr, %, 2015-9/2020). note: compound annual growth rate. source: moody’s. references [1] imf, global financial stability outlook, april, 2021. [2] cia website, available at https://www.cia.gov/. [3] islamic financial services board, “islamic financial services industry stability report 2020”, 2020. [4] as is known, islam is undergoing a constructive analysis of its own identity, deeply discussed among others in p. nicelli, “islam e modernità nel pensiero riformista islamico” [islam and modernity in islamic reformist thought], sanpaolo, 2009; and “syed muhammad naquib alattas and the islamic philosophy of education”, encounter”, vol. 41/2, 2016). [5] hrh prince m. al-faisal al-saud, "a state of trusteeship", in institute of islamic banking and insurance, anthology of islamic banking, 2000. [6] m. fahim khan, m. porzio, "islamic banking and finance in the european union, a challenge", edward elgar, 2010. [7] p. biancone, "scritti in onore di pellegrino capaldo” [writings in honour of pellegrino capaldo], 2014. based on the example of the ias/ifrs for conventional banks, the standards issued by the aaoifi provide the guidelines and criteria to be used in order to correctly and reliably represent the assets and income accrued during the year. however, this standardisation process requires numerous interventions by states with an islamic majority, which must adhere to the principles issued by international islamic institutions. [8] z.ahmad khan, "islamic banking and its operations", institute of islamic banking and insurance, 2000. [9] g.m. piccinelli, "the provision and management of savings: the clientpartner model", in khan and porzio (2010), 2010. [10] i. warde, "islamic finance in the global economy", edinburgh university press, 2000. [11] s. cevik and j. charap, the behavior of conventional and islamic bank deposit returns in malaysia and turkey, imf, wp/11/156. in 2010, a preliminary investigation showed furthermore that, three decades after its introduction, there remained substantial divergences between islamic banking and finance’s ideals and its practices, and much of islamic banking and finance still remained functionally indistinguishable from conventional banking. see f. khan, how ‘islamic’ is islamic banking?, journal of economic behavior & organization, 76 (2010). [12] b. akhtar, w. akhter, and m. shahbaz, (2017), "determinants of deposits in conventional and islamic banking: a case of an emerging economy", international journal of emerging markets, vol. 12 no. 2, pp. 296-309. [13] e. smolo, m. šeho and m. kabir hassan, "development of islamic finance in bosnia and herzegovina", journal of economic cooperation and development, 41, 2020. [14] i. moise, “cash-rich banks seek to cut deposits, jpmorgan and citi take step to avoid additional capital requirements", financial times, 5 may, 2021. [15] k.b. jedidia and f. boubakri, “islamic banking and the perspectives of savings mobilization in tunisia”, journal of islamic financial studies, december, 2018. [16] this provision is much more all encompassing than the anti-money laundering legislation envisaged in western countries, as a higher number of banned activities are envisaged. in the latter, if the sums derive from illegal activities, in accordance with anti-money laundering provisions, the bank shall block the account and report them to the competent authorities. as part of the beneficial owner audit information activity, the opening of ongoing relationships or the execution of occasional transactions is prohibited if: i) the customer refuses to provide information regarding the existence or not of beneficial owner; ii) the customer is unable to provide the information relating to the beneficial owner or cannot update such information and the information is not available from different and reliable sources; iii) the statement made by the customer and the evidence collected by the bank (including as part of the credit process, in case of borrower) do not match and the customer confirms the indications provided without adequately showing the reasons why there are no beneficial owners or different persons than those declared to be beneficial owners are found to exist. in these cases, an assessment must be made regarding whether to initiate the suspicious https://www.ojs.unito.it/index.php/ejif/index https://www.cia.gov/ 64 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6260 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/11/2021 accepted for publication: 03/03/2022 published: 22/04/2022 activity report procedure in accordance with the criteria defined in the anti-money laundering legislation in force. [17] world bank and islamic development bank group, "mobilizing islamic finance for infrastructure public-private parnerships", 2018. [18] r. hamaui, m. mauri, "economia e finanza islamica" [islamic economy and finance], il mulino, 2009. [19] institute of islamic banking and insurance (iibi), "islamic banking and its problems", 1993, london. [20] s.b. naceur, a. barajas, and a. massara, "can islamic banking increase financial inclusion?", imf, wp/15/31, 2015. [21] world bank, global financial inclusion database (global findex), available at https://data.worldbank.org/products/data-books/little-databook-on-financial-development. [22] a. demirguc-kunt, k. leora, r. douglas, "islamic finance and financial inclusion: measuring use of and demand for formal financial services among muslim adults", world bank, policy research working paper 6642/2013. [23] world bank, "global financial development report 2014: financial inclusion", 2014. [24] world bank, "leveraging islamic fintech to improve financial inclusion", october 2020. [25] world bank, "islamic finance. a catalyst for shared prosperity?", global report on islamic finance, 2016. [26] moody's, "growth prospects remain strong despite challenges from pandemic", february, 2021. [27] a. hauser, "why islamic finance has an important role to play in supporting the recovery from covid and how the bank of england's new alternative liquidity facility can help", uk islamic finance week 2020, december, 2020. [28] k. long, "islamic banking ripe for esg rebrand", interview with noripah kamso, former chairwoman of bank rakyat in malaysia, the banker, 2020. https://www.ojs.unito.it/index.php/ejif/index paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 robo-advisory for islamic financial institutions: shari’ah and regulatory issues abstract— artificial intelligence (ai) is the next global game changer in all big data and other technology-based platforms including islamic financial services. at the forefront of ai applications in financial services is robo-advisor. its potential disruption of the islamic financial services is imminent as it is being considered by some institutions due to its innovative virtual advisory and the absence of human factor intervention in the decision-making process. currently the islamic financial services industry is constantly guided by prescribed shari’ah related fatwah or rulings for innovative financial products with reference to shari’ah compliance. robo-advisors may then be considered to ease the iterative juristic review process to facilitate timely and more robust shari’ah legal opinions on those products. and since these robo-advisors are allegedly swift and smarter to support human judgment this might help achieve more timely, effective and efficient design and delivery of islamic financial services. this paper aimed at investigating the potential shari’ah and regulatory issues surrounding robo-advisors while adopting the relevant opinions and understanding of shari’ah classical and contemporary scholars. it also seeks to examine the legal implications of robo-advisors in the islamic financial industry and explore the technical requirements of this emerging phenomenon. the paper also looks into the current market volume of this new artificial intelligence mechanism and predicts the future of this disruptive technology in the islamic finance industry. keywordsrobo-advisory; islamic finance; shari’ah and regulation i. introduction after the markets collapse and the financial crisis in 2007 and 2008, robo-advisors started to surface in the mainstream financial advisory services, and started providing online investment solutions to various investors. this might be seen as an increasing suspicion by the young investors after the 2007 markets collapse, which comes out of the experiences of the then financial recession the following year. the market collapse has actually affected the financial advisors so badly, and took them a very longtime to regain their trust in the market. within that period, most of the media headlines where calling for the end of financial advisors and at the same time called for the wealth managers to adapt the robo-advisors so as to regain the market trust and take over from human advisors. this has also created another panic in the market, where the financial advisors believed that their job is going to be taken over by robo-advisors. (maurella van dar ree, 2019). these issues that instigated the emergence of roboadvisors in wealth management might not be the same for robo-advisors in islamic financial institutions. however, the disruption is still looming in the islamic financial industry. the duties of shari’ah advisors of an islamic bank or an islamic financial institution is quite different from the wealth management advisors, shari’ah scholars supervise and provide shari’ah rulings and related fatwahs for the products and services of the islamic bank or an islamic financial institution, this is however to maintaining the shari’ah compliance in the products and services provided by the islamic banks. thus, when introducing robo-advisors for shari’ah related fatwas, many suggest that robo-advisors will take over the jobs of shari’ah advisors. however, this is not the main issue, roboadvisors can serve as assistant to the shari’ah advisors for now, as hybrid advisory is also possible, so as to make the advisory services more efficient and maintain quicker responses to the markets need, however the islamic financial industry has to prepare itself for the modern technology disruption. the current trend in the financial advisory is moving towards new generation of financial technology enhancement. the innovation in modern technology advancement was the result of the critical need for more transparency and accessibility into the longstanding and well-known wealth management services providing industry and other related financial services. this critical trend is also looming to the islamic financial services, as well as islamic wealth management services. discussions across the fintech advancement portfolios suggested that robo-advisory services would definitely disrupt the traditional wealth management services and other financial services across the globe. however, many other researchers have contrary believed that the dominant trend maybe of collaboration between the financial institutions and tech companies in the other hand, which will allow banks to improve their services offering and build up new revenue streams using the robo-advisory services. the purpose of this research is to provide an insight on why islamic banks and other islamic financial institutions should leverage on this on-going crusade of roboadvisors and serve many clients out there in need of this innovative and novel services and look into the shari’ah related issues and regulatory requirements for robo-advisory services as part of the preparation for the technology disruption in islamic financial industry. ii. understanding robo-advisros the definition of robo-advisors is not very clear as what to include in the definition, this is because robo-advisory involves wealth management advices via automated processes that exclude human factor and influence. the novel technology uses mathematical algorithms instead to support market survey for investment decisions. this is however including many other asst. prof. dr. auwal adam sa’ad, assoc. prof. dr. sayed musa alhabshi, assoc. prof. dr. azman bin mohd noor, prof. dr. rusni hassan ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 financial advisory services such as the advisory services practiced by the islamic financial institutions and islamic wealth management services. robo-advisors delivered using online and mobile channels, it is an online portfolio management solution that aims to invest client assets by automating client advice. (deloitte and avaloq, 2017) some selective definitions of robo-advisors are discussed here to understand the features and the scopes of robo-advisors in the contemporary financial services. roboadvisors could be defined as an online service that uses algorithms to automatically perform many investment tasks done by a human financial advisor. angela scott-briggs also defines robo-advisors as online wealth management services that offer computerized, algorithm-based portfolio management without using human financial planners. some other scholars defined robo-advisory as an online portfolio management solution that aims to invest client assets by automating client advice. (angela scott-briggs, 2016). robo-advisors platforms distinguish themselves with a unique market strategy by offering their investor’s minimal capital requirements, low management fees and a simplified investment journey and initiate minimal capital requests. some robo-advisors provide advisory services for a capital investment of usd50 fifty united states dollars. advanced pooling technologies make it possible for investors without a large capital to get started and build up their investment portfolio, hence addressing the needs of a new segment of investors that has previously been neglected by traditional wealth management. however, most of the established firms are still charging a portfolio management fee of between one to two percent if not more, for assets under management (aum), robo-advisors are leveraging low-cost product portfolios such as etfs that provide asset diversification. they are not only charging lower portfolio management fees, they are also providing a more simplified fee structure as opposed to the complex fee schedules of traditional human advisors. (jonathan walter lam, 2016). however, some critical researchers suggest that roboadvisors providing equity portfolio recommendations are more suitable for short-term goals investments and not long-term. the reason behind this suggestion was that the researchers anticipate that robo-advisors are only trying to reduce shortterm volatility, though this is not necessarily convincing. however, the quality of questionnaires used by the roboadvisors is very vital especially when it comes to ascertain the risk preferences of the client. (wee kee chia, yash shah, 2018). many researchers believed that the questionnaires used by robo-advisors for financial planning did not reliably followed the psychometric standards, there are mostly very brief and therefore may sustain reliability and validity issues. it is also advised that the future of financial advisory services could be a hybrid model, where analysis is done by an automatic algorithm but the procuring, retaining, motivating and reassuring of clients will be done by human financial advisors, this is if the technology cannot be able to provide such services. (roszkowski, davey, and grable, 2005). iii. regulatory issues fr robo-advisors robo advisors are regulated under the securities and exchange commission (sec) in the united states. the commission takes charge of the federal securities laws and has the responsibility to protect the investors in the securities markets. and also regulates the services of human advisors as well as roboadvisors registered under the investment portfolios. under the us advisers act of the 1940, registered investment advisers rias are subjected to the imposed functional obligation have duty to provide advice in the best of their client investment interest, and if robo-advisors hold an asset related to a customer, they would have to register with sec and finra financial industry regulatory authority as broker-dealers. at the moment, the betterment holds customers’ assets and is a registered broker-dealer, however, wealthfront is not yet a registered broker dealer. (jill e . fisch, marion labouré , and john a. turner, 2018). the scope and the minimum protection afforded as the rias fiduciary duty was a matter of extensive debate in the united states, many scholars claim that the fiduciary obligation is vague and works with lack of predictability for the both parties, the investors and financial advisors. however, the fiduciary concept might be amended by contract. there is a potential advantage related to robo-advisors in which the quality of their advice could easily be reviewed and assess by the regulator, the case is not the same with human financial advisors, it is almost impossible to monitor all the private conversations suggested by human advisors with their clients. (jill e. et. 2018) however, it is very feasible to record and evaluate computer models of advice, this unimagined transparency provides more preferences to robo-advisors and made them more closely to the regulatory requirements. (jill e . fisch, marion labouré, and john a. turner, 2018). in the year 2017, the division of investment management of the securities and exchange commission, sec, releases regulatory compliance for robo-advisors, the commission realized that the unique business model offered by robo-advisors deserved to be given more concern. it also identified the need to guarantee that the robo-advisor is providing an appropriate advice to its customers, and the need to embrace and implement suitable compliance programs designed to the automated nature of the robo-advisor’s services. (sec 2017). some robo-advisors firms got some decisive regulatory actions taken by the regulator in various jurisdictions, particularly among the regulators across uk and the united states. in may 2018, the united kingdom financial conduct authority has surprisingly issued a warning to various automated advisors for misleading their customers specifically on pricing as well as lack of adequate and sustainability assessment framework. in december 2018, whealthfront advisers and hedgeable which are two most prominent roboadvisors in the us were penalized by the united states securities and exchange commission. wealthfront was fined ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 based on misleading and deceitful marketing and for having inadequate compliance program and hedgeable was also penalized based on misleading performance reporting. (maurella van der ree, 2019). iv. the use of robo-advisors for islamic financial services the shari’ah advisors duties in the islamic financial institutions have a special consideration under shari’ah governance framework provided by many central banks including the central bank of malaysia. there are special guidelines on shari’ah governance and has specifically identified the duties of the shari’ah advisory committee of an islamic financial institution. according to the guidelines, every committee member, is anticipated to be engaged in researching shari’ah issues provided by the bank, and the main responsibilities of the shari’ah advisory committee is to advise the board of directors on shari’ah matters relevant to its business operation, and endorse shari’ah compliance guide, and validate relevant documentation, couple with addressing matter to be referred to the shari’ah advisory council of bank negara malaysia. (bnm, 2005). the islamic financial services atmosphere wasn’t left behind in accepting robo-advisor in simplifying the islamic financial services and to ease the shari’ah supervision activities in islamic banking and finance. the islamic advisory company wahed becomes the first in the world to access halal robo-advisor; this mechanism that was only available in the united states and the united kingdom has now gone global. the wahed platform has now penetrated one hundred and thirty countries, mena region is one of its key markets including nigeria, pakistan and india. wahed being the first shari’ah based robo advisory services provider in the united states of america is actually traying to change the way muslims participate in the financial markets. wahed has various activities including the investment s&p shari’ah fund and sukuk vs commodity markets. wahed maintained that no matter where geographically an ethical investor is situated and whatever income demographic they fall under, they can access a shari’ah compatible and ethically related investment away from interest and other unethical investment portfolios. this is indeed a new development for islamic investment services. (journal.wahedinvest.com, 2019). with the current evolution of artificial intelligence (ai) robo’s are becoming very cognitive-enabled imitating human skills and emotional intelligence. robo-advisors are actually disrupting the current method of traditional wealth management and promising to ease the need for financial advisory by reducing human factor. the current advancement in fintech and artificial intelligence in the global financial markets and banking is overwhelming, banks and other financial institutions all over the world are expected to embrace these new innovations in order to achieve better in today’s disruptive banking and financial industry. artificial intelligence related virtual financial advisor provides an automated financial planning, which is generated by algorithm-based software with a very slight human participation. the technology provides its financial services to many clients at less cost compared to traditional advisors. (domini jug, et, 2018). the present-day preferences of digitally related economic ideas, has rendered robo-advisors to becoming more popular and more demanding than ever before. robo advisors facilitate providing financial advice online without human interaction and provide very reliable advice with lower cost. the conventional one to one advisory service is becoming less prevalent, and the trend shows that young generation has already started making firm financial decisions based on calculated results communicated by software rather than the predictable wisdoms of fellow human beings. these technological progressions, the preference of younger generation and immerging investors, and the growing popularity of robo advisors have forced financial institutions to rethink their banking approaches. robo advisor services offer clients financial advice and investment management services that have historically been accessible only to wealthier clients; it is now available to almost every client in need of the robo-advisory services. (collins, 2012). in fact, robo-advisors often promote their ability to outperform breathing financial advisors and it’s clearly understood why the robo-advisor market has been amazingly important. the markets value of robo advisors’ activities is overwhelming throughout the years. at the end of 2015, roboadvisors hit $60 billion assets of clients managed by them and it is estimated that it will cross $2 trillion by 2020. individual robo-advisor startups betterment and wealthfront have each attracted hundreds of millions of dollars in funding and now boast more than $10bn in assets. that no doubt has not gone unnoticed by established firms, a growing number of which have launched their own robo-advisor services. (jonathan walter lam, 2016) v. the innovation of smart muftis for shari’ah advisory services the contemporary islamic financial world lives in a new age of idealistic and tech investor mind-sets, it is anticipated that new technologies with customized features that cater to the islamic finance industry will soon emerge for the success and relevant efficiency in dealing with the new technology-based financial products and services within the domain of islamic banking and finance. in this context, it is good to know that islamic investors have recently started embracing these new technologies. however, dealing with islamic related businesses and products requires careful understanding and practice with more conscious to the restrictions and various shari’ah injunctions for shari’ah compliant investment in business activities. for instance, an authentic halal investment should be interest-free and away from gambling, alcohol, speculations and other prohibited activities in contracts. the maqasid al-shari’ah or the purpose of islamic law is to protect ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 the wealth and on top of that it gives emphasis on wealth circulations, speed dealing and financial literacy enhancement. henceforth, good advisory services will be essential to investors for healthier islamic investment and other islamic business activities. there are many challenges in executing the duties and fatwas related to islamic banking and finance industry, more innovations are required to move the industry to the next level and away from replicating and imitating the usury based financial services. however, in other for the islamic financial institutions to compete with their conventional counterpart, there should be innovative ideas that will give more advantage to the islamic banking and finance institutions. there is a need of speed advisory and timely shari’ah resolution and fatwas to the issues of islamic financial institutions. it is obvious that delays and late resolutions cost loss opportunities for the bank, which is not in line of the maqasid al-shariah. however, shari’ah advisors should also be careful in their duties, so as to make sure that their research work and any advice and endorsements have certified the shari’ah recruitment and contributes to the wellbeing of the islamic financial industry. (akram laldin, 2008). therefore, the use of robo-advisory or smart muftis will help in achieving a vibrant advisory services in islamic financial institutions; it will facilitate research, generate data, analyze and even execute the fatwah in a very short time. islamic banks may need to insert data into robo financial advisors for the available shari’ah complaint investment portfolios; this might be endeavored to providing relevant islamic wealth management structure for islamic robo-advisory purposes, it will definitely increase visibilities for those investments’ portfolios. if a shari’ah compatible business investor intends to know the investment return he may just insert his preferences and the robo-advisors will analyze various patterns, trends and will suggest a better investment portfolio for the client. (jonathan walter lam, 2016). this will give a chance for an islamic universal wealth management preference. the system allows anyone from anywhere to access, compare and analyze the results given by robo-advisor, and this will actualize the notion of the universal attitude of islamic financial products. smart muftis or robo-advisors are future mechanisms that may possibly disrupt the islamic financial institution’s advisory services in the near future. smart muftis might be able to evaluate the shari’ah sources and the existing rulings across the various schools of islamic jurisprudence and may suggest the best practices chosen by the contemporary islamic scholars on a certain issue or mu’amalat, the activities of smart muftis will simplify the shari’ah advisory services and ease the operations of islamic banking and finance institutions across the globe. while, financial literacy is very important in the 21 st century, and it is also a great potential that will add value to the knowledge sharing activities in islamic banking and finance industry. allah the almighty has asked those who have shari’ah knowledge to teach others and transfer the knowledge to the ummah. (qur’an, 9:122). smart muftis will not only help in sharing the knowledge alone, but will create much needed awareness among the public on islamic banking and finance. smart muftis can replace islamic financial literacy uplifting, corporate training and induction programs in the future. allowing access to the public would also create greater awareness of the islamic finance industry. when someone enters a question on a specific shari’ah ruling, a humanoid smart mufti robo software can answer the queries with details of a ready-made fatwah of the then and contemporary islamic scholars in islamic banking and finance. however, a massive work is required to achieving these expectations. (journal.wahedinvest.com, 2019). there are many important takeaways by implementing robo-advisory services in islamic banking and finance industry, these takeaways are massive visibility, cost efficiency and increased productivity in islamic banking and finance, as well as product development and financial literacy. with these takeaways, the islamic banking and finance industry will welcome a new banking and financing experiences which will for sure benefit all the stakeholders in the islamic banking and finance industry. the following paragraphs will identify how robo-advisors will increase visibility, productivity, and efficiency in product development and solve the financial literacy issues among the stakeholders of islamic banking and financial institutions. vi. resolving juristic shari’ah issues with rob0advisors in the history of islamic jurisprudence, each and every school of thought has its own rules and reliable secondary sources in which they relied upon in the absent of primary sources of law in other to decide on a current issue. this has actually contributed in sustaining different opinions across the islamic schools of thought. however, some of the scholarly rulings conducted by different schools might not be based on a reliable source, the reliable opinion might be acceptable in another school due to the authenticity of the source used by the imam or his fellow students. robo-advisors can have all this information and might be able to differentiate between authentic evidences, non-authentic and week evidences. and then advise with the selected opinion, which has relied upon the most authentic sources of islamic law. it is very important to mention here that most of the islamic finance issues are not deducted based on a particular school of thought alone, but rather based on the most authentic evidences, which has been used to determine shari’ah ruling according to comparativejurisprudence. for instance, hanbali school might have a different view on a specific matter in islamic finance. but that view might be used in the malaysian system maybe because the ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 shari’ah sources or evidences used to arrive to that ruling could be more authentic or the ruling was considers based on the maqasid al-shari’ah purposes, in contrary with the ruling in shafi’i school which is the original school followed by many south east asian countries and the dominant school of thought in malaysia. robo-advisors will be able to identify and analyze these kinds of issues across the shari’ah rulings related to islamic banking and finance industry. robo-advisors might also help resolve many shari’ah compliance issues in islamic banking and finance. shari’ah is a tech-friendly and it is in harmony with the purposes of shari’ah “maqasid al-shari’ah” which signifies protection of wealth and its circulation. this might be related to the facts that technology always played a role of an enabler to support financial institutions in the design and delivery of their products and services. the system does not dictate the features and functionalities of the banks’ products and services; rather, it is the other way around. the requirements of products and services of islamic banks dictate system functionalities. before islamic banks can offer products and services to the public, they have to obtain the approval of their shari’ah committee. therefore, the shari’ah committee has the final say on the new introduced product or service and not the technology itself, therefore a controlled shari’ah ruling and fatwah updates should be provided by shari’ah experts to make sure robo-advisors are doing the job correctly. shari’ah committee members will scrutinize the products and services to determine whether they comply with their shari’ah guidelines. once endorsed by the shari’ah committee, the products or services are ready to be configured into the system. therefore, the system just accepts and implement whatever inserted in it and will not act otherwise except by orders. therefore, the system would have to be built with features and functions to support the requirements of the products and services. once configured into the system, system users will have to perform user acceptance test to verify that the system is behaving according to their requirements. here is the issue of the system control, is also in the hands of its handlers, and the technology is not in control of the information installed, as it can be augmented, changed or even removed, therefore the fatwahs installed in roboadvisors could also be updated when necessary. shari’ah compliant requirement is quite subjective as it depends on interpretations by the shari’ah advisors of a specific bank or a specific country. it also depends, to a certain extent, on the strictness or lenience of the shari’ah committee members of the bank. this results in certain requirements being considered as shari’ah compliant in one bank but not in another, this might obviously become a challenge to the islamic banking and finance for robo-advisory services, technology wise. however, the rulings and the shari’ah fatwahs could be based on the aaoifi and ifsb shari’ah standards and resolutions, which have already resolved many issues and widely accepted by many countries across the globe. the example of this obstacle is the case of some products based on particular shari’ah ruling, which has been approved in malaysia for instants, but not approved in the middle east; the reason to this might be mazhab issue or from different understanding of the text, or hadith or other shari’ah sources and evidences. the robo-advisors or smart muftis might be designed to give fatwas according to the location, mazhab or based on the fatwahs that relied upon the most authentic shari’ah sources and evidences. smart muftis or robo-advisors might also be made flexible with configurable parameters to provide different practices of shari’ah requirements and rulings according to the practical approach of the islamic banking and finance industry. vii. how robo-advisors will help identify the “sahih” authentic and “ghair sahih” unauthentic hadith in other to smoothly come up with a shari’ah ruling on a particular islamic finance product or service, the shari’ah advisor might need to properly look into the available sources related to that issue. one of the issues is the hadith authentication and identifying the correct, weak or nonauthentic hadith. this practice could be based on the hadith narration, the chain, hadith text or other issues. identifying the authentic, weak or unauthentic hadith is one of the noble welldone efforts made by the prominent muslim scholars in the past, and there are many of its kind contemporarily. their work has a direct impact on the decision-making stipulated by the shari’ah advisors of an islamic financial institution. roboadvisors could be designed to enable data storage, which include the hadith clarity and the hadith based on “sahih” authentic or “ghair sahih” unauthentic hadith follows with other hadith categories. fiqh and mazahib juristic opinions are also among the most important job well done by the fiqh scholars in the past and present. starting with al-ijma’ al-ijma’ is a series of shari’ah rulings which has being accepted and anonymously agreed by the shari’ah jurists without any report of conflicting opinion or interpretation in a particular time, society or jurisdiction. robo-advisors’ data might need to be entrenched initially with the ijma’ rulings on islamic finance and economics matters and then followed by the information data of other juristic opinions according to the various schools of jurisprudence, and then other contemporary shari’ah issues discussed by the existing shari’ah scholars. robo-advisors might use these big data to decide on a fresh case or product introduced by an islamic financial institution for advice. viii. legal implications and tlegitimacy of roboadvisors for islamic financial institutions robo-advisors for islamic financial institutions and their legality is a novel area of discussion for islamic scholars as ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 well as the stakeholders in the islamic banking and finance industry. some scholars where reported to have disapproved the use of robo-advisors for the islamic fatwah in general and for islamic financial institutions in particular, while some scholars are in support of robo-advisors initiatives for islamic fatwah. however, it is highly understood that robo-advisors can assume the same responsibility as shari’ah scholars do. it can scrutinize documents or data information injected into it in a very fastest way and gives either the existing fatwah or even a new ruling by analyzing the closest fatwah related to the new issue using artificial intelligence technology. one of the most important issues discussed for islamic finance advisory services is possible negligence in addressing shari’ah issues in accordance with the shari’ah stipulated process of ijtihad, as any negligence may result in non-compliance and causes negative legal penalties. (akram laldin, 2008) therefore, shari’ah scholars may find robo-advisors very helpful and will assist them in their extensive fatwas and ijtihad process. shari’ah advisors need to be well established in various areas before making fatwa pronouncement oh product approval for endorsement, for instance a shari’ah advisor of an islamic bank required to have a good command of language and enough knowledge in shari’ah, legal and operational aspect of the product in question and general knowledge on how islamic banks operate. shari’ah advisors should also understand the purpose of the product and its procedure, so as to make sure that the interest of both parties is secured before the endorsement. these are good areas and opportunities where shari’ah advisors will continue to have a great impact in the era of robo-advisors. robo-advisors will also help in market survey and evaluation so as to identify the particular concern of islamic financial services and figure out exactly that the islamic finance products are not used as means to violet the precise islamic principles and non-compliant activities. robo-advisors will also be a good opportunity for the islamic banking and finance institutions to stay away from products designated to replicate conventional way of banking business and it will be a tool to tackling issues such as legal trick “hilah” in the fatwas related to islamic banking and finance matters. ix. using artificial intelligence (ai) for smart mufti development three different steps are to be followed in achieving the smart mufti initiative for better shari’ah adivory services in islamic banking and financial industry. phase 1, building an artificial intelligence (ai) criteria for identifying and screening shari’ah and regulatory issues relating to islamic finance using ai technology. the first phase is to use the ai screening software to identify and classify the potential shari’ah issues and also regulatory issues involved in the proposed product or services of islamic banking and financial institution. by specifying the screening and discriminant criteria to extract and analyze shari’ah rulings and opinions on shari’ah and regulatory issues by specific agency, ai could classify and tag similar interrelated rulings to facilitate cross referencing and elicit the nature of rulings. using an iterative process of building a taxonomy or hierarchy of general and specific rulings and criteria to identify, recognize, elicit and classify ruling according to a robust classification of shari’ah sources. with the dynamic yet robust classification, any new rulings can enhance the classification taxonomy and hierarchy to discern the maxim, method and ruling according to the classification nomenclature and criteria. this will be powered by ai based chatbots functioning as high level matchmaker gathering basic data from the earlier provided information on possible shari’ah issues criteria for islamic banks, the system will be answering quieries and creating a list of relevant shari’ah issues for a particular product. chatbot is an artificial intelligence ai program that simulates interactive human conversation by using key precalculated user phrases and auditory or text-based signals. chatbots are frequently used for basic customer service and marketing systems that frequent social networking hubs and instant messaging (im) clients. they are also often included in operating systems as intelligent virtual assistants. a chatbot is also known as an artificial conversational entity (ace), chat robot, talk bot, chatterbot or chatterbox. the data to be used in this stage as criteria for the ai for screening shari’ah issues could be generated from various souces such as the resolution of shari’ah advisory council of the securties commision, the shari’ah resolutions of the shari’ah advisory council of the central bank of malaysia and other standards and criteria provided by other relevant regulators. phase 2, in this stage the process is to generate shari’ah fatwah data base and feed the data into the smart mufti, the data to be feed-up are various fatwahs provided by the islamic scholars throughout the history of islamic jurisprudence. this phase will also focus on process and pathways in terms of authentication, traceability and priority of sources, robustness of the methods and legitimacy as well as technical and social acceptance of rulings. the fatwas and data should be in order and according to a specific shari’ah principle, for instance; all fatwahs related to bay’ murabahah would be generated together with the different views across the islamic schools of jurisprudence as well as the fatwah of the contemporary scholars accompanied with the related authenticated sources, the data will also include all the relevant sources and relevant evidences used to construct the shari’ah ruling. therefore, a high standard software could be invented using ai solution to do the job, a good example of this is xtracter. xtracter has a technology that is powered by artificial intelligence which is automatically capturing data from documents in the form ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 of digital, photograph or scanned. the technology might be used in a virtual software application using machine learning and big data, it doesn’t require manual template setup and can scale to a limited count of document design and its very good with document types such as invoice, contracts, receipt and so on. the diagram below explained how xtracter technology works. source: https://xtracta.com phase 3, robo advisors will be conducting ijtihad via the smart muftis, in this stage, the smart mufti will be used to conduct ijtihad based on protocol of specified categories of a newly proposed product which has no prior shari’ah fatwah across the islamic banking and finance industry. the smart mufti will use the data available after screening the proposal and use the ai technology to look at the connecting factors and the relevant fatwahs and possible shari’ah evidences to be used to make a proper decision on the new product. it is well said that once you have a machine and data an accurate prediction will be highly anticipated. this phase will be focusing on summative and formulative reporting to facilitate basis for shari’ah ruling and report to disseminate the endorsed rulings as well as user shari’ah friendly disclosures and literacy. x. conclusion the formation of shari’ah advisory committee for islamic banking and finance is part of the shari’ah governance framework introduced for the wellbeing of the islamic banking and finance industry. the functions of shari’ah advisory committee is to review, assess, evaluate and advise by expressing their opinions on the banking products or services and endorse framework, legal documentations, contractual obligations of the bank, standard operation procedure sops and other matters within the shari’ah governance framework such as risk, shari’ah audit and compliance. issues related to shari’ah standards, requirements, policies and procedure. the shari’ah advisory committee is independent from the board of directors and management of an islamic banking and financial institutions. for effective shari’ah advisory services, there should be a critical and constant advice to ensure that the activities of islamic financial institutions products and services are compliant to the shari’ah. for this to move smoothly, the involvement of robo-advisory will help the process by evaluating the sources of shari’ah on a certain issue to provide the necessary information available for the physical shari’ah advisor to accomplish the ruling accordingly, robo-advisors here act as assistant to the existing shari’ah advisors of an islamic financial institution. in the near future, the smart muftis might be able to execute in full the shari’ah advisory services for islamic financial institutions, this will probably be more relevant with the current fintech initiatives of actualizing the virtual banks, once the islamic virtual banks come into existence, robo-advisors and smart muftis will be effectively in practice and relevant to digital islamic banking and finance advisory services. the shari’ah scholars of islamic financial institutions will play a very important role in the making and updating the smart muftis for islamic financial institutions. a very rigorous regulatory framework must be in place to make sure that the inventors of the smart muftis and robo-advisors are competent shari’ah scholars with the sound shari’ah knowledge both by preaching, practicing and understanding of the maqasid al-shari’ah as well as knowledge and good experiences in islamic banking and finance industry. a possible collaborative affords should also be made between the shari’ah advisory firms and the tech companies for better services and mutual importance. shari’ah research firms and educational institutions might also consider training young shari’ah scholars with technology education and it skills; this will help in market viability, stability and sustainability. furthermore, the legitimacy of robo-advisors should also be in line with the legitimacy of the living islamic scholar, although this is not an issue when it comes to using technology for advising, the competency of robo-advisors has to do with the competency of the shari’ah scholars behind the robo-advisors technology. this is important for the smart-muftis innovation or robo-advisors that provide specific fatwas and resolve issues such as the issues and fatwas related to islamic banking and finance in a particular country or region or even a particular islamic bank or islamic financial institution. i believed in the near future, many shari’ah advisory firms might be licensed to provide robo-advisor services for islamic financial institutions, this is for a ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 better response and market efficiency for islamic banking, finance, islamic wealth management, islamic capital markets, sukuk markets, islamic money markets, takaful and other important segments of islamic banking and finance industry. islamic wealth managers should embrace roboadvisor technology, as it possessed a great opportunity for the muslims populations in the developing nations looking for affordable islamic investment portfolios, there are millions of investors stranded with no access to huge capital to invest with the traditional wealth management services providers. while, robo-advisors provide the opportunity for these people to invest with the little amount of wealth in their possession. roboadvisors are not discriminating between the asset possessed by the middle-income individuals and the highincome ones, the investment is just the same and it most likely to assist investors from these segments of people in the developing nations. references [1] angela scott-briggs (2016) “what is a robo-advisor, origin and history?”, published by tech bullion on november 24th, 2016. [2] ismail ali ahmad, (2014) “technology boosts islamic finance; its provides solutions” worldfinance.com, march 3. [3] deloitte and avaloq (2017) “emerging models of digital wealth advisory” deloitte tax and consulting 2017. [4] https://journal.wahedinvest.com role of robo-advisors-inislamic financial institutions. [5] maurella van der ree (2019) “embracing robo-advisory looks promising for the longevity of financial advisors. global financial markets institute. 2019 [6] guidelines on the governance of shari’ah committee for the islamic financial institutions gsp1, at, 9-11. [7] muhammad akram laldin, (2008) “duties and resonsibilies of shari’ah boards from a legal and regulatory perspective” published by amanie academy. www.amanieacademy.com. [8] jonathan walter lam advised by david f. swensen (2016) “roboadvisors: a portfolio management perspective” presented to the department of economics for consideration of award of distinction in the major yale college, new haven, connecticut april 4, 2016. [9] farida raswala (2019) “a study on the awareness and perception of robo advisory services among investors in pune city” ssrn electronic journal. [10] jill e . fisch, marion labouré , and john a. turner (2018) “the emergence of the robo-advisor”. the wharton school, university of pennsylvania 3620 locust walk, 3000 sh-dh philadelphia, pa 191046302. december 2018. [11] biancone, p.p., & radwan, m. (2016) shari’ah compliant “possibitily for italiam smes” european journal of islamic finance, (1). [12] wee kee chia, yash shah, (2018)robo-advisory: key to the untapped mass affluent market. synpulse solve.evolve publication. [13] biancone, p.p., & radwan, m. (2019) social finance and financing social enterprises; an islamic finance prospective. european journal of islamic finance. [14] dominik jung, florian glaser, willi köpplin (2018) robo-advisory: opportunities and risks for the future of financial advisory: recent findings and practical cases. november, 2018. [15] collins, j. michael, financial advice: a substitute for financial literacy? (2012). financial services review, vol. 21, no. 4, 307-322. available at ssrn: https://ssrn.com/abstract=2046227 or http://dx.doi.org/10.2139/s srn.2046227 http://www.amanieacademy.com/ https://ssrn.com/abstract=2046227 https://dx.doi.org/10.2139/ssrn.2046227 https://dx.doi.org/10.2139/ssrn.2046227 https://dx.doi.org/10.2139/ssrn.2046227 ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 24 islamic governance, maqashid sharia index, and islamic social reporting: the case of islamic banks in indonesia 1 faculty of economics and business, hayam wuruk perbanas university, surabaya city, indonesia (indonesia) contact author: kautsar@perbanas.ac.id abstract— many previous studies still examine the islamic maqashid index as a performance measurement system. this collaborative research uses the maqashid sharia index in another perspective as a determinant that influences the level of islamic social reporting. in addition, islamic governance and islamic social reporting were used in this study. the novelty offered from this study is on the research model which includes financial determinants and non-financial determinants of islamic social reporting. financial determinants in this study use profitability, company size, and age of the company. the non-financial determinants include islamic governance and maqashid sharia index. this study aims to obtain empirical evidence about the influence of islamic governance, maqashid sharia index, and financial performance on islamic social reporting. the sample of this research is 11 islamic banks in indonesia in the period 20152018. the data analysis technique uses partial least square with smartpls version 3 by applying convergent validity, discriminant validity, reliability and hypothesis testing. the research findings show that the maqashid sharia index and financial performance influence the level of islamic social reporting. the better the maqashid sharia index the wider the level of social reporting. the stronger effect produced by financial performance on the level of social reporting. in contrast, islamic governance does not affect the maqashid sharia index and islamic social reporting. keywords: islamic governance, maqashid sharia index; financial performance; islamic social reporting i. introduction the implementation of governance in islamic banks is different from conventional banks, namely the obligation to comply with sharia principles in islamic banks. sharia principles refer to the principles of islamic law in banking activities based on fatwas issued by the national sharia council which was formed by the indonesian ulama council. the low compliance with sharia principles against sharia principles provides an opportunity for fraud in islamic banks. therefore, guarantees regarding the fulfillment of sharia principles (sharia compliance) from a customer fund management activity by islamic banks are very important in the business activities of islamic banks [8]. even adherence to sharia principles does not only represent an operational system but must become a work culture through worship practices [32]. good governance is expected to increase the credibility, effectiveness, and efficiency of islamic banks. one of the important issues regarding the existence of sharia governance is the existence of a sharia supervisory board or what is known as the sharia advisory board (sab). this regulation regarding the sharia supervisory board is regulated in bank indonesia regulation no. 11/33/pbi/2009 [52] and bank indonesia circular letter no. 12/13/dpbs [53]. islamic banks are required not only to achieve profit maximization but also to maximize the achievement of rights to allah through the payment of zakat and the state through the payment of taxes. in addition, above all, the profits generated by islamic banks must be able to lead to increased security, health, and welfare for every muslim [33]. the concept of maqashid sharia is what distinguishes it from kautsar riza salman1 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 25 conventional banks. this is understandable because islamic banks use maqashid sharia as a foothold so that people can take advantage of islamic social financing and take advantage of funds from the surplus side. islamic banks provide sustainable and impactful financing for those who have limited access to conventional banks [41]. the maqashid sharia index (msi) in several previous studies [24], [39] used 3 indicators, namely educating individuals (tahdzibul fard), upholding justice (iqamatul 'adl), and producing benefits (jalbul maslahah). this shows that islamic banks have a very important role in the fields of education, justice, and benefit. this condition is relevant to the objectives of islamic banks, where islamic banks do not only aim to maximize profits but must be responsible to god and fulfill human rights socially [33]. islamic social reporting (isr) was first initiated by [15]. the isr was further developed more extensively by [36] in malaysia and currently, the isr is still being developed by further researchers. according to [15], there are many limitations in conventional social reporting, so he proposes a conceptual framework for isr based on sharia provisions that are measured using an isr index. the isr index is an extension of social reporting which includes public expectations not only regarding the role of companies in the economy but also the role of companies from a spiritual perspective. in addition, the isr index also emphasizes social justice in relation to reporting on the environmental environment, minority rights, and employees. [23] explains that the high isr value of islamic banks in indonesia is also influenced by the high value of disclosure on the theme of corporate governance. this happened because the government issued bank indonesia regulation number 11/33/pbi/2009 concerning the implementation of good corporate governance for islamic banks [52]. in addition, there are also regulations governing disclosure of social responsibility, including [48], [49]. the results of research on the effect of governance on the disclosure of social responsibility show contradictory results. the size of the sharia supervisory board is empirically proven to affect the disclosure of social responsibility [34], [43]. the results of other studies prove that governance represented by the size of the sharia supervisory board has no effect on the disclosure of corporate social responsibility [7], [21]. however, when compared to other islamic countries, the development of the isr index in indonesia is still relatively slow [39]. this is because isr disclosure in islamic banking in indonesia is still voluntary, not mandatory. in addition, there are also no specific regulations governing disclosure items in the isr index such as in islamic countries such as malaysia, sudan, bahrain, united arab emirates, iran, palestine, kuwait, bangladesh, and qatar, where the isr index has become a part of it. from the reporting of islamic organizations in the countries concerned. this is evident from the many studies on the isr index in these countries [10]. to improve the level of isr disclosure at islamic banks in indonesia, it is necessary to examine the factors that influence the disclosure. there are many factors that influence the level of isr disclosure apart from governance, including the maqashid sharia index, profitability, size, and age of the company. social disclosure in most studies still uses the global reporting initiative (gri). disclosure with gri has not revealed information about the principles that are in accordance with islamic teachings because they are still general in nature. current research uses islamic social reporting disclosures which according to [15] show accountability to allah and society and to increase trantsparency and provide relevant information to stakeholders. much of the previous empirical research used the basis of legitimacy theory and agency theory to explain the influence of several variables on islamic social reporting [40]. the company characteristics in this study use profitability, company size, and company age. in the context of the relationship between profitability and disclosure of social responsibility, managers in profitable companies tend to disclose information on social responsibility more broadly in order to obtain personal benefits such as promotions and compensation. several previous studies from [2], [7], [29], [47] succeeded in confirming agency and legitimacy theory and proved the positive effect of profitability on the level of corporate social responsibility disclosure. the greater the level of profit the company gets, the wider the level of disclosure of corporate social responsibility. based on agency theory, it can be explained that the larger the company size, the agency costs that must be incurred are also quite large. thus, the company will seek to reduce agency costs through broader disclosure of social responsibility. most of the research confirms both agency theory and legitimacy theory in explaining the relationship between company size and disclosure of corporate social responsibility, as research conducted by [1]-[2], [13], [19], [38], [42]. current research is important to do to address previous research gaps. in the context of the relationship between governance and disclosure of social responsibility, research gaps occur because of inconsistent findings from previous research. in addition, there are still few studies examining the effect of factors on islamic social reporting (isr). the finding of this study is a complete research model, namely the determinant model of islamic social reporting disclosure in islamic banks (figure 1). the determinants are not only financial determinants but also non-financial determinants. financial determinants include profitability, company size, and company age. the non-financial determinants include islamic governance as represented by the characteristics of the sharia supervisory board (ssb) and the maqashid sharia index. based on the background, the problem formulations in this study are: (1) does islamic governance affect islamic social reporting?, (2) does the maqashid sharia index affect islamic social reporting ?, (3) do firm characteristics as represented by profitability, company size, and company age affect islamic social reporting?, and (4) does islamic governance affect the maqashid sharia index?. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 26 figure 1. conceptual framework source: author’s elaboration ii. theoretical framework a. grand theory the first grand theory is agency theory. agency theory requires a separation between the principal and the agent, this trigger asymmetric information in which the agent has better information about the organization than the principal. the existence of asymmetric information can trigger agency problems in the form of moral hazard and adverse selection [20]. regarding the possibility of agency problems, according to [20], agency costs to suppress agency problems consist of (1) monitoring costs, (2) bonding expenditure, and (3) residual loss. [9] argues that a conflict of interest or agency problem arises when a conflict arises between the expectations or goals of the owner/shareholder and the directors, and when the owners have difficulty verifying what management is actually doing. the implication of agency theory for this research is that management as an agent is inseparable from any actions towards the principal. islamic banks know more about fund management than customers. this is what is often referred to as asymmetric information. with the existence of asymmetric information, it is possible that agency problems will arise [37]. the agency conflict can be resolved by implementing corporate governance. corporate governance is implemented through structures and mechanisms. the second grand theory is legitimacy theory. legitimacy is based on the idea that the company has a social contract with the community, whereby the company agrees to take actions that the community wants for the company's business sustainability. legitimacy theory argues that disclosures made by companies are related to environmental factors (economic, social, and political) that these disclosures legitimize the company [17], [28], [30]. in legitimizing its actions through disclosure, the company hopes to continue its business existence [28]. according to the legitimacy theory, disclosure of corporate social responsibility is carried out so that the community gives a positive response to company performance. this response will give birth to a good value of the company from the perspective of the community so that in the end it can increase the achievement of company profits. in order to test the theory of legitimacy, [27] compared csr disclosure on companies that do tax aggressiveness with companies that do not do tax aggressiveness in australia. the results of their study succeeded in confirming the legitimacy theory in the context of tax aggressiveness. b. islamic governance islamic banks must carry out their functions properly in accordance with applicable banking regulations and in accordance with sharia principles. to ensure the implementation of sharia principles, in islamic banking activities there is one very important party, namely the sharia supervisory board (ssb). the role of the sharia supervisory board is very strategic in implementing sharia principles in islamic banking institution. in bank indonesia regulation no. 11/33/pbi/2009 in article 47, ssb has the duty and responsibility to provide advice and suggestions to the board of directors as well as to supervise bank activities in accordance with sharia principles [52]. the implementation of ssb duties and responsibilities includes: 1. assess and ensure compliance with the sharia principles of operational guidelines and products issued by the bank. 2. oversee the process of developing new products of the bank to comply with the fatwa of the national sharia council indonesian ulema council. 3. requesting a fatwa from the national sharia council indonesian ulema council for new products of the bank for which there is no fatwa. 4. conduct regular reviews on the fulfillment of sharia principles on the mechanism for raising funds and channeling funds as well as bank services. 5. request data and information related to sharia aspects from the bank's work units in the context of carrying out their duties. according to bank indonesia regulation no. 6/24/pbi/2004 in article 26 (1) states that the number of members of the sharia supervisory board is at least 2 people and a maximum of 5 people [50]. bank indonesia regulation no. 11/33/pbi/2009 stipulates that ssb members may only hold concurrent positions as ssb members at the maximum of two banking institutions and two non-bank islamic financial institutions and members of the sharia supervisory board are prohibited from concurrently serving as consultants in all islamic banks [52]. one ssb member is allowed to concurrently serve as a member of the national sharia council. bank indonesia regulation no. 11/33/pbi/2009 regulates the sharia supervisory board meetings [52], including: 1. meeting of the sharia supervisory board must be held at least 1 time in 1 month. 2. decisions made by the sharia supervisory board are made based on deliberation to reach consensus. islamic governance maqashid sharia firm characteristics islamic social reporting european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 27 3. all decisions of the sharia supervisory board set forth in the minutes of the meeting are joint decisions of all members of the sharia supervisory board. the results of the sharia supervisory board meeting as referred to in paragraph 1 must be recorded in the minutes of the meeting and well documented. c. maqashid sharia according to salman et al. (2018) [39] islamic sharia is grouped into three, namely belief (aqidah), worship, and morality (akhlaq). akhlaq is an inseparable part of sharia. the main objective of implementing sharia is to achieve benefits (maslahah), by providing protection to humans. apart from aiming to avoid harm (mafsadah), sharia also aims to protect humans from damage, this goal is known as maqashid which is defined as the goal and target of islamic law. in this context, maqashid sharia plays a very important role for a society in maintaining one's wealth, encouraging everyone to generate, collect, preserve, protect, and distribute wealth fairly. therefore, the role of islamic financial institutions is very important to integrate policies to achieve the maqasid sharia [22]. according to [4], maqashid is defined as the intent, purpose, intention, cover, or principle behind islamic law or rules. the definition of maqashid al-ghazali focuses on the meaning of protection and preservation. maqasid sharia in its development is also a business model that involves human, social, economic, and environmental development [5]. d. firm characteristics profitability is the ability of a company to make a profit through its business operations using asset funds owned by the company. another definition also states that profitability shows the company's ability to generate profits and measures the level of operational efficiency and efficiency in using the assets it owns [31]. the age of the company reflects how long the company is able to survive. company age is estimated to have a positive relationship with corporate social responsibility disclosure. according to [46], the longer the company survives, the more information the public has about the company. company size is the variable most frequently used in making annual reports. generally, companies with a larger scale tend to disclose more information about increasing ownership due to high dividend receipts [6]. e. islamic social reporting corporate social responsibility reporting in conventional systems only focuses on material and moral aspects. the spiritual aspect should also be the main focus in corporate social responsibility reporting because decision-makers have the expectation that companies will voluntarily disclose the latest information to help fulfil their spiritual needs. therefore, there is needs to be a special framework for reporting social responsibility in accordance with islamic principles [15]. such a framework is not only useful for muslim decisionmakers but also useful for islamic companies in fulfilling accountability to allah and society. this framework is known as islamic social reporting (isr). islamic social reporting (isr) uses sharia principles as its basic foundation. sharia principles in isr produce material, moral, and spiritual aspects that are the main focus of corporate social reporting. islamic social reporting (isr) is an extension of social reporting which is not only in the form of a great desire from the whole community for the role of companies in the economy but is related to a spiritual perspective [15]. the current research uses an islamic social reporting framework with the main reference [15] which is modified with the items contained in the research of [36]. f. the effect of islamic governance on islamic social reporting the characteristics of the sharia supervisory board are the number of ssb members in a company and in islamic banking. the increasing number of sharia supervisory boards can increase the isr level disclosure. the more the number of members of the sharia supervisory board, the more effective and efficient the bank's performance will be so that the disclosure of islamic social reporting will increase. a large number of sharia supervisory boards with a variety of perspectives and experiences can result in better corporate report reviews, especially in terms of corporate governance and social responsibility reporting. the smaller the number of members of the sharia supervisory board, the ineffective and inefficient performance of islamic banks and companies so that the disclosure of islamic social reporting will decrease. this is because the number of ssb members is small so that there is a lack of company and islamic banking performance reviews and a lack of reporting on social responsibility. the influence of the variable characteristics of the sharia supervisory board with stakeholder theory is that the sharia supervisory board is also said to have an interest in companies and banks. a large number of sharia supervisory boards will make islamic companies and banks adapt easily. the relationship between stakeholder theory in this variable is that a large number of sharia supervisory boards will have the right to know all the information in companies and islamic banking. the impact can be seen through corporate social responsibility reporting that the sharia supervisory board will provide financial and non-financial information in accordance with the company's real conditions. the effect of the variable characteristics of the sharia supervisory board with agency theory, namely the greater the number of sharia supervisory boards, the more frequent meetings will be held between the principal and the agent so that the cooperation between companies and islamic banking will be increasingly established so that they can delegate decision-making authority. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 28 based on empirical research, [7] did not find the effect of the size of the sharia supervisory board (ssb) on the disclosure of islamic social reporting (isr). [7] uses the object of islamic banks in germany and produces empirical evidence that expertise, number of meeting frequency, and member size of the sharia supervisory board (ssb) do not affect the level of corporate social responsibility disclosure. their results differed from the empirical research conducted by [34], [43] which revealed that the size of the sharia supervisory board has an effect on islamic social reporting. based on the results of this study, it can be concluded that legitimacy theory is able to explain the effect of islamic governance on the level of responsibility disclosure. g. the effect of maqashid sharia index on islamic social reporting the influence of the maqashid sharia index on islamic social reporting can be explained in the context of legitimacy theory. in legitimacy theory, it is explained that to be accepted by society, companies must fulfill social contracts through disclosure of economic, social, and political information [17], [28], [30]. based on the theory of organizational sociopolitical legitimacy, it can be in the form of financial performance and the maqashid sharia index. companies that have good financial performance and maqashid sharia index tend to be more in line with social norms through broader disclosure of social responsibility. the results of the study of [36] found a positive effect of company performance on the level of corporate social responsibility disclosure. supporting the study of [36], [39] found that the maqashid sharia index has a positive effect on the level of corporate social responsibility disclosure. the higher the maqashid sharia index, the greater the impact on corporate social responsibility reporting. companies that perform well tend to express social responsibility at a higher level in order to gain the trust of the community so that they can maintain their performance in the future. their results differed from those of [18], [42] who did not find the effect of company performance on the level of corporate social responsibility disclosure. h. the effect of profitability on islamic social reporting the profitability of the company is related to the theory of legitimacy because if the profits obtained by large companies will get a wider disclosure of information. companies with high returns on investment will use relatively small debt. if the company wants to live in order to grow and develop, the company must earn a profit. profitability is closely related to the effectiveness of a company's management in determining strategic steps to gain profit. companies that have a higher level of profit will attract investors by providing better information to the public and other stakeholders by increasing social responsibility disclosure. this means that the higher the profitability, the wider the isr disclosure will be. high profitability means that the company will be more flexible and free in managing profits to disclose social responsibility to stakeholders. [35], [36] prove that profitability has a positive effect on the level of social responsibility disclosure. different results were found by [40] were the results of their study found no effect of profitability on the level of islamic social reporting. the argument of [40] is that corporate social responsibility for sharia entities is a form of implementation of maqashid sharia so that sharia entities are still obliged to disclose their social responsibility regardless of the level of profitability it generates. i. the effect of company size on islamic social reporting the size of the company can be determined based on the total assets owned. company size is an estimator variable in annual reports which is mostly used to explain various aspects of the company. the size of the company will influence the company's decision to disclose the information in the annual report. the isr in the annual report is significantly related to the company size and the disclosure value is higher for large, well-performing companies [29]. [29], [45] revealed that company size has a significant effect on isr disclosure. companies that have high total assets will conduct a wider social responsibility disclosure than companies that have lower total assets because more sources of funds are used to carry out social responsibility activities. the results of this study are supported by the study of [40] who succeeded in confirming the effect of company size on the level of social responsibility disclosure from the perspective of sharia. j. the effect of company age on islamic social reporting company age is associated with better performance and more experience so that it is able to reveal information in the form of broader corporate social responsibility [3]. the results of [29] found that company age has an effect on isr disclosure because long-established companies will gain the trust of investors and also affect the company's financial statements so that companies have more information along with the company's development and company growth. in contrast, the results of the study by [3] did not find an effect of company age on social responsibility disclosure. this is because companies are accustomed to carrying out corporate social responsibility by using other media such as magazines and the internet [3]. k. the effect of islamic governance on maqashid sharia index the regulation regarding the sharia supervisory board (ssb) is regulated in bank indonesia regulation no. 11/10/pbi/2009 where article 11 states that the sharia supervisory board (ssb) can concurrently be at the most at 4 other financial institutions [51]. the characteristics of the members of the sharia supervisory board which include european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 29 experience, expertise, and high professional and social networks show better performance. more and more members of the islamic supervisory board will also increase the level of compliance of islamic banks. in addition, better supervision will show a reduction in agency problems carried out by bank management. with the reduction of agency problems, the performance of maqashid islamic banks will be better [24]. iii. methodology this research is included in quantitative research because it uses quantitative data and uses statistical testing tools to test the research hypothesis. based on the source or type of data, this study uses indirect research or uses secondary data in the form of financial reports and company annual reports. secondary data sources can come from books and government publication journals with economic indicators, census data, statistical abstracts, media, and company annual financial reports [12]. meanwhile, according to [25], secondary data is data that has been collected by data collection agencies and published to the data user community. a. research variables islamic governance is governance that is implemented based on sharia principles. islamic governance in this study is measured by several indicators which include: a. number of ssb members according to bank indonesia regulation no. 11 of 2009 states that the maximum number of ssb members is five people. measurement of the variable size of the sharia supervisory board is by writing the number of members of the sharia supervisory board of each islamic bank in indonesia. b. concurrent positions as ssb members concurrent positions as members of the sharia supervisory board are members of the sharia supervisory board who perform more than one job apart from being ssb. measurement of multiple ssb positions in this study was carried out by assigning a value of one to the sharia supervisory board performing concurrent positions in accordance with bank indonesia regulations and giving a zero value to the sharia supervisory board who carried out concurrent positions that were not in accordance with bank indonesia regulations. c. the educational background of ssb members measurement of the educational background variable of ssb members is by giving a value of one to the sharia supervisory board who has a doctoral background. zero scores on the sharia supervisory board with a non-doctoral educational background (only one, not both). d. number of ssb member meetings the number of ssb member meetings in a year is calculated based on the realization of the frequency of ssb member meetings in a year. in this study, the maqashid sharia index is defined as the level of achievement of the objectives of the islamic entity. the goals to be achieved include tahdzibul fard (educating individuals), iqamah al-'adl (building justice), and maslahah (creating benefits). the main objective is individual education, in the sense that the islamic entity must develop the knowledge, skills, and spiritual values of everyone in the company. islamic entities must also provide information to all stakeholders that the products offered are in accordance with sharia principles. the second objective is to build justice, in the sense that islamic entities should be honest in all transactions and business activities that are carried out. this second objective indicates that all contracts in islamic banks must be free from unfair elements such as maysir (gambling), gharar (uncertainty), and usury. the third objective is to provide benefits, in the sense that islamic entities should develop investment projects and services of a social nature to improve community welfare. this third objective can be seen from the amount of zakat issued by sharia entities and the amount of investment in the real sector [39]. in addition to zakat, waqf can also be included in this third objective because waqf has played a strong islamic social financial instrument throughout islamic history [44]. the profitability used in this study is profit before tax and return on assets (roa). roa is a financial ratio related to potential profit or profit at the level of income, assets, and share capital. the size of the company is seen from the total assets owned by the company, which can be used for the company's operational activities. if the company has large total assets, the management will be more flexible in using existing assets in the company. the company size indicator uses [6]. company age is representative of the company period in the industry [29]. the age of the company can be measured from the length of time the company was established to date, measured in years. islamic social reporting is a disclosure of corporate social responsibility which is carried out based on islamic sharia principles. this variable is measured through content analysis with the following scoring conditions: a. value 0 if there is no disclosure of the item in the annual report. b. value 1 if there is a disclosure of the item in the annual report. if all items are disclosed by islamic banks, the maximum value is 35. the calculation of the isr disclosure index score in this study refers to the research of [36] where variable scoring is the number of items disclosed divided by the total number of items available multiplied by 100%. b. population and sample the population in this study are all islamic banks in indonesia. the sampling technique used was purposive sampling method. there are two criteria for sampling based on purposive sampling, namely (1) islamic banks that publish annual reports in the 2015-2018 period; and (2) data related to european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 30 the measurement of profitability, company size, company age, and islamic social reporting. c. method of collecting data data collected through the documentation method is quantitative data sourced from financial reports and annual reports for a period of 4 years starting from 2015-2018. financial reports and annual reports are taken from the website of the financial services authority and the websites of each islamic bank. d. data analysis technique the data analysis technique used in this study was partial least square analysis with smartpls version 3.0 software. pls is an alternative approach that shifts from a covariancebased to a variance-based sem approach. covariance-based sem generally tests causality or theory, while pls is more of a predictive model. pls can also explain the relationship between variables according to [11], [14]. iv. results and discussion based on the selected criteria, the research sample is 11 islamic commercial banks that have complete financial statements and annual reports in the 2015-2018 period. the samples in this study were bank muamalat indonesia, bank victoria syariah, bank bri syariah, bank jabar banten syariah, bank bni syariah, bank syariah mandiri, bank mega syariah, bank panin dubai syariah, bank syariah bukopin, bank bca syariah, and bank maybank syariah indonesia. a. convergent and discriminant validity test convergent validity testing is done by looking at the value of the outer loading of each research indicator. this study uses a rule of thumbs above 0.5 as a condition for each indicator to meet convergent validity. after eliminating some of the loading factor indicators below 0.5, the results of the second convergent validity test were obtained (table 1). the second test results show that there are no indicators that have a loading factor below 0.5. table 1. convergent validity testing msi isr firm characteristics islamic governance x1.2 0.667 x1.3 0.856 x2.2 0.902 x2.3 0.860 x3.1 0.717 x3.2 0.842 y1.1 0.594 y1.2 0.783 y1.3 0.869 y1.5 0.689 source: author’s elaboration discriminant validity testing is done by looking at cross loading. based on table 2, all variables have the highest correlation in themselves compared to the correlation on other variables so that the discriminant validity requirements in the measurement model are met. maqashid sharia index variable has a value of 0.882, higher than the correlation with other variables, namely 0.405 (isr), 0.175 (company characteristics), and 0.192 (islamic governance). table 2. discriminant validity testing msi isr firm charact. islamic governance maqashid sharia index 0.882 islamic social reporting 0,405 0,741 firm characteristics 0,175 0,559 0,782 islamic governance 0,192 0,419 0,257 0,767 source: author’s elaboration b. reliability test reliability testing using cronbach alpha and composite reliability. cronbach alpha and composite reliability were used to measure the reliability of the reflexive measurement model. the rule of tumbs in this study for the reliability test is 0.70. based on the results of the reliability test, two variables were obtained, namely company characteristics and islamic governance which had a score less than the rule of tumbs 0.70 (table 3). table 3. reliability testing cronbach’s alpha rho_a composite reliability average variance extracted (ave) maqashid sharia index 0.716 0.729 0.875 0.777 islamic social reporting 0.723 0.778 0.827 0.549 firm characteristics 0.371 0.386 0.758 0.612 islamic governance 0.312 0.336 0.738 0.588 source: author’s elaboration c. inner model r square value of 0.75 indicates strong; 0.50 indicates moderate or 0.25 indicates a weak model. r square (r2) in the model with isr as the dependent variable of 46.5% indicates that the model is in the moderate category, meaning that the islamic social reporting variable can be explained in the research model by 46.5% and the remaining 53.5%. model 2 with msi as the dependent variable produces r2 of 3.7% which indicates a weak model (table 4). european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 31 table 4. hypothesis testing results original sample (o) t statistics (|o/stdev|) p values islamic governance à islamic social reporting 0,246 1,474 0,141 maqashid sharia index à islamic social reporting 0,280 2,182 0,030 firm characteristics à islamic social reporting 0,447 3,624 0,000 islamic governance à maqashid sharia index 0,192 1,445 0,149 source: author’s elaboration d. the effect of islamic governance on islamic social reporting according to ningrum et al. (2013), the sharia supervisory board (ssb) is tasked with ensuring whether a bank complies with the rules and complies with sharia principles. based on hypothesis testing through smartpls 3.0, the results prove otherwise where the level of islamic governance has no effect on the level of disclosure of islamic social reporting. this research shows that related to islamic governance there are only 2 indicators that meet the validity and reliability test, namely multiple positions, and educational background. this concurrent position occurred in almost all islamic banks during the study period. likewise, there was a decline in the background of ssb members during the study period. the two other indicators, namely the number of ssb members and the number of meetings from the research results, do not meet the validity and reliability test so that they cannot be used in the hypothesis testing process. with indications of the two characteristics of islamic governance, the results of the study show that the level of islamic governance does not affect the level of islamic social reporting. the results of this study support the results of previous research conducted by [7], [23] which did not find the effect of ssb size on isr disclosure in islamic banks in indonesia. specifically, ssb was unable to play a role in disclosure. islamic social reporting because ssb is still focused on its duties and responsibilities in the operational activities of islamic banks, for example on new product approval, monitoring whether the contract is in accordance with sharia principles, and reviewing islamic bank financial statements [23]. the results of this study are different from [34], [43] who found a positive effect of ssb size on isr. e. the effect of maqashid sharia index on islamic social reporting in the research, there are 2 indicators of the maqashid sharia index (msi) that meet the validity and reliability tests, namely justice and welfare. conceptually it is stated that a high msi score can have an impact on increasing disclosure related to isr. this concept is in line with the theory of legitimacy, which states that islamic banks must fulfill social contracts through disclosure of information in order to be accepted by the public. islamic banks that perform well are not only financial performance, even including non-financial performance such as msi, tend to disclose social responsibility at a higher level to gain the trust of the public. the trend analysis shows that the two indicators (justice and benefit) are indeed more than the indicators of educating individuals (tahdzibul fard). however, among the three, the indicator of fairness is the best indicator produced by islamic banks. in addition, the upward trend also occurs in indicators of equity. the second indicator after justice is the welfare indicator, but the welfare indicator tends to decrease at an insignificant level. based on hypothesis testing through smartpls version 3.0, it is known that msi represented by indicators of justice and benefit has a positive effect on the level of isr disclosure. the results of the research prove empirically that islamic banks that have a good performance in terms of justice and benefit have a tendency to better isr disclosure. as previously informed, these findings are supported by the results of descriptive analysis. the average value of the maqashid sharia index variable represented by indicators of justice and welfare has the best performance and has increased during the study period. the results of this study support the study of [36], [39] who found that there was a positive influence on msi's disclosure of isr in islamic banks in indonesia. the better the maqashid sharia index which is indicated by the higher the score for the msi variable, the wider the social responsibility reporting carried out by islamic banks. islamic banks that have good performance tend to express higher social responsibility in order to gain trust from the public so that islamic banks can maintain their performance in the future. however, the current findings differ from those of [18], [42] who did not find the effect of company performance on the level of corporate social responsibility disclosure. f. the effect of profitability on islamic social reporting based on hypothesis testing through smartpls 3.0, it can be proven empirically that roa has a positive effect on isr disclosure. the results indicate that islamic banks that are able to manage funds in overall profit-generating assets will attempt to disclose isr on a broader scale. this is a form of accountability to owners of capital for the funds that have been provided and to add value to islamic banking. likewise, the results of this study are in line with the legitimacy theory in the relationship between profitability and european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 24/10/2021 accepted for publication: 13/12/2021 published: 30/12/2021 32 isr. based on this theory, it is revealed that isr disclosure can make the company more widely known by the wider community and can continue to grow. therefore, this is one of the priorities for islamic banks, especially a concern for islamic banks that have performed well in terms of profitability through disclosure of social responsibility on a broader scale. the results of this study are supported by the analysis of previous trends which show that the ratio of profitability, company size, and company age has increased during the study period. performance conditions that are getting better from year to year have contributed to the increasingly widespread disclosure of social reporting. the results of this study are in line with the study of [16], [29], [35]-[36], as well as [26] who also found a positive effect of profitability on isr disclosure in islamic bank in indonesia. however, the results of the current study differ from those of [40] were the results of their study found no effect of profitability on the level of islamic social reporting. g. the effect of company size on islamic social reporting company size will influence banking decisions to disclose information in the annual report. this is also in line with the stakeholder theory where if the total assets and total income of large islamic banks are then allocated to carry out extensive islamic social reporting disclosures, it will have a major impact on stakeholders. stakeholders will continue to improve their performance in order to obtain assets and increasing income. based on hypothesis testing through smartpls version 3.0, empirical evidence is obtained that company size has a positive effect on the level of disclosure of islamic social reporting. research proves empirically that islamic banks that have high total assets will disclose islamic social reporting widely compared to islamic banks that have low total assets because more sources of funds are used to disclose islamic social reporting. this is supported by the results of descriptive analysis, where the average value of total assets has increased from 2015-2018 and the isr variable which is represented by 5 indicators also has an increased average value from 2015-2018. the results of this study support [29], [36], [45], [40] who found a positive influence on company size on isr disclosure in islamic banks in indonesia. islamic banks that have high total assets tend to conduct wider isr disclosures because more resources are available. h. the effect of islamic governance on maqashid sharia index based on agency theory, it is stated that good governance can improve company performance due to the presence of appropriate control mechanisms. the control mechanism in this study used ssb characteristics. the better the ssb in carrying out operational supervision of islamic banks in compliance with sharia principles, the better the performance of islamic banks can be, both in financial performance and in the form of maqashid sharia index. the results showed that there are two indicators of islamic governance that meet the validity and reliability test, namely multiple positions, and backgrounds of ssb members. there is a tendency of underperformance in the two indicators in islamic banks. this condition causes the role of ssb to be unable to increase the maqashid sharia index. the results of the study states that the small number of concurrent positions of ssb members results in the performance of ssb members who are more focused and professional in sharia supervision. the minimum number of concurrent positions for ssb members is expected to improve the performance of ssb supervision so that agency problems can be suppressed and, in the end, can improve the performance of islamic banks. the results of the study contradict the statement of [24] which states that ssb holds multiple positions or does not have the same quality level. v. conclusion this study proves the importance of the role of the maqashid sharia index in improving islamic social reporting at islamic banks in indonesia. islamic banks, which have a high maqashid sharia index, tend to produce social reporting on a broader scale. the high index of maqashid sharia is indicated by increasing the attention of islamic banks to aspects of justice and benefit, so that it has a positive impact on the disclosure of their social responsibility. in addition, this study also succeeded in proving the effect of firm characteristics on islamic social reporting. the higher the level of profitability and the size of the company owned by a islamic bank, the impact on the increase in social reporting disclosed by islamic banks. another interesting finding from this study shows that the role of the sharia supervisory board is ineffective in influencing the level of social reporting disclosed by islamic banks. likewise, the sharia supervisory board variable does not affect the maqashid sharia index. this is because there are only two indicators that meet the validity and reliability requirements, namely multiple positions and educational background. one of the limitations of this study and an area that arises for future research is that the influence of the aspect of educating individuals as part of the maqashid sharia index on islamic social reporting was not investigated in this research. future research can use other indicators to measure islamic governance in order to better test the maqashid sharia index. this study has very important practical implications for islamic banks. the maqashid sharia index increases islamic social reporting with aspects of justice and benefits so that islamic banks must design and implement programs that are in line with the increase in the maqashid sharia index. in addition, islamic banks must increase 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[48] act 40 of the republic of indonesia act 2007 [49] act 21 of the republic of indonesia act 2008 [50] bank indonesia regulation no. 6/24/pbi/2004 [51] bank indonesia regulation no. 11/10/pbi/2009 [52] bank indonesia regulation no. 11/33/pbi/2009 [53] bank indonesia circular letter no. 12/13/dpbs/2010 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6504 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 31/01/2022 accepted for publication: 26/05/2022 published: 29/07/2022 9 evaluation of some key features of islamic finance in non-islamic economies: bulgarian perspective 1 department of international economic relations, university of economics varna, bulgaria contact author: kamdzhalov@ue-varna.bg abstract— in recent years islamic finance has steadily increased in popularity. in this respect, the research sets itself a task to evaluate some key features of islamic finance in the bulgarian financial market. to achieve this fuzzy ahp method and deductive, inductive reasoning are used. the results show that the understanding of islamic banking principles in bulgaria has social banking characteristics. these characteristics are related to consumer expectations that can be defined as fundamental or basic such as the provision of a financial product or service, interest-free loans and securities with a social function for stakeholders. the results are unique and representative of the bulgarian experts’ opinions, processed scientifically to showcase the potential of islamic finance in the local financial market. hitherto, presumably, no other research concerning bulgaria has done such an evaluation. the main limitation of this research is the lack of islamic financial institutions operating in the bulgarian market. the research relies on the knowledge of local banking experts on islamic finance principles. the findings can be applied in the decision-making process in the islamic finance context. keywordsislamic finance; fuzzy ahp; social responsibility; social impact financing i. introduction islamic finance has caught the attention of scholars and experts all over the world. there is evidence showing continuing growth of the sector worldwide. there is a diverse range of islamic financial institutions that are active not only in islamic countries, but also in some european countries as well. the scope of the activities of financial institutions and banks offering islamic financial services is expanding. today, approximately 150 financial institutions in more than 45 countries are developing, expanding, and implementing various forms of islamic financing [1]. one of the more popular paradigms of islamic finance is the social impact which it has on society. bearing this in mind, there are a few emerging questions. what are the perceptions towards the guiding principles of islamic finance in nonislamic economies? what are the key features of those principles and what are the preferences towards them on the bulgarian market? a study conducted to evaluate the interrelation between islamic finance and sustainable development [24] demonstrates the academic world's initial interest in the relationship between islamic finance and the sustainable development goals. the author of the research also reveals that this contribution is not being systematically interpreted by different stakeholders and in different countries. in this line of thought, the hypothesis that islamic finance has the potential to be socially responsible finance in the bulgarian financial market could be advanced. the practical implications of such an evaluation could be a possibility for future implementation of similar principles in the bulgarian financial market. in order to prove or disprove the raised hypothesis, the fuzzy ahp method has been applied. the goal of applying the fuzzy ahp method is to make measuring the arrangements in decision making easier for professionals in the field of finance. whether to a lesser or greater degree, these individuals are familiar with the principles that govern the functions of islamic finance. because of this, the principles and methods of operation of islamic finance serve as indicators and subindicators in accordance with islamic terminology. ii. literature review a review of literature has been conducted to summarize the scientific research in the areas of islamic finance and socially responsible finance and to specify the research gap and aim. the islamic law 'shariah' is based on the mutual benefit of individuals and communities. its mission is to protect human rights through the prophet's guidance to bring mercy into people's lives on earth. one of the concepts of maqasid al shariah (shariah underlying objectives) upholds the principle of serving the public interest. this should be done by maximizing benefit and minimizing harm to the community [25; 26; 27]. one of the main goals is poverty alleviation. from the maqasid al shariah perspective, the social constituent of islamic finance is vital. some authors [28] studied circular economy considering maqasid al shariah. the circular economy and the human well-being are closely tied to and are in the core of miroslav kamdzhalov1 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6504 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 31/01/2022 accepted for publication: 26/05/2022 published: 29/07/2022 10 social agenda. circular economy goals include environmental sustainability, economic prosperity, and social equity [29; 30; 31]. human, social, economic, and environmental development are all part of the circular economy model and are scientifically linked with maqasid al-shariah [28]. there is a significant overlap between socially responsible investment principles and islamic principles or maqasid-al-shariah objectives [43]. social finance is a new financial market that stems from the rise of the social economy and social entrepreneurship. it is linked to the limitations of government policy and the inability of markets to create efficient solutions to social and environmental problems. several authors have linked islamic finance to a social agenda. such a relationship is researched in [32]. it is possible to improve the process of social innovation by combining islamic and social finance instruments [33]. the islamic banks, as a main pillar of islamic finance and economy, should perform on a stable and increasing level. the maqasid al shariah index measures islamic banks' activities [34; 35] and improves islamic social reporting in terms of justice and benefits, requiring islamic banks to design and implement programs that are in line with the index's rise. furthermore, to expand islamic social reporting, islamic banks must increase profitability and firm size [36]. the appeal of islamic finance to western countries stems from the fact that it operates ethically, similar to socially responsible investments [37]. islamic finance is not limited to muslims but rather is available to everyone. this is supported by its ability to attract the attention of financial institutions, regulators and investors as a viable alternative to traditional methods. with the introduction of environmental and social policies in recent years, sustainability has changed both the behaviour of the company and the approach of the adopted model [39]. qoyum et al. [38] studied the effect of an islamic label on environmental, social, and governance (esg) performance. the research was conducted on the indonesian and malaysian financial markets. the conclusions show that islamic firms perform better on environmental and social issues than nonislamic firms. some authors [42] studied corporate social responsibilities (csr) in the malaysian banking sector and discovered that stakeholders of two full-fledged islamic banks in malaysia have positive views on csr. the findings indicate that csr is accepted in islamic banking because it is capable of promoting csr in banks that conduct business in accordance with shariah principles. over the last thirty years, islamic banks have gradually been introduced alongside conventional banking institutions in a number of countries [40]. conventional financial institutions have expanded their operations to offer islamic financial products to islamic investors. bank-financed entrepreneurs have been gradually increasing in most of the countries where islamic banks operate [25]. the potential for islamic finance to grow in europe is extremely high [31]. research on the ugandan market [44] shows, that the intention to use islamic banking is heavily influenced by attitude, subjective norms, and religiosity. islamic banking is a much more prominent platform than conventional banking. it provides financial inclusion and leads to stronger market mechanisms, preventing the predominance of finance over the real value sector [45; 46]. a research study of islamic finance in russia [47] indicates that more than thirty projects in the field are underway, demonstrating stable growth and enlargement. russia has a conventional economic system and around 10-17% of its population is muslim. nonetheless, the islamic finance market in the country is still in its infancy. due to fragmentation and geographical distortion, there is little internal competition. there has been consistent scientific production on ethical banking, finance impact, and social impact in the literature. following the theories and processes of the bank's development in parallel with finance, it is undeniably of utmost importance to investigate the social impact it creates in ethical banking [48]. overall, it can be concluded that the papers place insufficient emphasis on sustainable and ethical development, which distinguishes islamic banking from its traditional counterpart [49]. the conducted literature review also shows that such a topic has not been examined in the bulgarian scientific field. so far, no one has studied key features of islamic finance in the bulgarian financial market. a few researches have been done internationally combining islamic finance and the fuzzy ahp method [2; 3; 4]. meanwhile, the researches cited differs from that conducted here. the following research could be the basis for further studies in other non-islamic markets. iii. methodology people are guided and make decisions in many situations in life based on their attitudes and understandings. decisionmakers preferences are difficult to calculate due to their subjective nature. accurate evaluation data collection can be difficult in some situations. in a number of management situations, the assessment is based on the decision makers' knowledge and experience. fuzzy set theory and its associated fuzzy logic offer numerous opportunities in this regard. the method applied is a double comparisons measurement, which relies on an estimate dictating the extraction of priority scales. in the process of applying ahp, the goal is first to construct a hierarchy, then to establish estimates or conduct measurements of pairs of elements according to the criteria for extracting preference scales, which are then synthesized in the overall structure so that a preferred alternative can be chosen [5]. depending on the context of the decision-making, certain problems may arise as the process can often be hindered by the restricting and ambiguous nature of incomplete and unreliable data. the ambiguous and subjective information acquired from a reliance on the opinion of experts and their conveyance of linguistic variables could cause some distortions. in this regard the fuzzy logic method is suitable in such instances. there is sufficient research available, based on amendments to ahp in the context of fahp. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6504 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 31/01/2022 accepted for publication: 26/05/2022 published: 29/07/2022 11 in order to avoid uncertainty and inaccuracy fuzzy ahp hybrid method has been developed. this method is characterized by a membership function [6] as is shown on figure1. figure 1. fuzzy group a membership function. a membership function characterizes the fuzziness and depicts the degree of truth to the fuzzy logic. of course, the function can take on a form other than the one shown in fig. 1, however, in most cases it is more convenient to use a simpler form depicted in the same figure see figure 2, 3, and 4 [7]. figure 2. fuzzy group a membership function. figure 3. fuzzy group a membership function. figure 4. fuzzy group a membership function. according to zadeh [8], “let x be a space of points (objects), with a generic element of x denoted by x. thus, x = {z}. a fuzzy set (class) a in x is characterized by a membership (characteristic) function fa(x) which associates with each point in x a real number in the interval [0, 1], with the value of fa(x) at x representing the "grade of membership" of x in a. thus, the nearer the value of fa(x) to unity, the higher the grade of membership of x in a. when a is a set in the ordinary sense of the term, its membership function can take on only two values 0 and 1, with fa(x) = 1 or 0 according as x does or does not belong to a. thus, in this case fa(x) reduces to the familiar characteristic function of a set a”. iv. results in view of the aforementioned postulates about fuzzy sets in an analytical hierarchy and with the intent of measuring the arrangements in professional decision-making in the field of islamic finance, a unique model is developed, based on fuzzy ahp (see fig. 5), which is to be tested by bulgarian experts. the experts interviewed were middle and high level bank employees from four different bulgarian banks. two of the financial institutions are held by turkish entities, one by an austrian entity and one by a bulgarian entity. in order to process the received data, the r-program is used. figure 5. model of fuzzy sets in the analytical hierarchy of islamic banking by criteria and sub-criteria. source: author on figure 5 there are four principal criteria for evaluation of islamic banking suggested financial equity, participation in the financial system, financial stability, and social responsibility each of which is comprised of particular subcriteria. an expert’s evaluation is used to prioritize the derived criteria and sub-criteria. the criteria and sub-criteria presented further below in the text together with their corresponding latin denominations (in brackets) for the purposes of mathematical calculations, are as follows: criteria: 1. financial justice (fsp) 2. inclusion in the financial system (ufs) 3. financial stability (fst) 4. social responsibility (so) european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6504 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 31/01/2022 accepted for publication: 26/05/2022 published: 29/07/2022 12 sub-criteria: 1.1. partnership lending (kr) 1.2. risk taking (pr) 1.3. shareholding (du) 1.4. transfer of authority (dp) 2.1. propensity to lend in accordance with islamic principles (si) 2.2. participation of self excluded from financial system (us) 2.3. microfinancing (mf) 3.1. debt avoidance (id) 3.2. relying on real tangible assets (zm) 3.3. interest-free lending (bk) 3.4. profit and loss sharing (spz) 4.1. social entrepreneurship (sp) 4.2. impact investing (iv) 4.3. donation and charity (db) 4.4. social impact securities issuance (zk) the data used in the application of fuzzy ahp is obtained using every respondent comparing sub-criteria and criteria as double comparisons, expressing relative significance with language configurations (just equal, equally important, weakly more important, moderately more important, strongly more important, extremely more important). as a result, the estimates are transformed into fuzzy numbers using table 1. table i. triangular fuzzy colloquial scale. linguistic scale triangular fuzzy conversation scale triangular fuzzy reciprocal scale just equal (1,1,1) (1,1,1) equally important (2/3,1,3/2) (2/3,1,3/2) weakly more important (1, 3/2, 2) (1/2, 2/3,1) moderately more important (3/2, 2, 5/2) (2/5, 1/2,2/3) strongly more important (2, 5/2, 3) (1/3, 2/5,1/2) extremely more important (5/2, 3, 7/2) (2/7, 1/3,2/5) source: [9] according to chang’s method [9], for each level in the constructed hierarchy the double language estimates are transformed into triangular fuzzy numbers and are organized into fuzzy relative matrices, as follows: (1) a + b = c. (1) (1) where (2) a + b = c. (1) (1) represents the linguistic estimate for the variables i and j, while ã is a square symmetrical matrix. the initial verification for cohesiveness of the data gathered from the opinions of various experts shows a discrepancy in the acceptable limits. for this purpose, we use the following equations: (3) a + b = c. (1) (1) (4) a + b = c. (1) (1) where λmax is the biggest own value of the matrix for comparison, n is the size of the matrix, and ri(n) is the random index depending on n. that is why we are continuing the process under the scheme in question [9]: ========================================= islamic banking islamic banking is a suitable alternative form of banking for muslims and non-muslims alike. that is why it is considered a guiding principle in islamic economics and finance. the demand on islamic banking today is increasing constantly [10]. therefore, it is important to evaluate this phenomenon in conjunction with the religious affiliation of the potential participants on the market. l fsp ufs fst so fsp 1.0 0.55 0.53 0.45 ufs 1.1 1.00 0.68 0.70 fst 1.2 0.90 1.00 0.53 so 1.4 1.13 1.40 1.00 m fsp ufs fst so fsp 1.0 0.78 0.76 0.59 ufs 1.5 1.00 0.90 0.81 fst 1.6 1.20 1.00 0.61 so 1.9 1.40 1.80 1.00 u fsp ufs fst so fsp 1.0 1.1 1.1 0.83 ufs 2.0 1.0 1.2 1.00 fst 2.1 1.6 1.0 0.77 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6504 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 31/01/2022 accepted for publication: 26/05/2022 published: 29/07/2022 13 so 2.4 1.7 2.2 1.00 ========================================= financial justice it is also among the basic principles of the islamic model. financial justice guarantees equal rights for the participants in a transaction. islamic finance provides such opportunities so that the risk of engaging in a transaction can be allocated fairly among the partners. the result of a business project financed by an islamic bank is then distributed according to the predetermined contract conditions [11; 12]. l kr pr du dp kr 1.0 0.47 0.36 0.44 pr 1.4 1.00 0.44 0.33 du 1.8 1.56 1.00 0.34 dp 1.6 2.00 2.00 1.00 m kr pr du dp kr 1.0 0.63 0.43 0.60 pr 1.8 1.00 0.60 0.40 du 2.3 2.00 1.00 0.41 dp 2.0 2.50 2.50 1.00 u kr pr du dp kr 1.0 0.89 0.56 0.83 pr 2.3 1.00 0.83 0.50 du 2.8 2.50 1.00 0.52 dp 2.5 3.00 3.00 1.00 ========================================= inclusion in the financial system – many muslims avoid participation in the financial system for religious reasons. one of the sins for them is to deal with riba. usury is strictly forbidden by sharia. some sources [13; 14; 15] indicate that for this reason, more than three-quarters of muslims worldwide are left without suitable banks. therefore, full-fledged islamic banks or islamic windows give that opportunity for many people to benefit from the financial system. many entrepreneurs can find funding for their business this way. l si us mf si 1.0 0.48 0.39 us 1.4 1.00 0.67 mf 1.7 1.22 1.00 m si us mf si 1.0 0.67 0.49 us 1.8 1.00 0.80 mf 2.2 1.50 1.00 u si us mf si 1.0 0.97 0.67 us 2.3 1.00 1.00 mf 2.7 1.83 1.00 ========================================= financial stability according to this principle, islamic investment is approached with caution, and the decisionmaking process is carried out in-depth because of the bank’s participation in entrepreneurship. if the business plan is too risky, the financial institution stays away from the project. through careful audits and analyzes in recent years, islamic financial institutions have been working to reduce risks and improve financial stability in the field of islamic banking [16]. l id zm bk spz id 1.0 0.50 0.67 0.61 zm 1.2 1.00 0.43 0.56 bk 1.2 1.72 1.00 0.61 spz 1.3 0.89 0.78 1.00 m id zm bk spz id 1.0 0.69 0.80 0.69 zm 1.7 1.00 0.58 0.78 bk 1.5 2.17 1.00 0.89 spz 1.7 1.33 1.17 1.00 u id zm bk spz id 1.0 1.0 1.0 0.83 zm 2.2 1.0 0.8 1.17 bk 1.8 2.7 1.0 1.33 spz 2.0 1.8 1.7 1.00 ========================================= social responsibility the ethical and moral values of the islamic banking system not only serve as guiding principles, but also as basic characteristics of the islamic economy. social responsibility is an important part of the islamic economic environment. it plays an important role in promoting socially valuable investments, improving relationships and partnerships; gives a chance to many people at a better life and improves welfare [17; 18]. l european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6504 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 31/01/2022 accepted for publication: 26/05/2022 published: 29/07/2022 14 sp iv db zk sp 1.00 0.40 0.52 0.58 iv 1.50 1.00 0.58 0.43 db 1.06 0.94 1.00 0.47 zk 0.94 1.33 1.17 1.00 m sp iv db zk sp 1.0 0.5 0.72 0.83 iv 2.0 1.0 0.83 0.56 db 1.5 1.3 1.00 0.61 zk 1.3 1.8 1.67 1.00 u sp iv db zk sp 1.0 0.67 1.1 1.22 iv 2.5 1.00 1.2 0.78 db 2.0 1.83 1.0 0.89 zk 1.8 2.33 2.2 1.00 ============================================ the first verification is for the individual leading areas (from the criteria level) (from columns 1 through 6 of the raw data). it examines how much more significant from the point of view of islamic banking the leading criteria of financial equity, participation in the financial system, financial stability, and social responsibility are. an intermediate result after applying the formulas is calculated thus: (5) a + b = c. (1) (1) where (6) a + b = c. (1) (1) and (7) a + b = c. (1) (1) [5] fsp 2.522222 3.122222 4.055556 ufs 3.722222 4.388889 5.333333 fst 3.522222 4.222222 5.222222 so 4.666667 5.666667 6.666667 l m u fsp 0.1747498 0.1794381 0.1906005 ufs 0.2578907 0.2522350 0.2506527 fst 0.2440339 0.2426564 0.2454308 so 0.3233256 0.3256705 0.3133159 the weight of each indicator (obtained through the application of equations 5, 6 and 7) (in relation to islamic banking) shows a predominance of the criterion of social responsibility: financial justice (finjustice) 0.18 inclusion in the financial system (inclusionfinsys) 0.25 financial stability (finstability) 0.24 social responsibility (socresponsibility) 0.32 now we continue with calculations at the level of the subcriteria: 1. in relation to financial justice (columns 7-12) l m u kr 2.266667 2.666667 3.277778 pr 3.166667 3.833333 4.666667 du 4.728571 5.744444 6.855556 dp 6.555556 8.000000 9.500000 l m u kr 0.1355868 0.1317234 0.1348880 pr 0.1894227 0.1893524 0.1920439 du 0.2828523 0.2837541 0.2821216 dp 0.3921382 0.3951701 0.3909465 the weight of each indicator (obtained through the application of equations 5, 6 and 7) shows that the most significant subcriterion from the point of view of financial justice is the one related to transfer of authority: partnership lending (partnlend) 0.13 risk taking (risktak) 0.19 shareholding (share) 0.28 transfer of authority (transfaut) 0.39 2. in relation to inclusion in the financial system (columns 1315) l m u si 1.873016 2.155556 2.633333 us 3.055556 3.633333 4.333333 mf 3.888889 4.666667 5.500000 l m u si 0.2124212 0.2061637 0.2112299 us 0.3465347 0.3475027 0.3475936 mf 0.4410441 0.4463337 0.4411765 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6504 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 31/01/2022 accepted for publication: 26/05/2022 published: 29/07/2022 15 the weight of each individual indicator (obtained through the application of equations 5, 6 and 7) shows that the most significant sub-criterion from the point of view of participation in the financial system is the one related to microfinancing: propensity to lend in accordance with islamic principles (propenisl) 0.21 participation of self excluded from financial system (partselfexcl) 0.35 microfinancing (microfin) 0.44 3. in relation to financial stability (columns 16-21) l m u id 2.777778 3.177778 3.833333 zm 3.206349 4.022222 5.133333 bk 4.555556 5.555556 6.833333 sp 4.000000 5.166667 6.500000 l m u id 0.1910480 0.1773094 0.1718984 zm 0.2205240 0.2244265 0.2301943 bk 0.3133188 0.3099814 0.3064275 sp 0.2751092 0.2882827 0.2914798 the weight of each individual indicator (obtained through the application of equations 5, 6 and 7) shows that the most significant sub-criterion from the point of view of financial stability is the one related to interest-free lending: debt evasion (debtev) 0.18 pledging of real tangible assets (pledgtangass) 0.23 interest-free lending (intrestfree) 0.31 profit and loss sharing (proflostsh) 0.28 4. in relation to social responsibility (columns 22-27) l m u sp 2.500000 3.055556 3.944444 iv 3.511111 4.388889 5.500000 db 3.466667 4.444444 5.722222 zk 4.444444 5.833333 7.333333 l m u sp 0.1795690 0.1724138 0.1753086 iv 0.2521947 0.2476489 0.2444444 db 0.2490024 0.2507837 0.2543210 zk 0.3192338 0.3291536 0.3259259 the weight of each individual indicator (obtained through the application of equations 5, 6 and 7) shows that the most significant sub-criterion from the point of view of social responsibility is the one related to issuance of securities with social impact. social entrepreneurship (socentr) 0.18 impact investing (impactinv) 0.25 donation and charity (donchar) 0.25 issuance of securities with social impact (secsocimp) 0.32 v. discussion as is evident from the resulting data, according to bulgarian experts, islamic banking has a certain potential for development. that potential is undoubtedly subject to the criterion of “social responsibility”. the empirical study corroborates the conclusions outlined in other studies conducted in the european banking market [19; 20], according to which the goals of islamic banking coincide with those of corporate social responsibility. this creates a serious prerequisite for a better managerial banking system, which is subject to certain stable rules. in our case the key rules outlined by bulgarian banking experts are connected to four main sub-criteria intended to make embracing the principles of islamic banking in bulgaria easier, which are as follows: transfer of authority, interest-free lending, the practice of microfinancing and issuance of securities with social impact. all four sub-criteria outline clearly the relationship between the islamic practice of microfinancing, the decrease in social inequality, and the development of the economy. these conclusions are in line with a published study by the banking sector of kyrgyzstan as well as the role of the maqāsid alshari’a as a factor for the well-being of society [21]. the analysis shows that the topic of corporate social responsibility (csr) is relevant in the field not only of conventional but also of islamic finance. the one integral element which stands out between conventional corporate social responsibility and its islamic counterpart is the role of philanthropy. the sharia law encourages charity and philanthropy by preaching very specific acts in the performance of these obligations both at the individual and institutional levels: zakat, an obligatory financial act meant to promote charity towards those in need; sadaqah, a voluntary act of charity of varying forms; and others [22]. csr refers to the companies' obligation to preserve and contribute to the well-being of the society in which they operate. that is why csr is considered a crucial principle in islamic business. from the empirical data we can see that there is a correlation between the local and international attitudes of the corporate entity concerning social responsibility. from among the sub-criteria of social responsibility, according to the data from the research on fuzzy sets, the criterion with the greatest weight is “issuance of securities with social impact”. experts favour this tool, which is in direct relation to the attitudes of a wide range of global investment and public organizations. according to a study by oecd [23], the growing interest among investors, institutions and individuals with a blended european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6504 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 31/01/2022 accepted for publication: 26/05/2022 published: 29/07/2022 16 value or investments with double the lowest value which means doing good while benefiting from a moderate return on investment stimulates them to engage in impact investing. investment institutions have an additional incentive as they are obliged to represent the interest of their investor-clients in the social return on investment. investors, such as foundations or other organizations that provide grants as part of their csr or community participation programs, consider investments with social impact as an opportunity to transform grants after the end of the project or to weigh social benefits. vi. conclusion the results support the initial hypothesis. it is also evident that the fuzzy ahp shows potential for evaluation of key features of islamic finance. transforming verbal variables into numerical ones is a promising method for evaluating perceptions and attitudes. in the context of increasing interest in islamic finance and economics, similar researches are important in order to evaluate possible outcomes for society. the fundamental principles of islamic finance could be implemented in nonislamic economies. moreover, some of them already exist in the conventional economic environment. corporate social responsibility has already had a positive impact on people’s wellbeing. the way the principles of islamic banking are perceived in bulgaria has the characteristics of social banking. these characteristics are related to consumer expectations that can be defined as fundamental or basic such as the provision of a financial product or service, interest-free loans and securities with a social function for stakeholders. but there is room for further development. the potential for this development it should be associated with some more innovative aspects of social banking. however, this can only be expected in the long term as social responsibility is more closely linked to ideas such as green islamic banking and the use of smart it tools and networks in islamic banking. to this end, knowledge of the social aspects of islamic banking in bulgaria must be continuously enriched. meanwhile, due to the current legal schemes, there are several difficulties and complex profiles that impede the spread of islamic banks in europe in general [50]. bulgaria in particular faces the same obstacles in implementing islamic finance. in such purely secular jurisdictions, changes in legislation are being made to ensure a level playing field for islamic financial products without necessarily incorporating elements of muslim religious law into the country's commercial law [51]. the findings of the research could be taken into account in the decision-making process. policymakers and practitioners in the financial sector of the economy usually rely on such data. references [1] khavarinezhad, s., biancone, p., & jafari-sadeghi, v. “financing in the islamic system and sustainable economic development of selected islamic countries”. european journal of islamic finance, (19), 2021, 1823. 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"legal aspects in implementing islamic finance in conventional banking systems". the law and the business in the contemporary society, varna, 2019, 270-279. issn 2603-5073 http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 why islamic banks are not competitive in islamic country: an empirical evidence from pakistan islamic banking sector kiran javaria 1 and omar masood 2 lahore school of accountancy and finance, university of lahore, islamabad, pakistan 1, 2 kiranmaryam23@gmail.com 1 ; masood_omar@hotmail.com 2 abstract: islamic banks are founded on principles that constitute the guidelines governing any islamic economic or financial dealing. there are almost 180 islamic financial institutions operating all over the world with 8,000 branches contributing to 71%, or usd 1.72 trillion, of the islamic finance industry's assets 1 . there has been tremendous growth in the islamic banking sector especially in islamic countries with regions like gcc countries and malaysia leading the way. the situation in the “islamic republic of pakistan” has been quite different where there has been a steady decline in the total number of islamic banks and their profits. it is important to identify the reason behind decline and failure of pakistani fully fledged islamic banking sector. therefore, this study purpose is to highlight the main reasons for the decline of islamic banking profitability in pakistan. according to sbp, islamic bank bulletin 2018 2 , there are currently four fully fledged islamic banks operating with 12.9% market share of pakistan's banking industry. this study encompass a period of twelve years (2007 to 2018) which shows a gradual decline in the total number of fully fledged islamic banks in pakistan and gradually in 1 onakoya, (2013); kamal, ahmad & khalid, (1999); masood, (2013); dublin (2019) global islamic finance markets report 2019, "global islamic finance market growth, trends, and forecast", source: research and markets 2 state bank of pakistan, islamic banking bulletin: apriljune 2018, islamic banking industry progress & market share the reduction of their profits. this study contributes by analyzing both internal and external factors ((back specific/internal, environmental/macroeconomic and external factors) which have led to the decline in the profitability of fully fledged islamic banks. study is quantitative in nature and primary data was collected from 508 senior managers of pakistani islamic banks. conclusively, finding reveal that internal/bank specific, external factors have significant and positive impact on islamic bank’s profitability. the study provides clear, workable policy recommendations to be followed both by the senior banks management as well as the regulatory body (sbp). this study is truly unique as it clearly emphasizes the core weakness within the islamic banking sector of pakistan and provides practical recommendations and suggestions to save this declining sector. keywords: bank specific factors, internal factors, environment specific factors, external factors, profitability, quantitative research, fully fledged islamic banks, senior managers, islamic bank bulletin, primary data analysis introduction: in global markets, financial institutions are the major player and they play a vital role in creating and running country’s economy efficiently [19]. the banking industry is divided in two parts; one is conventional banking system and second is islamic banking system [30]. mailto:kiranmaryam23@gmail.com1 mailto:masood_omar@hotmail.com ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 in past decades, there were only conventional banks which perform operations based on interest. islamic banks were introduced as the result of conservativism trend, in which islam followers show their need to follow banking practices in light of sharia laws and ensure the soundness of their muslim economies as explained by masood, (2013)[18]. in today’s environment where high competition is prevailing in the economy, in order to retain customer in the competitive economy, financial institutions are focusing on some essential aspects which enhance the profitability of islamic banking sector [3]. these important factors lead towards a greater performance of financial sector i.e. bigger market share and better profitability [16]. today major problem faced by islamic banks is the decline in their profitability and there are various reasons that islamic banking sector is not as much as profitable as compared to conventional banks [19]. so, focus of this study is to analyze the reasons and factors which influence the islamic banking sector profitability in the long run. this study is considering eight major factors (quick ratio, cash deposit ratio, non-performing loans, net gearing ratio, asset composition ratio, service quality, religious obligation and competitive advantage), which may influence the islamic banking sector profitability. this study is helpful to understand the reasons of islamic banks profitability decline and low market share [18]. the study will be useful for policy makers and practitioners to make new policies for islamic banks and to focus on major problem faced by islamic banks [13]. islamic banks profitability: the most common measure used to examine the efficiency of a bank is called profitability analysis [15]. the profitability of the islamic bank is defined as how much profit a bank generates in respect of its operations. the profit of banks describes how much bank return is against its paid taxes and other expenses ([17][28]). the most common measure of bank performance and efficiency is called profitability analysis [15]. measuring the profitability of islamic banking sector is very important as it enables the banking system to stay competitive and finance the operations of banks. several researchers anticipate the islamic banking sector to be more profitable than the conventional banking system of the country [4][20][14]. purpose/motivation of study: the banking sector plays a vital role in development of economic system [23]. there has been tremendous growth in the islamic banking sector especially in islamic countries with regions like gcc countries and malaysia leading the way. the situation in the “islamic republic of pakistan” has been quite different where there has been a steady decline in the total number of islamic banks and their profits. it is important to identify the reasons behind decline and failure of the pakistani fully fledged islamic banking sector. therefore, this study purpose is to highlight the main reasons for the decline of islamic banking profitability in pakistan. according to sbp, islamic bank bulletin 2018 3 , there are currently four fully fledged islamic banks operating with 12.9% market share of pakistan's banking industry. this study encompass a period of twelve years (2007 to 2018) which shows a gradual decline in the total number of fully fledged islamic banks in pakistan and gradually in the reduction of their profits. this study is very important in nature because it identifies the reason that why islamic banks are getting bankrupt in an islamic country of “islamic republic of pakistan”. according to previous theoretical background and current scenario, this paper has identified various factors/reasons of islamic banks profitability decline. the factors identified by present study are bank specific/internal factors and external factors. this study has tried to include all aspects and problems which influence the islamic banking industry internally and externally. the motivation behind this study is to identify the problem/reasons that why islamic banks are not competitive in an islamic country “pakistan”. in 2007 there were 7 islamic banks including meezan bank limited, dubai islamic bank, bank islami pakistan, al-baraka (pak ltd), first dawood islamic bank limited (fdibl), burj bank limited, emirates global islamic bank limited (egibl) were working in pakistan (sbp islamic bank bulletin, 2007 4 ). currently there are only four fully fledged islamic banks working in pakistan. according to previous studies and pilot testing results, this study has identified various factors/reasons of decline in islamic banks profitability and these factors include bank specific/internal factors (liquidity ratios) and environment specific/external factors. lack of liquidity management (such as marketable securities, treasury bills) is one of the important issues faced by islamic banks in pakistan. these securities could be utilized either to manage liquidity excess or to cover the shortage of liquidity [3]. this issue is aggravated since many islamic banks of pakistan are working under different operational procedures from those of the conventional banks; the resulting non compatibility prevents the “state bank of pakistan” from giving support or controlling the activities of 3 state bank of pakistan, islamic banking bulletin: apriljune 2018, islamic banking industry progress & market share 4 state bank of pakistan, islamic banking bulletin: apriljune 2007, islamic banking sector ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 islamic banks if a shortfall in the liquidity occurs [27]. so, the liquidity management issue must come under the scrutiny and active discussion by the involved authorities in islamic bank sector of pakistan. aims and objectives of this study are: “to identify reasons of decline in profitability/bankruptcy of pakistan fully fledged islamic banks.” “to find the significant relationship between bank specific/ internal factors (non-performing loans, net gearing ratio, asset composition ratio, quick ratio and cash deposit ratio) and islamic bank’s profitability.” “to examine that weather external factors (competitive advantage, service quality and religious obligation) have significant and positive influence on islamic bank’s profitability.” “to identify difference between four sampled islamic banks in relation to their internal, external and macroeconomic factors” i. literature review: literature review chapter explains the theoretical foundation of study. in pakistan, there is a set of mixed background in context of ethnic and religion. the banking system in pakistan started in 1947 after independence, but islamic banking started in the 1980s when the government had identified the needs of its customers [30]. literature review chapter explains the current situation of islamic banking system in pakistan and how different internal and external factors effect islamic bank’s profitability. this chapter is divided into three sections where section one explains the islamic banking sector background and current situation of islamic banks in pakistan. section two explains relationship analysis and third section provide theoretical support/foundation of study. section 1: islamic banking sector and current situation of pakistan islamic banks 1.1. difference between islamic and conventional banking system: the main objective of all organization is to minimize their cost and maximize the profit [17]. performance/profitability analysis is the main step to measure the efficiency and development of financial institutions. the main goal of interest-based banks (commercial banks) is to earn profit and to achieve this key objective of profit maximization; they continue their operations and provide their services to customers [16]. while on the other hand interest-free islamic banks also do have profit earnings as their key objective for operating, but these banks seek to achieve social and economic prosperity without the exploitation of their customers [1]. as the interestfree and interest-based banks are operating at different principles. the study findings discovered that in term of profitability/ performance of both banks (interest based and interest free) there is no significant difference, while in term of credit performance there is significant difference of interest based as compare to interest free banks[32]. 1.2. history of islamic banks in pakistan in 1980, zia-ul-haq a president of pakistan has developed the islamic financial system under zia’s islamisation process. for this purpose, economical and financial segments were designed to innovate with islamic shariah principles [13]. at that time banks were supposed to start their operations but some islamic scholars and ulmma gave reservations on islamic banking principles. at the end in 1991, the supreme court of pakistan decided about riba under shariah law. zaidi (2003) [11] stated that after this historic decision, the government of pakistan was ordered to execute the islamic financial system in the country. the main purpose of islamic financial institutions in pakistan was to initiate the islamic policies. according to islamic shariah law, it was decided that to promote islamic banking parallel to the conventional banking system. moreover, akhtar, (2007)[3] has stated that the state bank of pakistan also promote and permit islamic shariah branches in each of the conventional banks[31]. 1.3. current situation of islamic banking in pakistan being a muslim country, pakistan has a favourable ground for islamic banking to grow and explore more opportunities. as per the teaching of islam riba (interest) is strictly prohibited, it was a solid ground to practice islamic banking after the independence of pakistan. after independence, the country had no trained and skilled workforce and there was also no infrastructure available [28]. the country has been faced with many problems and challenges, and most focus has been paid to these challenges. the country was following traditional banking and left by islamic ethics and norms [13]. it has recently been accepted that islamic banking system laws, standards, and ethics are being ignored in islamic ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 state. therefore, the focus has been directed towards the islamic banking system and the laws for islamic banking have been formulated [11]. an extensive growth was witnessed in the islamic banking sector from 2002 to 2010. although the growth-share of the islamic banking industry was only 5 percent, this growth was expected to increase in the coming years by about 15 percent [10]. yet, the expectations did not meet outcomes and the islamic banking industry did not flourish as expected to be in the next five years after 2010. in pakistan, the islamic banking sector accounted for just 12.9 percent of the total banking sector's market share, while conventional banking accounted for the remaining 88 percent in 2018 (sbp, islamic banks bulletin, 2018). there were lots of challenges faced by islamic banking sector during transition, at the same time this sector invites many opportunities for stakeholders and scholars to explore the new dimension of banking [30]. there were many studies conducted on islamic banking sector which were utilized as per need of country/pakistan [18]. figure 1 source: spb, islamic bank bulletin, (2018) according to the sbp report (2018), the market share of islamic banks (deposits) increased by 14.8 percent in 2018, while the assets base decreased by 12.9 percent (figure 1). section 2: theoretical and relationship analysis 1.4. importance of profitability in islamic banks the profitability of islamic banking sector defined that how much a bank is generating profit with respect to its operations. the profit of banks describes that how much bank return is against its paid taxes and other expenses [4]. the most common measure of bank performance and efficiency is called profitability analysis [15][33]. measuring the profitability of islamic banking sector is very important as it enables the banking system to stay competitive and finance the operations of banks. there are number of researches which expect that islamic banking industry should be more profitable than conventional banking system of country [4] [14] [20]. by applying the non linear, linear and generalized movement method statistical tests, researcher found the evidence regarding their hypothesis. it is analyzed that the islamic banks higher profitability stems from their restricted access of inter-bank market equity financing. thus, islamic banks have to rely on safer and cheaper source of investment financing like investment deposits etc [4]. conversely, samad (2008) [25] conducted his study on islamic and conventional banks profitability analysis through ratio analysis of return on asset, return on investment and earnings per share. the finding of study shows that conventional banking system has more opportunities than islamic banking system and conventional banks are more profitable since islamic banks opportunities of investment are very low and they are not allowed to give or take interest rate from depositor and lender. 1.5. relationship analysis influence of quick ratio on islamic bank’s profitability: alshatti (2015)[5], in his study, use quick ratio in addition with some other ratios. he calculated quick ratio by subtracting current assets and inventory and then dividing it by current liabilities, and found that quick ratio positively and significantly associated with profitability of jordanian interest based banks. h1: quick ratios is important factor to influence the islamic banks profitability influence of cash deposit ratio on islamic bank’s profitability rasul (2013)[23], use the cash deposit ratio to measure the liquidity of islamic banks of bangladesh. study examined the data of 11 years (from 2001 to 2011), and found a significant relation of this variable with the profitability. h2: cash deposit ratios is important factor to influence the islamic banks profitability. 11.6 13.5 12.9 13.7 14.6 14.8 0 2 4 6 8 10 12 14 16 june (2017) mar (2018) june (2018) market share of islamic banks (share in overall industry) total asset (billio n) market share of islamic banks ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 influence of non-performing loan on islamic bank’s profitability bhattarai (2016)[8] stated that there is significant influence of non-performing loans on profitability of commercial banks working in nepal. study found that nonperforming loan has negative influence on organization return on asset whereas the ratio of nonperforming loans positively influences the return on equity of bank. h3: non-performing loans is important factor to influence islamic banks profitability influence of gearing ratio on islamic bank’s profitability study conducted by [21] investigated the listed companies of sugar in pakistan stock exchange. researcher analyzed the association between debt to equity ratio/ gearing ratio and profitability of firm (return on asset and return on equity), the results of study showed that there is negative and significant relationship between gearing ratio and return on equity while positive influence of gearing ratio and return on asset. h4: net gearing ratio is important factor to influence the islamic banks profitability influence of asset composition ratio on islamic bank’s profitability the study conducted by [24] explained that asset composition ratio highly influence the profitability of firm. the study shows that this ratio explains whether asset of bank includes high debt or not. high debt to asset ratio is not good for organization as it has negative influence on the profitability of firm. h5: asset composition ratio is important factor to influence the islamic banks profitability influence of competitive advantage on islamic bank’s profitability study conducted by [10] results revealed that the entrant of new comers will not affect the existing banks profitability when there is huge competition prevail in the economy. researcher stated that competitive advantage of banks help them to gain long term profit in the market. h6: competitive advantage positively influence the profitability of islamic banking sector influence of service quality on islamic bank’s profitability the quality of service generated is highly depends upon customers and their ability to participate in process of service and also on the ability to recognize the service quality generated. according to [6], service quality positively and significantly influences the profitability of islamic bank as better quality of services is always preference of customer. h7: service quality positively influence the profitability of islamic banking sector. influence of religious obligation on islamic bank’s profitability yusoff and azurah (2014)[29] asserted that in order to figure out the muslims’ behavior regarding traditional services and suitability, the most essential element is religion. based on previous studies, [7] defined islamic ethical behavior. this study is pakistan based and according to this study customer choose islamic bank because it avoid interest which is prohibited in islam. the study found positive relationship between religious obligation followed by banks and customer preference also positive association found with bank profitability. h8: religious obligation positively influence the profitability of islamic banking sector. section 3: theoretical support/ foundation in this section, selected topic is supported by various theories which are used to define nature of relationship existence. 1.6. the anticipated income theory the theory of anticipated income was developed in 1944 and author of this theory was h.v. prochanow. prochanow in 1949 regarding liquidity management by the banks; according to this theory banks should offer short term as well as long term loans. the banks need to keep more liquid assets (quick ratio and cash deposit ratio); neither needs to invest in short term marketable securities for their liquidity management but they should manage their liquidity on the basis of anticipated income of the borrowers. 1.7. the asymmetry information theory the asymmetry information theory supported the concept of non-performing loans factor selected by present study. according to current study nonperforming loans of bank has serious impact on the profitability of organization. asymmetry information theory supported this concept and explained that ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 reasons of non-performing loans are wrong and irregular information flow between buyers and sellers and it cause low profitability of bank. 1.8. theory of reasoned action according to this theory our every action is based on some reason and theory of reasoned action model predict the behavioral intention of individual [12] [27]. so, customer action of making decision regarding islamic bank product is based on bank’s excellent competitive advantage, service quality and religious obligation (following shariah complaints). 1.9. conceptual framework ii. methodology methodology section shows the research approach, specification, data collection process and details of data in order for it to be examined. ramamurthy (2011)[22] describes that primary data source provides efficient information, and the researcher is able to examine new updated information. study utilized the primary data collecting technique. survey was conducted from senior managers of islamic banks in order to examine the internal and external factors influence on islamic banks profitability. researcher also gets input from senior managers regarding role (factors ranking) of internal factors in generating the profitability of islamic banks. this is the major contribution of present study, is identifying the various factors external and internal from profitability analysis of islamic banks. another contribution of methodology is that study collected data from fully fledged islamic banks the data was collected from ten big cities of pakistan. no study has been conducted to explore the reason of profitability decline and bankruptcy of islamic banking from last ten year. the present study focuses on fully fledged islamic banks and data was collected from major ten cities of pakistan because these cities are business centers and every islamic bank has their many operational branches in these cities. the sample of four fully fledged islamic banks includes meezan bank limited, dubai islamic bank, bank islami pakistan, al-baraka (pak ltd). the study is quantitative in nature and deductive [9] reasoning is applied to test the hypothesis. lastly, study’s methodology contributed in sampling techniques of study, a multi-stage probability sampling process was used. for this study researcher made strata of four provincial capitals and one federal capital (punjab, sindh, baluchistan, kpk and islamabad federal capital area). further, researcher made sub-strata (from big five strata) of ten big cities of pakistan includes karachi, lahore, faisalabad, rawalpindi/islamabad, gujranwala, peshawar, multan, hyderabad, quetta and bahawalpur. reason of first ten big cities choice is that, these cities are business centers in pakistan and have large population that’s why banks mostly target their branch network in these big cities so they can easily access their customers. after making sub-strata of big ten cities, the researcher was focused on disproportionate stratification [2] in which the size of each stratum is not proportional to its size in the population [26]. so for this study, sample of 417 senior bank managers who were able to provide time and easily accessible were used. econometric equation: pro (dv) = αo+β1 qr+ β2 cdr+ β3 acr+β4 npl+ β5 ngr+β6 ca+ β7 ro+ β8 sq + e the description of the models used in the current study is provided as below: pro (dv) = profitability qr = quick ratio cd = cash to deposit ratio acr = asset composition ratio npl = non-performing loan ratio ngr = net gearing ratio ca = competitive advantage ro = religious obligation sq = service quality ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 2. research analysis 2.1. demographic analysis the purpose of demographic analysis is to examine the sample characteristics of the study. this analysis includes age, gender, professional training and year of experience in islamic banking sector. basically, demographic analysis is used to analyze the personal data regarding participant of study. table 1: demographic analysis questions options percent obs gender male female 63.05% 36.95% 417 age below 20 21-30 31-40 41 & above 0.49% 16.75% 49.26% 33.50% 417 highest educational degree bachelors master professional degree doctorate others 10.34% 40.89% 36.45% 0.49% 11.82% 417 marital status single married 48.77% 51.23% 417 year of experience 1-5 years 5-10 years 10-15 years >15 years 28.08% 39.90% 25.12% 6.90% 417 professiona l trainings 1-5 years 5-10 years 10-15 years >15 years 22.17% 36.45% 27.59% 13.79% 417 islamic bank meezan bank limited dubai islamic bank bank islami pakistan al-baraka (pak ltd) 26.60% 24.63% 24.63% 24.14% 417 position/ role in bank senior loan officer branch manager senior direct sales representative senior relationship manager data processing officer customer relationship manager general manager bank marketing representative 10.84% 14.29% 11.33% 15.27% 12.32% 12.81% 11.82% 10.84% 417 branch name lahore karachi faisalabad rwp/isb gujranwala 10.34% 9.85% 11.82% 11.33% 10.34% 417 peshawar multan hyderabad quetta bahawalpur 9.85% 8.87% 9.36% 8.37% 11.33% table 1 shows the demographic analysis of primary data. in sample of this study, majority of senior manager of islamic banks were male. the highest educational degrees of most of the manager were “master” as shown in the table. the answer of marital status question shows that most of the senior branch managers of bank were married. after this researcher asked for the year of experience they have in banking industry and it shows that most of the manager 40% have between 5 to 10 year experiences. according to sample of islamic banks, most of the “senior bank managers” were working at meezan bank limited. there were 27% of senior banks managers who belong to meezan bank limited. there are eight positions in bank which are analyzed as senior post/ role in the banking sector. so, researcher collected data from those senior bankers for further analysis. most of the senior manager position / role in bank were senior relationship manger which was about 15% in islamic banks. the last question was about their branch name and address where most of the data about 12% was collected from faisalabad. 2.2. reliability analysis reliability analysis shows the consistency and stability of item used to conduct the study. table 2: reliability analysis variables no of items alpha mean competitive advantage 5 0.928 2.871 religious obligation 3 0.783 2.674 service quality 4 0.630 2.434 quick ratio 4 0.929 2.359 cash deposit ratio 4 0.705 2.539 non performing loans 4 0.929 2.431 net gearing ratio 4 0.664 2.468 asset composition ratio 4 0.648 2.589 ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 table 2 shows the reliability analysis which shows that all items understudy are reliable and consistent. so, the analysis shows that all item values are greater than 0.60 and lies above from the alpha range so it is stated that all items are reliable and accurate for further analysis. 2.3. normality analysis test of normality analysis is conducted to measure that data lies in normal distribution range and also to know that whether data is well-modeled. table 3: normality analysis variables skewness kurtosis competitive advantage 0.510 -1.107 religious obligation 0.333 -1.082 service quality 0.570 -0.295 cash deposit ratio -0.399 -0.070 quick ratio 0.007 -0.677 non performing loans -0.218 -0.405 net gearing ratio 0.098 -0.873 asset composition ratio -0.094 -0.688 table 3 shows the normality analysis of study. this method is used to check the normality of data through value of skewness and kurtosis. the skewness and kurtosis values of all variables understudy lies between -1 to +1 and +3 to -3 respectively and it shows that data lies in range of normality and it is normally distributed. 2.4. survey analysis of internal and external factors table 4: internal and external factors analysis very unimportant unimportant neither important nor unimportant important very important cash deposit ratio and profitability 6.25% 16.38% 11.25% 41.13% 25.00% quick ratio and profitability 15.38% 29.88% 21.38% 20.50% 12.88% non performing loans and profitability 8.00% 11.75% 17.38% 39.25% 23.63% net gearing ratio and profitability 14.25% 38.00% 14.00% 16.00% 17.75% asset composition ratio and profitability 9.75% 23.63% 22.13% 34.50% 10.00% competitive advantage and profitability 0.00% 1.00% 10.25% 40.50% 48.25% service quality and profitability 0.00% 3.63% 15.38% 50.25% 30.75% religious obligations and profitability 0.00% 4.13% 19.75% 54.38% 21.75% table 4 provides the details of senior bank manager response regarding influence of internal and external factors influence on islamic banks profitability. internal factors which influence the islamic bank profitability are quick ratio, cash deposit ratio, nonperforming loans, asset composition ratio and net gearing ratio. quick ratio is a measure of the company's ability to meet its obligations in the short term. data collected from the senior manager of islamic banks revealed that quick ratio is an unimportant factor of pakistan islamic banks. so, 12.88% or 13% of the respondent (senior bank managers) stated that quick ratio is very important to influence the profitability of banks. study explained that quick ratio has little contribution in generating islamic bank’s profitability. in commercial banks customer are attracted with high interest rate on deposits while in islamic banking system this activity is haram. so, islamic banks need to provide range of products which are acceptable in islamic shariah and help to increase customer interest. this activity help to increase the islamic banks cash deposit ratios and ultimately influence the profitability of islamic banks. so 25.00% or 25% of the respondent (senior bank managers) stated that cash deposit ratio is very important to influence the profitability of banks, 41.13% or 41% sated that cash deposit ratio is important for islamic banks. the analysis of nonperforming loans ratio and profitability shows that ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 most of the respondent agreed on the statement that non-performing loans ratio has negative influence on profitability of islamic banks. data collected from the senior manager of islamic banks revealed that nonperforming loans is an important factor of pakistan islamic banks. so, 23.63% or 24% of the respondent (senior bank managers) stated that non-performing loans ratio is very important to influence the profitability of banks, 39.25% or 39% sated that nonperforming loans ratio is important for islamic banks. when dues are already exposed to creditors of firms, they understand that company might not be able to pay back its debts. but in case of islamic banks gearing ratio plays very small role as islamic banks cannot make extra capital. islamic banks need to utilize their equity and they cannot rely on debt. so, 17.75% or 18% of the respondent (senior bank managers) stated that net gearing ratio is very important to influence the profitability of banks. the analysis of asset composition ratio and profitability shows that most of the respondent agreed on the statement that asset composition ratio has positive influence on profitability of islamic banks. data collected from the senior manager of islamic banks revealed that asset composition ratio is an important factor of pakistan islamic banks. so, 10.00% or 10% of the respondent (senior bank managers) stated that asset composition ratio is very important to influence the profitability of banks, 34.50% or 35% sated that asset composition ratio is important for islamic banks. external factors which influence the islamic bank profitability are competitive advantage, service quality and religious obligation. in case of religious obligation, many of the senior managers stated that customer have lack of awareness regarding islamic banks products. they explained that most of the customers think that islamic banks are not following religious obligation and they are charging hidden charges from customer which is equivalent to interest rate. the respondent (senior bank managers) explained that it is very important for islamic banks to follow religious obligations, sharia complaints, in order to become more profitable. so 32.17% of the respondent (senior bank managers) strongly agreed that religious obligation have major influence on banks profitability. in case of service quality, the senior manager describe that they are trying to provide excellent services to their customer but their services are not competitive to non islamic rivals/ conventional banking sector of pakistan. reason behind this phenomenon is, islamic banks need to be sharia complaint and they cannot offer financing for “haram product” which highly influence the profitability of banks. so 51.75% or 52% of the respondent (senior bank managers) strongly agreed that service quality has major influence on banks profitability. there is huge competition exist in banking sector of pakistan and having competitive advantage matter most for the islamic banks. islamic are not facing only islamic rivals but they also need to compete with non islamic / conventional banking rivals. so 37.80% or 38% of the respondent (senior bank managers) strongly agreed that their competitive advantage have major influence on banks profitability. open ended questionnaire: in your opinion what are other major factors and reasons of decline in profitability of pakistan islamic banking sector? researcher stated last question as open ended in questionnaire and asked for senior management opinion regarding islamic banks profitability decline. there are eight factors identified in this study and researcher asked the senior managers of islamic banks to identify factors other than variables understudy. different senior managers identified different factors as reason of islamic banks profitability decline. the major focused factors are given below:  low awareness of islamic banking products and procedure (lack of clarity of shariah compliance and awareness of islamic banking practices)  fear of wrong use of customer money in non-sharia products.  high liquidity keeping  lack of trust  not competitive like conventional banks  staff is not highly trained so cannot convince customer (need training)  customer religion sentiments does not match the islamic banks product offering ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 low inner satisfaction/faith cause less acceptability of islamic banks as compare to conventional banking sector. table 5 : result summary hypotheses theoretical support/results graphical representation results results/rea son h1: quick ratios is important factor to influence the islamic banks profitability positive and sig relation alshatti (2015), malik et al. (2016), ishaq et al. (2016) 33.38 percent senior bank managers agreed with this statement less contribution but significant h2: cash deposit ratios is important factor to influence the islamic banks profitability positive and sig relation mansoor khan, ishaq bhatti, and siddiqui (2008), shahchera (2012) 66.13 percent senior bank managers agreed with this statement positive and insignificant h3: nonperforming loans is important factor to influence islamic banks profitability negative and sig relation bhattarai (2016), kiran and jones (2016), lata (2015) 62.88 percent senior bank managers agreed with this statement negative and significant h4: net gearing ratio is important factor to influence the islamic banks profitability positive and sig relation nirajini and priya (2013), mwangi, et al., (2014), sabin & miras, (2015) 33.75 percent senior bank managers agreed with this statement less contributio n but significant h5: asset composition ratio is important factor to influence the islamic banks profitability positive and sig relation burki & niazi, (2010), riaz, (2013), ijaz et al. (2015) 44.50 percent senior bank managers agreed with this statement positive and significant h6: competitive advantage positively influence the profitability of islamic banking sector positive and sig relation heikal, malikussaleh, khaddafi & malikussaleh, (2016); healy, serafeim, srinivasan & yu, (2014) 61.30 percent senior bank managers agreed with this statement positive and significant h7: service quality positively influence the profitability of islamic banking sector positive and sig relation wijetunge, (2016); warde, (2010); altamimi (2010); khan and fasih (2014) 88.75 percent senior bank managers agreed with this statement positive and significant h8: religious obligation positively influence the profitability of islamic banking sector positive and sig relation yusoff and azurah, (2014); awan and azhar (2014) 87.34 percent senior bank managers agreed with this statement positive and significant iii. conclusion banking system is essential for the growth and development of any economy. islamic banks are an important part of the banking industry. islamic banks follow the teaching of islamic sharia in their operations and practices. the interest free banks’ earnings are not dependent on any kind of interest; instead they largely depend on the liquidity for their survival and capital enlargements. this study aims to trace the reasons behind enlargement or shrinkage of financial performance of islamic banks. in a nutshell, the aim of study was to identify the reason behind decline in the profitability of islamic banking sector in pakistan. conclusively finding reveals that internal/bank specific, environment specific/external factors have significant and positive impact on islamic bank’s profitability. overall study found that islamic banks try to balance the internal and external factors in order to prevent themselves from bankruptcy and to perform smooth operations. these results highlighted important issues faced by islamic banks nowadays in order to maintain their good profitability level. the study found that islamic banks cannot achieve expected profits enlargements without confirmation of its proper bank specific/liquid asset (liquidity level not too high, nor too low). according to statistics there is increasing trend found in nonperforming loans of islamic banks which is alarming situation for pakistani islamic banks. results of study are helpful for practitioners and policy makers to understand the customer needs of islamic product who follow the religious obligation and customer sentiments. awareness of islamic product is also very important factor as it is very important for high religious sentiments customer to understand that offered islamic product is not fake. the major reason of profitability decline identified by this study is “non-performing loans”. banks should develop specific techniques and tools to differentiate genuine and willful defaulters. banks must take first step of “client profiling” to improve the nonperforming loans management. recommendations and future suggestions of study: as per this study results and state bank of pakistan (sbp) report of september, 2019, islamic banks deposits dropped rs 8 billion in three months. the reports shows that islamic bank deposits were rs ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 11 2,407 billion in month of september, as compare to rs 2,415 billion in month of june, 2019 5 . according to senior managers of islamic banks, ib’s liquidity is spilling over since existing rules and regulations does not allow the bank to lend money to agriculturists, industries and other private sector. there is need to revise the policies of islamic banks and minimize the unnecessary over regulations imposed by sbp. according to senior manager of bank islami pakistan, “we are having rs 600 billion in surpluses, but we cannot use it to finance the private sector due to limited sharia compliant products. we are unable to disperse the surplus amount; there is dire need for new innovative financial regulation and product diversification in islamic banking sector”. islamic banks should focus on products which are already sharia compliant such as islamic mortgages. as stated by “ahmed siddiqui”, head of product development and shariah compliance at meezan bank ltd “islamic mortgage is one of the big investment opportunities for islamic banks as these mortgages are different and better than traditional home loans. islamic mortgages don't involve paying interest, as it is strictly forbidden under sharia law. in order to qualify for a sharia mortgage, you will typically need a deposit of at least 20% of the property”. the current state bank of pakistan (sbp) policy as well as government policy is determined to develop the pakistani mortgage market (house loans). in the current pakistan government under the leadership of prime minister “imran khan” the government along with the state bank of pakistan has set up a target for commercial banks to give 5% of their total loans portfolio for home loans. this is an excellent market prospect and islamic banks should use this opportunity to develop this product offering for pakistani customers. islamic banks can collaborate with construction companies to establish housing schemes in urban areas. it could be a combination of mortgage based project financing. 5 data submitted by banks under quarterly reporting chart of account (rcoa), islamic banking department state bank of pakistan, 2019 references: [1]. ahmad, r. 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[29]. yusoff, r., & azurah, n. m. k. (2014). selection factors of the acceptance alijarahthumma al bay (aitab) in kota bharu, kelantan. malaysian journal of business and economics, 1(2), 23–50. [30]. zubair, h. m & chaudry, n. g. (2014), islamic banking in pakistan: a critical review, international journal of humanities and social scienc, 4(2). ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 13 [31]. biancone, p. p., & radwan, m. (2018). shariacompliant financing for public utility infrastructure. utilities policy, 52, 88-94. [32]. biancone, p., & secinaro, s. (2016). the equity crowdfunding italy: a model sharia compliant. european journal of islamic finance, 5, 1-10. [33]. biancone, p. p., & radwan, m. (2016). european companies: evaluation for sharia compliance “opportunities and challenges”. european journal of islamic finance, (5). ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 14 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6167 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 11/03/2022 accepted for publication: 05/06/2022 published: 29/07/2022 18 smart cities and sustainable finance: the islamic perspective 1,2 faculty of economics, university of rome tor vergata, italy contact author 1: clapapa95@gmail.com contact author 2: noemirossiroma@yahoo.it abstract— in the current global context, policymakers are called to face complex and numerous challenges in achieving sustainable development with rapid urbanization and industrialization. the world’s population is growing, and cities will be increasingly condensed in the future. nowadays, cuttingedge technologies and digitalization are radically changing urban life and how cities are planned, financed, and managed. a new urban model, known as a “smart city”, is being developed throughout europe and elsewhere worldwide. in a smart city, all the infrastructures are interconnected and integrated in an efficient and functional way through ict by optimizing resource consumption, enhancing the quality of public services (government services) through participatory governance, and increasing citizens’ security. indeed, urban transformation requires multiple stakeholders to come together toward shared and common goals. city leaders face challenges in enacting changes in balancing the needs of citizens, government, businesses, ngos, and others: smart city development requires a strategic, long-term vision to create inclusive, fully integrated and synergistic systems. technological progress is a fundamental requirement for the development of smart cities, but it must be supported by sustainable financial instruments. this paper aims to conduct a comparative analysis of the smart cities’ projects and financial instruments used for implementing those models, traditional as well as innovative and sustainable. in particular, the analysis aims to highlight the ethical financial approach having in mind the european and islamic modelsthat characterizes some of these smart city models and the underlying idea of sustainability. keywordssmart cities, islamic finance, green sukuk i. introduction during the last ten years, the topic of smart cities has been thoroughly analysed by pointing out diverse urban context which diverges economically socially and politically. different cultures, categories of governance and management methods affect interactions among policymakers citizens and stakeholders involved in the decision-making process, especially in relation to green and sustainable policies. in such context, policy makers must move towards new urban ecosocial model by promoting sustainable investments in urban areas. moreover, the phenomenon of sustainable financial tools aimed at developing green and sustainable projects is widely discussed in literature [1-4] but what is missing is a unified vision from the financial point of view of the smart city concept, and a full funding system of these new urban realities. the overall rationale of this gap is extremely varied but, to completely overcome these barriers, it would be necessary to increase public awareness of the importance of sustainability to raise awareness of the use of sustainable financial instruments for financing these new entities. ii. methodology through the existing literature, this paper aims to contribute to the current debate considering the most advanced smart city models in europe and the islamic world from a management financial and cultural perspective. moreover, the following analysis has been carried out by combining the concept of sustainable and innovative cities with the islamic objectives (maqasid al -sharīʿa) to define a holistic model of sustainable cities based on an integrated and ethical approach to urban management financed by sustainable and islamic financial instruments.1 based on maqasid al -sharīʿa [5] [26 1 according to kamali, maqasid al -sharīʿa, profoundly rooted in qur’an and sunnah, are designed to promote social wellbeing and to repeal harms. as such, these objectives aim to establish justice, eliminate unfairness and alleviate poverty. thus, maqasid al -sharīʿa aim to o protect religion (din), life (nafs), intellect (aql), lineage(nasl) and their property (maal). moreover, these objectives provide guidelines to ensure the realization of maslahah (social wellbeing) and the prevention of mafsadah (harm) in everyday life as well as in the financial market. claudia papa1, noemi rossi2 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6167 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 11/03/2022 accepted for publication: 05/06/2022 published: 29/07/2022 19 29], islamic green finance, play indeed a key role in promoting innovation while preserving natural resources, and this study provides a comprehensive framework of the actualizing maqasid al -sharīʿa in smart, sustainable and innovative cities. iii. smart cities: one concept, different visions? the ongoing digital transformation, which is expected to rise rapidly, is radically changing economies, societies, and our daily life. today, cutting edge technologies are indeed profoundly changing urban life and how cities are planned, financed, and managed. digitalization is certainly becoming a powerful tool to stimulate paradigmatic shifts in urban development-related visions, strategies, and implementation. therefore, digitalization has a strong impact also on the urban environment making cities more liveable, sustainable, and energy efficient. cities have indeed a crucial role for the future because are the key to addressing societal challenges since they have the critical mass of different people and influences that come together to spark innovation and new ideas [6]. in this context, a new urban model known as smart city is being developed throughout europe as well as around the world including islamic countries, where innovative technology meets tradition. oecd defines these new urban realities as “initiatives or approaches that effectively leverage digitalisation to boost citizen well-being and deliver more efficient, sustainable and inclusive urban services and environments as part of a collaborative, multi-stakeholder process’’.2 according to the literature, in a smart city, all the infrastructures are efficiently interconnected and integrated by optimizing resource consumption, improving the quality of public services, and increasing citizens’ security as well. in such context, innovative technologies and connected solutions such as iot, big data, ict, ai, etc. are the drivers of economic growth, social wellbeing, and sustainable development, by enhancing quality of life and preserving social inclusion [7-13]. making cities more sustainable, safe, and liveable is a complex issue in the process of sustainable and inclusive growth, which requires to design and manage cities with an innovative and holistic approach (involving investments in infrastructure, mobility, buildings, separate collection systems, roads, health etc.) to pursue the path towards a greener future. achieving this goal presents complex and significant challenges which concern not only an ever smarter, greener, and sustainable world view, but also the strategic choice of ethical and sustainable financial modes. this is the crux of the matter. despite the growing awareness of the importance of supporting sustainable policies in line with the agenda 2030 (such as the decisions taken and the commitment made by the g20 leaders – inter alia by 2https://www.oecd.org/cfe/cities/oecd_policy_paper_smart_cities_ and_inclusive_growth.pdf (oecd, smart cities and inclusive growth p.8, 2020) designing greener safer and smarter cities-) apart from a few exceptions3, there has so far been no corresponding strong and incisive comprehensive policy to promote compatible financial instruments for implementing such projects. financing smart cities is indeed one of the main challenges which policy makers and local authorities are bound to face. across different countries, financing smart cities requires indeed various financial tools and models including both public and private actors as well as "hybrid" models known as public-private partnership (ppp) which can be fully exploited for creating greener, smarter, and sustainable cities. according to the recommendation on effective public investment across levels of government elaborated by the oecd, it is necessary to “mobilise private actors and financing institutions to diversify sources of funding and strengthen capacities” 4 at national and subnational levels. therefore, the issue of financing smart cities is of paramount importance for the development of these new urban models which are in the vanguard of environmentally friendly urban living, technologically advanced and socially inclusive. 5 to this regard, there are many structural and managerial differences between european smart city models and those of islamic countries. while in europe the development of sustainable cities is supported by the european structural and investments funds 6 , or by the 3 such as göteborg, amaterdam, masdar city, dubai, tianjin ecocity, singapore, etc. 4 recommendation of the council on effective public investment across levels of government, oecd, p.10, 2014 5financial and economic barriers may indeed hinder the development of energy-efficient and eco-friendly cities based on low carbon economies, renewable energies, and innovative technologies. however, to promote the development of smart cities, there are numerous obstacles which need to be overcome such as institutional and administrative barriers, data integration barriers, the lack of right competences to successfully manage smart cities, the lack of an efficient shared communication network among numerous stakeholders and limited funding. these and other hurdles can be overcome through numerous strategies such as innovative governance models by revising administrative abilities as well as involving citizens in policy decisions by promoting social inclusion and the development of public private partnership (ppp). [35-38]. the recommendations previously set out are necessary to overcome various hinder to build fully functioning, integrated, and interconnected smart city models. these recommendations should be implemented both in europe, with its multilevel and advanced governance structure, and in islamic countries, where, at least on paper, these tools should be more easily accepted and should obtain the favourable opinion of the local authorities and entities interested in financing smart cities. 6 even though there is not a specific european structural fund dedicated exclusively to the development of smart cities, the european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6167 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 11/03/2022 accepted for publication: 05/06/2022 published: 29/07/2022 20 implementation of innovative programmes (such as horizon2020, life, jumper, etc.), to date in the islamic world the need to finance smart cities is perceived not (only) as a requirement in compliance with sharīʿa objectives but rather as the result of political strategies aimed at accrediting a modern and efficient image of the state at an international level.7 iv. sustainable development and smart cities: the islamic perspective from the sixties onwards, the industrial field has experienced an unpredictable and unprecedented development, which led to a misbalance between available supply and expected demand. the world’s population is growing and with it the demand for resources and products. the growing shortage of natural resources over the short, medium, and long term, will lead to a steady increase in the cost of obtaining and using the worldwide demand. there are no endless resources in the world, and to ensure enough resources for future generations, it is necessary to promote new measures toward sustainable development such as climate change strategies, resource efficiency, social inclusion, and sustainable urban planning8 [7], [14-19] [33]. from an islamic perspective, sustainable development is the perfect balance between economic-social progress and the effective and efficient exploitation of resources [20-25]. from an islamic point of view, sustainable development means achieving the ideal balance (mizan) european structural and investment funds are known to be one of the main financial instruments used by the european union within its economic and social cohesion policy for the development of smart cities. 7 about the gulf countries, and in particular to the saudi arabia, where a wide innovative reform programme is currently underway, in order to change the widespread perception of the country as the emblem of a radical, conservative islam, resistant to any form of modernisationthe development of smart cities contributes to affirming the country's leadership not only in the islamic world but also at international level. thus, saudi arabia confirm the image of a technologically advanced and cutting-edge country. in this context, there is therefore a growing need for a greater awareness of the actual effectiveness of an all-round sustainable system. 8 the most common definition of sustainable development is the one given by the united nations in 1987, introduced in the brundtland report, also known as our common future. this report defines the sustainable development as the ‘‘development that meets the needs of the present without compromising the ability of future generations to meet their own needs’. furthermore, it states that ‘’sustainable development has evolved as the guiding principle for global longterm development”. it specify that sustainable development consists of three pillars interrelated to each other: economic, social, and environmental one. between economic and social progress and the effectual and efficient exploitation of natural resources. indeed, unsustainable consumption and production and wastage of resources violate sharīʿah fundamental and general objectives (maqasid al -sharīʿa). the social aspect of sustainability requires an equal and fair distribution of resources in a way to ensure equal opportunities for all by promoting social inclusion and integration, economy development and poverty reduction and reducing environmental risks (maslaha). in such a system, based on environmental protection, equal distribution of resources and sustainable finance, work opportunities are created to improve living standards, and social cohesion, promote sustainable development and support human and social needs. islām gives indeed a great emphasis on environmental preservation, which plays a key role in human life and towards the ecological transition path. therefore, according to islām, people must adopt moderate and responsible behaviour (wasatiyya) in production and consumption to ensure an effective and efficient allocation of resources considering the needs of every member of society [26-29]. in doing this, people work towards increasing the sustainable consumption and production pattern through better allocation of resources, based on eco-friendly investments and fair distribution of resources. considering the abovementioned principles some of the most developed islamic countries, such as the united arab emirates, qatar, and saudi arabia, have elaborated a strategic path for achieving sustainable development in compliance with islamic tradition. the concept of sustainable development is strictly related to the concept of smart cities which promote interactions between citizens and innovative technologies for a sustainable urban living environment. therefore, smart cities are seen to create a sustainable urban development with citizen’s engagement in policy decisions by harnessing innovative technologies [6-13]. moreover, a smart city often requires effective collaboration and support across different stakeholders, both private and public [30-34]. the development of smart cities models requires indeed a right policy mix, which allows an efficient coordination and interaction between different stakeholders to overcome conflicts in decision-making process. although cities are becoming even smarter and more sustainable, these new urban realities require a new data management system which should be integrated and interconnected by providing access to information and exchange of data among private and public stakeholders [8,11] [31,35-38]. hence, in the implementation of a sustainable urban development model, smart cities represent an ideal solution and play a central role in promoting the image of moderate and modern islamic cities, open to innovation, progress, and technology. 9 nevertheless, local 9 moreover, in an ever changing world, thanks to their peculiarities, smart cities can be a catalyst for the development of halal tourism. for more details please see: p. biancone, s. secinaro, s. islamic european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6167 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 11/03/2022 accepted for publication: 05/06/2022 published: 29/07/2022 21 authorities should develop appropriate objectives and strategies to face the challenges and address climatic, urbanization, energetic and financial issues. smart cities are not an unattainable utopia anymore, but they are still a new concept with new technologies and require a new infrastructure investment model. in this context, the main question is how to finance the development of smart cities. according to the literature, the financial instruments used to promote the development of smart cities differ widely among different countries and may include both public and private funding as well as hybrid financing modes, known as a public-private partnership (ppp) [30], [32] [35-38]. technological progress is indeed a key driver for the development of smart cities, but it must be supported by sustainable financial instruments. among different sustainable financial instruments, social impact investments are one of the most effective and efficient for achieving the un sdgs as well as for promoting the development of smart city projects which are completely ecofriendly, technologically advanced, and socially inclusive. sustainable investments generate both socio-economic and environmental benefits such as reduction of pollution and greenhouse gas (ghgs) emissions, energy efficiency, and tackle climate change while increasing public awareness of the importance of sustainable development. [39] while sustainable and responsible investment (sri) are increasingly rising worldwide, the growing trend of green finance should be seen as an opportunity to explore the islamic financial instruments as compatible tools to promote the development of smart cities both in islamic countries and elsewhere around the world. v. islamic finance and ṣukūk the islamic financial system is based on moral and ethical objectives and therefore it is structured to converge socio-economic needs by supporting sharīʿah compliant financial instruments to foster sustainable economic growth, social wellbeing, and the protection of the environment [24] [41-43] [49-52]. the islamic finance aims indeed at promoting sustainable development in its multiple dimensions such as economic growth, poverty reduction and wealth distribution, financial and social inclusion, and preservation of the environment. therefore, islamic finance enhance the promotion of sustainable development through the principles of fairness, equality and ethics which are profoundly rooted in the above-mentioned objectives of maqāṣid al-sharīʿah. this makes islamic finance an alternative financial system to promote sustainable development globally [5] [44-48]. [5154]. indeed, due to the large scale of the needed financial resources, policy makers are turning away from conventional financial instruments, and are heading towards alternative finance and globalisation through halal tourism. quaderni di diritto e politica ecclesiastica, 131-142, 2021 financial tools to achieve sustainable goals and safeguard profit. while zakāt and awqāf represent useful financial tools to support small-medium projects, the islamic (i.e., sharīʿah compliant) bonds, known as ṣukūk, (sing. ṣakk) can be successfully used to finance bigger projects [53-59] [71]. in the international capital market, ṣukūk are indeed becoming as one of the main islamic financial instruments used by governments and private institutions to raise finance. the accounting and auditing organization for islamic financial institutions (aaoifi) defines ṣukūk as “certificates of equal value representing undivided shares in the ownership of tangible assets, usufructs and services or (in the ownership of) the assets of particular projects or special investment activity”10. more in details, aaoifi defines sukuk as “proportional undivided ownership right in tangible and intangible assets, monetary assets, usufructs, services, debts or a pool of these assets, or a business venture such as a muḍārabah or mushārakah”.11the fundamental principle is that of a strict correspondence of a financial bond to its underlying material asset. based on islamic profit and loss sharing principle (pls), the main difference between ṣukūk and traditional bonds lies in the fact that ṣukūk grant investors a share of an asset instead of an ownership of debt. additionally, ṣukūk are based on different islamic contracts to generate obligations and mutual relations between issuers and investors. depending on the underlying contract, ṣukūk can be classified as: ijarah ṣukūk (leasing), muḍāraba ṣukūk (entrepreneurship), murābaha ṣukūk (cost plus mark-up), salam ṣukūk (sale with prepayment anticipato pretio -, or late delivery), istisnā’ ṣukūk (manufacturing contract), musharakah ṣukūk (partnership), hybrid ṣukūk (convertibles and tradeables). regardless of the legal nature, ṣukūk are issued to finance sharīʿah compliant projects by paying profits instead of sharīʿah forbidden interests of loans [58], [60-62]. parties involved in the process of issuance of ṣukūk are the originator, who is the person/company who wishes to raise funds, the special purpose vehicle (spv) namely the issuer of ṣukūk -, and the ṣukūk holders who hold ownership rights on the underlying asset and its cash flows. issuing ṣukūk12 is like a western law securitization process, given (that) the ṣukūk structure relies on the creation of a spv. the latter is a separate legal entity with no part in the borrower’s liabilities. the spv issues ṣukūk certificates in consideration of certain goods underwritten by the investors. the originator subsequently buys the required asset using the gains of the sale of the certificates. moreover, the spv protects the underlying assets from creditors if the originator faces financial problems. 10 aaoifi shari’a standard no.17, p. 468 11 aooifi ifsb-15 – revised capital adequacy standard for institutions offering islamic financial services, p. 106,2013 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6167 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 11/03/2022 accepted for publication: 05/06/2022 published: 29/07/2022 22 the capital raised must be used for investments in specific assets rather than for undetermined purposes. the funds raised by the investors are later used by the spv to buy assets from the originator who, in turn, uses the capital raised to finance sharīʿah compliance projects. in this way, the investors become pro-quota owners of the originator’s goods, which can be the object of specific contracts made by the spv (such as muḍāraba, musharakah, ijarah etc.). in the end, the originator can purchase the asset back from the special purpose vehicle at its normal value and distributes the revenues to the ṣukūk holders [59] [63, 65]. even though the global ṣukūk market is smaller than the bond one, it has been growing rapidly since the economic-financial crisis, and its future looks bright. because of the specificities of the ṣukūk market, the private sector is becoming increasingly interested in the market, which is expected to preserve high levels of liquidity, which will continue to raise interest among financial institutions. vi. green ṣukūk: sustainable ethical and financial instruments the islamic green finance market represents an opportunity for economic social and political integration, through which several roles, information and competencies come together. anyway, under different contexts, both private and public actors contribute to fostering the promotion of islamic green finance which can be a driver for the growth of green investment at the global level. [44-46]. to support green and sustainable projects, islamic financial institutions have been issuing a particular kind of sharīʿah compliance bonds, called green ṣukūk. green ṣukūk are islamic green bonds which provide funds for sustainable projects and climate change solutions such as renewables energies sources, low carbon technologies and other environmental assets [66-71]. therefore, eligible asset for these kinds of ṣukūk are identified by climate bond standards certification scheme such as renewable energies, smart mobility and infrastructures, energy efficiency, light rail, electric vehicles etc. this scheme is used by investors, bond issuers and governments at a global level to ensure that investments contribute to addressing climate change and developing smart cities. from a financial point of view, green ṣukūk are likewise traditional ṣukūk (expecting that the proceeds of green sukuk can only finance eco-friendly projects) and therefore the issuing process includes the same steps of the conventional one [61,65]. for the revenues to be admissible for sustainable projects, investors need to take into account that the mobilized capital will not finance activities forbidden by sharīʿa. hence, a better understanding of sharīʿa objectives and rules is required to promote the diffusion of the green ṣukūk, and the development of the market. as the following examples demonstrate, green ṣukūk provide not only economic benefits but also social and environmental ones while integrating the concept of social maslaha through sustainable financial instruments. by issuing green ṣukūk, investors have indeed the chance to combine financial aims with wider societal impact in their investment activity since their specific assets produce both financial returns and positively impact the environment (such as renewable energies and infrastructure projects, smart mobility projects, waste management resources and so on). moreover, green ṣukūk, in addition, to generating social wellbeing and economic returns, enable investors (the ṣukūk holders) to benefit from sustainable projects. green ṣukūk can link indeed socially aware investors with companies that want to deliver social outcomes driven by an overall aim of improving social welfare as well as sustainable development which is perfectly in line with sharīʿa main objectives. hence, green ṣukūk raises awareness among different investors about how green and innovative projects – which are the basis of smart citiescan face current challenges such as climate resilient growth. for these reasons, green ṣukūk are becoming increasingly popular in the investment strategy of numerous islamic countries and cutting-edge companies working in these fields. thus, green ṣukūk allow the –increasingdevelopment of the global sharīʿa compliant capital market to raise fund for environmentally friendly projects with socially meaningful impact such as smart and sustainable cities. according to bashar al natoor malaysia, indonesia, and the united arab emirates are one of the main drivers for ṣukūk issuance and are therefore the main countries most active in the market of green ṣukūk. historically, the tadau energy sdn bhd, issued the first green ṣukūk in 2017 in cooperation with the world bank and with the central bank of malaysia. the underlying contract of this green ṣukūk were isti sna’ ṣukūk and iǧāra ṣukūk issued to finance the construction of a 50mwac solar plant in kudat sabah, for a total amount of 250 million rm. numerous issuers followed the footprints of tadau and in the same year, the first green sovereign ṣukūk, (based on iğāra ṣukūk) was issued in indonesia to finance eco-friendly and sustainable projects, for a total amount of approximately $1, 25 billion. thanks to new and sustainable economic development strategies, there is also a strong push for green ṣukūk in the united arab emirates, where the first middle east green ṣukūk was issued by the national bank of abu dhabi (now first abu dhabi bank) in 2017. moreover, in the united arab emirates, there are also numerous "green" initiatives -which require significant investmentssupported by sovereign funds and which could be the driver for the development of the middle east green bond and green ṣukūk market.13 13 among these initiatives, “the abu dhabi vision 2030”, a longterm economic vision, developed by the government in consultation with the private sector, aims at reducing the emirate’s oil dependency by achieving a 64 per cent contribution to gdp from non-oil sectors by 2030 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6167 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 11/03/2022 accepted for publication: 05/06/2022 published: 29/07/2022 23 the emerging market of green ṣukūk is a selfregulating market despite several guidelines and different principles such as the green bond principles developed by the international capital market association (icma). according to the latter, the green bond principles “are voluntary process guidelines that recommend transparency and disclosure and promote integrity in the development of the green bond market by clarifying the approach for issuance of a green bond. the gbp are intended for broad use by the market: they provide issuers guidance on the key components involved in launching a credible green bond; they aid investors by promoting availability of information necessary to evaluate the environmental impact of their green bond investments; and they assist underwriters by moving the market towards expected disclosures which will facilitate transactions”14however, these guidelines, concerning both the green bond issuance and the terms of insurance, might not be compatible with islamic principles15. additionally, the islamic development bank is strongly committed to widely promote the development of green ṣukūk 16 . the bank is mainly focusing on non-sovereign infrastructure projects to foster economic development, job creation, social inclusion and the transfer of skills and competencies to achieve sustainable growth in its member countries. the use of green ṣukūk for the development of smart cities is doubly advantageous since, in addition to being financial instruments based on principles of transparency and social responsibility, green ṣukūk are a means to achieve a tangible, determined end, closely linked to the real economy such as sustainable projects. over the last years, green ṣukūk have indeed become more popular for funding sustainable and eco-friendly projects including smart mobility, infrastructure projects, energy-efficient buildings, sustainable waste management, renewable energy projects and other projects aimed at mitigating the effects of climate change, which are fundamental for the development of the smart cities17. the 14 https://www.icmagroup.org/sustainable-finance/the-principlesguidelines-and-handbooks/green-bond-principles-gbp/, p.8 15indeed, according to sharīʿa, the insurance contract is unlawful, and it is regarded as unjustified enrichment based on the prohibition of ġarar (uncertainty) in financial transactions. 16 https://www.isdb.org/sites/default/files/media/documents/202101/a nnual%20impact%20report%20on%20isdb%20debut%20green% 20sukuk%20%28dec%202020%29_0.pdf 17after the tadau energy which issued the first green ṣukūk in 2017, quantum solar park malaysia has issued the world’s largest green ṣukūk (rm1 billlion) to finance the biggest solar photovoltaic plant project in southeast asia which is located in pendang. (the company partnered with the norwegian statec, cimb, and maybank). concerning the gulf countries, even though saudi arabia is the largest issuer of ṣukūk, the gcc’s first green ṣukūk was issued by the national bank of abu dhabi in 2017 and in 2019 by the uae-based real estate developer majid al-futtaim which raised $600m to fund green buildings and energy efficiency projects. in the same year, the reason why the issuance of green ṣukūk is gaining ground is that green ṣukūk have not only economic and environmental advantageous but also social ones. indeed, as previously set out unlike the green bonds, the ṣukūk holder is the owner of some undivided share of underlying assets and therefore he/she will benefit from the management of the underlying assets. thus, the eco-friendly project financed with these instruments contributes to both reducing the environmental impact and improve community life while increasing social wellbeing. therefore, green ṣukūk among all others financial instruments sharīʿa compliant, can play a crucial role in addressing threats faced by the environment and have the potential to promote the development of affordable, reliable, sustainable, and modern cities. indeed, according to the literature, there are numerous eco-friendly projects that have been financed with green ṣukūk (such as photovoltaic systems, electric vehicles, waste management systems, etc.), as in the gulf countries or in malaysia and indonesia. what is missing, however, is an overall vision of the smart cities from a financial perspective. exploiting the peculiarities of the islamic financial system, and in particular the green ṣukūk could therefore be the keystone for the development of these new urban realities not only in islamic countries but throughout the world. green ṣukūk have indeed the potential to attract a wider pool of investors, both green and sharīʿa compliant ones (both conventional and islamic ones) since there are notable shared values and aims between green and islamic finance in terms of advocating certain principles such as ethical and moral ones. therefore, for conventional (green) investors green ṣukūk are a viable financial alternative able to meet their goals for green investments and could result in bringing in more investors from western countries with sustainable investment mandates into ṣukūk markets. moreover, green investors are particularly interested in issuing green ṣukūk for two main reasons: the first one lies in the fact that green ṣukūk provide investors that their money are used to finance green and sustainable projects, and the second one is that there are many greener financial tools on the equity side of the capital market instead of on the fixed income side. additionally, since ṣukūk are similar to a conventional fixed income security, these financial instruments can bridge the fixed income supply gap for green investors because money are reserved for specific green purpose. the development of smart cities requires significant investments and that is the reason why the public sector has traditionally provided sustainable funds for urban planning. saudi-based islamic development bank issued its first green €1 billion ṣukūk to finance climate change, renewable energies, and sustainable projects across its 57 member countries, as an instance for the potential of financial institutions in promoting sustainable finance. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6167 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 11/03/2022 accepted for publication: 05/06/2022 published: 29/07/2022 24 indeed, private investors have only recently started to invest in green projects since an inadequate risk-return profile was one of the major hurdles to attracting private investors for infrastructure projects. since sustainable urban infrastructure projects of smart cities have a cost premium and carry more risks than conventional projects, there was the need to overcome this and other hurdles to develop financially viable, smart and sustainable projects in cities. in light of this, islamic finance, through innovative financial tools such as green ṣukūk helped to overcome these barriers (e.g., the riskreward profiles of sustainable investments). using green ṣukūk to implement smart cities projects can mitigate initial costs and project risks by balancing the real or perceived risk of investments with a limited commercial track record but strong sustainable development impact and effects. therefore, financing sustainable projects -such as sustainable infrastructure projectswith islamic green ṣukūk, has the potential to raise money from both public and private investors while ensuring climate-smart design standards. in addition, as stated above, with green ṣukūk, investors do not have to opt between financial returns and environmental benefits and can be issued to finance sustainable projects by various investors including municipalities, banks, companies and any other private investors. therefore, given the social ethical principle and emphasis on risk sharing and asset-backed financing, green ṣukūk can play a crucial role in financing smart, green and innovative projects and enhancing public and private collaboration for juster, low-carbon and sustainable cities. nonetheless, to ensure continuous progress in this field, steady innovations and new ways of thinking are needed. for example, one such innovation is to use crowdfunding as one of the fundraising options for green ṣukūk by allowing investors to finance innovative and sustainable projects alternatively. these projects such as solar park, renewable energies projects, sustainable infrastructure etc. have good participation rates and excellent prospects for long-term development indeed. lastly, the establishment of a comprehensive legal framework, joined with financial technology revolution such as crowdfunding etc, can be a catalyst in promoting the overall growth of the green ṣukūk market. as stated above, islamic finance can play a crucial role in supporting economic and social development indeed. however, the islamic development bank has to spread the knowledge of these instruments while exploring relevant policy, legal and regulatory framework as well as institutional interventions needed to promote islamic green finance. in doing so, the implementation of sharīʿa standards and rules to simplify the creation of a more stable, efficient, and international financial system is paramount of importance. on top of this, the current global pandemic not only has significant health effects but also socio-economic ones. nevertheless, the covid-19 pandemic is heightening public awareness of sustainability issues with a growing global recognition that law carbon economy, sustainable development, innovative and (sustainable) financial instruments as well as smart cities, is the only way forward. hence, covid-19 is leading to global awareness of the importance of a greener future based on the efficient and effective exploitation of resources since there is no room to develop unsustainable projects. in such a context, the dissemination of the knowledge of the islamic financial instruments (particularly the green ones such as green ṣukūk) can be crucial and inevitable for achieving this objective worldwide. vii. conclusion when technological innovation, policy makers, and citizens come together to improve the quality of life by creating an efficient shared information network, with a longterm strategic vision, that is when cities truly become smart and sustainable. achieving this goal presents complex and significant challenges which concern not only an ever smarter, greener, and sustainable world view, but also the strategic choice of ethical and sustainable financial modes. building sustainable and resilient cities, requires indeed significant investments, most of which take place at national as well as at subnational level and managed by local authorities. both public and private investments are therefore needed to make cities smart, sustainable, inclusive and climate resilient. however, access to finance represents one of the main hurdles to implementing an efficient smart city strategy, and policymakers need, therefore, to develop original strategies to differentiate funding as well as strengthen citizens' access to finance and involve them in decision-making processes (as agents of change). in this context, the islamic financial system based on moral and ethical objectives (maqasid al -sharīʿa) can play a crucial role in promoting social equilibrium, innovation, and sustainable economic growth which is the very basis of the concept of smart cities. islamic finance provides indeed sustainable financial instruments known as green ṣukūk capable of reducing environmental impact by allocating funds to eco-friendly projects (e.g., renewable energies, electric vehicles, smart mobility) while increasing social wellbeing. moreover, financing eco-friendly projects by issuing green ṣukūk can mitigate initial costs and project risks by balancing the real or perceived risk of investments with a limited commercial track record but strong sustainable development impacts and effects. therefore, given the social ethical principle and emphasis on risk sharing and asset-backed financing, green ṣukūk can be the keystone for enhancing public and private collaboration and for creating more just, low carbon, and sustainable cities throughout the world. however, if on one side islamic financial instruments – first of all, the green ṣukūk – represent an alternative to conventional tools in achieving sdgs, on the other side the bigger problem is related to the lack of a global, comprehensive vision of the cities which includes economic, social and environmental issues. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6167 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 11/03/2022 accepted for publication: 05/06/2022 published: 29/07/2022 25 in terms of policy implications, this requires new policy practices based on smart and inclusive decision-making processes which promote the development of innovative and sustainable financing strategies. policymakers should therefore diversify the financing mix by fostering sustainable and ethical financial instruments and eventually moving away from financing tools that do not promote the transformative vision of the 2030 agenda. references [1] e. agliardi, r. agliardi, “financing environmentally-sustainable projects with green bonds”, the economics of climate change and sustainability in environment and development economics vol. 24, pp. 608-623, cambridge 2019 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international license received: 15/03/2022 accepted for publication: 26/05/2022 published: 29/07/2022 1 research methods for islamic banking and finance law: interdisciplinary research method sanaa kadi1 1 university of helsinki, finland contact author: sanaa.kadi@helsinki.fi this study presents an original guideline for choosing valid research methods when analyzing islamic banking regulations and islamic finance laws. it presents a theoretical model that explains the complexity of the field of islamic banking and finance, provides legal scholars with a brief analysis of the various issues and challenges that may arise while researching islamic banking and finance law, and offers different possibilities and solutions to progress and supply high-quality research into islamic finance. research on islamic finance in recent decades has produced extensive literature; however, most of it is descriptive and lacks standard research methods. this creates uncertainty for young scholars and graduate students about the method that should be adopted to address the legal approach to islamic banking and finance. the outcome of the study leads to the fact that due to the complexity of the subject, multiple research disciplines may interfere with each other in answering different research questions. accordingly, various solutions have been proposed to help researchers and students with their choices. the study offers an original and unique standard for legal scholars in approaching islamic banking and finance law. keywords-research methods; methodology; islamic finance law; islamic banking law i. introduction the research methodology of islamic finance is different from the research methodology of conventional finance. empirical research, however, shows that different research literature comparing the performance of both sectors gives different results depending on the research methods utilized during the studies [1]. moreover, in 2022, salami, tanrivermiş, and abubakar[2] recognize four categories of stakeholders in their research on the methodology of islamic finance: the first category is classified as islamic scholars having a relative understanding of islamic finance from the quran, hadith, and other islamic sources, including islamic jurisprudence (fiqh); the second group of stakeholders identified in islamic finance research is scholars acquainted with research methodologies, and they are frequently researchers; the third group recognized is the market investors and persons seeking islamic finance research outcomes to make the right investment choices. the fourth group is unlike the others and comprises those who review or implement universal financial standards in the various states involved with islamic finance. the results showed that the first three groups of stakeholders recognized are not combined, thus leading to the fact that most of the research outcomes in islamic finance are redundant. therefore, the standardization of methodology is a challenging mission.[2] islamic banking and finance law deals with rules that apply to the islamic banking and finance system. this implies its consistency with the principles of islamic law and engagement with islamic economics. islamic principles are interpreted differently due to the variances in the islamic schools of jurisprudence.[3] after the financial crisis of 2008, the islamic banking and finance sector started to attract more investors from its conventional counterpart.[4] islamic financing has expanded due to its different benefits.[5] besides, ikra, rahman, wanke, and azad stated in 2021 that research on islamic banking has increased since 2008 with an annual growth rate of 12.5%.[6] beik and nursyamsiah (2022)[7] stated that this is seen as an aspect of opportunity for the sector.[7] recently, islamic finance professionals began to adapt and adjust theories to make islamic finance an appropriate industry; this required the islamic finance industry to convert from a sharia-based system to a sharia-compliant system.[8] in addition, the islamic finance industry is witnessing diverse phases of development in different states.[3] while in modern times, conventional disciplines use standardized research methods and practices, research methods and techniques adopted in the islamic disciplines, including islamic economics and finance, are lacking standardization.[9] besides, islamic finance has attracted a huge scientific interest[10] although research on islamic finance in european literature is not abundant.[11] on the other hand, statistics show that in the period between 2005 and 2017, 490 theses and dissertations on islamic banking and finance have been approved worldwide, and 268 were accepted in different universities in the uk between 1980 and 2017.[12] durham university in the uk launched the durham centre for islamic economics and finance[13], and other european universities have established programs and courses on islamic economics in their curricula. hence, independent styles and varied mechanisms have been european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6628 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/03/2022 accepted for publication: 26/05/2022 published: 29/07/2022 2 developed by different islamic institutions, experts, scholars, researchers, and instructors, mostly in the field of islamic economics and finance; in the meantime, they have implemented methods and techniques that refer to conventional standards yet are adapted to islamic thought; this is due to the fast growth of the islamic finance industry, unlike the field of research and professional development of islamic finance, which was left a long way behind.[9] when analyzing islamic banking and finance from a legal standpoint, the first central instruction is to carefully choose what research methods are best suited to provide high-quality research and answer the research questions consistently. previous literature in the field of islamic banking and finance was more focused on historical and theoretical progress and descriptive examination.[14] there is an urgent need to explore research techniques and research methodology in islamic banking and finance.[14] furthermore, it is recommended to find research standards and mechanisms intended for islamic banking and finance based on sharia law.[9] research should also avoid descriptive analysis and needs to focus on bringing new findings that add further value to the existing literature. legal researchers implement proper research methods that they have learned in faculties of law; however, islamic banking and finance is a recent and unique field of research that has developed rapidly in different directions. about this current debate, we need to inspect what the appropriate research methods that can be used by legal academics are. the purpose of this research is to fill the gap in the current literature by offering solutions and alternatives for research methods. this study is important because previous literature on research methods in islamic finance has concluded that islamic finance studies have abusively used different research methods,[14] leading to contradictory results. contrary to previous research on methodology, this study is exclusively original because it carries a whole analysis of several situations and issues and brings different alternatives and solutions to approaching islamic banking and finance law even if the legal researcher has no solid background or has no previous knowledge at all in the field of islamic finance. this will encourage and benefit law students wishing to study or examine islamic banking and finance law. the subsequent section debates the main academic theories on research methods; the following section presents the research methodology aimed at assessing the different research methods in islamic economics and finance and their relationship with the legal field; the discussion section analyzes the main findings and discusses them according to the present literature. this is followed by the last section of this study that offers a summary of the conclusions. ii. literature review research methodology in islamic economics has several facets. there are many factors influencing it positively or negatively. for example, beik and nursyamsiah (2022) [7] consider research methodology as having strength aspects because research methods have a spiritual value; they are justified by islamic jurisprudence and use different research methods; they also consider that the conventional theory is dominant and that there is a lack of research topics applied in islamic theory.[7] thus, different aspects are discussed in this part of the study. a. the need for standardization in research methods for islamic banking and finance law all during the past centuries of islamic jurisprudence, muslim scholars tried to construct and plan solid, suitable, and valid islamic research methods to bring out evidence from the primary sources of islamic law.[15] different methods and techniques are used when researching islamic banking and finance; also, islamic banking and finance and their conventional counterpart are different in ideologies, yet the same methodologies are implemented to research both sectors[14] and this can lead to different outcomes. therefore, there is a need to use a unified method to research islamic banking and finance and circumvent the misuse of position.[14] on the other hand, the number of universities worldwide offering programs in islamic finance and economics is increasing, and teachers and lecturers of islamic economics and finance who are involved in the industry can improve the quality of teaching in higher education.[16] in 2020, 21 among the universities offering islamic finance programs are counted in the qs global world ranking university list; this is one of the key factors to success in developing standard research methods in the field of islamic finance.[17] it is the market that determines the progress of standardization. so far, the focus of scholars and researchers on integrating classical legal interpretations complicates this central element.[18] therefore, it was mistakenly stated that islamic financial law echoes the resonances of traditional islamic law in contemporary financial markets; islamic financial law is a hybrid model of law which represents modern market activities and legal facts. the refusal to revise the law prevents the development of islamic finance law.[18] moreover, there is a need for further collaboration between legal researchers, sharia scholars, and different islamic financial institutions (ifis) to develop guidelines and standards to achieve the social and economic goals and islamic principles they follow.[19] this would support researchers and graduate students doing their research about islamic finance and help them in choosing the correct research methods that they need to utilize in their work to develop islamic banking and finance law. b. history, religion, philosophy, ethics, society, and economics to understand the law european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6628 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/03/2022 accepted for publication: 26/05/2022 published: 29/07/2022 3 islamic law (sharia) started to develop after the beginning of islam. teaching and methodologies in islamic studies have developed through several periods; the early period, consisting of the foundation of islam, took place in both mecca and medina through discussion circles, a basic model called halaqa; then during the medieval period the seat of power was moved to damascus and islamic teachings had a great interactive exchange with greek philosophy found in the new territories.[17] this influenced the development of the islamic civilization, and more precisely the development of new teaching and research methods of islamic philosophy, such as debate, lectures, correspondence, reading circles, and scientific trips.[17] at that time, islamic economics started to flourish especially with the development of islamic legal canons and the progress of the teachings and jurisprudence concerning the objectives of islamic law (maqasid al-sharia) and the islamic jurisprudence on commercial transactions (fiqh al muamalat). there is a precise methodology of islamic law called usul alfiqh; the purpose of this methodology is the understanding and authentication of the legal sources and the extraction of the legal rulings.[15] recently, islamic finance started to attract global interest due to its ethical principles that are linked to the goals of sustainable development.[20] gilani[21] stated that islamic banking got a global increase because of the growth of ethical banking and that the islamic banking and finance industry used this ethical label to attract clientele. many other authors[22] have revealed that the islamic finance sector is not directly interested in environmental and social sustainability policies even if economic sustainability practices are developed. recent research has shown that the islamic banking industry realizes only 35% of the ethical and moral goals of islamic economics[23] however, in another study in 2021, prandi and colecchia[24] concluded that, notwithstanding the critiques, the islamic financial model remains authentic and loyal to its ethical principles.[24] on the other hand, biancone, saiti, petricean, and chmet[25] demonstrated in 2020 that the literature on islamic finance emphasizes the banking sector, comparisons with conventional banks, rates and portfolios, examination of governance and control structures; they ended up in their study with the fact that analyzing the ethicality of islamic banking and finance has been relegated to a secondary position[25] this leads to interesting questions about the factors that influence the choices of islamic finance researchers and scholars. we can suggest that islamic banking and finance as an economic system is comparable to its conventional counterpart; some of the financial instruments rely on the standardization and harmonization of islamic securities with the general standards of global securities to flourish.[5] however, we cannot disagree about the fact that islamic banking and finance has gotten its power from divine prescriptions and was also influenced by historical and philosophical developments. it has progressed through socioeconomic factors and been branded with ethical values. for that reason, there is a need to adopt interdisciplinary research methods to make a legal analysis. however, a major point needs to be raised about the type of methods used to analyze these questions. it is important to remember that islamic legal norms and their primary sources can easily be distorted from their real meaning if the research method is wrong or if it is inaccurately used.[15] therefore, if the aim of the research is associated with the legal norms and rulings of sharia law and sharia principles, it is required to use usul al-fiqh methods.[15] besides, if the purpose of the research is to analyze factual outcomes, behaviors, or reality practices, then it is better to use modern research methods that supplement the islamic methodology.[15] the reason behind this choice of proceedings is that the practices of muslims, the factual reality of specific islamic systems or institutions cannot be constantly illustrative of what islamic law is intended to be.[15] in consequence, researchers of islamic studies have the responsibility to identify and acknowledge the aims of their research in order to provide sound and valid results with strong evidence. correspondingly, the economic analysis of law is a major research method that tries to find answers to elementary questions regarding the effects of legal norms on the behavior of the concerned stakeholders and how the effects of these legal norms are acknowledged by society (sanchez-graells, 2017). in that sense, islamic jurisprudence and economics have different methodologies “as the former is normative and the latter is descriptive” [26, p. 120]; thus, using economic analysis of islamic banking and finance law will support the research of the effects of islamic banking and finance law and how the effects of these legal rules are necessary for the different stakeholders and the social order in general. c. economics and islamic law theoretical economic understanding leads researchers to determine problems of legal decision-making and facilitates resolving these problems.[27] firstly, because the economic theory affords methods to analyze the legal reality of the decision-making, and secondly it offers a normative outline and practical standards to select specific substitutes as solutions.[27] additionally, islamic banking and finance law is the result of different disciplines all interacting together and creating a unique framework that is worth profound analysis and an eventual assessment of how the legal norms of islamic banking and finance are constructed, interpreted, and implemented. thus, empirical research has shown that the resemblance between islamic banking and its conventional counterpart is not beneficial to the former.[28] moreover, the purpose of integrated knowledge research methods in economics and finance is to bring regulations and financial solutions and remedies that focus on human well-being rather than organization economic interests.[26] this will support the identification of the issues and challenges related to this financial sector and will help find justifiable remedies and sustainable solutions for the future. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6628 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/03/2022 accepted for publication: 26/05/2022 published: 29/07/2022 4 as discussed above, literature on islamic banking institutions has been using different research methods. to analyze the financial performance of banks, in 1979 a method called camel was developed in the usa; the north america bank has adopted this method to examine the consistency of financial lending establishments; camel is a well-known method to analyze banking performance even though many other methods were developed later.[11] this is the case for the islamic banking system; camel was implemented by islamic banking researchers and experts. it is commonly used for the ranking of islamic banks based on their performance and used even in comparing islamic banks and conventional banks; however, this method is not always effective because the data needed to analyze performance is not always available on the different platforms that supply databases of different islamic banks.[11] moreover, the methodology of positive economics is not neutral and has prejudiced western economics during the last 100 years[26] islamic finance is taking similar steps due to the dominance of the positivist paradigm.[26] the performance of the islamic banking industry is constantly measured according to its resilience to financial crises and shocks;[29] it is measured according to its performance even during the crisis of the covid-19 pandemic,[30] or in situations where the price volatility of energy resources and precious metals was notable.[4] therefore, researchers should always try to find a suitable method to analyze islamic banking performance in a way that supports the purpose of the research questions and does not create more prejudice or bias to the islamic financial system by using the same criteria that are used for conventional banking since the two sectors are based on different ideologies. this is a challenge that researchers should always consider before deciding what research methods they employ when evaluating the islamic banking and finance sector and what their purposes are. another challenge is the free access to or availability of open data for research purposes concerning islamic banking, as the banking sector is a sensitive sector, which makes the work of researchers complicated when dealing with a database, especially at the beginning of their career. d. international business research methods also, researching islamic banking and finance from a legal standpoint includes analyzing international business regulations. to succeed in the international business field, scholars need to master high-quality research methods;[31] research quality in the field of islamic finance is not of particularly high quality on the global level.[9] that is why it is important to think about the methods to use before starting a thesis. mckim[32] argued in 2017 that theses and dissertations nowadays more often include the concept of “mixed methods”; besides, there was also an increasing interest by graduate students in mixed methods because they help them understand the phenomena better than if there was only one specific method used. students give value to mixed methods because they see the utility of using them; researchers need to adapt to the fact that they will instruct and tutor graduate students, so they need to understand how their students perceive research.[32] therefore, international business (ib) scholars are confronted with choosing specific research methods due to the special characteristics of international business studies.[31] students who yet believe in their capacity to succeed in their studies with good grades, students interested in statistics, and those having a positive attitude about the field of statistics, are less anxious about learning how to deal with data analysis.[32] consequently, we suppose that including mixed research methods will be valuable for graduate students and other researchers in the future. moreover, when the researcher plans to continue working in the same field of research after graduating, it is essential to develop different skills of analysis by using different research methods. besides, the internationalization of academia obliges legal researchers who want to succeed in their careers and publish in high-quality journals to learn new scientific skills and new research methods. this is an expected, if not inevitable, situation that every legal researcher should be aware of. iii. methodology a. critical legal research as a tool to find remedies for legal issues in islamic banking and finance research work at the doctoral level is expected to be critical.[33] accordingly, examining islamic banking and finance law must include critical legal thinking to improve the quality of the research.[12] the field of islamic finance has a huge debate about whether islamic financial instruments are effective tools for the challenges of the conventional financial system, and this remains one of the central legal research questions in this field. however, as the juridical structure by which society is regulated is considered as valid and lawful, it is extremely hard for a researcher, especially at the beginning of his career, to bring a new idea that is completely against a valid positive law.[33] moreover, even if the aim of the researcher’s criticism is to repair and find remedies to the issue, the subjective contribution might be distrusted by the legal orthodoxy.[33] modern islamic banking and finance have roots going back to the beginning of islam when islamic partnership contracts – mudaraba and musharaka – were common practices and lasted for many centuries as transaction tools; these contracts have ceased to develop, but came back to the surface again after the end of colonialism.[34] grossly defined, two chief features of islamic banking and finance are: firstly, capital deposit is guaranteed but interest is prohibited on deposits;[35] secondly, loans are interest-free, and speculation is prohibited,[36] but investing through islamic partnership contracts applies the principle of profit-and-loss-sharing (pls).[37] these principles – especially the interest-free principle – are, from a western point of view, completely different from conventional banking rules. islamic finance is a system using a specific form of legal and financial norms which are compliant with islamic law european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6628 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/03/2022 accepted for publication: 26/05/2022 published: 29/07/2022 5 (sharia), later developed to become islamic economics[38] and islamic finance law. in addition, the islamic financial system is not governed only by sharia law since islamic finance is not necessarily situated in an area where islamic law is the applicable law.[38] islamic finance was introduced into many western countries, and several conventional banks are opening islamic windows that offer islamic products. furthermore, states in which islam is the religion of the majority do have a conventional banking system as well and offer usury contracts that are not sharia-compliant. minkkinen (2017) explains that the pure theory of law is not only to afford theoretical frameworks for decision-makers and lawyers on how to interpret the law; the only purpose of the pure theory of law is to recognize legal norms and to define them scientifically; in that way, the objects of research are also identified in a scientifical method. b. islamic banking and finance law methodology for future studies the core principles of islamic banking and finance are taken from the quran; their justification is based on morality and common sense. morality as a western legal norm, in the sense of critical legal method, more precisely from a kantian perspective, is not a result of a cause[33] morality is an autonomous will of the individual to do something, not an obligation coming from a specific consideration, but then again, from the point of view of kelsen, the standardization of legal norms in the society allows undertaking the scientific description of that same society significantly, and that society is the normative order.[33] in that sense, the legal norms that regulate islamic banking and finance will support addressing the normative order of islamic business law that regulates islamic banking and finance. in other words, using the critical legal method will help us analyze whether islamic banking and finance as it is applied nowadays is complying with the normative order that allah first ordered in the quranic texts, or is just a deviation from the legal norm that ought to be in order to legalize banking and finance instruments for the muslim society and to sell its products as moral and ethical by attracting the attention of a larger community worldwide. also, it is important to understand the socioeconomic and political factors and their influence on improving islamic finance.[39] alotaibi, helliar, and tantisantiwong[40] have stated that the different stakeholders of islamic finance expect the islamic finance industry to comply with the religious rules and principles of islamic economics; however, they found in their study that islamic funds do not always respect business ethics and that they only partly follow these principles. on the other hand, the islamic banking industry is more concerned with mitigating operational risks.[41] this is useful for verifying whether the islamic financial industry is ethically complying with the principles of islamic banking and finance that originate in islamic law. in that respect, each researcher should utilize different research methods that support the different research questions. however, aguinis, ramani, and cascio[42] argued in 2020 that the challenging issues reported in ib published articles consist of examining models of theories in a specific state with a particular legal system throughout a precise period, or through connections or variances between two different states, or investigating a specific commercial product type in a specific market in a specific area. aguinis, ramani and cascio therefore suggest that instead of considering these particular challenges as insufficient evidence or limitations, they should reconceptualize these challenges and make from them new theoretical outcomes of further development [42, p. 1599]. furthermore, research questions, statements, and shared knowledge can be strongly emphasized through pragmatism as this helps capture information when linking data with theory; this is specifically beneficial throughout the incorporation phase of mixed methods.[43] therefore, the conclusions that will arise from this research will bring further theory development and will be beneficial to future researchers. moreover, salami, tanrivermiş, and abubakar (2022)[2] offer interesting solutions to make islamic finance research more valuable for appropriate stakeholders such as business operators and ordinary people. one suggestion is that islamic finance researchers should reduce their concentration on the econometric modeling characteristics and put more emphasis on explanation of results in a method that ordinary persons may well comprehend. moreover, researchers in islamic finance, particularly using accounting ratios in their research, should consider the rules of international financial reporting standards (ifrs) implemented in the specific state where the research is conducted. otherwise, the results, mostly in cross-border research, can be affected.[2] these suggestions are also valid from a legal research perspective, as legal scholars are not expected to have a solid background in econometric modeling research methods. they focus more on economic results to find sustainable solutions and remedies and facilitate decision-making. iv. discussion a. the need for a further survey to reveal new research methods researchers need to supply evidence that supports their claims or arguments; as a result, their research outcomes will stand valid.[15] ib research turns out to be multifaceted and diverse; there is a need to be conscious of the challenges a researcher may face when deciding on what research methods should be implemented.[42] shannon-baker[43] argued that instead of being worried about whether a researcher selects the ultimate research method, it is more relevant to look at the reasons for this choice. the purposes of research on islamic european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6628 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/03/2022 accepted for publication: 26/05/2022 published: 29/07/2022 6 banking and finance law are wide and complex, which makes it unique in its genre.[44] the uniqueness of each research plan and research question points toward the construction of a mixed-methods research design that fits with the plan and the questions of each research; thus, the construction of this design requires that the research methods be in interaction with the research questions.[44] moreover, research methods are just a tool to support researchers in their investigation work, and tools can be developed to cope with modern research: artificial intelligence (ai) tools, for instance, developed by machine learning (ml), are constantly progressing in the field of islamic finance.[45] besides, the implementation of fintech regulations in islamic banking and finance will necessitate skillful legal scholars that are able to analyze regulations on the financial industry using computer-based technologies.[46] therefore, academics and legal scholars in general and researchers in the field of islamic finance must be concerned with learning the modern technologies of the 21st century to develop their research skills following the needs of the industry. b. modern laws vs. islamic law legal scholars can influence the islamic financial sector in many ways; one example is that when an islamic financial sector needs to develop new islamic financial products, lawyers and jurists can participate with the bankers on the sharia-board level in the creation and the marketing of new islamic financial products. their role is major when adjusting and amending a current conventional product, which is not originally sharia compliant.[47] then by replacing these non-compliant features with islamic ones, in the end adding a traditional contract name from islamic jurisprudence, it can be advertised as a shariacompliant product.[47] lawyers that have participated in the creation of these islamic financial products can influence research as well; as they are legal scholars, academics, panelists, and university professors, they can analyze the products as islamic and sharia compliant. also, from an islamic law perspective, it is important to make the distinction about the aim of the research itself; if the research purposes are to analyze correct answers related to islamic practices and performances, then the use of modern legal and socio-legal research methods is possible with reference to sharia law. but if the purpose of the research is to analyze norms and principles of islamic law, then, it is essential to use usul al-fiqh methodology.[15] furthermore, the epistemology of usul al-fiqh in the 20th century started to give more importance to universal ethical principles in contrast to the specific injunctions of the islamic legal texts, such as the principle of public interest, maslaha, which is a major standard for making new legal rules; this example can explain the process of the exertion (ijtihad) of the islamic jurists and scholars to develop specific fiqh rules by using the principles of usul al-fiqh.[48] another important issue is maqasid al-sharia or the goals of islamic law; according to beik, swandaru and rizkiningsih, maqasid al-sharia must be a crucial element when measuring islamic values in islamic economics and the finance industry.[49] for example, if the research is on maqasid alsharia as an islamic legal principle, the use of usul al-fiqh is desirable. but then if the aim of the study is, for example, to measure the importance of maqasid al-sharia in improving the performance of the islamic banking industry or the level of social reporting, then quantitative research methods, for example, can be utilized.[50] also, rafikov and akhmetova[26] propose the solution of using the collective ijtihad method to solve the challenges of multidisciplinary approaches to islamic finance. it is essential to approach islamic banking and finance with an interdisciplinary research method. in other words, it is important to a) combine the research questions and the different sciences related to these questions, and to b) look to the purpose for which each specific research method is applied. this will give a background for the legal analysis and lead to coherent and reliable results. v. conclusion as an assumption of what was discussed above, standardization of research methods in islamic banking and finance is a particularly challenging project. this is due to the complexity of the disciplines influencing islamic banking and finance. accordingly, legal research in the field of islamic banking and finance is also complex; legal scholars specializing in that field are experts in different fields. therefore, harmonizing islamic banking and finance law methodology is difficult as well. however, central recommendations and instructions for choosing the right methodology are discussed in this paper. they can be resumed as follows: a) critical legal analysis of islamic banking and finance law is a valuable methodological tool to find solutions and remedies to different laws and regulations concerning the islamic financial sector; it can also help decision-making and enhance management and supervision of the different bodies and institutions of islamic finance. legal researchers should also avoid descriptive research since it does not bring new knowledge or add value to the islamic financial sector. b) it is also appropriate to consider that the primary goals of islamic banking and finance are different from the goals of its conventional counterpart; thus, using the same research methods for both sectors can lead to different results. this is effective from a legal standpoint because research results of legal scholars can also influence regulations, management, supervision, decision-making, and court decisions of the islamic financial sector in diverse ways; hence, legal scholars studying islamic banking and finance law need to avoid the abusive methodology used in conventional banking and finance law. c) legal researchers need to familiarize themselves with new techniques and skills, especially data analysis and mixed methods, if they want to produce high-quality research. moreover, artificial intelligence (ai) and machine learning are revolutionary tools that help the european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6628 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/03/2022 accepted for publication: 26/05/2022 published: 29/07/2022 7 research of metadata and accelerate developing legal learning to stay up to date with the fast-growing financial sector and the introduction of islamic fintech. finally, the solution that i recommend for each researcher planning to approach islamic banking and finance law is to implement multidisciplinary approaches, especially when authoring a thesis or a dissertation in the legal field of islamic banking and finance. however other considerations are necessary: firstly, it is important to consider what the best research methods that suit the questions of the research itself are; accordingly, it is imperative to remember that when analyzing islamic legal texts, norms, and rulings, usul al-fiqh methodology is the right method because explicit analysis needs to be conducted to avoid the misuse of legal texts; besides, when analyzing islamic legal practices, regulations, and behaviors of the islamic finance industry, modern research methods can be utilized. secondly, one should consider all the probable challenges related to the chosen methodology, such as the familiarity with the research method, access to information, specific skills, technical knowledge, and the limitations that can hinder the research. thirdly, it is important to know how to associate the results of the conducted research with theory to capture information that can be beneficial to other researchers or that suggests additional future research. finally, it is important to demonstrate that the selected research methods bring new, valuable, and valid results to islamic banking and finance law. this is particularly because not much literature has been provided about the best research methods for islamic banking and finance law as a part of islamic business law studies, which is itself a combination of different disciplines and fields of law. thus, this study brings novel and unique findings for legal studies in the field of islamic banking and finance and contributes to developing legal methodology and legal learning. it also supports young researchers’ understanding of the possible challenges and issues they may encounter in the future during 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[50] k. r. salman, “islamic governance, maqashid sharia index, and islamic social reporting: the case of islamic banks in indonesia,” european journal of islamic finance, vol. 19, 2021, doi: 10.13135/24212172/6158. paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 bibliometric analysis of islamic finance abstract— islamic finance and islamic banking have been the subject of central scientific interest, as demonstrated by the significant increase in publications on the subject in recent years. in the present paper, the use of the bibliometric analytical technique is proposed to examine the research on islamic finance. the objective of the study consists in carrying out a bibliometric analysis of all the publications on scopus relative to islamic finance. the parameters used include the type of document (article), the language of publication (english). among other things, the author, the publication models, the distribution of the thematic category, the distribution of the author's key words, the country of publication and the most frequently cited article are analyzed. the different rankings reinforce the fact that bibliometric understanding of scientific impact is a multidimensional construct. however, the bibliometric analysis does not take place in an institutional and political vacuum. the institutional context of quality evaluation of public and private research increasingly determines which metrics are applied, with consequent effects on performance evaluation. through analysis, citation rates are proposed, and the impact factors of journals are quantitative and objective indicators directly linked to published science. the objective of this paper is to identify the future trend of research in the field of islamic finance. keywords-component; bibliometric; islamic finance; ethics i. introduction (heading 1) islamic finance and islamic banking have been the subject of central scientific interest, as demonstrated by the significant increase in publications on the subject in recent years [1]. this growth is influenced by factors such as the introduction of a wide range of macroeconomic measures and structural reforms of financial systems, the liberalisation of capital movements, privatisation, the global integration of financial markets and the introduction of new and innovative islamic products. [2]. the growth is also materialized because according to the report the banker, (2015) the islamic finance assets have a compound annual growth rate of 12.7%. while western countries, such as the united kingdom and switzerland, have been listed among the top 20 most significant countries in total compliance with the sharia (muslim law) of goods. in according to [4]–[6] the islamic financial system cannot merely be defined as "without interests" because it does not provide a faithful picture of the system as a whole; without doubt, the core of the system is the prohibition to perceive and pay interest, but is supported by other principles of islamic doctrine that support the sharing of risk, the rights and duties of persons, property rights and the sacredness of contracts. furthermore, the islamic financial system is not limited to the banking sector but covers the capital formation, capital markets and all types of financial intermediation. in order to comply with the requirements imposed by the islamic law, criteria of screening of the sharia are adopted, as the investments should always conform with the sharia. islamic finance, in accordance with what is regulated by the islamic law, should be seen as part of social finance, which can be defined as an approach to the mobilization of private capital, which provides a social dividend and an economic return, thus achieving social and environmental objectives [7]. islamic finance, therefore, has many implications in terms of ethics and social objectives (hassan, chachi, & abdul latiff, 2008; naughton & naughton, 2000; rokhman, 2010; syariati & syariati, 2012). in the present paper, the use of the bibliometric analytical technique [8] is proposed to examine the research on islamic finance. the objective of the study consists in carrying out a bibliometric analysis of all the publications on scopus relative to islamic finance. bibliometric analyses describe the scientific communication quantitatively thus creating a structure of an area of research, the central themes and the existing correlations, for example, in the form of clusters and networks [9]. in this context, a detailed analysis of the development of research will contribute to a selective evaluation of the different aspects of the scientific panorama inherent in islamic finance. the parameters used include the type of document (article), the language of publication (english). it also analyses the author, the publication models, the distribution of the thematic category, the distribution of the author's keywords, the country of publication and the most frequently cited article. the different rankings reinforce the fact that bibliometric understanding of scientific impact is a multidimensional construct. however, the bibliometric analysis does not take place in an institutional and political vacuum. the institutional context of quality evaluation of public and private research increasingly determines which metrics are applied, with consequent effects on performance evaluation. through the analysis, quotation rates are proposed; the impact factors of the journals are quantitative and objective indicators directly linked to the published science. luigi bollani, federico chmet ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 the objective of this paper is to identify the future trend of research in the field of islamic finance. ii. methodology scientometrics is informally defined as the discipline that studies the quantitative features and characteristics of science and scientific research, technology and innovation. within scientometrics, bibliometrics copes with the statistical analysis of books, articles, or other kinds of publications [10]. the screening methodology conducted in september 2019, in the foreground, for precise research and as complete as possible, sought all references to "islamic finance" in "all fields" of scopus and were found 4051 scientific contributions. for the selection of the results, the criteria for inclusion were used: peer review articles (therefore, books, reviews, articles presented at conferences, etc. were excluded), accordingly 2938 articles were identified written in english, 2879 articles, that they were published in a magazine that had at least one-star ajg, 546 articles from 25 different journal. therefore, the results include a time frame for publications between 1999 and 2020. the following table number 1, summarizes the different steps in the research of the literate subject of this bibliometric analysis. table 1 scopus "all fields" keyword "islamic finance" 4.051 document type article 2.938 language english 2.879 source title (abs) articles 546 source title (abs) journal 25 own source the ajg, which was called the abs guide before 2015, is recognised as an influential scientific journal ranking system. it is based upon peer review, editorial and expert judgements and is informed by statistical information relating to citations. the guide not only is based on a weighted average of journal metrics but also reflects the perceptions of the subject experts and scholarly associations [11]. the ajg was chosen because it was widely adopted as a policy tool and because it is commonly used by researchers in scientific articles [12], [13], that are the subject of bibliometric analysis carried out with bibliometrix [8]. the rigorous bibliometric and network analysis (for example, analysis of quotations and citations) has the function of tracing the structure of knowledge of this topic. the analysis of the network through bibliometric tools has proved useful in identifying established and emerging areas of topical interest. (aria & cuccurullo, 2017). bibliometrix an r package for performing comprehensive quantitative research in scientometrics and bibliometrics it allows importing bibliographic data from several sources (including scopus). in addition, it evaluates co-citation as well as other kinds of measures, such as coupling, scientific collaboration and co-word analyses. the statistical analyses were done the statistical software r-studio. iii. a global overview on islamic finance as a result, we found 546 documents. it is worth noting that the keyword used "islamic finance" is deliberately very general to broaden the overall picture of the research field under consideration, but focused on high-quality journals. figure 1 shows the number of islamic finance publications over the years; the time interval starts in 1999 and ends with the 3 publications already available online in 2020. it can be noted that from 2008 to 2014 there is an increasing trend of publications, even if limited. 2015 is the year that marks the significant increase in publications; peaks of 114 and 103 publications are respectively in 2017 and 2018 about the subject under consideration. in september 2019, there will be a scientific production of 62 publications; it will be interesting to verify at the end of the year whether the scientific production on islamic finance of the journals taken into consideration will maintain the consistent results of the previous two years. table 2 below shows the sources from which the publications were taken and the total number of publications over the years; the table shows that the international journal of islamic and middle eastern finance and management has published 153 articles on islamic finance over the years. it follows journal of islamic accounting and business research with 108 articles. both journal of islamic economics banking and finance and qualitative research in financial markets and addiction research in international business and finance, all three journals, have published 33 articles on islamic finance. the minimum number of publications is 4. in the following figure 2, the historical trend of the scientific production of the five most productive scientific sources is illustrated. ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 figure 1 table 2 sources articles international journal of islamic and middle eastern finance and management 153 journal of islamic accounting and business research 108 journal of islamic economics banking and finance 33 qualitative research in financial markets 33 research in international business and finance 33 managerial finance 29 emerging markets finance and trade 27 journal of international financial markets institutions and money 20 physica a: statistical mechanics and its applications 14 journal of banking regulation 10 journal of financial regulation and compliance 10 global finance journal 8 journal of corporate finance 8 journal of risk finance 7 international journal of business governance and ethics 6 journal of financial services research 6 journal of risk 6 international review of financial analysis 5 journal of banking and finance 5 risk governance and control: financial markets and institutions 5 international journal of finance and economics 4 journal of behavioral and experimental finance 4 journal of financial stability 4 journal of multinational financial management 4 review of development finance 4 as regards the h-index defined as “a scientist has index h if h of his or her np papers have at least h citations each and the other (np − h) papers have fewer than ≤ h citations each” [14]–[16] it can be seen that in the selected sample, the author with the highest h-index is hassan mk equal to 7. table 3 takes into account h-index, total citations (tc), number of publications (np) and fractionalized articles. the construction of the table is based on the section of the first ten authors who produced the most significant number of ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 publications, but it should be noted, however, the presence of authors such as hesse h. and ihk m. who appear in this sample only once, with their paper that was cited 194 times. table 3 as for the affiliation, in the selected sample, it was identified that the international islamic university malaysia is the most productive university with 51 papers, followed by the university of malaya with 18 scientific contributions and the global university of islamic finance. on the other hand, the less productive universities on the subject of reference are: international centre for education in islamic finance, la trobe university and the universiti sains islam malaysia with 7 papers for each. table 4 affiliations articles international islamic university malaysia 51 university of malaya 18 the global university of islamic finance 16 university of new orleans 16 durham university business school 14 lorong universiti a 14 universiti utara malaysia 14 universiti kebangsaan malaysia 12 universiti teknologi mara 12 qatar university 10 university of manouba 9 international islamic university 8 king abdulaziz university 8 universitas indonesia 8 universiti sains malaysia 8 university of reading 8 international centre for education in islamic finance 7 la trobe university 7 universiti sains islam malaysia 7 the following table illustrates the first ten papers in relation to the total number of citations, ranging from 194 to 51; in the first column are indicated the authors with the reference year, in the second column, the title of the paper, in the third column the journal on which the article was published, in the fourth column the number of citations and in the last column the percentage of citations per year. regarding the international journal of islamic and middle eastern finance and management publishes quality and indepth analysis on current issues within islamic and middle eastern finance and management. the journal welcomes strong evidence-based empirical studies and results-focused case studies that share research in product development and clarify best practices. the main topics are: islamic finance islamic management as can be seen from the table below, 3 of the most cited articles have been published in this magazine. the journal of banking and finance magazine publishes theoretical and empirical research articles covering all major fields of research in the financial and banking fields, focusing on financial institutions and the money and capital markets in which they operate. two of the ten most cited articles have been published in this journal. the journal of islamic accounting and business research magazine provides a dynamic forum for the advancement of accounting and business knowledge based on the shari'ah and islamic activities that impact on the well-being of society. particular emphasis is placed on the interaction between islamic business ethics, accounting, auditing and governance, in the promotion of responsibility, socio-economic justice (adl) and eternal success (al-falah). two of the ten most cited articles have been published in this magazine. physica a: statistical mechanics and its applications is a physics journal, which is very friendly in publishing papers dealing with econophysics and statistical mechanics applications to economics. an article of the ten most cited was published in this journal. journal of multinational financial management publishes rigorous and original articles on the management of multinational enterprises. theoretical cases are covered, focusing, for example, on exchange rate risk management, hedging strategies, international financial planning and international financial planning mergers. an article of the ten most-cited has been published in this magazine. author h_index tc np articles fractionalized masih m 6 192 17 5,25 hassan mk 7 128 15 5 dewandaru g 5 158 9 2,5 baaquie be 2 11 8 5 saiti b 3 41 8 2,583 archer s 4 89 7 2,917 grassa r 3 24 7 5 masood o 5 58 7 2,5 asutay m 1 6 6 2,417 masih amm 4 74 6 2,5 ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 journal of international financial markets, institutions & money publish rigorous, original articles dealing with the international aspects of financial markets, institutions and money. an article of the ten most-cited has been published in this magazine. it should be noted that, of the sample taken into account, therefore, 546 articles: 76 articles were cited only once; 173 articles were never mentioned. table 5: highly cited articles, descending order by number of citations author(year) title source total citati ons tc per year (ihk & hesse, 2010) islamic banks and financial stability: an empirical analysis journal of financial services research 194 21,55 56 [18] review and analysis of current shariahcompliant equity screening practices internati onal journal of islamic and middle eastern finance and managem ent 97 8,818 2 [19] how strong are the causal relationships between islamic stock markets and conventional financial systems? evidence from linear and nonlinear tests journal of internati onal financial markets, institutio ns and money 71 14,2 [20] factors influencing intention to use diminishing partnership home financing internati onal journal of islamic and middle eastern finance and managem ent 71 6,454 5 [21] shari'ah supervision, corporate governance and performance: conventional vs. islamic banks journal of banking and finance 67 16,75 [22] determinants of corporate social responsibility disclosure: the case of islamic banks journal of islamic accounti ng and business research 64 8 [23] determinants of customers' intention to use islamic personal financing: the case of malaysian islamic banks journal of islamic accounti ng and business research 60 7,5 [24] institutional quality thresholds and the finance growth nexus journal of banking and finance 55 9,166 7 [25] understanding the objectives of islamic banking: a survey of stakeholders' perspectives internati onal journal of islamic and middle eastern finance and managem ent 53 4,818 2 [26] an analysis of stock market efficiency: developed vs islamic stock markets using mfdfa physica a: statistica l mechanic s and its applicati ons 51 10,2 according to the clarivate analytics, (2018) “highly cited papers are the top one percent in each of the 22 esi subject areas per year. they are based on the most recent 10 years of publications. highly cited papers are considered to be indicators of scientific excellence and top performance and can be used to benchmark research performance against field baselines worldwide". this measure is useful in the sense that separates each article depending on its field and it is a known fact that depending on the field, the number of citations used per article is different. so, it is good way to highlight important articles from diferentelds. these papers signalize, in some way, research paths in the literature. the study by ibrahim & rizvi, (2017) assesses the correlation between the stability of banks and their size, so whether it is more convenient to remain "smaller" or be "larger" from the point of view of stability. the potential nonlinear effects of size on the soundness of banks and the role that regulation plays in strengthening or weakening the dimension-stability ratio are examined. the results show that "larger" islamic banks are more stable. as far as regulation is concerned, activity restrictions and capital rigour play a role in strengthening the stability-size ratio. on the other hand, the positive stability-size ratio is weakened by a higher power of control and private surveillance. the article of derigs & marzban, (2008) aims to analyse the impact of the application of alternative shariah screens on the resulting universe of halal assets and to demonstrate that the shariah screening procedures, currently used in practice, are inconsistent concerning the discrimination between halal and haram. the study by presents a critical point of view on the framework underlying numerous studies, which start from the assumption that the islamic financial system is only weakly ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 linked or even decoupled from the conventional markets. through a quantitative study, it is evident that the decoupling of the islamic market from its conventional counterparts is not scientifically founded. after analysing the most cited articles, the most important scientific articles are proposed in the following figure 3, the historical direct citation network is proposed, this is a graph submitted by [29]. the following representation allows us to identify the most significant work on the subject under analysis, i.e. the islamic finance; its historical development is traced year by year, identifying various strands of connection [(the first consisting of ahmed, 2010; charles, darné, & pop, 2015); dewandaru, masih, bachab, & masih, 2015) (the second consisting of abduh & azmi omar, 2012; kassim, 2016) (the third consisting of čihák & hesse, 2010; khediri, charfeddine, & youssef, 2015; mollah, hassan, al farooque, & mobarek, 2017; mollah & zaman, 2015) (the fourth consisting of [18], [36]–[41] ] and pointing out the evolution of the work. despite the fact that there has been evidence of islamic finance since 1999, the analysis of this sample of articles identifies the most important historical production, that which develops between the years 2008 and 2017, with the greatest concentration between 2008 and 2012. figure 3 the first paper to be analysed is (charles, darné, & pop, 2015): the article contributes to the literature on the impact of the filtering criteria of the shari'ah on the risk of the islamic indexes of the islamic dow jones concerning the conventional counterparts. it can be deduced that the islamic indices and the conventional indices are influenced by the same extreme events which can condition the estimate of the risk. on the whole, the islamic indices seem to be riskier than their traditional counterparts and show superior performance in the entire period (1996-2013). the work shows that the islamic indices are riskier than the non-islamic indices. the result can be explained as the consequence of a lesser diversification of the islamic indices, which leads to a higher concentration of risk in specific sectors, such as industrial and technological companies. the next link is to the paper (dewandaru, masih, bachab, & masih, 2015): the study contributes to the literature of the trading strategies, using a sample of islamic securities quoted on the islamic market of the islamic and american dow jones; even if the risk of the strategy can be relatively higher. the paper which originated the strand of study is [1]; it is a paper which analyses the global financial crisis and the model of islamic finance, which assumes the role of minimizing the gravity and frequency of the financial crises, introducing the financial system based on the sharing of risk. the result is explained as a consequence of the expansion of credit to the growth of the real economy, allowing credit, above all, for the purchase of real goods and services which the seller owns and disposes of and which the purchaser wishes to receive for delivery. the second link in the citation network takes into consideration (abduh & azmi omar, 2012) and (kassim, 2016) both studies deal with the development of the islamic banking and financial system and economic growth in the case of indonesia and malaysia. islamic finance has provided significant contributions to the real economy, effectively carrying out the role of financial intermediation of collection and channelling of funds for the activities of investment. the third link in the citation network takes into consideration (čihák & hesse, 2010) as the lead study of three other studies: it points out that the small islamic banks tend to be financially stronger than the small commercial banks; the large commercial banks tend to be financially stronger than the large islamic banks and the small islamic banks tend to be financially stronger than the large islamic banks. this may reflect the challenges of credit risk management in large islamic banks. the market share of islamic banks does not have a significant impact on the financial strength of other banks. the paper by (khediri, charfeddine, & youssef, 2015) shows that islamic banks are, on average, more profitable, more liquid, better capitalized and with a lower credit risk than conventional banks. we also find that islamic banks are, on average, less involved in off-balance-sheet activities and have greater operational leverage than their conventional counterparts. the study (mollah, hassan, al farooque, & mobarek, 2017) analyses whether governance structures influence the risk-taking and performance of islamic banks compared to conventional banks. the governance structure of islamic banks plays a crucial role in risk-taking and in the financial performance that differs from conventional banks. in particular, the governance structure of islamic banks allows them to take higher risks and achieve better performance due to the complexity of products and transaction mechanisms. however, islamic banks maintain a higher capitalization than conventional banks. the article by (mollah & zaman, 2015) analyses governance about the performance and responsibility of boards of directors and the effectiveness of governance mechanisms separately for islamic and conventional banks. the shari'ah supervisory bodies generate a positive impact on the ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 performance of the islamic banks when they play a supervisory role, but the impact is negligible when they perform only a consultative role. the effect of the structure of the board of directors (dimensions and independence of the board of directors) and of the power of the ceo (duality between ceo and ceo assumed internally) on the performance of the islamic banks is, on the whole, harmful. our findings confirm the positive contribution of the shari'ah supervisory bodies, but also underline the need for more effective enforcement and regulation. the fourth link in the citation network takes into consideration (al-kayed, zain, & duasa, 2014; derigs & marzban, 2008, 2009; hassan & syafri harahap, 2010; ho, 2015; mansoor khan & ishaq bhatti, 2008; rosly, 2010). derigs & marzban, 2008 analyzes the impact of the application of alternative shariah screens on the universe of halal assets and to demonstrate that the shariah screening procedures, currently used in practice, are inconsistent with the discrimination between halal and haram. in the analysis of the article, it emerges that, until now, there was no universal or generally accepted understanding of how to transform the clear rules of the shariah into a system of verifiable investment guidelines. mansoor khan & ishaq bhatti, 2008: the main objective of this document is to direct world attention towards the development of the islamic banking sector, its infrastructures and supporting institutions. it describes islamic banking as a growing discipline, adding to global finance more ethical, competitive and diversified instruments and systems. derigs & marzban (2009), analyze the effects of the different strategies to build financial portfolios compatible with the shariah. the difference between conventional and current shariah portfolio management is the application of sectoral screens and financial screens that reduce the wealth universe. the two authors show that with the proposed concepts, it is possible to realize shariah-compliant portfolios which have yield and risk profiles comparable to the traditional unencumbered portfolios. hassan & syafri harahap, (2010); the document aims to identify whether there is a discrepancy between the social activities of companies reported in the annual reports of islamic banks and the index of disclosure of corporate social responsibility, which has been developed based on the islamic business ethics framework. the results show that the overall average index of disclosure of social responsibility of one islamic bank out of seven is above average and issues of social responsibility are not of significant concern to most islamic banks. rosly, (2010): the focus of this article is on financial reporting and legal documentation of the contract to determine the shariah's legitimacy of financial instruments in islamic financial institutions. the document identifies and supports approaches that must be applied in a package to determine the status of shariah-compliant in order to avoid costly errors and disputes. al-kayed, zain, & duasa, (2014) analyzes the effect of the capital structure on the performance of islamic banks to guide financial managers for the collection of capital funds. they can use high capital ratios that increase the solidity and security of the bank and reduce the return required by investors, or they depend on islamic deposits and bonds, which are considered to be cheaper sources of financing because of their tax refund. the management must carefully decide the appropriate mix of debt and equity, i.e. the capital structure, to maximize the value of the bank. ho, (2015) aims to review the methodologies of screening of shariah investments by users of global islamic finance, including index providers, shariah service providers, islamic banks, a regulatory authority, an association body and fund managers. most of these users practice a screening method at two levels: qualitative and quantitative. iv. main keywords the following figure (4) shows the most commonly used keywords in islamic finance articles. the author's keywords, which are those provided by the original authors at the time of publication of the document. the two most frequent author keywords are "islamic banks", "islamic banking", "islam" and "islamic finance", as can be seen from the graph, the size of the circle surrounding the keyword is an indication of its use. for this reason, the most used keywords, mentioned above, occupy a substantial part of the graph. the other two elements are expressed by "density" and "centrality"; therefore, the keywords that occupy the centre of the graph are the closest to the research conducted. on the basis of the graph below, a close correlation of the scientific production is identified with what is described above in the historical direct citation network; therefore, the centrality of the treatment of risk is perceived, which is associated with the keywords "risk-sharing", "risk management", "volatility", etc.. macroeconomic aspects emerge that are manifested in the keywords "economic growth" and "financial crisis". besides, it is perceived that the substantial part of the scientific production focuses on shariahcompliant and the analysis of differences with the traditional banking and financial system and the analysis of the performance of the same. however, a lack of respect for the historical direct citation network emerges, that is, the keywords "ethical banking" and "ethics" are not identified in the following figure because they are present respectively only 3 and 4 times; therefore the reference literature on the above-mentioned journals tends, almost, to neglect the aspect of the ethics of finance or the bank, preferring comparisons with the traditional banking and financial system and portfolio analysis. ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 figure 4 in the following figure 5 is given evidence of the country collaboration. on the basis of the analysis of the keywords in which the keywords "pakistan", "uk" and "malaysia" emerge clearly and of the affiliation of the authors, it can be identified how the collaborative networks are active in the world and poles of very high production are, obviously, countries where the muslim faith is the main one, such as the part of the arabian peninsula, pakistan, indochina, indonesia, malaysia, singapore, bangladesh, but, not only, also the usa, canada, united kingdom and france. figure 5 v. conclusions this article shows that the literature on islamic finance focuses very much on banking, rates, comparisons with traditional banks and portfolios, analysis of governance and control structures. in the journals taken into consideration in the present work (according to the criteria described in the methodology) from which the sample of selected articles comes, it can be deduced that the ethicality of the finance and the bank is placed in second place. ethicality means a banking company that can produce profit and sustainable development; therefore, sustainable development and ethics, in islamic banking, represent another distinctive factor compared to its conventional counterpart. islamic banks still concentrate only on the shariah, which means ethics, if applied, since one of the three pillars of islam is destined to transform the islamic banking system into a real universally successful banking system [42]–[45]. it has been examined that the literary interest in islamic finance is growing and it is a relatively recent issue since the first publications date back only to 1999. the high quality of data coming from articles published in top journals allows us to find significant results concerning the best scholars, the leading journals and the keywords of this multidisciplinary field of research. in conclusion, concerning the future trend of the publications, since in the sample analysed, there are three papers with publication date 2020, it is worth analysing them in detail. the study by [46] analyses the impact of the development of the sukuk market (shariah-compliant bonds) on the capital ratios of islamic banks. the study shows that the development of the sukuk market had a negative effect on the capital ratios of the islamic banks; therefore, the development of the sukuk markets stimulated competition between the islamic banks, inducing them to maintain lower capital ratios. the same study also shows that the commercial opening and liquidity of the banks are positively and significantly correlated to the patrimonial coefficients, while the size of the banks and the reserve ratio for losses on credits are negatively and significantly correlated to capital relations. the study [47] analyses the corporate governance in the structure of private companies, assuming that it plays a vital role in the creation of a corporate culture of awareness, transparency and openness. in this context, the study provides an overview of governance mechanisms in the arab gulf countries and india by analysing the impact of corporate governance mechanisms on the financial form of the companies considered. he concludes that transparency and disclosure have an insignificant negative impact on the performance of companies. as for the latest paper to be published in 2020 [48] it analyses whether market power affects the effect of banking regulation and supervision on the assumption of banking risks in islamic banks. in particular, three regulatory instruments are analysed: the capital requirements, the limitation of the activities and the official powers of supervision. the study comes to the following conclusions: the power of the banking market reinforces the negative impact of capital regulation on the assumption of banking risks. the negative effect of asset restrictions on stability decreases when banks exercise more market power. ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 there is no conclusive evidence that their competitive behaviour conditions the negative effect of supervisory power on banks' risk-taking. islamic banks are distinguished from conventional banks about competition and risky behaviour. the results differ according to the business banking model. these results could be useful for banking regulators in light of the implementation of the regulatory framework for islamic banks. the adoption of basel iii represents a significant regulatory challenge, as it does not take into account the specificities of islamic banks. the themes, as mentioned above, are correlated in an almost uniform way to the scientific production of reference. on the whole, it can be deduced that sustainable and ethical development, which in islamic banking represent a distinctive factor concerning the traditional counterpart, are lacking in emphasis in the 2020 papers. references [1] a. ahmed, «global financial crisis: an islamic finance perspective», int. j. islam. middle east. finance manag., vol. 3, n. 4, pagg. 306–320, 2010. 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[48] a. louhichi, s. louati, e y. boujelbene, «the regulations–risk taking nexus under competitive pressure: what about the islamic banking system?», res. int. bus. finance, vol. 51, pag. 101074, 2020. ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 11 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 can the dow jones sustainable index be useful for evaluating dow jones islamic market companies? maura campra 1, sabrina pucci 2, and valerio brescia 3 abstract— in recent years, the focus on sustainability and social impact has increased, companies through environmental programs and social practices have also begun to change their model in response to the demands of stakeholders and the market. a more sustainable approach is also driven by the 17 goals defined by unesco in the sustainable development goals. the idea of sustainability derives directly from the concept of csr (corporate social responsibility), a real way of doing business in a strategic way, which consists in acting responsibly from a social and environmental point of view and in building solid and long-term relationships between companies and stakeholders, from the supplier to the final consumer. the "mediterranean commission for sustainable development" (mcsd) established in 1995 started the project "sustainable development indicators" (sdi), which aims to develop indicators of progress towards sustainable development in the countries of europe, africa and asia that face the mediterranean, offering the great opportunity to compare developments in the process of integrating the environment into profoundly different national reality policies. currently, the most widespread worldwide of all the sdi indicators is the dow jones sustainability index (djsi), established in 1999. the index is the first to assess the financial performance of global companies that follow sustainable principles. unfortunately, all the studies conducted through the use of djsi to evaluate the main sustainable firms do not consider the sharia compliant market but are based only on the dow jones market. therefore, there is no sustainability model that takes into account the companies that have had access to the dow jones islamic market. this gap in literature and in practice does not allow us to confirm or contribute further to the use of the sustainability indicator with models that are particularly sensitive to the sharia compliant criteria. the statistical analysis has verified a difference between companies belonging to the dow jones market and the dow jones islamic market model. this difference confirms the interest in testing the behaviour of the social and environmental sustainability index as well as the economic one even in companies belonging to the shariacompliant market. the qualitative analysis of the models allows a possible future adoption in these markets based on scientific and literary evidence. keywords-component; sustainability, finance, dow jones islamic market; dow jones sustainable index, social indicators. i. introduction in recent years, the focus on sustainability and social impact has increased, companies through environmental programs and social practices have also begun to change their model in response to the demands of stakeholders and the market [1], [2]. a more sustainable approach is also driven by the 17 goals defined by unesco in the sustainable development goals. the global policy launched in 2016, guides the world on the road ahead over the next 15 years: the countries, in fact, have committed themselves to reach them by 2030 [3]. in the western countries as well as in the countries of the middle east the objectives are changing the approach of all stakeholders also impacting on companies [4]. the eurobarometer survey of 2017 shows that environmental responsibility is considered by european citizens to be an essential economic factor. out of around 28,000 people surveyed, the 94% believes that the most polluting companies are required to compensate the community for the environmental damage caused and the 87% says they think they are playing a primary role in protecting the environment, for example through their purchasing choices, separate collection, and recycling or reducing car use [5]. the consumer begins to act in an increasingly responsible way towards the environment and towards society and begins to become aware of the new role he is assuming. based on the choices made during the purchase act, the consumer can be merely buying a particular brand or a specific product concerning another [6]–[9]. it is, in fact, aware of being able to directly and indeed influence the 1 maura campra, full professor, department of economics and business studies, university of piemonte orientale “amedeo avogadro”, novara, italy 2 sabrina pucci, full professor, school of economics and business studies, university of roma tre, rome, italy 3 valerio brescia*, research fellow, department of management, university of turin, turin, italy, email: valerio.brescia@unito.it ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 decisions of the companies, which must know how to seize this opportunity making sustainability an integral part of their being and their actions[10], [11]. this new economic and social context, the companies need to integrate the objectives related to the pursuit of profit and the sale of their products, with those relating to the impact that it can have on society and the environment [12]–[14]. the idea of sustainability derives directly from the concept of csr (corporate social responsibility), a real way of doing business in a strategic way, which consists in acting responsibly from a social and environmental point of view and in building solid and long-term relationships between companies and stakeholders, from the supplier to the final consumer [15], [16]. however, in the reference literature it is not possible to identify a single definition of csr, but the green book drafted by the european commission in 2001 defines it as a voluntary integration of social and environmental concerns in commercial operations and in relations with the interested parties [17] p.7. the concept "on a voluntary basis" is fundamental in this definition. companies are not in fact "obliged" by any law to integrate csr into their management, but on the contrary they can decide, in a completely voluntary manner, to act responsibly, because it is felt as a duty towards the environment and the community of which are part [18]. the "mediterranean commission for sustainable development" (mcsd) established in 1995 started the project "sustainable development indicators" (sdi), which aims to develop indicators of progress towards sustainable development in the countries of europe, africa and asia that face the mediterranean, offering the great opportunity to compare developments in the process of integrating the environment into profoundly different national reality policies [19]. currently, the most widespread worldwide of all the sdi indicators is the dow jones sustainability index (djsi), established in 1999. the index is the first to assess the financial performance of global companies that follow sustainable principles. the managers who work for djsi are active in the search and management of sustainable portfolios according to reliable and objective parameters. the index is reviewed annually in september and more every four months to make sure that its composition represents 20% of the companies, both in the sam sector and in the stoxx sustain universe, a leader in sustainability. in fact, non-financial information changes the company's perception and investments and therefore becomes a strategic tool for the company [20], [21]. unfortunately, all the studies conducted through the use of djsi to evaluate the main sustainable firms do not consider the sharia compliant market but are based only on the dow jones market. therefore, there is no sustainability model that takes into account the companies that have had access to the dow jones islamic market. the dow jones islamic market index includes thousands of broad-markets and has been regulated since 1999 through a board that verifies the requirements of companies that want to be part of it. this gap in literature and in practice does not allow us to confirm or contribute further to the use of the sustainability indicator with models that are particularly sensitive to the sharia compliant criteria. islamic companies and banks have greater stability in the event of a crisis [22]–[24], so studying them from an environmental and social point of view can provide useful elements to improve current business models and sustainable approach also in the stock market. ii. method the approach linked to sustainability, to the role of company and market disclosure is examined in the article. the conducted study analyses the dow jones market and the dow jones islamic market in order to understand the possible existence of a real difference between the two markets as highlighted in the literature [25] and therefore the usefulness of applying sustainability indicators in a different market to define the model and behaviour of companies. the differentiation of approach and regulation is conducted both at the statistical level and through qualitative analysis. the sample group of firms is composed by top performer companies defined in the two reference markets on 14/07/2019 were considered to conduct the statistical analysis and verify the actual existence of a difference in behaviour on the market [26]. the statistical analysis was carried out using the stata 13.0 software. after an analysis of the distribution of the two analysed groups, the kolmogorov-smirnov test was performed to confirm the real difference in the results of the analysed companies in the two markets, giving p <0.05 as a significant value [27]. the theoretical gap in terms of indicators and social and environmental evaluation of companies in the sharia compliant market is deepened through the descriptive analysis of the attribution and construction method of the dow jones sustainability index and of the scientific evidence found in the literature in the use of the index for business value analysis. iii. discussion and results 3.1 results the companies analysed in the dow jones islamic market present higher and more performing revenue results at the same time than the dow jones market. the charge and average charge of the companies in the dow jones islamic market are higher than those of the dow jones market. this first element could lead to the presumption of an effective higher performance of the models of companies based on the dow jones islamic market. the average charge of the dow jones market sample is 1.69 with a standard deviation of 1.709 while the average charge of the sample in the dow jones islamic market is equal to 4.03 with a standard deviation of 2.283. in percentage terms the charge does not vary significantly with respect to the charge values, the average for the group of companies present in the dow jones market is equal to 1.19 while the average for the group of companies present in the dow jones islamic market is equal to 4.23. considering the sample, the two groups have a non-normal distribution which therefore requires non-parametric tests. the nonnormal distribution of the results on the market of the two analysed groups requires carrying out to confirm that the results are different therefore that what is highlighted in terms of charge is not accidental, the test of kolmogorov-smirnov. the test by kolmogorov and smirnov is a method of statistical analysis which allows to compare a sample of data and a theoretical distribution (or two data samples) in order to verify the statistical hypothesis that the population from which the data originate both the one in question (or the hypothesis that both samples come from the same population). the kolmogorov and smirnov test is in fact based on the cumulative frequency-it must be relative to the data and on the analogous concept of distribution of a continuous variable. in the analysed sample, the first test analysis result relating to the charge is 0.022, therefore significant, the result is also confirmed by the same test carried out on the charge as a percentage with a result of <0.001. therefore, a real difference in behaviour between two groups of companies is confirmed. 3.2 general structure of an index the sustainability index is the primary tool used by financial operators (institutional, but also private) within socially responsible investments (csr) [28]. socially responsible investors, that are subjects who decide to invest only in listed companies that see a highgrade objective with respect to the mere creation of value in the short term, respecting the environment and the development of social conditions, can be either individuals (that operate directly or through the mediation of the managers), and institutions [29], [30]. the sustainability indexes are in all respects real stock indexes with the only characteristic of referring to specific types of companies. precisely for this reason we must now clarify a primary concept, the classification according to criteria and sector of belonging [31]. the sustainability indexes, in addition to the basic classifications ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 previously seen, provide for two specifications: classification by sector, classification according to inclusion/exclusion criteria. concerning the first family of indexes, financial companies envisage the possibility within themselves to exclude, and categorically prohibit, any direct and or indirect participation (thus extending the analysis also to companies belonging to the same value chain) to specific sectors. areas that are considered to be in open contrast with a series of universally recognized environmental, social but above all ethical principles. the sectors widely recognized as dangerous, or in conflict with the basic principles of any socially responsible investment, are spirits, tobacco, gambling, arms sector (military armaments and civil armaments), nuclear energy, adult entertainment, gmos, oil sector, particular sub-sectors of the chemist. in summary, all the belonging companies, have direct and/or indirect interests, to obtain percentages of revenues or sales from the above indicated sectors are automatically and irremediably excluded from the sustainability indexes and therefore from all the instruments representing socially responsible investments. in the second case, instead, each financial company creates a set of inclusion/exclusion criteria to carry out a particularly careful study of the company, the company group or the entire value chain. the analysis of the company, according to these criteria, highlights its degree of attention, practices and relations with respect to the single criterion; a numerical score (the rating) is linked to the single company-criterion relationship and from the weighted sum of these the environmental, social, governance rating and finally the overall score come out. score by which companies belonging to the same sector are classified to determine whether they are included in the index [32]. this methodology, used by all the financial companies analysed in this work, is called "corporate screening" (or "portfolio") and is the original form of application of the inclusion/exclusion criteria in the selection process. with the natural developments of the sector in recent years, the methodologies for selecting companies so far have also adapted over time. the engagement process is a widely used assessment tool among the various financial companies as it ensures a very precise result. this evaluation system requires the company to actively commit itself to environmental, social and governance issues and to modify, or even create, its activity based on the new esg criteria being evaluated. these criteria can be created by an external company competent in the field, such as a research institute, a consulting company, with which to establish a continuous and constant dialogue aimed at improving the current conditions of the company (with respect to esg criteria) and to fix a process of evaluation by stages. two forms of this type are shareholder advocacy and communitybased investment. the community-based investment is the set of activities aimed at providing financial resources to all those subjects that the normal banking assessment procedures exclude from the resource allocation process. in the traditional banking system, the analysis procedure of company’s worthy of credit granting follows standard criteria and indicators. all companies that do not fall within certain parameters are categorically excluded. the community-based investment tool intends to solve what the system sees as "market failure". this problem is felt above all in smes, even better if startups, which are unlikely to have a very solid financial and equity structure. this feature excludes them from the financing that they themselves need for their own development. within the family of indices based on inclusion and exclusion criteria, the most common criteria are exclusion (violation of human rights, violation of the worker's rights, poor attention to the environment, reduced communication and information transparency on the main issues, lack of an adequate corporate governance system, lack of declared mission, code of ethics and system of well-defined values) and inclusion (particular attention to the enhancement of internal human resources, excellent intra /extra company communication, excellent relationship with stakeholders; possession of adequate environmental management systems, support for particular social initiatives, efficient eco/products/ services, excellent corporate governance system. currently the considered indicators provide for evaluation processes that go beyond the company boundaries, considering instead the role of the company with respect to the entire community with which it comes into contact (supplier companies, local communities, environment, competitors, partners, political environment etc.) with particular attention to the relationship with stakeholders [33]. it is precisely on this last evolution that the concept takes shape, or rather the instrument, of engagement and therefore of taking into consideration the commitment that the company must put in place for a better overall evaluation; through good or best practices, discussions, observations, requests, proposals to identify the best, and most rapid, socially responsible development paths. 3.3 dow jones index the dow jones (full name dow jones industrial average) is the best-known index on the new york stock exchange (the nyse new york stock exchange) and was created in the united states to assess the growth rates of the american economy. the index is calculated, unlike other indices that take into account the capitalization (and therefore the relative weight of the various companies) weighing the price of the main thirty securities of wall street. this choice, in the opinion of the negative writer, has determined, over time, a significant decrease in the importance of the index in the sector of membership since it is now inadequate to represent the entire performance of the us stock listings [34]. the sustainability indices were launched back in 1999 and have long been the benchmarks in the sector regarding the approach and performance of the various companies compared to the environmental and social issue. all the proposed indexes have been created, and are managed, in collaboration with the robecosam company. the indices are intended to trace the performance of the world's largest companies in the three fundamental themes of sustainability: economy, the environment, and social relations. the indices are intended to be a point of reference for all investors who have integrated the issue of sustainability within their financial portfolios, and to represent a reference platform for all those companies that want to adopt the best sustainability practices. 3.4 dow jones sustainability index it includes a world index (reference index) and a series of regional and national indices; furthermore, the collaboration between dow jones and robecosam allows the creation of sub-indices customized according to the needs of investors. the absolutely innovative aspect of the sustainability indices of dow jones and robecosam resides above all on the selection process used to identify from a starting universe those that will become the constituent companies of the various sub-indices. the assessment of sustainability at the corporate level can be represented through indicators defined upstream that determine sustainability through a questionnaire that is compiled by the various stakeholders. in particular, the process of assessing sustainability at the corporate level is based on a questionnaire to be drawn up annually, consisting of a minimum of 80 to a maximum of 120 questions that range along the three pillars (called dimensions) of sustainability: cost-effectiveness, the environment and sociability. the objective is to assess the ability of the analysed company to create value over the long term. there are several questionnaires depending on the sector the company belongs to according to the sector classification proposed by gics. the evaluation process, once completed, is replaced by the continuous monitoring process. news and other types of information are evaluated in a process that takes the name of media and stakeholder analysis (msa) which aims to bring out all the information on topics such as: economic crime, corruption, fraud, illegal commercial practices, violation of rights human disputes between workers and companies, accidents or environmental disasters ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 that also indirectly involve the companies being evaluated. msas can reduce the overall sustainability rating by influencing inclusion in one of the djsi indexes. companies labelled as "eligible" are linked to a sustainability score (score) determined by the csa (corporate sustainability assessment) of robecosam. the classification takes place on a sectorial basis and the top-ranked players in each sector are selected to be part of the dow jones sustainability indices. as seen for the sustainability indexes proposed by the ftse also in this case the responsibility for the management of the indexes falls on a committee that in this case takes the name of djsi design committee. it has been said that the evaluation criteria are both general and specific for the individual sectors. the general ones are based on standard managerial practices and on performance measured on themes that are absolutely present in every company, we talk about corporate governance, human capital development, risk management and corporate crises, just to name a few. these criteria apply to all companies belonging to the fifty-eight sectors identified by robecosam and represent approximately 40-50% of the evaluation process. the remaining part is covered by specific questions for each sector identified by robecosam and they want to analyse the ability to respond to the themes of environment, sociality and costeffectiveness of the company. table 1 defines the criteria and weights for three specific sectors in order to give evidence of the differences and of the weight attributes. figure 1 shows the weight representation of an industry. table i. the criteria and weights for three specific sectors in djsi size analysed bank sector energy sector pharmaceutical sector economic dimension x anti-crime policy x corporate brand management x codes of conduct / fight against corruption x x x corporate governance x x x customer relationship management x x innovation management x market opportunities x marketing practices x price risk management x research and development x risk and crisis management x x x stakeholder involvement x measurement systems/ score card x weight economic size 38% 30% 40% environmental dimension biodiversity x business opportunities on financial services / products x business risk projections x climate change management x climate change strategies x x electricity generation x environmental footprint x environmental policy / environmental x x x management systems environmental reporting x x x process eco-efficiency x distribution x risks related to water (use and pollution) x weight environmental size 24% 35% 10% social dimension addressing cost burden x bioethics x corporate citizenship and philanthropy x x x controversial issues and dilemmas on loans / financing x financial inclusion / construction capacity x contributions on improving external health conditions x human capital development x x x indicators on work practices x x x occupational health and safety 5% 4% 2% reporting on corporate socialization x x x stakeholder involvement x x social standards for suppliers x x strategy to improve access to medicines or medical products x attraction and talent retention x x x total weight social dimension 38% 30% 50% source: own elaboration on the djsi criteria. figure 1 example of representation of weight energie sa – djsi report 2018 several studies have analysed how the djsi could help to evaluate firms on the market. an important study conducted by lópez, garcia, and rodriguez in 2017 highlighted for the first time the difference between companies listed in the dow jones sustainability index and ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 companies listed in the dow jones global index. the analysis was conducted on 55 companies, mainly considering economic indicators between the two groups of companies. the authors, during the seven years covered by the study (1998 – 2004), have found significant changes observed in profitability and profit indicators such as margins and return on assets and equity. the authors have not succeeded in identifying differences or relationships on the cost of capital between groups of companies with a policy of environmental and social sustainability and companies that had not integrated this policy. the study does not identify differences between the two groups of companies as regards the cost of capital despite the fact that the literature shows that transparency affects the price of capital [35]– [39]. the literature presents several studies that use the dow jones sustainability index to evaluate the company. cheung in 2011 considers a sample of us stocks on the dow jones sustainability world index to evaluate stock returns, risk and liquidity. however, the study does not reveal the effects of the announcement of the inclusion of the companies in the list of the dow jones index on the examined indicators [40]. we have to wait until 2010 to have a wide-ranging study, including 658 companies over a 14-year series to have empirical evidence of the relationship between social performance and financial results. garcia castro et al. [41] consider three variables to evaluate performance, roe, roa and tobin's, but without identifying a correlation with companies that apply a social approach and are present in the dow jones sustainability index. moreover, the literature highlights that the market value is increased when more transparency is given to non-financial information such as environmental and social information [42]–[44]. 3.5 dow jones islamic market the dow jones islamic market index series includes thousands of broad-markets, blue-chip, fixed-income and strategy and thematic indices that have passed rules-based screens for shariah compliance. launched in 1999, djim world was the world’s first global shariahcompliant benchmark. compliance concerns muslim investors would otherwise face in constructing islamic investment portfolios. to determine their eligibility for the indices, stocks are screened to ensure that they meet the standards set out in the published methodology. companies must meet shariah requirements for acceptable products, business activities, debt levels, and interest income and expenses. the screening methodology is subject to input from an independent shariah supervisory board. by screening stocks for consistency with shariah law, the indices help to reduce research costs and compliance concerns muslim investors would otherwise face in constructing islamic investment portfolios [45]. the role of a shariah supervisory board in a financial institution is to ensure that all of the institution's financial undertakings are pure, or in religious terms, free from unlawful (haram) elements. shariah supervisory boards base their advice and opinions, orfatawa, on their readings and interpretations of: the qur'an, which is believed by muslims to be the revealed word of god (allah); the sunnah or practice of the prophet of allah, prophet muhammad, upon him be peace; the consensus of the scholars (ozaa); and the opinions of the classical jurists and their successors [46]. the first level of screening by the sharia supervisory board entails examining the primary or core business of a company (equity security), which is not much different from secular-oriented, socially responsible screening. if the company's core business is in the "sin" sector, as interpreted by shariah scholars, the company must be eliminated from consideration immediately. the sector businesses fall within six general categories: alcohol, tobacco, pork products, conventional financial services (banking, insurance, etc.), defence/weapons; and entertainment (hotels, casinos/gambling, cinema, pornography, music, etc.). the majority of sharia scholars and supervisory boards consider these six industries and their financial instruments to be inconsistent with sharia precepts and unsuitable for islamic investment purposes [47]. the second level of screening involves scrutiny of the financial ratios of companies that passed the first level. by this level of screening, the primary or basic business of the company has already been determined to be halal, or in compliance with sharia precepts. the concern of the second level of screening is with elements of haram (unlawful) income that may incidentally become part of the total income of the company. many companies that promote development through the provision of beneficial and human services are based in non-muslim countries where there are no laws prohibiting the giving and taking of interest [48]. nearly all companies in such countries routinely place excess corporate funds in interest-bearing deposits, certificates of deposit ("cds"), bonds, bills, notes, and other interest bearing and principalguaranteed instruments. in addition, these companies invest in other companies participating in the same investments. in these ways, income from interest and impermissible income will also form a part of the total earnings of companies that otherwise conform to sharia precepts [49], [50]. finally, many islamic investors have modest savings, and the opportunities for investing their money in ways that will prove profitable to them and beneficial to humanity are limited. investments are encouraged in companies that benefit the shareholder through dividends and capital appreciation and society through medical advances, technology, consumer products, services, and the like [51]. when such investments contain elements at a secondary level of the haram, the muslim shareholder must take steps to purify that haram income. the scrutiny applied to the financial ratios or capital structure of companies in question may be accomplished by means of the following three criteria: total (conventional) interestbearing debt to market capitalization; total (conventional) accounts receivable to market capitalization; or total (conventional) cash and conventional interest-bearing securities to market capitalization. the indexes evaluated through these criteria show how the companies present in the djim had greater profits with reference above all to the technological sector [52]. although it has been highlighted by other studies that these companies have not always positive effects on performance as they are strictly conditioned by geopolitics events that affect value and stability [53]. both the conducted analysis, statistical analysis and the literature confirm a different behaviour on the market of the companies belonging to the dow jones islamic market compared to the others, in terms of charge and stability on the market. these elements suggest that the results and the literature on social indicators (djsi) created for the dow jones market may have different results compared to the dow jones islamic market. iv. conclusion and remarkable sustainability is an element of social impact that has changed both the behaviour of the company and the approach of the adopted model with the introduction of environmental and social policies in recent years [54]. these elements are very often part of the disclosure provided to stakeholders and consumers, some indices in particular created for the dow jones markets are significant for studying the company's performance with respect to economic, social and environmental results. as the possibility of expanding islamic financial instruments with greater social impact in western countries with similar models has been highlighted [23], [24], [47], [55], it is also possible to try to apply models and analysis tools for companies on western markets in islamic markets. the indicators of the dow jones allow to study the companies present in the western markets confirming a greater return on assets and equity for those with greater results in terms of sustainability. the relationship between disclosure and stakeholder perception has been confirmed several times for these companies. however, there is no literature on sustainability applied to companies in the dow jones islamic finance. this gap could be filled by introducing sustainable indicators such as djsi also to evaluate companies in the sharia ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 compliant markets. the analysis of the essential elements for the board that evaluates access to the dow jones islamic market can be integrated into the elements and the weights attributed in the djsi allowing a future comparison not only of the markets but also of the results obtained by the companies in terms of social impact and environmental. currently, as it has been highlighted in discussion fourth-generation composite indexes that involve both the company and the stakeholders allow a greater and complete vision of the company in environmental and social terms, the adopted questionnaires could therefore be redefined and integrated, including the elements required for access to the islamic market. the conducted analysis allows for greater consideration, although the analysis carried out for a year and already highlighted in the literature confirms a greater return of companies present in islamic markets, but there is no evidence of how these companies are actually sustainable in environmental and social terms. therefore, although the sustainable development goals policies are being implemented all over the world, we do not know that they are not exact, and the scholars cannot make comparisons about the companies and the effects of the models in economic terms. an islamic business model with greater market stability may therefore not be the best in terms of social and environmental sustainability and impact. future analyses could therefore focus on the development and application of dji social indicators applicable to the islamic market which for the moment is not considered and only after a comparison between the results obtained between companies with high djsi in the dow jones market. references [1] c. gimenez, v. sierra, e j. rodon, «sustainable operations: their impact on the triple bottom line», international journal of production economics, vol. 140, n. 1, pagg. 149–159, 2012. 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[55] l. corvo e l. pastore, «the challenge of social impact bond: the state of the art of the italian context», european journal of islamic finance, 2019. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. buerhan saiti, istanbul sabahattin zaim university, turkey prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4581 1 role of islamic finance during covid-19: a study on practical implication of zakat as short-term emergency support system abstract— islamic finance has always been well known for its unique characteristics to deal with finance. however, few countries pay heed on islamic rules and regulations and fewer actually prefer to run based on it, the reason is obvious the oppositional standpoint with capitalism. nevertheless, as the world is facing serious public health crisis like covid-19, and all normal economic activities cease to function properly, conventional finance is facing serious challenges handling this situation. though covid-19 has already been called as great equalizer, not discriminating based on any social, economic, or political strata, under-developing countries are having quite a hard time surviving this crisis, and bangladesh is not an exception, especially the vulnerable community of bangladesh. the objective of this study is to find out the practical implication of zakat as short-term emergency support system for vulnerable community of dhaka north city corporation. to conduct the study, primary source of data was used, following a semistructure questionnaire using quantitative method of data collection, and convenience sampling style was used for limited mobility induced by covid-19 lockdown. the study finds out that the practical implications of zakat are quite useful especially as a short term emergency support system during the covid-19 crisis, this study also finds out that zakat can be used as a tool for building resilience also only if smaller number of zakat recipients are selected. keywords-islamic finance, covid-19, zakat, short-term support system, vulnarable community. i. introduction coronavirus disease or more popularly known as covid19 is a dangerous novel series virus that emerged in november of 2019 from wuhan, china. though it has significant lower mortality rate comparing other viruses of its series, but it is way more dangerous due to its serious level of contagious characteristics. as a result, it is creating far reaching impact on social, political, economic, and religious as well as so many other dimensions throughout the world. as discussions are taking place, days are passing, more and more countries being affected by covid-19 and the death toll rises [1]. international project, research for creating vaccines and medicines by hundreds of governments, thousands of industry researchers and hundred thousand of academic group is taking place, however; any formal institutional approval on any vaccine and medicine is yet to come [2],[3]. the impact of covid-19 is so far reaching that actual estimation of it is out of question. in broader socio-economic, political, financial, religious labels, the impacts are subcategorized from aviation, tourism, education, human rights, politics, corruption, prison, transport, religious practices, food industry, fashion industry, restaurant, religious practice, sports, and even military sector. according to a report of asian development bank, due to covid-19 outbreak, the global economy could possibly suffer from an estimated 8.8 trillion usd [4]. where the world‟s most developed countries are finding it hard to confront covid-19, least developed countries like bangladesh is facing grave dangers, not only because it‟s economic status but also because its capital is the most crowded city in the whole world [5], creating challenges to maintain social distancing, as a result this crisis is creating a new layer of vulnerable community in the city as the normal workflow has come to an end. as reported till november 6th of 2020, a total of 4,17,475 was infected and 6,036 died by covid-19[6]. sharia compliant finance or more popularly known as islamic finance is a financial activity that complies with islamic sharia law for practical implication of islamic economics. the mode of islamic banking under islamic finance is consists of murabahah (cost-plus), ijara (leasing), wadiah (safekeeping), mudarabah (profit-sharing and lossbearing) and musharaka (joint venture), while the social finance mode includes waqf, zakat and qard hassan, etc. all of these instruments of islamic finance are unique in their own attributes, and zakat is not an exception. according to united nations development program, zakat can be an important instrument for supporting emergency program as crisis response and have significant usefulness as short-term emergency support system mitigating the aftermath of covid19 [7]. md. tanvir alam* *graduate student, department of peace conflict and human rights studies, bangladesh university of professionals, dhaka, bangladesh. email: babu.taanvir@gmail.com submitted june 2020, revised december 2020, accepted december 2020 ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4581 2 objectives of this study the objective of this study is to find out the practical implication of zakat as short-term emergency support system in bangladesh by measuring how effective zakat was mitigating the aftermath of covid-19 to the donee. ii. literature review the literal meaning of the term zakat is "that which purifies"[8], it is a form of religious charity but obligatory in nature for who meet the criteria. zakat is one of the five pillars that uphold the religion islam, position as right after praying (salah) as third [9]. in the beginning zakat was a mere socially constructed idea, but as prophet muhammad migrated to city of medina with the very first muslim community, it was made obligatory to the muslims [10]. although zakat is often considered as poverty alleviation approach, the actual implication is beyond that. a recent study by abbas about firm‟s value and zakat potential shows critical insight. using data from yearly financial statement of enormous 227 mining and manufacturing companies, the study revealed that zakat have positive impacts on the profitability of firms [11].however, in this study zakat is considered as conventional tool for using as a short-term emergency support system. islamic finance especially zakat has always been a crucial means to poverty eradication in muslim countries. however a study in early 90s took place in pakistan revealing crucial insight, the cross sectional study was conducted based on random sample survey and identified zakat only as means to temporarily solution to poverty reduction and not an effective method for permanent rehabilitation for poor, the study concluded with few recommendation of modification of contemporary zakat system if to make it more meaningful instrument for poverty eradication [12]. later in the mid 90s, another study on socio-economic development and zakat funds was conducted by anwar, he emphasized on innovative financial approaches for development as most of the muslim countries were facing underdevelopment, he proposed a mechanism to utilize zakat fund for long-term investment for socio-economic development, his mechanism illustrated that there is potential for zakat fund as long term investment for the pace of socioeconomic development especially for under-developing countries [13]. another earlier study such as by thomas and miora in 2005 was conducted in one of the muslim country pakistan, on the role of social welfare by zakat. the study initially showed that zakat provides minimal advantage to the poor community, especially the elderly, the reason behind this poor implication of zakat identified by authors as corruption, favoritism and greed. however, the authors find zakat as a potential tool for social welfare as it ensures rehabilitation and redistribution of wealth [14].another study by nazri et al published in 2012 implied that zakat as an institution to alleviating poverty has lost its pride. the authors suggest that this declining situation can be improved if collaboration with microfinance institutions is considered [15]. after the fall of soviet union, capitalism was spreading its tentacles across the world, leaving its aggressive profit seeking attitude among countries, riba (interest) was becoming prevalent and common practice even in few muslim counties. during the millennium another country in south asia name bangladesh, was facing serious poverty related problems, many five-year plan, three-year plan and two-year plan was initiated but no desired result came out of it. though micro credit and social safety net program relieved little tension but poverty was still at large. during that time islamic finance mainly waqf and zakat was gaining popularity for poverty reeducation because of its multilayer instrumental supporting mechanism including free education, scholarship, medical treatment. a study indicated the absence of formal islamic finance mechanism to reeducation of poverty as a great deal for government of bangladesh; it suggested that government should consider making state-controlled zakat system for ensuring effective poverty eradication tool [16]. later in the year of 2008 during worldwide financial crisis, an influential study was published. the study intends to reveal the primary causes of the financial crises, and identified the reason as inadequate market discipline of the financial system which leads to excessive lending, high leverage and finally the vicious cycle that cause the decline of assets prices and helped to form economic slowdown. the study also finds out that islamic finance can be a proper tool to inject discipline into the system and thus mitigating financial instability and preventing such occurrence from ever happen again, along with that the study recognize the role of zakat as great medium for supporting the poor and vulnerable community that emerged during the crises. however, the study couldn‟t find any suitable mitigating measure from islamic finance instruments to minimize the crises but it did find out the potential role of prevention [17]. another study was conducted in 2010 by laila on zakat and food security. it proposed to achieve food security by mechanism of zakat as an instrument of islamic finance. it argues that zakat can be utilized as an effective instrument against socio-economic problems range from poverty to natural disaster through food security, although necessary modification depending on geographical and social variables should be applied before implementing. the study found positive role that zakat plays over poverty and food security, even empowering poor but that would require strong safely net program integrated with enhanced zakat fund. finally this study suggests that zakat can play vital role in emergency support system if government support is assured [18]. focusing on a broader grey zone, another study was conducted in the next year 2011 supporting chapra‟s statement of islamic finance as disciplined finance. this study argues that diverse islamic economic practices can have a distinct role to play if institutional support is given, however coordination must be assured and to successfully implement and desired scheme, this study also reveals that other islamic finance instruments such as sadaqa, qard hasan can help create social stability [19]. like many other muslim countries zakat is a state administrated matter in malaysia, though it didn‟t happen ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4581 3 overnight, many phases and transformation took place for the zakat institution to reach on this stage. it s to be believed that state controlled institutions can better perform solving state level challenges like poverty, illiteracy, vulnerability and improving capacity building, however actual success depends on several factors including collection of zakat, zakat management, zakat distribution and maintaining sharia rules [20]. while bakar and ghani conducted a study in 2011, they argued zakat as an islamic institution having ties with islamic economics aims to cater for the social welfare of muslim‟s. they suggested that zakat can contribute to improve the minimum quality of life of poor people but to ensure that a proactive mechanism for distribution is prerequisite. their study advised ghazali invented maslahah approach for implementation while measuring standard for minimum quality using abraham maslow‟s human development theory [21]. poverty reeducation has always been a priority in most of the muslim countries, and every time it gains momentary velocity after each economic slowdown or crises, where the islamic finance industry showed promising potentiality by demonstrating growth and development over the past few decades; however its full potential is yet to be realized, moreover it would require to eliminate the gap between islamic finance practice and theory [22]. a study on zakat took place in 2014, this study argued that muslim countries are underestimating zakat as strategy to fight against poverty. while examining the role and impact of zakat on 3 muslim countries, the study finds out many interesting insights. it argues that zakat should be integrated with poverty reduction program to not only elevate poor people out of poverty but also to improve their living standard, however that would require additional islamic finance tools to incorporate with, it also suggests that muslim government body should take zakat as obligatory institution matter not voluntarily and leave it up to citizen, along with hat government should also consider formulating poverty reduction policy at national level and vital stakeholders such as practitioner, researcher, social worker and policy makers should work together for poverty eradication because poverty is a complex challenge and to solve it will require sophisticated approach from all level [23]. an influential study was published in 2016 by beik and pratama, it analyzed the impact of effectiveness of zakat program for alleviating poverty for participating households. the study was conducted based on primary source of data using administrative questionnaire and following interview of around 120 participates, the scale for determining effectiveness were consist of four indices. the study finds out that zakat utilization program has a positive impact over welfare index, it helps to decrease poverty rate and increase income rate for participated households [24]. another influential recent publication by radwan and biancone, provides critical insight on islamic finance as unconventional finance for social finance. they argue that innovative and unconventional ways of social finance are demand of time, but it is hard to discover an effective one because of many challenges including high risk, governance problem, evaluation problem and difficulties of measuring social value; however they propose islamic finance offers wide range of instrument with innovative potentiality, they argue that these instruments can create positive impact on social enterprise development [25]. iii. methodology this study intends to find out the practical implication of zakat as short-term emergency support system during covid19 pandemic outbreak in dhaka north city corporation of bangladesh by measuring how effective zakat was mitigating the aftermath of covid-19 to the donee. the study was conducted based on primary source of data, using semistructured questionnaire following a descriptive quantitative method. the sampling style was convenience sampling because limited mobility due to of pandemic lockdown. the data were collected by both online and physical interview of 100 respondents as both zakat recipient/donee and giver. respondent types zakat recipients (50) & zakat givers (50) data source type primary data source method quantitative method questionnaire semi-structure sampling style convenience methodology iv. analysis and findings the analysis was done in four phases, upon receiving data from both zakat recipients (50) & zakat giver (50). analysis of zakat giver 0 5 10 15 20 25 30 35 1-2 person 3-5 person 6-10 person 11-20 person zakat giver ` graph 1: number of zakat recipients by giver as the graph 1 shows, among the respondents of zakat giver, 6 respondents gave zakat to 1-2 persons, 14 respondents gave zakat to 3-5 persons, 22 respondents gave zakat to 6-10 persons, and 8 respondents gave zakat to 11-20 persons. suggesting that most zakat giver usually helps around 6-10 persons by giving zakat, and then the most people usually give zakat to 3-5 persons. ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4581 4 28 4 7 11 emerging vulnarable group old vulnarable group relative non-relative graph 2: zakat recipient group type as the graph 2 shows among the respondents of zakat giver, 28 respondents gave zakat to emerging vulnerable group, 11 respondents gave zakat to old vulnerable group, 7 respondents gave zakat to relative and only 4 respondents gave zakat to non-relative, which suggests that most people gave zakat to emerging vulnerable group due to covid-19 crisis, and the next most zakat giver group give zakat to old vulnerable group, while relative receive more priority then non-relative, implying covid-19 as a factor to zakat giving. analysis of zakat recipient 11 19 15 5 1-4 families 5-10 families 11-20 families 20+ families graph 3: zakat from number of families graph 3 shows that among the respondents of zakat recipients, 19 recipients received zakat from 5-10 families, 15 recipients received zakat from 11-20 families, 11 recipients received zakat from 1-4 families and only 5 recipients received zakat from 20+ families. this analysis indicates that most of the zakat recipients usually get zakat from 5-10 families, while the next most zakat recipients get zakat from 11-20, and the least recipients gets zakat form only 1-4 families. however, recipients from only 1-4 families get zakat on higher scale comparing those recipients who gets zakat from first 2 categories. the first 2 categories recipients who get zakat from many families (5-20 altogether) usually receive low zakat from each family comparing the latter category. 26 12 1 8 3 0 5 10 15 20 25 30 most useful useful neutral moderate least useful graph 4: usefulness of zakat graph 4 shows that among the zakat recipients, 26 recipients consider received zakat as most useful during the covid-19 crisis, and 12 recipients consider received zakat as useful, while only 1 recipient considers it as neutral, and 8 recipients as moderate and 3 recipients as least useful. according to the analysis and discussion the final findings of the study suggest;  most zakat givers have a tendency to cover wider population as zakat recipient.  new emerging vulnerable group due to covid19 received more zakat, as zakat giver considered it as a factor to select zakat recipients.  most zakat recipients receive zakat from many families although in smaller amount, while least zakat recipients receive zakat from few numbers of families but in higher amount.  most of the zakat recipients consider zakat as most useful, especially during covid-19 crisis.  although in smaller scale, but selecting fewer zakat recipients from individual zakat giver increase the chance of building resilience for needy people.  zakat acted as an effective immediate but shortterm emergency support system for the vulnerable community.  zakat have successfully mitigated the aftermath of covvid-19 for the emerging vulnerable community induced by coronavirus outbreak in dhaka city. ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4581 5 v. concusion poverty profile of muslim world was already severe before corona‟s arrival. as a result, the outbreak hits hard all the muslim countries especially least developed countries like bangladesh. many new vulnerable groups emerged during this crisis period. but it was a relief that the holy month of ramadan appeared during the crisis with its blessing and unconventional financial instruments. as it already discovered that islamic finance with its diverse instruments have enormous potential for social finance [26]. the study finds out that zakat is indeed effective as a short–term emergency system for venerable community, and have successfully mitigated the aftermath of covvid-19 for the emerging vulnerable community induced by coronavirus outbreak in dhaka city, besides; it can also be used as a tool to build resilience but with modification of it like selecting fewer zakat recipients. the paper has few limitations induced by covid19 restricted mobility affecting data collection process; however, the finding of this study suggests parallel effectiveness of zakat on alleviating poverty as earlier studies like ali and hatta‟s (2014) paper titled as „zakat as a poverty reduction mechanism among the muslim community: case study of bangladesh, malaysia, and indonesia‟ suggested [27]. this paper leaves a trail for researchers to study different aspects of zakat which ranged from studying possibilities of modality of zakat modification as a financial instrument for improve its effectiveness and to wider state-controlled zakat management system for bangladesh and so on. references [1] harris.c, coronavirus statistics: latest numbers on covid-19 cases and deaths, euronews.com, may 29, 2020 [2] zhang l, liu y. 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[20] ab rahman, azman & alias, mohammad & najib, syed. zakat institution in malaysia: problems and issues. global journal althaqafah. 2. 35-41. 10.7187/gjat122012.02.01., 2012 [21] bakar, m. h. a., & abdghani, a. h. towards achieving the quality of life in the management of zakat distribution to the rightful recipients (the poor and needy). international journal of business and social science, 2(4). 2011 [22] mujahid, syed & adawiah, engku. the potential of innovative financial tools: social impact bond (sib) and sustainable and responsible investment (sri) sukuk, towards the sustainable growth of the islamic finance industry. 2015 [23] ali, isahaque & hatta, zulkarnain. zakat as a poverty reduction mechanism among the muslim community: case study of bangladesh, malaysia, and indonesia. asian social work and policy review. 8. 10.1111/aswp.12025, 2014 [24] beik, irfan & pratama, caesar. zakat impact on poverty and welfare of mustahik: a cibest model approach. afebi islamic finance and economic review. 1. 1-12, 2016 [25] biancone, paolo pietro & radwan, maha. social finance and unconventional financing alternatives: an overview. european journal of islamic finance. 10.13135/2421-2172/2818., 2018 [26] biancone, paolo pietro & radwan, maha. social finance and financing social enterprises: an islamic finance prospective. 10.13135/24212172/3176,2019 [27] ali, i. and hatta, z.a., zakat as a poverty reduction mechanism among the muslim community: case study of bangladesh, malaysia, and indonesia. asian social work policy rev, 8: 59-70. https://doi.org/10.1111/aswp.12025. 2014 http://dx.doi.org/10.22617/brf200144-2 https://doi.org/10.1016/j.sbspro.2013.08.474 http://www.jstor.org/stable/41259525 https://doi.org/10.1111/aswp.12025 ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4581 6 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 impact of islamic microfinance on borrower‟s income in pakistana case study of akhuwat humera tariq mahmood alumni; hamad bin khalifa university, qatar abstract—microfinance is a process of providing financial access in the form of micro-credits, and other services such as microinsurance, savings, checking accounts and payment systems to the poor who do not have access to conventional banking. lack of collateral and capital assets put limitations on the marginalized community to access the funds through the conventional banking system which leads to their financial exclusion. it is grasped that the objective of financial inclusion can be achieved at its full potential through redistributive instruments (zakah, awqaf, qard al-hassan) of the islamic microfinance industry. pakistan microfinance review (2017) revealed that akhuwat (a leading islamic microfinance organization based on voluntarism and philanthropy) had maintained its outreach top spot in terms of active borrowers (820,000) during the year 2017. this study is conducted to analyze microfinance services provided by akhuwat and its effects on borrowers’ income and consumption. the study adopted the qualitative research designed by applying questionnaires and interviewing techniques to collect data. the study finds that there was a reasonable increase in the income and consumption of the borrowers. results indicate an average increase of 18 % in rural borrowers’ income and an average increase of 23% in urban borrowers’ income. the study recommends that vocational training should be provided to people in rural areas to enable them to engage in diverse business activities instead of solely relying on agriculture-related business. keywords-islamic microfinance, qard al-hassan, financial inclusion, demography, literacy, consumption i. introduction numerous developing countries afflicted by poverty applied various poverty mitigation strategies to combat poverty and uplift the economic conditions of unprivileged people in societies. unfortunately, it is witnessed that the strategies remained unsuccessful in escalating the living standards of the poor. this phenomenon requires a multidisciplinary approach to deal with poverty alleviation which is afflicting human society. microfinance was introduced as a tool to fight poverty [1]. microfinance organizations are aimed to support the groups who are neglected, low-income earners and cannot approach conventional banks due to lack of collaterals. moreover, microfinance helps the poor to start the small business or production activity to generate additional income at the low financing cost. it is argued that microfinance organizations, on the one hand, support the unprivileged groups, on the other hand, do not escalate their living standards due to interest payments on providing credits [2]. leikem argued that traditional microfinance services focused on empowering lower-income businesses whereas the poor could not get many benefits from microfinance and their incomes remained unchanged [3]. furthermore, these traditional microfinance institutions (mfis) based on interestbearing foreign donations for their capital do not conform to shariah principles. islamic scholars realized the need for shariah-compliant solutions to deal with poverty in muslim countries. islamic microfinance was introduced, which gained popularity all over the world, to help the poor by meeting shariah principles (prohibition of riba (usury), gharar(uncertainty), maysir (gambling), illegal activities, and unearned income. muslims and non-muslims both are getting benefit from islamic microfinance institutions (imf). however, the islamic financial system is based on shariah and promotes justice, equitable distribution of income and wealth. it undoubtedly contributes to balancing the social and economic features of human society and helps in poverty alleviation by avoiding the exploitation of the poor. islamic microfinance got more significance in the world economy after the world crisis in 2008. islamic microfinance paved its way due to its distinct features and proved more productive as compared to conventional. islamic microfinance products such as charity, zakah, awqaf are more productive and efficient in poverty reduction [4]. according to the latest research in 2019 by the international monetary fund (imf), pakistan is ranked 40 in the list of top hundred countries affected by poverty. its gdp per capita is usd 1,541. this ranking is measured by taking gdp per capita of one hundred eighty-seven countries [5]. the microfinance industry in general and islamic microfinance institutions, in particular, are playing a vital role in poverty alleviation in pakistan. micro watch report represented a significant increase in microcredit outreach in some areas of pakistan [6]. during the last quarter of 2018, the net growth of active borrowers in karachi is 37,852; bhakkar is 15,719; sargodha is 14,681; rahimyar khan is 14,303; jamshoro is 14,211. however, akhuwat (leading islamic microfinance provider) remained the top-ranked microfinance provider with 820,000 active borrowers during the year 2017 [7]. despite previous studies conducted to measure the efficiency, sustainability, and impact of microfinance institutions on various socioeconomic variables. nevertheless, the literature on islamic microfinance, its models, product designs and its role in financial inclusion is also available. ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 data of akhuwat foundation in pakistanhave been analyzed in past literature to assess the socio-economic impact of microfinance on borrowers in various dimensions. however, there is still room for further research work to assess the impact of educational level and different business activities on the income and consumption level of the borrowers with their rural-urban breakdown. moreover, this study will fill the gap in existing literature by assessing the impact of microfinance on the income and consumption of borrowers in terms of demography (rural vs urban), education level (literate vs illiterate), gender (male, female) and nature of profession or business activities (agriculture, trading, beauty saloon etc.). since these factors are deeply linked with the progress and economic growth of the society. this study is undertaken to identify additional factors connected with the income growth of the poor and up-lifting the basic standards of the poor population. ii. methodology this research is a qualitative case study that uses a field research approach. akhuwat borrowers form the target for the case study. since the nature of the study is exploratory. therefore, primary and secondary data are collected to analyze different factors affecting the borrowers‟ income and consumption. primary data is collected by interviewing the borrowers which are carried out with one respondent at a time. secondary data consists of online sources such as articles, journals, thesis, books and some reports for the latest statistics. two hundred forty-seven borrowers are sampled for the study. one hundred and twenty-six borrowers are selected from rural and one hundred twenty-one from urban areas respectively. in rural areas, beneficiaries were selected from jajjal, kothakalan, mandiusmanwala, ratipindi, sikandarpura, and dera ghazi khan. whereas the beneficiaries in urban areas were selected from lahore. the list of the borrowers was provided by the akhuwat on request. in order to interview the borrowers, a questionnaire has been developed. iii. research limitations and future prospects  the study could not cover all socio-economic factors and focused on the area (rural versus urban borrowers) and education level of borrowers. a graph within a graph is an “inset”, not an “insert”. the word alternatively is preferred to the word “alternately” (unless you really mean something that alternates).  data was collected through telephone, having an inperson interview can bring in more details for analysis.  data collected from twelve branches of akhuwat organization splitting out in rural and urban locations. a large sample size from additional branches can enhance analysis. iv. literature review literature review for this study is divided into three sections. the first section entails an overview and a general understanding of conventional and islamic microfinance, the role of microfinance institutions, and their efficiency in terms of poverty alleviation. the second section involves literature on the impact of micro-finance on borrowers‟ income, consumption, and living standard. despite the availability of plenty of literature on microfinance, relevant and latest literature is reviewed to understand the current performance of microfinance institutions and the impact of their services on borrowers‟ income and consumption. the third section discusses akhuwat model as a case study. its operations and business model are reviewed for the study. available literature provides information on various aspects of microfinance and has discussions on almost all sections of literature reviewed for this study. for instance, shirazi conducted a study to investigate the net impact of microfinance concerning pakistan [8]. he applied the counterfactual “combined approach” to study the economic impact of pakistan poverty alleviation fund (ppaf) microcredit on the status of households. furthermore, he applied the with-without approach and before-after approach. with the approach “withwithout”, he explored the status of borrowers and contrast with the status of non-borrowers. whereas by approach “before-after”, he investigated the change in the status of the group before borrowing and after borrowing during the period of their benefitting. findings of shirazi‟s research revealed that traditional microfinance has a positive but marginal impact on economic uplifting of borrowers. traditional microfinance benefitted to better off than poor. poor were found more inclined towards smoothing their consumption instead of utilizing the funds for investments. shirazi recommended a model by which the poor can access funds for investments to become an entrepreneur and earn a meaningful living. however, it does not address how demography, literacy and business activities affect incomes and consumption of borrowers. this study will provide further information to the existing literature. khaleeq and shirazi used ppaf data to find the impact of microfinance on the poor [8]. they found that the impact of microfinance was significant on the non-poor borrowers compared to the poor. they made a case for islamic microfinance and suggested extending its scope through product diversification, innovation and downscaling operations of islamic banks linking microfinance institutions, particularly for fund sourcing, sharia‟ advisory, and technology transfer. iqbal & shafiq argued on the standpoint of islamic finance in terms of financial inclusion in their paper [9]. they focused on the importance of qard-al-hassan (qh) and social wellbeing through cooperation and compassion. authors posit that qh is vital for social and financial stability and mobilization of substantial resources for uplifting the economically weak ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 oic countries. also, iqbal and shafiq have recommended the establishment of some policies to reduce poverty through a model of qard-al-hassan. authors stated qard al-hassan as one of the most efficient and effective channels for combating poverty, but other factors such as demography, literacy, and capacity building through various business activities are vital as well. this study assesses the effectiveness of qard-alhassan models by taking demography, literacy and business activities of borrowers into account. chaudhry et al. assessed operations of akhuwat, it's business model, its philosophy and its sustainability [10]. the authors focused on key success factors of akhuwat foundation. our study will be exploring more factors and potential to get maximum output from akhuwat microfinance services in the wellbeing of existing borrowers and poverty alleviation. beall has provided a deep insight into the sustainability of microfinance institutions in general and akhuwat in particular [11]. moreover, the study provides an overview of different approaches to sustainability such as the institutionalist approach and welfarist approach. institutionalists are of the view that operational self-sufficiency without donations is mandatory for the microfinance institutions for their long term sustainability. however, welfarists believe that donors are a reliable source of income to be added in income/expenditure ratios. this study examines akhuwat thoroughly to find out if akhuwat model which is based on donations is sustainable in the long run or it has some weaknesses and threats to its sustainability. furthermore, it provides an overview of the latest standing of akhuwat in terms of its sustainability, threats, weaknesses besides covering the impact of its microfinance services on borrowers‟ income and consumption. the study of jaafar is an excellent addition in the literature of microfinance [12]. the author has provided a thorough review and profound insight into the qard al-hassan model for microfinancing. the focus of the paper is concepts of qard alhassan, sources of funds of this model, a case study of akhuwat as leading interest-free micro-loan provider. some details on akhuwat in terms of the effects of demography and literacy are covered in this study. it also gives an update on the sources of funds and outreach to borrowers. although the available literature reviewed touch on various aspects of micro-finance and akhuwat, this study gives a detailed investigation of microfinance impact on the income of akhuwat rural borrowers‟ vs urban borrowers; and impact on the income of akhuwat literate borrowers‟ vs illiterate borrowers. v. a case study of akhuwat & its operations akhuwat was officially registered in 2003, and its first branch came into operation in the city of lahore. it has been achieving success and meeting its objectives year by year. its model has gained popularity in the east and west as well. it is a representation of the phenomenon of muakhat. it has printed an example in the history of microfinance of transforming the borrowers into donors. akhuwat‟s mission is to alleviate poverty through the empowerment of families who are socially and financially marginalized. it empowers unprivileged and neglected families by providing interest-free loans and unlocks their entrepreneurial potential, builds their capacity and provides social guidance to them. all these endeavors are intended to achieve its vision “a poverty-free society built on principles of compassion and equity”. akhuwat is a foundation that started with a donation of pkr 10,000. later it received another donation of pkr 1.5 million during 2003. this foundation was registered under the societies registration act of pakistan in the beginning. currently, it is registered under securities & exchange commission of pakistan. akhuwat is considered as a pioneer in the islamic microfinance industry in pakistan. it has applied the model of qard al-hassan which is by shariah principle (interest-free borrowing). this model has embraced significant progress and popularity on the globe [10]. akhuwat is not only providing interest-free microfinancing, but its scope and services are also much beyond than interestfree microfinancing. akhuwat is serving humanity in various dimensions. it is providing house building/ repair loans to those who want to repair their houses or enhance their houses by constructing additional rooms but have not sufficient funds. marriage loans are given to those who have a deficit of funds to marry their children. akhuwat is also offering its services to raise the education level in society. it provides a 100% scholarship to those children/youth who are committed to getting higher education but cannot afford the educational expenses. akhuwat is running a cloth bank to provide new and old clothes to the needy. it is being operated by the transvestite group (a neglected group) so that this group gets some reasonable status in society and can have a decent living. akhuwat is also engaged in offering training, coaching for developing skills to start any business. it supports capacity building in society so that the poor can live with dignity by utilizing their skills instead of depending on charity. akhuwat qard al-hassan model is more successful than conventional microfinance. this organization receives funds for its operations from the public, local philanthropists, government, institutional donors and pakistanis who are living in foreign countries. in contrast to conventional microfinance institutions, akhuwat does not depend on international aids for the sake of avoiding the interest involvement in loans. as conventional institutions charge high-interest rates due to the credit line based funding. the foundation depends on local donors. the board of directors and the team is very dedicated to working hard towards collecting donations by initiating some fundraising activities. ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 vi. sources and funds akhuwat aims at shariah-compliant loans and eliminates all shariah prohibited elements. akhuwat has prominently participated in financial inclusion. moreover, akhuwat is successful in its recovery of loans. its recovery rate is 99.9% with zero interest rate. akhuwat borrowers are so satisfied with akhuwat services that they are also willing to becoming volunteers. some borrowers who had benefited from akhuwat loan and able to expand their business, they are voluntarily becoming donors for the wellbeing of others. akhuwat is sourcing its funds through donations, application fees, insurance, and partnering with local and foreign organizations and governments. vii. business model of akhuwat according to akhuwat founder dr. saqib, processing each loan incurs an expense of 6% -10% (annual report, 2017). this cost is not being charged from the borrower despite no harm or shariah violation involved in charging this expense. so far akhuwat has accepted this financial burden at its end without putting any pressure on the poor in the society. however, us$1 for the application fee is accepted from borrowers as a voluntary contribution to a moral purpose. moreover, akhuwat has a dedicated workforce who are also participating in donations. they are willing to work on low wages for the sake of serving humanity and committed with the achievement of akhuwat‟s mission. akhuwat borrowers are also free to donate as per their capacity and volunteering cause. unlike traditional microfinance institutions, akhuwat provides equal opportunities on the basis of justice without any discrimination. it is witnessed that some mfis focus on women empowerment only. however, in case of akhuwat, we find no gender discrimination, women and men, old and young, rural and urban, educated and uneducated are equally being benefitted. a quarterly update on microfinance outreach in pakistan has indicated that akhuwat continued its leadership in the market during the first quarter of 2018 with capturing 15% of total market share. it remained the largest supplier of the net increase in active borrowers for the quarter 59,767 borrowers. [6]. viii. sustainability akhuwat has managed its expenses and income through contributions from its donors, local governments and international corporates. it is witnessed that akhuwat can raiseits funds and donations constantly, which indicates its operational sustainability [13]. also, akhuwat has not only transformed its borrowers into donors but rather has also maintained its rapport with its donors. various studies revealed that mfis are focusing on profitability and effective outreach to the poor result in a trade-off between both objectives. therefore, mfis should revisit their objectives. nevertheless, judged by its continuing ability to raise donated funds and other forms of grants, akhuwat can be considered operationally and financially „sustainable [12]. akhuwat had surplus funds of pkr 186 million in the year 2013. this amount increased to pkr 986 million in 2017 [14]. this shows akhuwat long term operational strategy to maintain parity between its income and expenditures. despite all the positive indicators, there have been risks associated with akhuwat relying heavily on local governments, grants, donations and running welfare programs with the collaboration of certain international organizations. with the change in the political scenario, if the new government has a change in its priorities, the operational sustainability of akhuwat can be at risk. ix. data analysis & findings the prime focus of this study is to investigate the extent to which literacy and various business activities affect the income of akhuwat borrowers. as mentioned earlier, one of the main aspects of akhuwat operations is to provide interestfree loans to its borrowers to facilitate their businesses and help them increase their income levels and increase their living standards. however, the demography and literacy levels of these borrowers could affect the economic results of the borrowers. here we analyze how the literacy level of the borrowers and the various business activities that can play a role in the income levels of akhuwat borrowers. data collected from the akhuwat borrowers from rural and urban branches are analyzed to see the impact of gender mix, education level and business activities available in rural and urban on the income increase. a. gender impact on borrower’s income (rural vs urban) out of a total sample of 247 borrowers provided by akhuwat officials, 126 were from rural areas, and 121 were from urban areas making up a split of 51% and 49% respectively. table i. gender mix in rural vs urban areas ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 1) rural and urban: out of the sample of 126 borrowers from rural areas, 125 are male borrowers, and only one is a female borrower with a proportion of 99.21% and 0.79% respectively. out of 121 borrowers from urban areas, 70 are male, and 51 are female borrowers making up a proportion of 42.15% and 57.85 %. the findings revealed that the average income of the rural household before borrowing was pak rs 61,270 and the average income of the urban household before borrowing was pak rs 82,281. after borrowing, the average income of the rural borrowers, rose to pak rs 72,262 and the average income of the urban borrowers increased to pak rs 100,901. after, borrowing, the average income of rural borrowers rose by pak rs 10,992 (18%) whereas the average income of the urban borrowers increased by pak rs 18,620 (23%). 2) male and female: the average income of the rural female borrowers before borrowing was pak rs 60,000 and the average income of the urban female borrowers before borrowing was pak rs 80,882. after, borrowing, the average income of the female rural borrowers, rose to pak rs 70,000 and the average income of the urban female borrowers increased to pak rs 98,627. the average increase in income of rural female borrowers is pak rs 10,000, and urban female borrowers are pak rs 17,745 with an average increase of 17% and 22% respectively. female borrowers in urban areas are earning 5% more than female borrowers in rural areas. the average income of the rural male borrowers before borrowing was pak rs 61,280 and the average income of the urban male borrowers before borrowing was pak rs 83,300. after, borrowing, the average income of the male rural borrowers, rose to pak rs 72,280 and the average income of the urban male borrowers increased to pak rs 102,557. the average increase in income of rural male borrowers is pak rs 11,000, and urban male borrowers are pak rs 19,257 with an average increase of 18% and 23% respectively. percentage increase in male urban borrowers is 5% more than the percentage increase of male rural borrowers out of a total sample of 247 borrowers provided by akhuwat officials, 126 were from rural areas, and 121 were from urban areas making up a split of 51% and 49% respectively. b. education level comparison of rural and urban borrowers the results indicate that the average education level of borrowers from urban areas is higher than the borrowers from rural areas. table ii. education level of rural and urban borrowers out of the sample of 247 borrowers, 74 (59%) were illiterate in rural areas, whereas 66 (55%) were illiterate in urban areas. the remaining population in urban areas has a higher education level. the average income of rural illiterate borrowers before borrowing is pak. rs. 58,750 and after borrowing is pak. rs. 70,500. this shows an average increase in pak. rs. 11,750 (20%). the average income of urban illiterate borrowers before borrowing is pak. rs. 83,333 and after borrowing is pak. rs. 105,500. this shows an average increase in pak. rs. 22,167 (27%). these results indicate that illiterate borrowers from urban borrowers have a 7% higher increase in their income compared to rural counterparts. the average income of rural „primary‟ borrowers before borrowing is pak. rs. 63,581 and after borrowing is pak. rs. 74,122. this shows an average increase in pak. rs. 10,541 (17%). the average income of urban „primary‟ borrowers before borrowing is pak. rs. 84,773 and after borrowing is pak. rs. 103,742. this shows an average increase in pak. rs. 18,970 (22%). these results indicate that borrowers with education level primary from urban areas have 5% higher increase in their income compared to rural counterparts. however, the average income of rural borrowers with education level „middle‟ before borrowing is pak. rs. 58,333 and after borrowing is pak. rs. 70,667. this shows an average increase in pak. rs. 12,333 (21%). the average income of urban with education level „middle‟ before borrowing is pak. rs. 81,000 and after borrowing is pak. rs. 99,400. this shows an average increase in pak. rs. 18,400 (23%). these results indicate that borrowers with education level „middle‟ from urban areas have 2% higher increase in their income compared to the rural counterpart. ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 moreover, the average income of rural borrowers with education level „matric‟ before borrowing is pak. rs. 60,000 and after borrowing is pak. rs. 71,000. this shows an average increase in pak. rs. 11,000 (18%). the average income of urban with education level „matric‟ before borrowing is pak. rs. 90,000 and after borrowing is pak. rs. 105,000. this shows an average increase in pak. rs. 15,000 (17%). these results indicate that borrowers with education level „matric‟ from rural areas have a 1% higher increase in their income compared to the urban counterpart. the average income of rural borrowers with education level „intermediate‟ before borrowing is pak. rs. 55,938 and after borrowing is pak. rs. 67,688. this shows an average increase in pak. rs. 11,750 (21%). the average income of urban with education level „intermediate‟ before borrowing is pak. rs. 79,533 and after borrowing is pak. rs. 97,800. this shows an average increase in pak. rs. 18,267 (23%). these results indicate that borrowers with education level „intermediate‟ from urban areas have 2% higher increase in their income compared to the rural counterpart. the average income of rural borrowers with education level „graduate‟ before borrowing is pak. rs. 58,077 and after borrowing is pak. rs. 69,846. this shows an average increase in pak. rs. 11,769 (20%). the average income of urban with education level „graduate‟ before borrowing is pak. rs. 80,143 and after borrowing is pak. rs. 98,000. this shows an average increase in pak. rs. 17,857 (22%). these results indicate that borrowers with education level „graduate‟ from urban areas have 2% higher increase in their income compared to rural counterparts. the average income of urban with education level „masters‟ before borrowing is pak. rs. 79,000 and after borrowing is pak. rs. 86,000. this shows an average increase in pak. rs. 16,000 (23%). however, there was no borrower from rural areas with education level „masters‟ in the sample provided by akhuwat. generally, the educational level affects the earning capacity of the household, however, the results do not show any increase in earnings due to education level. this difference could be due to the business experience rather than the education level only. further, the business skills and experience are more relevant than the education level of the borrowers engaged in these small scale basic business activities. c. business activities of rural and urban borrowers table iii. business activities of rural and urban borrowers the results indicate that the average income of borrowers from rural areas before borrowing was pak rs. 61,270 and after borrowing was pak rs. 77,262. it represents an average increase of pak rs. 10,992 (18%) in household income. borrowers during the interview highlighted that before borrowing from akhuwat, they were borrowing from agricultural banks and they were paying a large share of their income in the form of interest. since they do not have to pay interest on akhuwat borrowing, therefore they have an increase in their income. even though they did not experience a big shift in their income after switching to akhuwat financing, they are satisfied because they refrain from sharia prohibited financing (riba). results from urban areas revealed that the average income of households before borrowing was pak rs. 82,281 and after borrowing was pak rs. 100,901. it is observed that there is an average increase of pak rs. 18,620 (23%) in the household income of urban borrowers. it is further noticed that urban borrowers have a higher increase of 5% as compared to rural borrowers. the higher increase in income of urban borrowers has been witnessed from the following business activities:  30% to 34% increase: other small business activities such as retail shops fall in this range which provides the highest increase of 32% in the yearly income.  25% to 29% increase: construction and materials business activities, stationery & printing, transportation, manufacturing, and mechanical workshops lie under this category. however, construction & materials business activity provides the overall second-highest increase of 28% in the yearly income. in your paper title, if the words “that uses” can accurately replace the word “using”, capitalize the “u”; if not, keep using lower-cased.furthermore, stationary & printing, transportation, and manufacturing activities provide the third-highest increase of 26% in the yearly income. ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7  20% to 24% increase: auto workshops, beauty salons, and housing business activities fall in this range.  15% to 19% increase: electronics and grocery shops provide the lowest increase of 16% and 18% respectively the average increase yearly income of urban borrowers is 23% (average of all the above described multiple activities). the result is a manifestation of the effect of the place of the borrower on the level of success accrued. the increase in the income of urban dwellers is higher than rural households. according to akhuwat management, borrowers of urban centers have certain advantages that those in rural areas do not have. these advantages include skill development, broader customer base, the ability to expand the scale of business and material impact to make a profit within the shortest possible time. it is important to note that although the rural dwellers had a modest change in income as compared to the city dwellers, they were able to pay the loans they contracted. according to akhuwat, borrowers were able to pay the loans within the agreed period. they also have an easy installment plan to facilitate their repayment capabilities. the capacity most of the borrowers from urban areas ranges monthly sum of 1,000 to 3,000. a borrower from rural areas who take a loan for agriculture purposes returns the money after six months upon harvesting the crops. since akhuwat provides flexible and affordable repayment plan, its recovery rate is maintained at 99.80% to about 100% during the years 2001-2017. d. impact of akhuwat borrowing on spending this section analyzes the spending and food sufficiency level of borrowers before and after borrowing. findings revealed that akhuwat microfinance has a significant impact not only on the income increase of the borrowers but also on their spending ability has increased. they are in the position of meeting their expenditures better than before borrowing. their standard of living is improved. borrowers from rural and urban areas have shown a shift from lower spending categories to higher spending categories. the percentage of borrowers in rural areas are spending below pak rs. 2,000 decreased from 12.5% to 4%, showing that they moved to a higher expenditure bracket. a similar trend was observed in urban areas where the percentage of borrowers is spending below pak rs. 2,000 decreased from 10.25% to 3.25%. the percentage of borrowers in rural areas are spending between pak rs. 2,000-4,000 decreased from 24.5% to 12.25%. in urban areas, the percentage of borrowers is spending between pak rs. 2,000-4,000 decreased from 18.25% to 14%. the percentage of borrowers in rural areas are spending between pak rs. 4,000-6,000 increased from 28% to 36.25%. similarly, the percentage of borrowers in urban areas spending between pak rs. 4,000-6,000 increased from 27.65% to 31.75%. the percentage of borrowers in rural areas are spending between pak rs. 6,000-8,000 increased from 18% to 24.25%. similarly, the percentage of borrowers in urban areas spending between pak rs. 6,000-8,000 increased from 22.75% to 26.55%. the percentage of borrowers in rural areas are spending at higher amounts: between pak rs. 8,000-10,000 and greater than pak rs. 10,000 increased from 15% to 18.5%, and 2% to 4.75%, respectively. in urban areas, the percentage of borrowers spending: between pak rs. 8,000-10,000 and greater than pak rs. 10,000 increased from 17% to 19.45%, and 4.1% to 5%, respectively. the findings revealed that a higher percentage of borrowers in both urban and rural areas spent higher amounts after borrowing. the greatest amount of increase was seen in the middle range of pak rs. 4,000-6,000 in both areas. e. food sufficiency level most of the borrowers from the rural areas, as well as urban areas, responded that they have complete meals. 93.2% and 94.3% of borrowers from rural and urban areas confirmed that they have complete meals most of the time. overall food sufficiency in urban and rural areas is about 47 percent. only 7.2% and 6.25% of borrowers from rural and urban areas replied that they do not have enough food. generally, the households are in the food self-sufficiency level. food sufficiency response in rural areas ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 figure 1. food sufficiency response in urban areas x. conclusion this study has been conducted in order to analyze the relationship between demographic factors such as location, gender, and age of borrowers and results from the interest-free loan scheme provided by akhuwat organization. this study also analyzed the impact of education level and geographic location of borrowers on the utilization of loans. the study has been based on the data collected from akhuwat borrowers from rural as well as urban areas. the results indicate that average income increased by 18% and 23% of rural and urban borrowers respectively. our result also shows that only 0.79% of women borrowed money from akhuwat to run some business activities in rural areas. the results of the study on this factor were entirely different in urban areas. 42.15% of women and 57.85% of men from urban areas borrowed money to run the business. some of these women were single income earners while others were second income earners for the family. having second income earner in the family because of women participating in the economic activities of the family raises household income as well as helps the society for the poverty alleviation. women living in urban areas prevail certain advantages such as more economic opportunities, social acceptance of working women, higher competitive environment to name a few. this study also analyzed business activities available in rural areas compared to the opportunities available in urban areas. the study shows that there are not many options available to people living in rural areas. our results indicate that all of the borrowers selected from the rural areas were engaged in farming and related activities. comparing these results with borrowers from urban areas, it became apparent that they have far greater opportunities available. our results show that they are mainly engaged in retail, manufacturing, services, small businesses, construction, transportation, and various other activities. moreover, the main part of our study is to compare the impact of the education level of borrowers on their ability to utilize the loan efficiently. the study indicates that 20% were illiterate borrowers from rural areas whereas there were 27% illiterate borrowers from urban areas. also, the ratio of educated borrowers was higher in urban areas compared to rural areas. generally, the education factor plays an important role in better utilization of the loan. however, due to the smaller scale of activity and value of the loan, the education level is not significant in making any big difference. the major consideration of loan approval is need-based. an important aspect of the achievement of positive results from this program is the skill development of the borrowers. individuals with an entrepreneurial mindset and new business ideas have done well through this program. the final part of our study is to assess the food sufficiency of borrowers. most of the borrowers from rural areas, as well as urban areas, responded that they have complete meals. 93.2% and 94.3% of borrowers from rural and urban areas respectively confirmed that they have complete meals most of the time. overall food sufficiency in urban and rural areas is about 47 percent. only 7.2% and 6.25% of borrowers from rural and urban areas respectively replied that they do not have enough food. generally, the households are in the food selfsufficiency level. xi. recommendations the results of our study show that akhuwat interest-free loan program has a positive impact on the financial conditions of the borrowers. the following recommendations will furtherhelp to improve the outcome of its program.  provide vocational training to people in rural areas so that they can have other options than relying only on agriculture business.  provide loan with the complete business package so that borrowers do not face difficulties in operating business activities in the beginning and carry out business successfully.  increase loan size so that borrowers can benefit more and they come out of permanent dependency on loans and become self-sufficient.  similar to providing agriculture input to farmers, akhuwat should consider providing tools and small machinery to farmers, so that they can deploy advanced farming techniques.  provide more opportunities for women from rural areas. women from urban areas already benefitting from the akhuwat program  increase the coverage of rural areas by creating additional branches and deploying additional resources.  borrowers appreciated the program and acknowledged the benefits received through the current limit of the loan amount. however, they can do much better if the loan limit is extended to 40,000-50,000 pak rupees. references [1] a. b. onakoya, &a. o. onakoya,“islamic microfinance as a poverty alleviation tool: expectations from ogun state, nigeria,”scholarly journal of business administration, 2013, 3(2), 36-43. [2] b. n. aldosari, “islamic microfinance system and poverty alleviation,” international journal of development and economic sustainability, 2016, 4(6), 33-44. [3] l. kirsten, "microfinance: a tool for poverty reduction?"senior honors projects.paper 300, 2012retrieved fromhttps://digitalcommons.uri.edu/cgi/viewcontent.cgi?article=1308&c ontext=srhonorsprog https://digitalcommons.uri.edu/cgi/viewcontent.cgi?article=1308&context=srhonorsprog https://digitalcommons.uri.edu/cgi/viewcontent.cgi?article=1308&context=srhonorsprog https://digitalcommons.uri.edu/cgi/viewcontent.cgi?article=1308&context=srhonorsprog ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 [4] m. n. aslam, “role of islamic microfinance in poverty alleviation in pakistan: an empirical approach,” international journal of academic research in accounting, finance and management sciences, 2014, 4(4), 143-152. [5] v. matara, “list of top 100 poorest countries in the world 2019,” 2019 retrieved march 15, 2019, retrieved from https://victormatara.com/list-of-top-100-poorest-countries-in-the-world/ [6] “a quarterly update on microfinance outreach in pakistan” microwatch, 2018, (50), q4. retrieved march 22, 2019, fromhttp://microfinanceconnect.info/assets/articles/f06cb03452cffb78df 8aaaa26f02a02a.pdf [7] a. basharat, “pakistan microfinance review 2017,” pakistan microfinance network, 2017. [online]. available: https://pmn.org.pk/wp-content/uploads/2020/03/pmr2017.pdf. [accessed: 25-jun-2020]. [8] n. s. shirazi “targeting and socio-economic impact of microfinance: a case study of pakistan,” islamic economic studies, 2012, 130(608), 1-56. [9] z. iqbal &b. shafiq,“islamic finance and the role of qard-al-hassan (benevolent loans) in enhancing inclusion: a case study of akhuwat,” 2015acrn oxford journal of finance and risk perspectives: special issue of social and sustainable finance,4(4), 23-40. [10] a. a. chaudhry, k. s. khan, &a. hassan, “transforming lives through empathy, compassion, societal well being and management best practices case of akhuwat, pakistan,”journal of management and research, 2016, 3 (2), 37-59. [11] j. s. beall, “akhuwat: potential for a sustainable islamic interest-free microfinance model,” scripps senior theses. 2016, vol. 755 [12] a. z. jaafar, “an inquiry into the sources of funding for qard hasan based mfis: acase study of akhuwat,” the wharton school, university of pennsylvania, 2018, retrieved: https://repository.upenn.edu/wharton_research_scholars/168?utm_sourc e=repository.upenn.edu%2fwharton_research_scholars%2f168&utm_m edium=pdf&utm_campaign=pdfcoverpages [13] m. harper, “akhuwat of lahore: breaking the rules.” enterprise development andmicrofinance, vol. 23, no. 1, pp. 70–80. – 12, 2012 [14] “akhuwat financial statements for the year ended, june 30, 2014,” akhuwat, 2014. [online]. available: https://akhuwat.org.pk/wp-content/uploads/2020/01/report-2014.pdf.; “akhuwat financial statements for the year ended, june 30, 2015,” akhuwat, 2015. [online]. available: https://akhuwat.org.pk/wp-content/uploads/2020/01/report2015.pdf.;“akhuwat financial statements for the year ended, june 30, 2016,” akhuwat, 2016. [online]. available: https://akhuwat.org.pk/wp-content/uploads/2020/01/report2016.pdf.;“akhuwat financial statements for the year ended, june 30, 2017,” akhuwat, 2017. [online]. available: https://akhuwat.org.pk/wp-content/uploads/2020/01/report-2017.pdf. about:blank about:blank about:blank about:blank about:blank about:blank about:blank https://akhuwat.org.pk/wp-content/uploads/2020/01/report-2014.pdf ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 contemporary responses to the criticism of islamic banks in malaysia department of finance, international islamic university malaysia department of business administration, international islamic university malaysia department of finance, international islamic university malaysia department of economics, international islamic university malaysia abstract--the rapid growth of islamic banks has become a focus of all investors and consumers. malaysia has put in a lot of effort to develop and gather acceptance from all citizens of the country for islamic banking. hence, throughout the sector’s expansion, there have been several critics, such as shariah scholars, investors, and consumers. for instance; a lack of shariah experts in both economics and shariah itself, interest rates as benchmark, similarities with conventional banks etc. as the malaysian islamic banking system is growing and expanding, as are its critics. therefore, the main purpose of this study to provide adequate arguments on the contemporary criticisms and challenges being faced by islamic banks in malaysia. this study has adopted a qualitative approach; conducting semistructured interviews and observations. the findings recognised shariah compliancy, interest rates as a benchmark, and a lack of shariah scholars are the most pertinent current issues for islamic banks in malaysia. through the supports of scholars, policy makers, and consumers, these issues can be resolved over time with islamic finance literacy. the outcome of this study may benefit policy makers, investors, muslim consumers, as well as stakeholders of islamic banking and finance. keywords: issues and challenges, criticisms, islamic banks, islamic banking and finance, malaysia i. introduction islamic banking is defined as a banking system which is in consonance with the spirit, ethos, and value system of islam and governed by the principles based on islamic law (shariah) (kunhibava, 2012; mustafa, 2019). as a consequence, justice and fairness are the core institutional pillars of islamic law and it‟s inherent in the legal framework to ensure all activities including economic endeavors are compliant(arumsari, wiranatakusuma, & ahmad, 2018; mohamed, 2019). thus, it follows that shariah, called fiqh muamalat (islamic rules on transactions),the rules and practices of fiqh muamalatare derived from the quran and sunnah, as well as other secondary sources of islamic law such as opinions collectively agreed among shariah scholars, analogy, and personal reasoning. interest free banking is a narrow concept denoting a number of banking instruments or operations which evade interest (rhanoui & belkhoutout, 2017; samad, 2019; sanyinna & omar, 2017). islamic banking, the more general term, is not only to avoid interest-based transactions banned in islamic shariah, but also to remove unethical and un-social practices along with avoiding the receipt and payment of interest in its transactions and operations(kunhibava, 2012). in a practical sense, islamic banking is the transformation of conventional money lending into transactions based on tangible assets and real services and whose operation is based on islamic principles of transactions of which profit and loss sharing (pls) is also key feature in islamic banking, as well as participating in a business with the client as financier in different as financial positions (lo & leow, 2014; samad, 2019). however, odeduntan and adewale(2013) reiterated that islamic banks are steadier than conventional banks in terms of their financial engagements in the current time. the model of an islamic banking system leads towards the achievement of a system which helps to achieve the objectives of islamic economic prosperity. along with the growth of islamic banking globally (aldarabseh, 2019; rhanoui & mohammad abdul matin chowdhury 1 , md. abdullah al masud 2 , md atiullah 3 , and jayadul islam tanvir 4 ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 belkhoutout, 2017), the islamic banking sector has taken further steps in malaysia by the grace of the almighty and through the efforts of malaysian central bank (bnm) (majid, samsudin, laton, & aziz, 2016). malaysia is said to be the hub for the islamic banking industry in the world (lo & leow, 2014; majid et al., 2016). nowadays, the number of banks is growing, as well as facing challenges and criticisms by the public and policy makers in regards to current islamic banking practices. moreover, the rapid growth of the islamic banking sector worldwide has opened the eyes of policymakers and shareholders in conventional banks (biancone & radwan, 2016). in terms of trust and confidence in islamic banks as compared to conventional banks, it has been found that, though islamic banks have less liquidity, these banks provide more assurance and confidence to their customers (rahman, 2019; biancone & radwan, 2018).attention has also been drawn by western countries and the business community from all other faiths. transactions in islamic finance and banking are facing challenges in the modern era of technology and economic development. for instance; a lack of qualified islamic economic expert, particularly those that have both conventional banking and shariah background (supardin, 2020). furthermore, islamic banks are criticised for being too similar to conventional banking in malaysia (kitamura, 2019). these critiques and issues have been described by consumers and policymakers as well as shareholders, expressing concerns about shariah compliance and the interest rate benchmark. the core objective of this research is to analyse the criticisms and challenges of the current islamic banking practices in malaysia which have arose throughout the years. in addition, past research and consumers have also acknowledged the facts and that banks need to deliver effective evidence to ensure the compatibility of current islamic banking practices are abided by under shariah rules and regulations. nonetheless, to achieve the objective of this paper, there are two questions to be scrutinised. firstly, how does the islamic banking industry remain compliant with islamic knowledge and shariah compliance? secondly, how are islamic banks going to improve the current practices of the islamic banking industry to enhance their sustainability? ii. theoretical background in this paper, two theories are being adopted and discussed to explain the contemporary issues and challenges of current islamic banking practices. namely, islamic banking and finance theory and the tawhidic paradigm will be discussed. these theories also are facilitated by the authors to provide in-depth knowledge concerning islamic banking and its current practices. a. islamic banking islamic banking is the way of conducting transactions which observes islamic rules and regulations (samad, 2019). it is mainly to confirm the eligibility of islamic norms in transactions(rhanoui & belkhoutout, 2017). in malaysia, islamic banking activities started in the 1980s (kunhibava, 2012; lo & leow, 2014) and the first ever fully fledged islamic bank was established in 1983, offering islamic banking products and services (kunhibava, 2012). however, over time, there have been many islamic banks established which have started to offer many products. lately, the introduction of several financial instruments and products have enlarged the market over the years with the refinement of islamic scholars. these include mudarabah (trust financing), murabaha (trade financing), musharakah (equity financing), ijarah (lease financing), and many other products that are based on several islamic contracts (mustafa, 2019). islamic banking and financial institutions are established based on shariah or islamic rules and regulations. the foundations are initiated from the holy scriptures, fiqh, and islamic revealed knowledge (lo & leow, 2014; samad, 2019). therefore, islamic banks and financial institutions are strictly constrained to follow a few principles, such as not dealing with interest, illegal goods and services related transactions, activities, and transactions that involve speculations (rhanoui & belkhoutout, 2017). b. tawhidic paradigm the tawhidic paradigm is a paradigm which relates to attaining performance in line with faith („aqīdāh), worship („ibādāh), and ethics (akhlāq) in life as servants and vicegerents of allah. in daily life, one must earn excellent value that is compounded upon the value of life as servant and vicegerent of allah in the world and days after death. in addition, the tawhidic paradigm brings the fundamental philosophies of islamic teaching into administrative activities. on the one hand, the islamic way of life is entrenched in any action as in doing charitable deeds for individuals and society. furthermore, both tasks, personal interest and collective interest, must be combined as an act of worship to please allah. while humans can use their cognition to formulate, implement, and evaluate administrative strategy, the revelations from the quran and the sunnah of the prophet, pbuh, guide human reasoning. according to sarif (2014), the tawhidic paradigm framework is connected with two dimensions of human life, ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 which are worldly and the hereafter, in the aspect of all types of decision making, operating business endeavours, and creating new ideas. the author also added that it imitates the application of rationality in expressing, applying, and assessing tactics with the intent to implement the faith as retainer and vicegerent of the almighty allah in the highest possible way. iii. literature review the essence of existing literature is to comprehend past studies on issues of islamic banking, with a concentration on different countries. islamic banks are profit-oriented associations with the distinction that they lead their undertakings exclusively with the aims of making decisions based on shariah and in accordance with its general aims (kahf, 2005). islamic banks are not very different from conventional, on the basis of pls (profit and loss sharing) paradigm (beck, demirgüç-kunt, & merrouche, 2013; chong & liu, 2009; mallin, farag, & ow-yong, 2014). similarly, majid et al.(2016) posited that the islamic banking framework is no different than conventional banking in malaysia. however, there are apparent similarities and differences between both islamic and conventional banks (mahmood, 2010). islamic banks still remain indistinguishable through function and operation from conventional banking (alam et al., 2019; khan, 2010). islamic banks are different than conventional counterparts in their operations, even though they play a similar role to financial intermediaries that are monitored by shariah law (louhichi, louati, & boujelbene, 2019). the contracts that are implemented in islamic banking products and services differ from conventional structures(doumpos, hasan, & pasiouras, 2017). interestingly, khan (2010) found that majority of islamic banks are impotent to provide shariah compliant vehicles. therefore, they find several shariah scholars those are willing to certify controversial instruments as shariah compliant. this idea is supported by ali and kasim (2019). successively, bank directors are using shariah supervisory boards in order to achieve their objectives and engage in all shariah activities which have created a few issues for islamic banks in bangladesh (alam et al., 2019). although, islamic banks are solvent in regards to managing risks, since they have good quality assets and sufficient funds (beck et al., 2013). louhichi et al. (2019) outlined that islamic banks provide many diverse products that are based on profit and loss sharing, and several products are based on mark-up percentage. indeed, there is an ongoing debate on interest rates as a mark-up for islamic debt instruments used by islamic banks (ibrahim & shah, 2012; waemustafa, 2013) which is not permitted by extant shariah scholars (hermanto, 2018; samad, 2019). thus, interest rates are used as benchmark by islamic banks which known as the rate of return (majid et al., 2016; rhanoui & belkhoutout, 2019). determining the rate of return for islamic banks is one of the biggest challenges to accommodate in the modern banking system and in islamic banking system, it is known that the rate of return is pls-based for depositors. hence, there is no noteworthy difference between interest rates of conventional banks and the rate of return that islamic banks pay to their depositors, though islamic banks are plsbased (chong & liu, 2009; ito, 2013; mushtaq & siddiqui, 2017; mustafa, 2019). remarkably, islamic banks are highly responsive with rates of returns movements for depositors during interest rate hikes (akhatova, zainal, & ibrahim, 2016; aysan, disli, ng, & ozturk, 2016). moreover, in malaysia, a tawarruq contract does not fulfil the sale contract requirement (fa-yusuf & ndiaye, 2017) and it is a way to bypass interest taking (bilal & meera, 2015). khan (2010) and majid et al. (2016) noted that the price of products and services of islamic banks are higher than conventional banks. unexpectedly, naqvi et al. (2017) outlined that there three main features of islamic banks that initiate a high degree of inter-mediation which are; capitalization, improved liquidity, and better service quality. these findings are supported by a previous study by shabbir and rehman (2019), which states that bank employees are not knowledgeable in regards to being responsive when serving customers. subsequently, waemustafa (2013) identified that the education of islamic banking and finance are not expressly provided for clients and staff. likewise, majid et al. (2016) found the lack of awareness and knowledge about islamic finance in malaysia. it was also found that islamic banking and finance plays a significant role in economic growth and development in malaysia (khaliq & thaker, 2014). from past studies, there are two types of criticism laid at the door of the islamic banking industry. one group criticise constructively and another group destructively (lone & ahmad, 2017). in detail, one group offers criticism to improve the industry whereas the other party is very cynical about the islamic banking industry. in fact, islamic banks are not charitable institutions but are the institutions that consider the investors‟ desire through the time value of money and returns on their capital investment align with market variations. a study criticised islamic economics (kuran, 2004)as irrelevant to modern economic ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 challenges, but another study by the same author criticised the concept of islam (kuran, 2012). similarly, khan (2010) pointed out the extensive discrepancies between ideals and practices of islamic banking and finance. khan (2016) made suggestions to improve islamic banking, making it even more islamic. subsequently, it was clear that there are many scholars who aren‟t clear about the concept, process, and implementation of islamic banking. ali et al. (2014) hinted that shariah scholars have limited knowledge and experiences over islamic finance and banking in bangladesh. in alignment with the idea, majid et al. (2016) clarified that there is very few knowledgeable and expert people in islamic finance and banking, supported by abdul-rahman, latif, muda, & abdullah, 2014; abosedra & bernard, 2018; amin, abdul-rahman, & razak, 2014; kamil & iqbal, 2017; kasim, sanusi, mutamimah, & handoyo, 2013; rhanoui & belkhoutout, 2017; and yaacob & donglah, 2012.furthermore, an islamic bank can educate those with a non-islamic shariah background bankers in regards to managing a bank‟s operations(ahmed, manwani, & ahmed, 2018; waemustafa, 2013). dr. mohd daud bakar (the chairman of the shariah advisory council, malaysia) noted that shariah scholars do not permit digital currency in islamic finance because they do not understand the concept of digital currencies (pikri, 2018). as a result, it is difficult for shariah supervisory boards to find adequate and expert scholars to guide islamic banks‟ operations and activities (alam et al., 2019). however, there are still instrumental deficient among islamic banks and institutions in order to adopt crypto currency or digital currency by following shariah principles (chowdhury & razak, 2019). iv. methodology this study is descriptive exploratory and explanatory in nature. the objective is to employ a qualitative research approach as the key research methodology to have a deeper understanding of the issues connected to the involvement of the improvement of banking services provided by islamic banks. this study articulates some issues and interviewed two experts from the industry. the first participant is currently serving an islamic bank as the shariah advisor and the second participant is a former islamic bank employee. both of the participants are also academic members of respective universities. the study has undertaken an observation at bank premises to observe the banking services of the bank as well. the approach involves the use of detailed observation of the banking services and conducting an intense and/or prolonged contact with participants. this will allow the researcher to gain a holistic overview of the context under the study and capture data on the perceptions of actors from the inside (lee, collier, & cullen, 2007). to accomplish the objective of the research, an exploratory study has been conducted to help the researcher spell out the understanding of the problem and be able to find out what is happening, to seek new insights, to ask questions, and assess the phenomena in a new light (saunders, lewis, & thornhill, 2007). v. findings a summary of the semi#-structured interviews with two islamic banking practitioners and academics and a previous islamic banker in malaysia is presented below (table 1).the first interviewee is a shariah adviser who served in an islamic bank in malaysia and the other interviewee is presently serving as an academic member of a reputed university, but he was also an islamic banker in malaysia. the findings from the two participants are discussed in this part of the study. from the participants‟ interview, this study identified four themes in the data which are summarised in the table below: table: summary of findings theme participant 1 participant 2 discussion shariah governance structure bank negara malaysia has offered a structure of a shariah governance framework to ensure the bank practices are compliant with shariah. the government shouldn‟t see it only from the banking side. if it is islamic banking and finance, there are many other sides such as waqf, zakat, sadaqah etc. government should look at those concepts to develop when it is islamic banking and finance. malaysia is very successful because of very good infrastructure, rules and regulations ,and the government currently giving very strong support. however, what we want to see is more improvement of islamic finance; all islamic finance is mostly contained in conventional system such as contracts, the products concept is more towards a debt concept. islamic banks are obliged to follow the rules and regulations that are imposed by bank negara malaysia (bnm). in fact, all islamic banks are bound to follow the structure and systems that have been introduced by bnm. therefore, there is no way to adopt any prohibited structures to practice by islamic banks in malaysia. conventional benchmark because conventional banking has dominated the there is no other benchmark to determine the in regards to benchmarks, islamic banks are ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 financial system for a long period, islamic banks are still a new industry in the market. there are a lot of major players in terms of conventional banks and they are experts, whereas islamic banks are still lacking structuring of the benchmark to determine their pricing and profit rate. there is no other option to follow by the islamic banks to be acceptable worldwide. however, there could be research about the structure of islamic banking benchmark. interest rate. then again, there are some other concept that exist such as palm oil, gold, tawarruq etc, all these are based on commodities, but still, the benchmark of commodities is also interest. now, islamic bank must find some alternative benchmarks rather than using conventional benchmarks. required to maintain worldwide transactions and policies. indeed, the industry is still new in the financial market. therefore, it is still structuring its own benchmarks to apply in the financial market. in addition, even though there are some products and transactions that are like conventional banks, these are still in alignment with islamic contracts and rules. therefore, it is not wise to find the similarities among the products from conventional and islamic products. shariah experts and islamic finance scholar previously, they were limited but with the support and efforts of bnm, it has structured some special universities like inceif and research institutions like isra to come up with experts in islamic finance. however, the numbers are still not enough, but it has been increasing recently as some of the universities focus on islamic financing in more depth. therefore, many experts they have to have different scholars in each and every different concept of shariah. everything can properly work with due respect of ummah. the definition is very strong. if they find things wrong everything will be wrong. if the right definition can be found, everything should be done the right way. numbers of islamic scholars can be improved in this way. it is observed that some universities and institutions in malaysia are offering islamic banking courses and training for students, increasing the number of scholars in the industry, as well as experts. therefore, the growth of islamic scholars is not lacking anymore. are appearing. challenges and criticism of islamic banks customer awareness and knowledge of islamic finance are the challenges of the islamic banks. there are some things that are necessary to overcome these challenges like trainings, educating the public in the schools from primary level. the real challenges are that the products look like conventional banking; the lack of islamic scholars who know about islamic finance very concisely. in order to overcome those challenges, the government should give full support. in that regard, the government shouldn‟t see it only from the banking side. if it‟s islamic banking and finance, there are many other sides such as waqf, zakat, sadaqah etc. the government should look at those concepts to develop when it is islamic banking and finance. islamic banks should come out from the conventional systems as much as they can, and the government should fully support this. the challenges and criticism of islamic banking practices are solved slowly. it is noteworthy that there are very few minor criticisms is in the market. however, those criticisms can be solved according to the grace of holy scriptures and the tawhidic paradigm. scholars put effort into solving issues and at the same time, provide innovative ideas to tackle the challenges. moreover, the government also must offer full support to overcome those challenges and lessen the criticism about islamic banking practice. vi. discussion and suggestions from the interviews, it is observed that islamic banks are obliged to follow the rules and regulations that are imposed by bank negara malaysia (bnm). it is also acknowledged that all islamic banks are obliged to follow the structure and systems that are formulated by bnm(majid et al., 2016). this finding is supported by louhichi et al. (2019). due to this, it would be illegitimate to adopt any prohibited structures to practice islamic banking in malaysia. in regards to competition ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 with conventional banks, islamic banks can tackle it with innovative products and operational activities (kitamura, 2019). it is observable that islamic banks are successful in competing with the existing banking industry. in addition, islamic banks performed better than conventional banks during a financial crisis (bitar, hassan, & walker, 2017; doumpos et al., 2017; ebrahim, jaafar, omar, & salleh, 2016; li, ee, boo, & rashid, 2016; louhichi et al., 2019; narayan, rizvi, sakti, & syarifuddin, 2019). as a result, islamic banks are growing and conventional banks are also operating islamic banking branches due its significant performance (biancone & radwan, 2018). both interviewees admitted that the challenges and criticisms of islamic banking practices are diminishing slowly. it is noticeable that there are very few minor criticisms in the market. however, those criticisms have been solved by the grace of the holy scriptures and tawhidic paradigm. scholars must put their efforts into solving these issues and, at the same time, provide innovative ideas to tackle these challenges. indeed, shariah compliance denotes two types of perspectives; conservative and moderate ways obligated to involve in islamic financial activities (hermanto, 2018). also, in regards to benchmarks, islamic banks are required to maintain worldwide transactions and policies. certainly, the industry is still new in the financial market. hence, it is still working to structure its own benchmark to apply in the financial market. even though there are some products and transactions that are like conventional banks, those are still in alignment with islamic contracts and rules. this enables malaysian muslims to use modern banking systems under an islamic umbrella (kitamura, 2019). in this scenario, islamic banks put maximum effort into maintaining their shariah policies through banking activities. islamic banking and finance has a lack of qualified islamic economic experts who have an integrated modern banking and shariah background (supardin, 2020). in regards to the scarcity of knowledgeable, shariah scholars, the interviewees noted that universities and institutions in malaysia are offering islamic banking courses and training for students. as a result, there is potential for development in shariah related human capital in malaysia. not to mention, the interviewees agreed with the challenges of insufficient innovative products, talent, and slow adoption of financial technologies facing islamic banks, as also supported by majid et al.(2016). though some of the islamic banks are using financial technology (fintech) currently, several banks are unable to adopt innovations due to high costs. moreover, the response to fintech by islamic banks is slow, notwithstanding their comprehension of the potential impact (ali, abdullah, & zaini, 2019). therefore, it is a huge challenge for islamic banks that are not able to adopt financial technology across the board. surprisingly, the reflective part of the observation identified both the strengths and weaknesses of the banks. as a customer, we never realize how to respond from an employee‟s perspective. as an observer, we saw from both sides. this study observed that the service quality needs to be improved by the islamic banks especially behavior, approach, and professionalism towards customers. in several discussions, the service quality is observed to be not up to mark (m. ali & raza, 2015; kunhibava, linga, & ruslan, 2018; sukmana & ibrahim, 2017). moreover, banks must provide sufficient information in regards to all products and services offered (amin, 2019). according to ali and raza (2015), a lot of services need to follow the model of conventional banks in terms of business model, customer satisfaction, and efficiency (see also, sanyinna & omar, 2017). however, in some situations, it is questionable whether the business model is islamic or conventional due to similar forms and computation. service quality has no issue with compliance; therefore, bank directors and managers are required to train and educate employees to serve customer with professionalism. vii. conclusion and recommendations religious names and concepts are very sensitive when they are used in practice. the first issue arises with regard to the compliance of implementing the concept of sharia into the practical world, based on shariah rules and regulations and using islam in a commercial perspective (rhanoui & belkhoutout, 2017). it is crucial nowadays to be compliant, since critics are keen to point out the compliance of shariah in application to islamic banking industries. islamic banks are trying to offer distinct products and services as well as working to islamise conventional banking operations in order to be competitive in the market. however, the practical issues of the islamic banking industry are the key factor to find the reliability for muslim ummah (sanyinna & omar, 2017). according to the interview data, both of our respondents admitted the reliability of islamic banking and its practices are in line with islamic knowledge. islamic finance and banking refers to shariah compliant financial transactions. adding to it, the products and services that are offered by islamic banks do not contain any prohibited practices or conditions that are ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 inconsistent with islamic principles and laws. there are some products or services that are offered by islamic banks which are similar to conventional banks‟ products, but it does not relate to the repealing the islamic norms and regulations (mustafa, 2019). those concepts are adopted from the current practices of conventional banking that and have been analysed by islamic jurists to evaluate the compliance of islamic rules so that they don‟t contain any forbidden concepts. islamic banks are indeed providing an immense service to the muslim ummah while competing with conventional giants in an environment where all infrastructures has been tailor-made for the latter. just as other banks are profit-making, islamic banks also exist to make profit but in accordance with shariah. someone may perceive this profit motive as an un-islamic approach, however these profits are not un-islamic and islamic banks purify their income with zakat and charitable activities, just as other businesses do. even though the islamic finance and banking industry is littered with plenty of criticism and allegations, its progress is an important and notable factor and, as in every industry, there will be pros and cons, but as muslims there is a duty to protect the industry. one can use his academic writing and oration abilities to criticise the practices of the islamic banking and finance industry as un-islamic, but it does not contribute to society, rather it will distance ummah from the industry and they will continue to use interest-based finance. despite critiques about the industry, scholars and orators should come up with solutions which will encourage islamic banks to be more islamic and compliant. the findings recommend that future researchers explore the islamic banking system and whether it can be a viable, unique alternative to the conventional banking system. also, the findings of this study point in a direction to investigate the way to develop islamic banking systems to be more competitive, with significant and workable products and services that are compliant with islamic principles. finally, this study can contribute to future study as part of literature reviews as positive views on islamic banking and finance and its acceptability as islamic compliant financial system. references [1] abdul-rahman, a., latif, r. a., muda, r., & abdullah, m. a. 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(2012). shari‟ah audit in islamic financial institutions : the postgraduates ‟perspective. international journal of economics and finance, 4(12), 224–239. https://doi.org/10.5539/ijef.v4n12p224 ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 11 http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 analysis of the determinants of capital adequacy ratio: the case of full-fledged islamic banks in the gulf cooperation council (gcc) abdilatif mao ali abstractthis study empirically analyzes bank-level and macroeconomic factors that have impact on the capital adequacy ratio (car) of the full-fledged islamic banks in the gulf cooperation council (gcc) and how they influence the banks’ capitalization decisions. this study covers a six years period ranging from 2013 to 2018. car ratio is a key stability indicator that measures the capability of banks to absorb unforeseen losses. to conduct the analysis, secondary data gathered from the annual financial reports of the banks as well from international economic database are used. using multiple linear regression model, the effect of return on assets (roa), return on equity (roe), financing to deposit ratio (fdr), operating expense to operating income (oeoi), bank size (size), non-performing financing (npf) as bank-specific explanatory variables and economic growth (gdp) and inflation (inf) as a proxy for macroeconomic explanatory variables on the car of the banks are studied. due to multicollinearity issues, roa is dropped. as a result of the regression analysis, oeoi and fdr are observed to positively and strongly impact car of the examined banks while size is found to have negative and significant effect. roe, npf, gdp and inf demonstrated insignificant influences on the banks’ car. this study reveals varying and significant under and over regulatory capitalization decisions across the banks. additionally, extreme expenditures and financial losses suffered by some banks are also discovered. keywords: capital adequacy ratio, full-fledged islamic banks, gulf cooperation council. i. introduction the islamic banking sector in the gulf states has always been the biggest campaigner for islamic financial system in the world as it the birthplace of the official shariacomplaint financial products offering institutions in the world following the opening of dubai islamic bank in the uae and islamic development bank in the kingdom of saudi arabia in the 1970s. since then, this sector continued playing a key role in the islamic banking system and currently dominates the industry as it represents the biggest share in the islamic financial system. the stability of gcc islamic banks became the focal point of many researchers [1]–[3], as it attracted investments not only from muslim customers but also from non-muslim clients who developed adverse inclination against the conventional banking system following the global financial crisis (gfc). the consequential realization of the impermissibility of the interest-based banking lead to the ample growth of the islamic banking industry [4]. according to biancone and radwan [5], the ethical-based operations of the islamic financial system, which is quite analogous to the ethical finance promoting aspect of social responsibility investment, appealed to the western countries as an attractive system. as compared to the conventional banks, islamic banks in the gcc remained relatively resilient to the spill-overs of the gfc up until it spread out to the real economy [6]. as a measure for financial stability, capital adequacy ratio (car) has long been recognized as one of the most efficient among other indicators in the realm of finance. as per estrella, park, & peristiani, if the riskweights assigned to bank assets precisely represent the risk level of the weighted assets then an enhanced and meaningful separation between safe and vulnerable banks can be realized using capital adequacy ratio [7]. capital adequacy ratio is defined as the level of capital a bank is required to hold in order to withstand risk exposures emanating from credit, market, and operating risks, and also to absorb possible financial damages and to guard their debtors [8]. according to the official definition of the basel committee on banking supervision (bcbs), “the capital ratio is the amount of regulatory capital divided by the amount of risk-weighted assets. the greater the amount of risk-weighted assets, the more capital is needed, and vice versa” [9]. in reference to universal regulatory standards, banks are required to maintain a minimum car of 8% to be labelled as safe and stable and to show adherence to banking regulations. however state bank regulators can set different capital ratios they deem appropriate for their banking sectors. for instance, central banks in the gcc, except for saudi arabia, all set a car in the range of 11% to 14.2% except state bank of saudi arabia who sets specific car requirements for each individual bank even though 8% is the minimum benchmark [10]. the capital adequacy ratios of the islamic banks in the gcc are ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 found to be generally higher than that of other banks in the region. post implementation of the basel iii norms, the average car of the islamic banks in the gcc in 2015 stood at 17.89% indicating the comfortable satisfaction of the enhanced basel iii framework in the bloc [11]. nonetheless, higher car does not necessarily imply immunity from insolvency as seen in the case of berhad islamic bank in malaysia who became bankrupt despite having an extremely higher car of 31% [12]. according to the authors, berhad islamic bank reduced other banking ratios like profitability or leverage to raise its capitalization ratio which resulted the dooming of the bank despite having immense capital base. reference [2] stated that the higher level of capital ratio in the islamic banking sector of the gulf states could be due to reliance on shareholder equity funds as a pivotal source of capital rather than debt-like financing instruments or the lack of rigorous risk-management tools at their disposal. as apparent as it is, the number of factors impacting the capitalization level of banks is plenteous. despite the number of studies conducted by numerous researchers to determine factors that influence the decision of banks when setting their capital adequacy ratios, a very few number of studies focused on the banking sector in the gcc. yet, none of them attempted to study purely the islamic banking institutions in the region. henceforth, this study attempts to study and analyze the determinants of capital adequacy ratios of the full-fledged islamic banks in the gcc. in section ii, a brief review of the gcc islamic banks is presented followed by literature review in section iii. section iv presents research methodology whereas section v contains the finding and discussion of the results gathered. in the last section (vi), conclusion and recommendation of the study is provided. ii. islamic banking institutions of the gcc over the years, the gcc, which comprises oil-rich countries of bahrain, kuwait, oman, qatar, saudi arabia, and uae, experienced buoyant economic activities resulting from alongside other factors – a booming islamic banking sector which played a key role by intensifying credit extensions and assisting the overall financial stance of the banking industry in the region. such improvements in the banking sector is accompanied by a wave of reforms including modernizing the financial stability strategy frameworks and financial safety nets, and enhancing the supervisory policy of the banks which contributed to the improved resilience of the banking sector in general [13]. the importance of islamic banking sector in the region is unquestionable one given the demographic dominance of muslim customers and the constant growth witnessed in the sector. according to the international monetary fund (imf), the year-to-year total asset growth of the islamic banking sector was nearly the double of its conventional counterparty with a growth rate of 11% and 6% respectively since 2006 [13]. the islamic banking sector takes huge credit for the inclusion of previously non-banking customers due to religious reasons into the banking system by offering sharia-compliant financial products which consequently developed the banking industry of the region. one major player for the growth of this sector and provision of islamic financial instruments is the ambition of banks in the start-up or growth phases who are longing to gain market share [14]. with respect to market share, the islamic banking sector in the gcc established its solid ground in the market by crossing the 25 percent threshold that necessarily suggests that banks in this sector to be considered as systematically important banks in the member states [15]. more specifically, the share of islamic banking institutions in the region witnessed a significant upsurge raising from 31% in 2008 to 45% in 2017 indicating the substantial penetration of this sector in the gulf financial market [16]. according to the imf report [13], islamic banks in saudi arabia claimed the biggest portion in terms of market power in the gcc islamic banking industry with a 29% market share, which is 1 percent more than the market share of uae islamic banks in region that stood at 28% in 2016. the market share of qatari and kuwaiti islamic banks in the region were 17% and 15% respectively whereas bahraini islamic banking institutions enjoyed a 9% market share. the islamic banks in the sultanate state of oman remained the least among the member states with only a 2% market share in the region. the state of oman houses only two islamic banking institutions that are the most recently opened ones in the region. yet, in 2016 omani islamic banks were named as one the fastest growing countries in term assets alongside the islamic banking institutions in maldives and palestine [17]. in terms of global islamic financial service industry (ifsi), the gcc, apart from sukuk products, outperformed all the other regions in every other segments with a total market share of 42%, which is almost 13% higher than its nearest competitor in 2017 as stipulated by the islamic financial services board (ifsb) in table 1 below [18]. the global islamic commercial banking market in the year 2017 was valued at around 1.7 trillion dollars with a projected growth amounting to about 2.4 trillion dollars in the year 2023. such growth is suggested to be driven by the table 1: global ifsi by sector and by region (usd billion, 2017) ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 source: ifsb [2018]. islamic fintech which enjoyed an investment of nearly 12.6 billion dollars from 2015 to 2018 [16]. as stated in the report, a number of islamic banks in the gcc, mainly in bahrain and kuwait are exerting tangible efforts to lead the way. for instance, kuwait finance house (kfh) in bahrain launched a digital service called benefitpay to support its cashless society. on the other hand, bahrain islamic bank partnered with bahrain fintech to make bahrain a leading fintech hub for the arab world. bahrain also houses one of the first sharia-compliant digital bank called meem. the locus of gcc islamic banks in the global islamic banking system clearly goes beyond the mentioned undertakings. wilson [19] stated that the islamic banking sector in the gulf region have long been a highly innovative one regarding product development and provision of services owing to the ongoing competition with its conventional counterparty for the domestic markets. considering the significant developments carried out by the gcc member states, the author dubbed the region as the center for islamic capitalism where the western capitalism elements are objected. measuring the impact of the developments of islamic banking system in the gcc on the economic growth of the region, mohd. yusof & bahlous [20] concluded that this sector is colossal to spur the regional economic growth, supporting the theoretical nexus between finance and growth. the islamic banking sector in the gulf bloc is credited for the conversion of revenues generated from petroleum exports into investment projects including innovations which contributed to the growth of the gcc economy [21]. the gulf region is a region that is highly dependent on proceedings from oil sales as it is one of the major oil exporting blocs in the world. however, the non-oil sectors is expected to be the main driving force behind the economic growth of the region in the approaching years [22]. the banking industry as a channeling institution plays a key role in providing funding to other non-oil sectors in the economy especially small and medium-sized enterprises (smes) who strongly rely on bank funds as they find it extremely hard to acquire funds from the under-developed capital markets. considering the cited facts and references, it is apparent that the gcc islamic banking institutions is not exclusively at the heart of the banking system of the gulf states but also at the wider global islamic financial system. iii. literature review capital adequacy ratio is a percentage indicator developed initially by the bcbs to evaluate the solvency level or soundness of banks. it refers to the amount of regulatory capital maintained by a bank to offset the inherent risk exposures of its risky assets. this ratio equips banks with a tool that can measure the level of losses they can absorb. based on capital adequacy ratio, the sufficiency of bank capital and the loss endurance level of banks during financial downturns can be measured or ‘judged’ [23]. to preserve depositor confidence and prevent banks from becoming bankrupt, capital adequacy is a requirement for banks [8]. according to hadjixenophontos & christodoulou-volos [24] and pham & nguyen [25], car serves two main purposes: first, it shows banks how safe they are from financial shocks. second, it shows bank stakeholders, like shareholders and depositors, that their interests are protected. asserting on the crucial part played by the banking system in the economic development, reference [24] argued that it is imperative rather that an option for banks to understand the significance of capital adequacy ratio to act as a preventive measure and the elements influencing a bank’s decision regarding their capital structures. in an attempt to investigate which factors influence how banks set their capital adequacy ratios, a number of researchers conducted empirical studies on different banking sectors. this study presents all prior similar studies covering islamic banking institutions to have a better reflection on the influencers of bank capitalization decisions. darwanis, & mursal (2019) studied the entire islamic commercial banks operating in indonesia from 2015 to 2017. using multiple regression model, the author investigated the effect of return on assets (roa), financing to deposits ratio (fdr), bank size, net interest income (nim), and deposit (dep) on the capital adequacy ratios (car) of the banks. the results of the study revealed that roa, fdr, nim, and size inversely influence car while dep effects car positively. these banks raised their car as their level of roa, fdr, size, and nim dropped but the rising level of dep warranted parallel increase. the author recommended the said banks to keep the car at 14% set regulators [26]. sutrisno (2018) conducted similar examination on a sample of 55 islamic banks serving rural customers in indonesia from 2015 to 2016. the author analyzed the degree and direction that return on assets, net profit margin (npm), fdr, nonperforming financing (npf), and operating efficiency (oeir) influence the car of these ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 banks utilizing a quarterly data obtained from the banks’ financial reports. as a result of the multiple linear regression analysis, it was concluded that, apart from roa and oeir, all other variables npm, fdr, and npf have a significantly positive effect of the car reported by the banks, implying that the increasing level of efficiency (npm), risky financing (npf), and liquidity (fdr) caused the capitalization level of these banks to upsurge to be cautious [27]. mohammed (2018) examined the effect of some banklevel variables on the car of a combination of conventional and islamic banks operating in the gulf region for the period of 2006 to 2015. employed a multiple linear regression on a panel of data, it was established that asset quality, management quality, and return on assets have a positive and significant association with car, whereas bank size and liquidity proved to inversely influence car of islamic banks. net interest income and credit risk demonstrated a poor association with the main variable. however, different findings were observed when the analysis was conducted on both industries simultaneously or on conventional banks only. in terms of connection between bank efficiency and car, the author revealed that capital ratios of islamic banks negatively affects their efficiency but in a lower magnitude as compared to the conventional banks [28]. hewaidy & alyousef (2018) conducted similar investigation on all listed banks in kuwait between 2009 and 2016. remarkebly, bank type is stated to have no significant effect on car, implying that explanatory variables investigated under this study have similar effect on the car of both islamic and conventional bank. apart from profitability metrics like roa, roe, and nim and macroeconomic factors like gdp and inflation, which are found to be insignificant, factors like bank size, loan loss reserves to total loans (asset quality), and net loans to asset (liquidity) indicated a negatively significant association with car whereas loans to deposits (management quality) demonstrated a positive and significant relation with car of kuwaiti banks [29]. ayub & javeed (2016) observed the financing approach of five islamic banks in pakistan from 2004 to 2014, a ten year period. the authors found that capital regulations in pakistan had an adverse impact on these banks financing strategies and recommended the reduction of risky assets and investment in low risk government securities to represent themselves as well-capitalized banks. allocating a portion of retained earnings to capital bucket or issuing new equity shares were another effective approaches the authors recommended as well, since acquisition of capital from the market proved to be expensive [30]. valipour pasha (2015) studied the possible cause for the surge of nonperforming loans (npl) in the iranian banks and its correlation with the capital ratios of 19 islamic banks in iran from 2007 to 2012. the findings of the study suggested an inverse association between the two variables. thus, increasing the capital ratios, banks could manage to lower their level of nonperforming loans and hedge themselves from hazardous financial situations arising from lack of provisioning for loans. the author stated that npl shows the vulnerability level of banks, thus it should be lowered by serving only high quality debtors [31]. prior from this study bateni, vakilifard, & asghari (2014) studied the same jurisdiction and investigated the factors influencing capital ratios of six banks between 2006 and 2012. as found from the regression analysis, the car increased when the percentage of return on equity (roe), loan asset ratio (lar), and equity ratio (eqr) went up. however car of the studied banks declined when their sizes grew in terms of total assets showing that larger iranian banks enjoy lower supervisory restrictions than smaller ones and invest on riskier assets [32]. asma & khadidja (2015) investigated the influence of capital regulations on the financial performance of 17 islamic banks in malaysia and studied the impact of six bank-level variables extracted from 16 islamic banks’ financial reports for the period between 2006 and 2011. using a panel data methodology, the authors realized that as the degree of credit risk (cr) and profitability (roe) increased the banks raised their car. on the other hand, a positive association between car and roa is observed indicating that the banks allocated additional capital to protect owners as the additional profits raised the owners’ capital. other variables like liquidity risk (lr), operating efficiency (opr) and bank size (bs) have been found to have no significant effect of car of investigates islamic banks [33]. in egypt, ansary & hafez (2015) studied determinants of car on 36 commercial banks including 4 islamic banks for the period 2004 – 2013. according to the findings, profitability, liquidity and management quality displayed a positive and significant correlation with risk-based capital while bank size and credit risk indicated a negatively significant correlation. however, as for pre-crisis period, asset quality, profitability and size are found to be negatively correlated with car whereas only profitability showed a negative association with car. in terms of postcrisis, the authors concluded that liquidity, management quality and asset quality are directly and significantly related to car, and size is indirectly correlated with the capital ratios of the banks. however, it is worth mentioning that the effect of the variables on car are assumed to be similar on all types of banks as the authors did not provide any distinctive results for islamic banks [34]. the study of abusharba, triyuwono, ismail, & rahman (2013) is probably the first one conducted to learn the determinants of car of entirely islamic banks. the authors investigated the islamic commercial banks in indonesia from 2009 till 2011 applying multiple regression analysis model. the authors found a positive and significant relationship between car and profitability (roa) and liquidity (fdr), and a negatively significant association between car and nonperforming financing (npf) as a ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 measure for asset earning quality. however, operating expense to operating income (oeoi) and total deposits to total assets (da) representing operating efficiency and deposit structure failed to show any strong effect on the banks’ capitalization decisions. as per the authors’ conclusion, the capital of the studied banks were experiencing depreciation due to the credit risk originating from the financing modes like mudarabah, musharaka and murabahah, hence set their car at higher level [35]. iv. research methodology a. data sampling given the numerical nature of the variables examined for the purpose of this research, a quantitative research methodology is used. a quantitative research is defined as a research method that gathers data in the form of numbers and analyzes it using mathematical techniques mainly statistics, in order to explain an issue or a phenomenon [36]. since the focus of this study is on the islamic banking division of the gcc, a population of all the full-fledged islamic banks operating in the gcc from 2013 to 2018 is targeted, thus making it a census study. when the examined subjects are small in numbers, the outcome of a study is more reliable when all the subjects are included in the study as argued by žmuk, lutilsky, & dragija [37]. banking sector in the gcc houses a total of seventy nine (79) locally incorporated commercial banks, of which twenty eight (28) banks are full-fledged islamic banks – bahrain 6, kuwait 5, oman 2, uae 7, qatar 4, saudi arabia 4, licensed as sharia-complaint financial institutions by the central banks of each member country [38]–[43]. this study examines the 28 full-fledged islamic banks in the gcc for a six year period from 2013 to 2018, giving us a total observation number or sample size of 168 observations gathered from different secondary sources. as for banklevel variables, the data are collected from the annual financial reports of the banks. concerning the macroeconomic variables, this study relied on world bank and on united nations conference on trade and development (unctadstad) as its source. b. variable measurements this research examines the influence of specific independent variables on a single dependent variable as its main variable. in the context of a causality relationship, a variable whose variance is observed and recorded due to an influence by another independent variable is defined as dependent variable [44]. independent variables, also known as explanatory variables or predictors, are variables that are not affected by the actions of the researcher and bear the capacity to stand on their own. jupiter defined independent variables as the input and the covariate that makes up the model in a linear regression [45]. the dependent variable of this study is capital adequacy ratio (car) of the banks while return on asset (roa), return on equity (roe), operating efficiency (oeoi), liquidity (fdr), bank size (size), asset quality (npf), economic growth (gdp), and inflation (inf) represent the corresponding independent variables. below the definitions and measurements of the variables are provided: 1) dependent variable: capitalization: capital adequacy ratio (car) car measures the sufficiency level of regulatory capital maintained by a bank to offset unforeseen losses. it is used as an indicator for financial stability. the minimum required car is 8% car under the basel standard [46], however state banks normally exercise different ratios applicable to their situations. car is calculated by dividing tier 1 and tier 2 capital by the total risk-weighed assets (rwa) as presented by [32]. tier 1 capital is the primary source of capital used on the going-concern while tier 2 capital is the secondary source of capital used on the gone-concern. risk-weighted assets are assets of the banks classified according to their inherent risks. car = tier 1 capital+tier 2 capital total risk weighted assets (1) 2) independent variables: profitability: return on assets (roa) roa is a ratio indicating the amount of profits a firm generates from its total assets in percentage form. it displays the fraction of profit earned from single dollar invested in assets. as stated by saragih, a higher roa ratio shows a more effective utilization of company assets to generate net profits and increased company performance [47]. roa is derived by dividing after-tax net income by the total assets of an entity as shown by paudel & khanal [48]. after-tax net income are profits derived after all expenses are deducted including zakat payables. total asset refers to all economic resources of an entity. roa = net income after tax total assets (2) profitability: return on equity (roe) roe measures the rate of return earned utilizing shareholders’ equity. roe gives a picture on how effectually bank management utilize shareholders’ money [49]. roe expresses the amount of profits derived from each dollar of shareholders’ equity invested in a bank. in terms of profitability and potential for growth, roe acts as the most significant indicator for banks [50]. roe is the ratio of after-tax net income to the total equity of an entity ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 [48]. after-tax net income are profits derived after all expenses are deducted including zakat payables. total equity are the amount of assets remaining after all liabilities and share of investment accountholders are deducted as underlined by the accounting and auditing organization for islamic financial institutions (aaoifi) [51]. roe = net income after tax total equity (3) operating efficiency: operating expenses to operating income (oeoi) oeoi shows the amount of expenses incurred to generate revenue from a bank’s operating activities. this ratio indicates how efficiently banks are handling their expenses to generate profits from their operations. operating efficiency is a measurement of bank output relative to input utilized, where a higher ratio implies that expenses of the bank is rising leading to a decreasing bank profit [52]. oeoi represents total operating expense of an entity to its total operating income as used in the work of lotto [52]. operating expenses are the all expenses incurred for the normal operations of the banks excluding impairment provisions and income tax. operating income represents all profits generated from a bank’s normal operations. oeoi = operating expense operating income (4) liquidity: financing to deposits (fdr) fdr indicates the amount of depositor funds used for financing purposes. it shows the liquidity level of islamic banks. as defined by iqbal, liquidity is the ability of banks to meet their financial obligations towards deposit withdrawals, maturing loan demands, and overall liabilities without experiencing setbacks [53]. generally an fdr ratio in the range of 80% to 90% is typically viewed as ideal. fdr is the ratio of total financing to total deposits [26]. total financing is total amount of assets financed by a bank. total deposits are the deposits from bank customers and unrestricted investment account holders. fdr = total financing total deposits (5) bank size: log total assets (size) bank size refers to the overall size of a bank indicated by the total amount of economic resources or assets owned by a bank. given its robustness to research sensitivity and commonality in usage, log total assets is used as a proxy for bank size [54]–[57]. log total asset refers to the total assets of the banks converted into us dollars and computed in terms of logarithm to have comparability among banks size = log(total assets) (6) asset quality: nonperforming financing (npf) npf measures the amount of uncollectable funds or nonperforming financing from the total financing of a bank. asset quality is measured by dividing nonperforming loans of a bank to its total outstanding loans where a rise of this ratio indicates a downgrading asset quality management of banks [28]. as stated by indriastuti & m. ifada, an npf ratio that is below 5% is acceptable indicating healthy financing activities of banks [58]. the calculation of npf is found with the division of nonperforming financing of a bank to its total financing volume as employed by raniah, khairunnisa, & triyanto [59]. nonperforming financing: all impaired or highly unrecoverable funds granted to customers while total financing are all funds granted by banks to finance customer projects. npf = non−performing financing total financing (7) economic growth: growth domestic product (gdp) gdp is a macro-economic indicator that shows the yearly economic growth of a country. gdp growth often results in higher profitable activities and further investment opportunities for firms creating an increased demand for financing by firms [60]. the higher the gdp ratio the better for an economy. economic growth a nation is calculated using the annual rate change of its gdp [61]. gdp: the entire goods and services produced within the boundaries of a specific country for specific duration. gdp = annual gdp growth rate (8) inflation: consumer price index (inf) inflation measures the percentage change in the prices of general goods and services represented by consumer price index (cpi). it refers to situations where the general price level in an economy increases continuously or, where the value of money undergoes continuous decline [62]. the inflationary situation of a nation is derived by measuring its annual cpi change as provided in the study of alper & anbar (2011) [61]. cpi represents the rational change in the yearly average prices for a basket of consumer goods and services. ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 inf = annual cpi rate (9) c. data validation before performing any statistical analysis, the validity and reliability of the collected data must be tested in order to ascertain the accuracy of the regression model to be applied and adherence to some underlying assumptions. as stressed on by ghasemi & zahediasl a researcher should seriously consider statistical assumptions since failure to uphold such assumptions might hinder the possibility to draw accurate and reliable conclusions about the facts [63]. to perform such tests and all the subsequent statistical measurements, the statistical package of stata is used. 1) normality tests: as a first step, normality test is performed and nonnormality of the data due to outliers is observed. nonetheless, such non-normality is unaccounted for as the number of observations or sample size (164 observations) of this study is sufficiently large to relax this assumption as stated by prior researchers involved in the field [63], [64]. on the other hand, yang argued that regression analysis show resilience and robustness against non-normality of the error terms as conclusions drawn from such analysis remain valid despite nonnormality [65]. henceforth, the outcome of this study is presumed to be valid and reliable regardless of the normality assumption failure. 2) multicollinearity test: one major test conducted before a regression analysis is performed is the multicollinearity test which assesses the existence of linear relations among the explanatory variables of a research. technically, the issue of multicollinearity emerges when two identical independent variables having similar purpose but with different measurements are included in a model. an example of such phenomenon is the presence of two variables representing height in a model where one variable is measured with inches and the other with feet. to test the issue of multicollinearity, the commonly used variance inflation factor (vif) is employed. a vif value exceeding 10 indicates multicollinearity problem in a model. as a result of the test, return on assets (roa) is found to have an 11.93 value which is greater than the required 10 (refer to table 3 below). to fix this problem, dropping roa is conceived as a viable option to avoid distortion in our data. to assume no multi-collinearity problem in a model, only variables that have no exact linear functions with one or multiple variables should be included in the model [64]. 3) heteroscedasticity test: another validity test is the test of heteroscedasticity. heteroscedasticity refers to situations where the variances witnessed in the residuals of the dependent variable is caused by the predictors in the model which is not preferred. in classical linear regression, the residual or error term in the model is assumed to have equal variance or are homoscedastic across the observations. thus, the violation of such assumption is referred to as heteroscedasticity [66]. the presence of heteroscedasticity leads to producing a p-value that is smaller than it should be in normal conditions. to detect heteroscedasticity, a numerical and graphical tests of breusch-pagan (bp) test and residual-versus-fitted (rvf) graph respectively are conducted. the bp test discovered a p-value of 0.2152, thus accepting the null hypothesis of homoscedasticity. furthermore, the rvf graph confirmed the result of bp by illustrated equal spreading of the data points below and above the zero line. table 3: multicollinearity test (vif) variables vif roa 11.93 roe 5.27 oeoi 5.91 fdr 1.67 size 1.38 npf 1.10 gdp 1.10 inf 1.20 d. model specification in order to examine the effect of bank-level and macroeconomic level factors on the determination of gcc islamic banks capital adequacy ratios, this study employs a multiple linear regression model on a panel of data consisting of 28 cross-sections (the selected banks) and 6 time periods ranging from 2013 to 2018. multiple linear regression refers to statistical models where the effect of multiple number of variables or independent variables on a single dependent variable is examined to test possible causal relationship. as argued by abusharba, triyuwono, ismail, and rahman, regression models come in handy when the model is needed to explain the inter-relationship between the outcome variable and explanatory variables [35]. the regression model of this study is as follows: carbit = α + β1roebit + β2oeoibit + β3fdrbit + β4sizebit + β5npfbit + β6gdpbit + β7infbit + εbit in the above equation, 𝛼 is the constant value while β1...n represent the coefficients of the explanatory variables. t represents time period while i and b represent the 28 banks and 6 gcc member states respectively. the symbol ɛ is the ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 error term reflecting all other influencing factors absent in the model. v. findings and discussions a. descriptive statistics. as visible in table 4, the total number of observations in this study is 168 giving us a fairly sufficient data-set to run our analysis. the descriptive analysis in the table has been summarized as follows: capital adequacy ratios (car) of the islamic banks in the gulf states displayed a mean of 20.29% indicating maintenance of capital ratios above the minimum international and domestic thresholds on the average. the standard deviation of car was 10.8 % signifying fluctuations among the banks in holding regulatory capital. the minimum and maximum car values were 1.7% and 97% respectively further supporting this variance. some islamic banks in the gcc failed to maintain the required minimum while some others followed a very extremely prudent approach holding regulatory capital almost equivalent to its risky assets. roe exhibited an average value of 8.2% and a standard deviation of 6.8% indicating that the returns earned from shareholder equity of the observed banks require improvements given the slight variance among their ratios. a minimum value of -20.4% shows that the least profitable bank lost almost as much as the most profitable one with a roe of 21.2%. in terms of operating efficiency oeoi, the mean value was 59.4% indicating that on the average the banks managed their operating expenses poorly. yet, the banks differed highly with a standard deviation of 68.2% which is substantial. the minimum and maximum oeoi value were 3.18% and 558.9% respectively supporting the extreme deviation. the maximum value shows extremely overspending of more than 5 folds the anticipated profit. an average fdr of 95.7% and a standard deviation of 39.4% are found indicating the large and varying liquidity positions of the banks respectively. a minimum and maximum fdr of 1.5% and 455.8% clearly shows how some banks kept customer deposits extremely idle (1.5%) while some others financed more than depositor funds (455.8%). the average size of the banks measured with logarithm of total assets was 7.182944. the standard deviation of size was 0.668 with a minimum of 6.000757 and maximum of 9.355704 signifying the varying sizes of the examined banks. the mean asset quality (npf) stood at 4.78% among the banks indicating a satisfactory asset quality management on the average. on the other hand, the standard deviation of 7.72% showed that the banks were quite consistent regarding this factor while a range between 0 and 0.83 point out that none of the banks faced unfavorable financing problems. the findings show banks succeeded in avoiding any financing impairment and recovered all its finances. the average gdp of the region was 2.65% indicating healthy economic conditions in the region. this favorable condition is mutual among the stated given the variance of 1.91% which is smaller. the least and highest growth rate were -2.866% and 5.42% respectively showing a decline in the first case. inflation (inf) rate of the region was 2.22% with a standard deviation of 1.04% exhibiting stable inflationary positions in the gcc. in addition to the highest inflation of 4.07% suffered by the region, the region experienced a deflation of -0.0237%. table 4: descriptive statistics variables obs. no. mean standard deviation min max car 168 0.202924 0.1084205 0.01732 0.9707 roe 168 0.081892 0.0683937 -0.20376 0.21207 oeoi 168 0.594768 0.6822212 0.031882 5.899902 fdr 168 0.957305 0.3941127 0.015888 4.558445 size 168 7.182944 0.6681826 6.000757 9.355704 npf 168 0.047879 0.0771992 0 0.83 gdp 168 0.026489 0.0191467 -0.02866 0.054165 inf 168 0.022255 0.0104029 -0.00237 0.0407 b. correlation analysis in table 5, the analysis of the correlations among the variables is presented using the spearman’s rank correlation matrix. spearman’s correlation matrix is applicable to data sets that are not normally distributed due to outlier effects [67]. as evident in the table, the association between car and roe is negative and significant at 5% level which means that bank capitalization level drops as the profit rate surges. profitability (roe) has a negative and strong relation with oeoi and fdr, but a positive and significant correlation with bank size. fdr exhibits a significantly positive linear relation with car showing analogous direction of liquidity and risk-based capital levels. liquidity (fdr) seems to drop when nonperforming financing (npf) and inflation rate (inf) escalates. apart from the inverse strong correlation with roe, oeoi has no significant association with any variable. the relation of bank size with car is inverse but insignificant, while the relation of the former with roe is the only positively significant one. this implies that banks grow as they make more profits. the correlation between asset quality (npf) and car is inverse and significant at 5% level. this means that car increases when the rate of impaired financing assets declines. npf has inversely strong relations with fdr and size indicating that asset quality improves (npf drops) when financing activity and bank size expands. the relationship of gdp and inf with car are negative but weak to account for. gdp ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 has zero strong relation with any variable while inflation (inf) rise reduces liquidity and sizes of banks. table 5: spearman’s rank correlation note: (*) symbolizes significance at 0.05 level c. regression analysis in a multiple regression analysis, there are a number of approaches including fixed effect model (fem) and random effect model (rem) each having specific properties. the main element that differentiates rem from fem is that the rem model assumes that the independent variables of the model have no correlation with the unobserved time-invariant effects in the model while the fem assumes an association [68, p. 1061]. to determine the most suitable model for this study, the hausman test is performed and indicated that the most fitting model for our regression is the rem since the generated p-value is greater than 5%, thus accepting the null hypothesis of random effect model. in table 6, the results of the regression analysis are presented. as shown in the table, the r-squared (r-sq.) and akaike’s information criterion (aic) are 0.851 and -667.8 respectively ascertaining the overall fitness of the model. generally, an optimal model is said to be one with the highest r-sq. and the least aic values [69]. on the other hand, the probability significance of the model is less than 0.05 (prob. (wald chi2) = 0.0000)) rejecting the null hypothesis that explanatory variables of the study do not influence the corresponding dependent variable. the adjusted r-square (adj.r-sq.) is 0.813, implying that 81.3% of the variances on the dependent variables is explained by the independent variables after having adjusted by the number of cases and variables. as visible in table 6, only three variables namely; operating efficiency, liquidity and bank size have significant influence on capital adequacy ratio. operating efficiency (oeoi) has a strong impact on car of the examined banks with a power of less than 0.01%. the coefficient of oeoi is 0.11 which means that capitalization level of the gcc islamic banks increases by 11% when oeoi rises by 1% or operating efficiency drop by one percent. this ratio should be interpreted carefully as a higher oeoi ratio implies that banks incur more expenses to generate income in their normal operations leading to operating inefficiency. hence, a lowering oeoi ratio is preferred. the results found contradict the findings of most prior researchers who found it to be an insignificant factor even though they anticipated a significant and positive impact [33], [35]. as far as our knowledge extends, no prior studies on entirely islamic banking sector found similar results. yet, studies on conventional banks revealed significant but negative influence of oeoi on the capital adequacy of banks [70], [71]. the finding of this study reveals that islamic banks with increased operating costs experience rising capital ratios. rahman [72] states that rising bank costs or expenses leads to a diminishing level of bank stability. liquidity represented by financing to deposit ratio (fdr) is found to strongly influence car of the examined banks with a p-value below 0.01%. the coefficient of fdr is positive 0.0952 implying that these banks raise the regulatory capital level (car) by 9.52% as the level of financing activities intensifies by a single percentage. the result found supports the findings found in the studies of prior researcher that focused on islamic banks as well [27], [35], [73]. however, the finding contradicts the observations of mursal, darwanis, and ibrahim (2019) who found an inverse effect of fdr on the capital adequacy ratios of the indonesian commercial islamic banks indicating tendency to lower capital base when financing volume is expanded and greater returns are expected [26]. on the contrary, gcc islamic banks tend to act prudently and support their financing endeavors with reserved capital in order to have contingent plan in case of unfavorable circumstances. bank size calculated in terms of logarithm of total assets (size) reveals an inverse and significant effect on the car of the islamic banks in the gcc at less than 1% pvalue. due to the log transformation, the nature of the impact of transformed variable and its interpretation changes unlike the original variable [74]. the rule of thumb for log transformed variable is to divide 100 by its coefficient value. hence, the coefficient of size becomes v a ria b le s c a r r o e o e o i f d r s iz e n p f g d p in f c a r 1 r o e 0.217 4* 1 o e o i 0.029 7 0.434 5* 1 f d r 0.153 7* 0.276 8* 0.03 62 1 s i z e 0.052 4 0.328 3* 0.09 34 0.019 8 1 n p f 0.337 6* -0.1 0.01 21 0.275 5* 0.394 3* 1 g d p 0.090 8 0.089 5 0.06 93 0.116 2 0.121 3 0.13 63 1 i n f 0.118 7 0.149 8 0.06 96 0.202 1* 0.180 2* 0.04 19 0.14 54 1 ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 0.000307 (0.0307/100). the adjusted coefficient of size of negative 0.000307 shows that the said banks tend to reduce their car by 0.03% because of a one percent expansion in terms of their sizes. our observation supports almost all prior studies that was conducted on the islamic banking sector of this nature [26], [28], [33]. our result is inconsistence with the findings of asma & khadidja (2015) who revealed a weak and positive outcome when it comes to bank size [33]. the remaining factors including profitability (roe), asset quality (npf), economic growth (gdp) and inflation (inf) failed to exhibit any tangible influence on the capitalization level of the islamic banking institutions in the gulf states for the duration of this study at any significance level (5%, 1%, and 0.1%). this means that these variables pose no significant effect and can be neglected. table 6: random effects model predictors coefficients (beta) p-values (power) t-values profitability (roe) 0.00562 0.936 -0.08 operating efficiency (oeoi) 0.11 0.000*** 15.80 liquidity (fdr) 0.0952 0.000*** 8.77 bank size (size) -0.0307^ 0.003** -2.99 asset quality (npf) -0.066 0.121 -1.55 economic growth (gdp) -0.0993 0.581 -0.55 inflation rate (inf) -0.406 0.181 -1.34 constant 0.281 0.000*** 3.65 obs no 168 bank no 28 r-sq. 0.851 adj. r-sq. 0.813 aic -667.8 prob. (wald chi2) 0.0000 significance level: * p<0.05, ** p<0.01, *** p<0.001. note: ^ coefficient of size is adjusted and justified above. vi. conclusions and recommendation in this paper, six bank-level and two macroeconomic variables has been examined to determine the extent of their effect on the capital adequacy ratios of the gcc islamic banks. the focus of this paper has been entirely on the commercial banks offering only sharia-compliant products in the region. using a panel data for 28 banks in 6 gcc member states between 2013 and 2018, a regression model has been developed to carry out the analysis. according to the findings of the regression model, return on equity (roe), asset quality (npf), economic growth (gdp) and inflation (inf) have no significant impact on the car of the said banks. the mild average fluctuation of the economic indicators (gdp and inflation) can explain why such macrolevel factors have no effect on the banks’ capitalization decision as the region did not experience extremely changing economic conditions over the years. as shown earlier, operating efficiency (oeoi) directly and strongly influences car, which means that the studied banks raise their car as their operating costs rise. in any financial year, increasing costs might result from aggressive banking activities including financing customer demands to gain larger revenues. such behavior warrants practicing banks to rise their car to withstand the risk exposures from risky assets financed. in the gcc, the growth of islamic banks is significant and driven by start-up banks who aggressively provide sharia-compliant financial products to its customer in order to achieve growth. generally, islamic banking institutions in the gulf region experience increasing costs. to solve this issue these banks need to detect relevant cost drivers behind such increasing expenditures to achieve productive efficiency. plus, establishing effective cost management policies should be of great importance for these banks. liquidity (fdr) of the banks revealed a significantly positive impact on the car of the gcc islamic banks. this indicates that when these banks increasingly use their customer deposits to finance projects they increase their car to lower exposures from customer defaults to some extent. unlike conventional banks who benefit from welldeveloped liquidity markets, islamic banks still suffer from under-developed security markets as they lack wider options of sharia-compliant liquid instruments. hence, the proportional change of fdr and car should not come as a surprise considering the absence of strong liquidity management instruments. central banks in the gcc and islamic banking industry in general should increase their efforts to develop islamically applicable and effective liquid instruments to curb possible liquid-asset shortages. in terms of bank size, the influence of size on car is found to be negative and significant implying that gcc islamic banks lower their car as their size in terms of total assets grows. this indicates that smaller gcc islamic banks experience higher capital ratios as compared to bigger ones who enjoy higher asset diversifications leading to reduced risks and lower car. bigger banks normally reap the benefits of bail-outs from central banks during financial downturns because of their important role in the financial system. in addition to that, large banks enjoy easy access to capital markets which further relaxes their capital regulation requirements. small and medium banks tend to undertake riskier investments to achieve growth, thus raise their regulatory capital as a preventive measure which in turn enhances their financial stability. the banking regulators in the gcc should develop policies that can encourage smaller ejif – european journal of islamic finance no 14, december (2019) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 11 and medium banks to pursue growth while enacting appropriate capital regulations. as far as our knowledge extends, this is the only study that focused on the full-fledged islamic banks in the gulf region. this study is limited to the islamic banks that offer only sharia-compliant financial products in the region excluding wholesale and investment islamic banks that cater to only bigger projects; 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[74] j. pek, o. wong, and c. m. wong, “data transformations for inference with linear regression: clarifications and recommendations,” practical assessment, research and evaluation, vol. 22(9), pp. 1–11, 2017. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5896 1 performances of sharia mutual funds in indonesia: empirical evidence from a developing economy helmi muhammad *1 , niki puspita sari 2 , adita nafisa 3 1 department of sharia economics, faculty of economics and business, universitas islam raden rahmat malang, indonesia 2,3 department of management, faculty of economics and business, universitas islam raden rahmat malang, indonesia * corresponding author abstract— this study aims to analyze the performances of sharia mutual funds, especially in the sharia mutual funds on stocks, money market, fixed income, and mixed funds. to enact such a purpose, a descriptive quantitative approach was used in the investigation of on sharia mutual funds listed in indonesia stock exchange 2015-2020 following the criteria of sharia mutual funds of actively operate in indonesia stock exchange which has great performance seen from net asset value (nav). the data analysis was carried out using phases of determining the rate of return calculated from nav, the measurement of total risk with the standard deviation proxy, and the measurement of its performance using sharpe ratio. the results indicate that fixed return of sharia mutual fund carries the best performance compared to the stock, money market, and mixed investment funds. it has a higher return per unit risk and maximum probability of investment return above the income with riskfree. these research findings can be a reference for investors, primarily those who follow sharia rules, in making mutual funds investment related decision in the future. they also can consider the sharpe ratio to select the type of sharia mutual funds in indonesia, as the proper hedge investment. keywords-component; performance; mutual fund; sharpe ratio i. introduction sharia mutual funds experience a rapid development following the growth of technology and other commodity [23]. sharia mutual fund is an investment method for the investors with minimum knowledge, skills, and ability to directly invest. it is also seen as an ethical investment method. besides considering the moral dimension, sharia mutual funds only select the suitable assets and securities to the sharia rules (islamic law) [17]. currently, in choosing the type of investment, investor consider the risk, return, as well as the compliance to ethics and religion [11]. the basic principle or sharia mutual fund investment relies on its compliance to islamic financial system accepted by the world as a unique, ethical, and universal system [10], [37]. the sharia fund investment also brings periodic dividend for the investors, as the stock investment [14]. the dividend is obtained from the fund invested in various companies that comply to sharia. as mentioned in the islamic principle, investment should be made considering the islamic ethics, as the halal guarantee [27] and sharia compliance requires consistency of all transactions with islamic principles [9]. the manager is not allowed to purchase the stocks from companies who have the elements of usury, alcohol, gambling, tobacco, etc. besides, they are also prohibited to purchase the stocks of companies that bring negative effects for society, environment, or discriminating the employees [16]. even with limitations in islamic investment, the ethical investment trend has grown exponentially. in the last 20 years, the sharia mutual funds investment has become the alternative for ethical investors who comply to islamic values [16]. through the assets management companies, the sharia mutual funds investment has an interesting reciprocal relationship for the purpose of investment on different securities following the islamic laws. in relation to the global sharia mutual fund investment development, it has attracted the interest of investors [29]. in indonesia, sharia mutual funds experience a significant growth in the last six years. per december 2020, its net asset value (nav) reached 74.37 trillion, with 289 sharia mutual funds companies. its nav increased by 38.4%, from 53.74 trillion in 2019. besides, its performance increased by 55.8% in 2019, from 34.49 trillion in 2018 to 53.74 trillion. meanwhile, in 2018, it improved by 21.8% in 2017, from 28.31 trillion to 34.49 trillion. a spectacular increase occurred by 89.87% in 2017, from 14.91 trillion in 2016 to 28.31 submitted june 2021, revised august 2021, accepted august 2021 ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5896 2 trillion. in 2016, its nav went up approximately 35.3% in 2015, from 11.02 trillion to 14.91 trillion [36]. the accelerated sharia mutual fund performance shows the investors’ concern on ethical investment with greater return and lower risk. the results of previous studies suggest that sharia investment has lower risk exposure than conventional investment, so that it attracts the interest of investors who comply to sharia [28]. besides, it also has a greater performance, primarily during an economy recession [19]. previous studies on sharia mutual funds bring mixed results. using sharpe ratio and jansen measurement method from 21 companies, it is known that there are four companies with positive and consistent performance during the study period [31]. other findings show that there is no difference in the performance of sharia and conventional mutual funds seen from the level of risk and sharpe method [5]. in addition, using sharpe, treynor, and jensen's alpha methods, the performance of sharia mutual funds shows good performances during the crisis period [41]. the finding from previous research also shows that the sharia mutual funds have lower volatility than the conventional mutual funds [38]. in addition, other than the risk and return as the cut off, the sharia investors also consider the islamic principle, positioning it as the intriguing research topic [3], [26]. the results from those studies indicate the superiority of islamic financial system (sharia mutual funds) in the investment processes that also consider ethics and compliance toward sharia. unfortunately, those studies of sharia mutual funds have not investigated the type of sharia mutual funds that should be considerable and they have specifically not analyzed the performance. thus, this study investigates the performance of sharia mutual funds types, consisting of stocks, money market, fixed return, and mixed investment funds. their performance was measured using the sharpe ratio [35] to assess the excess return by considering the total risks. based on the previous research, the sharpe ratio was used as the performance index that has been generally used to measure the investment portfolio performance [39], including the sharia investment [15]. ii. literature review sharia mutual fund is the collection of individual capital managed to be invested by a specific investment institution following the sharia [17]. consequently, the sharia investment is made following the five primary prohibition of usury (riba), speculation (maysir), excessive uncertainty (gharar), investment on the prohibited activities and the division of risk and return [18], [34]. these fundamentals guide the sharia mutual funds investment. it has a strict filter to select the portfolio following the sharia rules [18], [22]. in this context, islamic scholars have made criteria of sharia filter to analyze sharia compliance [22]. the qualitative filter includes the business sector. the sharia mutual funds should not involve the businesses that are prohibited in islam, such as the industry of alcohol, cigarette, biotechnology for human cloning, or the company that attain capital from loan, to avoid interest. besides, sharia mutual funds also have to follow the criteria of quantitative of financial filter [13]. the criteria put aside the investment on company with loan, liquidity, and investment based on high interest. sharia mutual funds do not involve the investment on the fixed capital investment, such as the bond company, certificate of deposit, warrant and their derivatives such as the put and call option. the funds invested in this investment should also be free of interest-based loan, speculation or the excessive uncertainty. the accounting and auditing organization for islamic financial institutions (aaoifi) suggests some filters of financial ratio [1]. the sharia mutual funds only invest in the companies with the financial ratio within the set range. if their ratio has gone above the ratio set by islamic scholars, then the investment is prohibited. the financial ratio involves the debt to market capitalization ratio, the cash ratio and cash and interest-bearing securities to market capitalization ratio, also cash and account receivables to market capitalization ratio. related to the investment standard aaofi stated the total debt of a company should never exceed the 33% of its company's total market capitalization. this limitation is applied to ensure that the company has no excessive death rate, because the interest-based debt is prohibited in islam. therefore, sharia mutual funds made no investment in the company stock that increased its interest-based debt higher than 33% of its market capitalization. the second financial filter is the cash ratio and securities with interest toward market capitalization. this ratio ensures that the investment on interest-based security is in the acceptable level. according to the sharia investment rule, the prohibited investment is in the fixed income investments such as securities, corporate bonds, government bonds, certificates of deposit and preferred stock. the aaoifi established that the total interest-based saving should not go above 33% of the company’s market capitalization [1]. thus, this sharia mutual funds could not invest on the companies that take more than saving interest 33% from its market capitalization or total asset. the third criteria are in the ratio of cash and receivables to market capitalization. the sharia mentions that all liquid tools such as cash and credit should be traded in the nominal rate to avoid interest. the aaoifi also set the total value of tangible assets of a company should never exceed 30% of its total assets. therefore, the sharia mutual funds only invested in companies with accepting cash and credit ratio to their market capitalization [28]. sharia funds investment should independently be analyzed, since sharia fund still has efficiency and carries effective investment opportunities even it comply to the islamic laws [11], [32]. it is due to the sharia funds investment tends to be selective on the small capital companies that give premium [19]. even with its compliance to islamic laws, it carries great influences, especially on the religion based geographic area [25]. therefore, it is essential ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5896 3 to know the types of available sharia funds suitable for the investor purposes before investing on sharia mutual funds companies or asset management companies. sharia mutual funds can be classified into regular income funds (monthly or quarterly) and growth funds focusing on the capital growth with appreciation toward the security that follows sharia that gives no yearly or quarterly income [17]. iii. methods this study employed a descriptive quantitative approach [12] that focused on the sharia mutual funds 20152020. this period is a very significant growth of sharia mutual funds in indonesia. the data were obtained from indonesia financial services authority, consisted of four types of sharia mutual funds, subsisting of stocks, fixed income, mixed investment, and money market sharia mutual funds. these four types of sharia mutual funds were selected based on criteria of the sharia mutual funds actively operated and had the best performance seen from their net asset value (nav) on 2015-2020. the following is the data analysis procedure. a. determining the mutual fund realization rate of returnusing the below formula: = description: ri = investment return rate navt = net asset value in the current month navt-1 = net asset value in the previous month b. determining the mutual fund's expected rate of return using the formula below: e( = n 1 description: e(ri) = mutual fund's expected rate of return i ri = realized return rate from mutual funds i n = the total period of transaction c. determining the rate of risk from the mutual funds 1) determining the mutual funds variance var = n – 1 description: var (ri) = variance of return on investment i e(ri) = mutual fund expectation rate of return i ri = realized rate of return from mutual funds i n = the total period of transaction 2) determining the standard deviation of mutual funds σi = ) σi = mutual fund’s standard deviation i var (ri) = variance of return on investment i d. measuring the return risk-free description: rf = monthly average risk-free return bi rate = bank of indonesia rate on the specific period n = total n period e. calculating the mutual funds performance using sharpe method = description: spi = index sharpe of portofolio i rpi = average return of portfolio i rf = average return of a risk-free asset sdpi = standard deviation of portfolio i returns iv. results and discussion this study was conducted to investigate the performance of sharia mutual funds in indonesia, primarily the stocks, money market, fixed income, and mixed investment mutual funds during 2015-2020. the analysis was started by determining the return rate calculated from the net asset value, the total risk ratio with the proxy or standard deviation, and the measurement on sharia mutual funds efficiency using sharpe ratio. a. determining the return ratio the return ratio of sharia mutual funds have been calculated by calculating the average net value asset in every year from each sharia mutual funds type [28] from 20152020. the results of that calculation are presented in table 1. ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5896 4 table 1. the average return ratio of sharia mutual funds 2015-2020 year stocks sharia mutual funds money market sharia mutual funds fixed income sharia mutual funds mixed investment sharia mutual funds 2015 -0.00032 0.01044 0.02935 -0.00719 2016 0.00897 0.01464 0.05531 0.00644 2017 0.01073 0.05074 0.05902 0.02323 2018 0.01580 -0.00520 -0.00271 -0.00196 2019 -0.01390 0.03835 0.01061 0.00732 2020 -0.00353 0.03129 0.01703 -0.01049 average 0.00296 0.02338 0.02810 0.00289 table 1 shows the return ratio from types of sharia mutual funds, including the stocks, money market, fixed income, and mixed investment mutual funds. the highest return ratio was observed from fixed income mutual funds in 2017, with 0.05902 value of the average realized rate of return. the second greatest average return ratio was found in the money market mutual funds (0.05074). the third most significant average return ratio was also observed on money market mutual funds in 2019 (0.03835) and 2020 (0.03129). the fifth most significant average return ratio was observed in mixed investment funds in 2017 (0.02323). meanwhile, mutual fund type with the least average return ratio was the stocks mutual funds in 2018 (0.01580). even if each type of sharia mutual funds fluctuated, but the trend positive on money market and fixed income mutual funds had been observed. generally, the data in table 1.1 shows the average realized return rate of sharia mutual funds in 2015-2020, with the greatest return ratio in fixed income mutual funds. the fixed income sharia mutual funds can be an alternative for investors using investment manager to gain yield. the period of 2015 to 2020 is a turning point for economic growth marked by the potential for information technology growth, although at the end of 2020 it began to decline rapidly [30]. however, investors see a great investment opportunity in the sharia mutual funds with some logical consideration such as risk and return, business diversification and ethics. the findings from some current studies also aligns with it. during the period of economy growth, small business has the opportunity to conduct mutual funds investment in developing their businesses, that at a time will aid the economy acceleration [33]. even if, during that period, the market is in the bearish situation, and then sharia mutual funds remain to be optimistic, but it is not in 2020 because of covid-19 pandemic. the impact of this pandemic has been suffered by corporations. however, islamic business performance (e.g. islamic banks) have a strong immunity on the economic performance during the pandemic [2]. likewise, the positive trend of sharia mutual funds is maintained. as explained in the previous study that sharia mutual funds can survive even during the financial and economy crisis situation [6], [19]. in addition, the results of return ratio calculation also indicate low volatility level of sharia mutual funds. even if all types of sharia mutual funds have ever experienced negative return, but they have satisfying turning point. for instance, the money market mutual funds which encountered negative point in 2018, but gained positive trend in the next several years. the results of this study is in line with a previous study that shows sharia mutual funds have a lower volatility than the conventional mutual funds [20], [38], [4]. another previous study also states that during a bearish market, conventional mutual funds’ performance on fixed income get worse during the high volatility period [8]. further, using the univariant and multi-variant system that usually fixed income conventional mutual funds gets low during a recession [8]. the finding of this study contradicts the findings from study conducted by on equity conventional mutual funds [21], but fixed income conventional mutual funds seems no investment facility that protects investors from the decrease during recession period [8]. therefore, sharia mutual funds’ investments carry out the hope and it is seen as bringing positive opportunity to improve the economy. the return ratio presented in table 1.1 indicates that the volatility of sharia mutual funds can respond the market movement. such conditions is indicated as great opportunity for investor to get credit for their sharia mutual funds investment portfolio based on the trend performance in the market [23]. b. measurement of risk sharia mutual funds refer to an essential investment method for individual investor who have limited skills and ability to invest directly. through the asset management company, the investor can invest in a number of distinctive securities. in this context, the risk and return analysis on the sharia mutual funds become the determinant of the investment decision. even if sharia mutual funds are classified as great investment, but it still carries risks. there are several risks that should be considered, such as the market risks, risk of reduction, risk of sharia compliance, and so forth. in this study, the total risk was measured using monthly refund standard deviation [40]. the results of total risk calculation are presented in table 1.2. ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5896 5 table 2. average risks of sharia mutual funds 2015-2020 year stocks sharia mutual funds money market sharia mutual funds fixed income sharia mutual funds mixed investment sharia mutual funds 2015 0.01178 0.01282 0.03840 0.01011 2016 0.00787 0.04065 0.03185 0.00655 2017 0.00606 0.02023 0.04070 0.00736 2018 0.00652 0.02366 0.00499 0.00614 2019 0.00645 0.01937 0.00440 0.00671 2020 0.01809 0.01987 0.01656 0.00949 average 0.00946 0.02277 0.02282 0.00773 table 2 shows that the most significant risk ratio from sharia mutual funds have been observed with the fixed income sharia mutual funds obtained 0.04070 in 2017, followed by the money market sharia mutual funds of 0.04065 in 2016. in the yearly average, the fixed income sharia mutual funds also have the greatest risks, followed by money market, stocks, and mixed investment sharia mutual funds. interestingly, the fixed income sharia mutual funds in 2019 were the lowest risk compared to the other types of sharia mutual funds (0.00440). it demonstrates that fixed income sharia mutual funds are the best alternative for the investors, without set aside the other types of sharia mutual funds as the investment diversification in their portfolio. the risks of sharia mutual funds demonstrated in table 1.2 also show the volatility of each period. the risks of each sharia mutual funds type fluctuate differently, in each period. additionally, the stocks mutual funds have a very smooth trend, followed by mixed investment sharia mutual funds. however, the fixed income and money market sharia mutual funds do not show the similar trend. the extreme risks symptom is observed in the 2016 to 2017, and 2018. during those periods, the money market sharia mutual funds’ risk increased from 0.01282 in 2015 to 0.04065 in 2016 and reduced to 0.02023 in 2017. similarly, the fixed income sharia mutual funds also increased from 0.031854 in 2016 to 0.04070 in 2017, then it has been observed to reduce drastically to 0.00499 in 2018 and to decrease again to 0.00440 in 2019. that pattern of risk movement suggests the investors to stick to risk and return as their cut off in making investment related decision, aside of other consideration, as confirmed by previous study [3]. in the macro scale, after a global crisis, investor present investment style adjusted to the risks. investors choice on the fixed income sharia mutual funds may be caused by the non-pessimistic risk exposure, even if it carries equal yield to the conventional version. it confirms that sharia mutual funds bring a less worrying risk than the conventional mutual funds. it supports the findings from previous study [41]. even if another study explained that sharia mutual funds is more risky than the conventional mutual funds with proxy of standard deviation [23]. the findings of this research also indicate that even if the investors have various risk preference, but the sharia mutual funds remain to be an excellent selection, especially for those investors who comply to the sharia principles. the findings from previous study also confirms that investors who comply with sharia are more sensitive toward risk exposure [28]. c. the calculation of sharia mutual funds performance the investors of sharia mutual funds use a lot of considerations, including calculating the risk and return ratio of the portfolio. this consideration is taken to ensure that their investment meets their expectation since each portfolio performance becomes the indicator of investment selection. in this study, the performance of sharia mutual funds portfolio was measured using sharpe ratio. as explained that sharpe ratio is used as performance index and generally used to assess the performance of an investment portfolio, including the sharia mutual funds [39]. the results of that calculation are presented in table 1.3. table 3. performance of sharia mutual funds in 2015-2020 calculated using sharpe method year stocks sharia mutual funds money market sharia mutual funds fixed income sharia mutual funds mixed investment sharia mutual funds 2015 -3.45088 -3.66646 -5.84256 -1.35726 2016 -1.38651 -0.43237 0.12675 -1.61323 2017 0.20379 0.28849 3.07370 -18.7588 2018 -2.30126 -1.17405 -1.59730 -1.22195 2019 -2.91039 0.20934 0.36163 -3.96783 2020 0.58012 1.90549 2.15369 -4.12144 average -1.54419 -0.47826 -0.28735 -2.35959 according to table 3, averagely, the fixed income sharia mutual funds have the most excellent performance, followed by money market, stocks, and mixed investment sharia mutual funds. this interpretation is obtained from the average sharpe scores of fixed income sharia mutual funds is greater by -0.28735 point than the other type of sharia mutual funds. the standardize perspective indicates that the greatest sharia mutual funds should carry the biggest sharpe ratio, indicating a higher return rate per unit risk. another perspective also shows that investors choice should be made based in the maximum investment return probability of sharia mutual funds above the risk-free level. this interpretation supports previous argumentation that the higher sharpe ratio of the fund indicates the higher expected return per unit of risk ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5896 6 [24]. except in the negative return level, it is not applied for the best mutual funds’ performance using sharpe ratio [21]. the results of this study confirm the finding that the average sharpe ratio is followed by the average positive excess return during the research period. the results on sharia mutual funds’ performance illustrates the way an investor decides to invest in sharia mutual funds. even if, there is a sudden negative average sharpe ratio, but it is followed by the positive average ratio. it indicates the sharia mutual funds in indonesia demonstrate great performance. many supporting factors of that phenomena, such as investors preference on sharia portfolio, and the market share that mostly are moslem. as mentioned earlier, the muslim majority countries tend to present good sharia mutual fund performance [19]. besides, the performance of fixed income sharia mutual funds that remain great, indicates the ability of the investment manager or companies in diversifying the portfolio. this research result signifies the conformity with the previous phenomena that sharia mutual fund investment manager’s ability and accuracy becomes the essential element of great performance since they need to obey the sharia principles [7]. the effects of global economic crisis and the covid-19 pandemic since 2020 caused an economic slowdown in indonesia, but the sharia mutual funds’ performance remains to be optimistic. the sharia screening criteria of selecting the proper portfolio by investment manager yields better sharia mutual funds’ performance and return, during this economic slowdown. the previous study explains that a combination of skills to select superior sharia mutual funds portfolio and the negative market timing ability of conventional mutual funds’ investments offer a better hedging opportunity during the economic slowdown [7]. the conventional investors (without religious orientation) can also take the hedging opportunity by investing on sharia mutual funds as part of their portfolio diversification. they can also adopt the screening criteria applied in sharia mutual funds investment so that they can improve the performance sharia mutual funds during the bearish trend market [7]. in line with the earlier argumentation, sharia mutual investment helps protect the reduction risks during the economic crisis [3]. v. conclusion the sharia mutual funds growth is observed in indonesia, as a developing country. the net asset values (nav), as the performance indicator of the sharia mutual funds experience significant development during the period of this research. the increase of sharia mutual funds’ performances in indonesia represents the investors’ expectation for an ethical investment that carries yield in the normal risk ratio. the excess return of sharia mutual fund calculated from the nav indicates the volatility in responding to the market. besides, the pattern of market move also shows that the investors always hold on the risk and return as their cut off in making the investment related decision, other than the other consideration. the sharpe ratio was used to calculate the performance of sharia mutual funds. the results suggest that fixed income sharia mutual funds have the most excellent performance compared to the other types of sharia mutual funds, such as stocks, money market, and mixed investment funds. it indicates that fixed income sharia mutual funds have a higher return per risk unit and maximum probability to attain sharia mutual funds return exceeds the risk-free return. the results of this study are expected to be the reference for investors, primarily those who comply with sharia, in making decisions relevant to their investment in the future. the investors can also consider the sharpe ratio in deciding the type of sharia mutual funds in indonesia, as a developing country. this findings on this study can be suggestions for investors. they should consider the risk of sharia mutual funds, other than the benefits offered when they make the investment. future studies are encouraged to investigate the performance of sharia mutual funds based on different market cycles. references [1] aaoifi 2015. shari’ah standards. accounting and auditing organization for islamic financial institutions. 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[41] yudanto, a.a. 2017. performance analysis of sharia and conventional mutual funds during 2008 and 2013 crisis periods. info artha. 1, (jun. 2017), 39–60. doi:https://doi.org/10.31092/jia.v1i1.69. ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5896 8 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4914 1 the social role of islamic banks in indonesia during the pandemic of covid-19: reflection of market share 1 department of accounting, stain majene, indonesia, ahmad.abbas@stainparepare.ac.id 2 department of accounting, iain parepare, indonesia, andiayufrihatni@iainpare.ac.id abstract—the objective of this research is to reveal the social role of islamic banks in indonesia in helping the nation survive in the midst of covid-19 pandemic in the context of market share. this research highlights islamic commercial banks in indonesia. the mixed research method under sequential explanatory model is used in this research. the result of this research demonstrates that banks with the largest magnitude have shown a fixed position. there is no change of position on their concentration ratio at pre and along pandemic period. the final result of this research finds that all the banks have implemented their social role in the midst of coronavirus outbreak through the donation. a self-protection assistance tool for health workers is the type of donation provided by all the banks. further finding in this research reveals that the magnitude of market share owned by the banks tends to reflect types of social involvement. keywordscovid-19; csr; market share; social role i. introduction the company has the role to increase the national welfare. the source of its going concern derives from stakeholder consisting of investor, shareholder, internal management, government, and public. the existence of firm provides the contribution affecting the national economy by applying the tax and helping increase the welfare through the employment, the fulfillment of people’s need, and social program of donation. the social problems occurred in the midst of society enable the company to take part of helping the nation. the firm performance is not only deriving from economic activities, but it is also from social and environment. therefore, its social problems also become the responsibility for companies. nowadays, one of the global problems is coronavirus pandemic. the emerging impacts encourage each country to make policies including social distancing, work from home, the decline of activities outside the home, and the enactment of lockdown. most strategies use isolation or quarantine, promotion of public health measurement such as hand washing, social distancing or preparation of health system, and postponement of public gatherings[1]. in indonesia, the policy of lockdown may be not the best way. the data of april 5 th 2020 have reported 2.273 infected people during march and the rate of victims may continue to increase every time [2]. a country should consider any support from corporate industry. society is one of stakeholders in supporting the business growth. the impact of the spread of this pandemic has actually been suffered by the corporate area [3], [4]. thus, firms should put their concern. the role of business industry in the midst of coronavirus outbreak has been found by scholars[5]. they can be involved socially in providing the donation, but how about the industry suffering the stagnant growth. in indonesia, islamic banking is an industry suffering market share with stagnant growth over the years. as reported by financial services authority [6], the existence of market share of islamic banks in indonesia is approximately6% in the national banking industry. it may be a challenge for enhancing their market power during the pandemic of covid-19. however, this phenomenon will be interesting when islamic banks are involved socially in optimizing the social program. based on the starting data, they seem to have strong immunity on the economic performance during the pandemic of coronavirus. most islamic commercial banks in indonesia gain the income. the average rate of growth gains positive value of 22.31%. table i. the income during the pandemic no. name of bank march 2020 april 2020 growth million rupiah 1 bri syariah 291,229 284,833 -2.2% 2 bni syariah 494,399 591,948 19.7% 3 bank mandiri syariah 538,341 539,625 0.2% 4 btpn syariah 89,052 128,936 44.8% 5 bank aceh syariah 41,550 54,195 30.4% 6 bpd ntb syariah 776 131 -83.1% 7 bank victoria syariah 8,800 9,095 3.4% 8 jabar banten syariah 21,554 26,985 25.2% 9 bank mega syariah 7,115 2,535 -64.4% 10 panin dubai syariah 662 765 15.6% 11 bank bukopin syariah 2,017 7,556 274.6% 12 maybank syariah 18,325 23,457 28.0% 13 bca syariah 291,229 284,833 -2.2% average 22.31% ahmad abbas 1 and andi ayu frihatni 2 submitted july 2020, revised december 2020, accepted december 2020 mailto:ahmad.abbas@stainparepare.ac.id mailto:andiayufrihatni@iainpare.ac.id ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4914 2 financial services authority in indonesia namely ojk relaxes requirements for bank’s assets quality assessment concerning borrowers in the forms of the financing and other provision of funds through regulation no. 11/pojk.03/2020 [7]. it has been enacted to anticipate the disruption enabling to emerge in the islamic banking industry with the purpose of supporting the stimulus for economic growth and each islamic bank in indonesia has applied the credit restructuring policy to customers. islamic banks use sharia principles for undertaking their business[8]. they have a fundamental tenet that all financial transactions follow the sharia doctrine derived from quran and sunna as well as secondary sources (ijma and qyias) covering all aspects including social practices[9]. under the ethical principles, islamic banks actually represent a possible potentiality for financial instrument so as to achieve social welfare[10]. for understanding the csr under islamic principle, the paradigm of consciousness of taqwa serves as a foundation. firms instilling good csr practices in their business should embrace issues such as environmental practices, occupational safety, philanthropic contribution, and socially beneficial activities so that they could be blessed by god and achieve the ultimate happiness in the world and the hereafter[11]. therefore, social practice of islamic banks enables to occur during the pandemic. this research aims at discussing the social practice implemented by islamic banks called as banking social responsibility. since market share is related to social performance[12] and its scale boosts social performance investment [13], this research appears to demonstrate the magnitude the market share followed by the types of social involvements. we would like to capture the concern coming from the islamic corporate sector by highlighting the banking institution. we design this research under the mixed method starting with the statistical analysis then continued by using the interpretive paradigm under content analysis. this research provides two key insights. first, the islamic banks embracing islamic corporate value can show their social synergy in the midst of pandemic. second, this research documents the social responsibility of islamic banks amplifying the tenet of legitimacy. this research is structured as follows. section 2 reviews the literature with regards to market share and corporate social responsibility (csr). section 3 describes the data and method used to present the finding discussed into section 4. we end this research with a conclusion containing future directions. ii. marker share and csr the analysis of market power is still the concern for scholars[14]. under the market power theory, market share can be related to the financial performance. it has been found to be positive relationship[15], [16]. based on the concept of the structure-conduct-performance (scp), a more concentrated bank due to the support of a greater market power leads higher profitability. it has the positive nexus empirically as found by scholars [17]–[19]. market share can be regarded as a key indicator of market competitiveness. firms concentrated more in the market structure lead the change of market power. they can obtain profitability greater than competitors. when market share increases, a business may have a greater profit margin[20]. the role of market share and structure is a reflection of profit for the firm[21]. the concentration ratio relates to the competition from the perspective of the number and size distribution of firms in the industry[22]. market power is important for being utilized by the banking[23]. islamic banking should identify their power in the market. the increasing market share, due to seize greater power, affects the increase of banking performance[24]. islamic banks undertaking the differentiation of product can obtain greater power in the market so that market share becomes higher[15]. as a result, market share is a measurement of the level of sales or assets. if market share increases, the leader of firm gains more than the others. market share is an indicator for csr spending. it has been found that low market share shows correlation with low social spending[25]. socially responsible action will provide some benefit to the company. it actually attracts the pool of customers and its disclosure has greater impact on the market share [26]. social responsibility embodies the economic category concerning how to be profitable, the legal category concerning how to be a good corporate citizen, the ethical category concerning how to be ethical, and the discretionary category related to a good corporate citizen making philanthropic benefits in which the responsibility is purely voluntary [27], [28]. it has been engaged with shareholder value[29]. a company holds the social performance with the purpose of increasing the reputation, competitive advantage, the capital accessibility, the interest of stakeholder, and social contract with society. csr is a commitment for increasing the welfare[30]. corporate area should be aware that the business activities can be useful in social and environment aspects. the response coming from stakeholders particularly government and investor is a feed-back for the business success generating the increase of value on the shareholders[31]. therefore, csr can engage the partnership with government, society, and investor. firms communicate their csr through a disclosure in the report and own webpage. for the management, csr is a business tool providing the strategy for the success in the firm. the institutional ownership has stronger effect on the csr[32]. furthermore, the existence of a firm is supported by stakeholders. stakeholders is the group affecting significantly the success and the failure of an organization[33]. in the classical view, csr undertaken by firms tends to increase the profit. under the tenet of stakeholder, all have the rights to obtain information related to company activities affecting the decision making[34]). the power of stakeholders is useful in the company. there are two types of stakeholder, namely primary and secondary stakeholders[35]. primary stakeholder relates to ownership involved operationally to support the business including employer, customer, investor, and supplier and secondary stakeholder is not part in the business entity, e.g. government and netizen. the theory of legitimacy ideally elaborates the tenet of stakeholder in which the going concern ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4914 3 of a firm is affected by people having the ownership. government, society, and mass media are part of affecting the business. when the firm is not in line with them, the threat can emerge affecting the business legitimacy [36]. the tenet of legitimacy emphasizes the nexus between company and society. the company may operate social performance to ensure that its behavior is found legitimate [37]. a mass media has the role to build the firm’s image. the disclosure of social value is a conduct to communicate the role to public [5], [38]. the positive response is the form of success of social practice leading the expectation on the level of business performance. a company with csr practice can improve the image and has developed a balance image in society [39]. csr practice ideally provides a good understanding from customers. there is a significant relationship between effective implementation of csr and brand perception[40]. it leads into a financial return. iii. research methodology this research started the data analysis with quantitative method. the sample of this research is islamic commercial banks listed in financial services authority over the period of 2020 [7]. the data consisting of financial statements were collected. the total number of islamic banks was 14 companies. table ii. total islamic commercial banks no. name of bank 1 bri syariah 2 bni syariah 3 bank mandiri syariah 4 btpn syariah 5 bank aceh syariah 6 bpd ntb syariah 7 bank victoria syariah 8 bank jabar banten syariah 9 bank mega syariah 10 bank panin dubai syariah 11 bank bukopin syariah 12 maybank syariah 13 bca syariah 14 bank muamalat based on the use of purposive sampling, we established the judgment to determine final sample in this research. the criteria were availability of data. we employed the data of the end of year of 2018 and 2019 as well as march to april 2019 and 2020. the bank with incomplete and ineligible data was eliminated so that total final sample was 13 banks. tabel iii. final sample no. name of bank 1 bri syariah 2 bni syariah 3 bank mandiri syariah 4 btpn syariah 5 bank aceh syariah 6 bpd ntb syariah 7 bank victoria syariah 8 bank jabar banten syariah 9 bank mega syariah 10 bank panin dubai syariah 11 bank bukopin syariah 12 maybank syariah 13 bca syariah this research is designed using a mixed method. it combines quantitative and qualitative research with designing the method using sequential explanatory and exploratory, and concurrent triangulation model[41]. in this research, we used sequential explanatory. we started this research with the analysis of the quantitative data. statistical analyses were used to find the magnitude of market share. to measure it, we utilized total assets as a proxy. we also utilized total revenues to strengthen the result of this research. market share was calculated by dividing the bank’s total assets by its industry’s total assets. individual market share showed the percentage of power earned by a certain bank in the market. we established march and april 2019 and 2020 because those months were the time of massive spread of coronavirus to almost all regions in indonesia. as a result, this research could see which banks implement its social performance. having found the magnitude of individual market share, we began to discuss the social role of the sample and used the qualitative analysis to connect the level of market share and the number of social involvements. from an interpretive paradigm, we did interpret qualitative data collected by the disclosure of media. social media capability enables higher social visibility and credibility in the terms of social responsibility [42] and social involvement using the disclosure of online media or own webpage has been utilized by scholars[43], [44]. the type of qualitative used in this research is interpretive using the technique of content analysis. it aims at discussing the social role of islamic banks. this research collected the data covering the period of coronavirus from march 2 nd to june 30 th , 2020. the analyses of data were made into three steps. first, we identified the activities the social involvement exposed by the sample in the media or each own website. second, we reviewed the actions of the sample in the context of the involvement in aiding the citizen. third, we further selected the banks having the voices in the media exposure. in the measurement, we give score of 1 for each sample involved socially amidst covid-19 pandemic and no voice is given 0. we really became careful to understand the content in this research. after all voices were recorded, the types of social involvement of the sample were calculated and then we did interpret the context after finding the meaning of the text. iv. result and discussion a. the magnitude of market share and types of the social involvement each company attempts to gain greater power in the market industry. we measure the level of market share in the islamic banking using the total assets and total revenues. as shown in table iv, three banks consisting of bank mandiri syariah, bni syariah, and bri syariah have the highest value in the total assets and revenues, meanwhile bank victoria syariah and maybank syariah were two banks having the lowest value. ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4914 4 table iv. market share panel a. using the measurement of total assets name 2018 2019 2019 2020 dec dec march april march april bri syariah 14.39% 14.97% 14.67% 13.83% 14.05% 14.63% bni syariah 16.68% 16.22% 16.74% 16.11% 17.01% 16.78% bank mandiri syariah 37.47% 38.87% 37.49% 38.03% 38.19% 37.80% btpn syariah 5.13% 4.76% 4.77% 4.97% 5.33% 5.40% bank aceh syariah 8.38% 9.13% 8.62% 8.74% 7.65% 7.38% bpd ntb syariah 2.88% 2.78% 3.18% 3.49% 3.29% 3.35% bank victoria syariah 0.75% 0.84% 0.66% 0.70% 0.69% 0.70% bank jabar banten syariah 2.58% 2.66% 2.52% 2.65% 2.44% 2.47% bank mega syariah 2.68% 2.90% 2.79% 2.84% 2.72% 2.84% bank panin dubai syariah 3.72% 3.47% 3.18% 3.44% 3.59% 3.66% bank bukopin syariah 2.25% 0.35% 2.48% 2.46% 2.02% 1.99% maybank syariah 0.24% 0.26% 0.25% 0.26% 0.24% 0.24% bca syariah 2.85% 2.79% 2.65% 2.47% 2.78% 2.77% panel b. using the measurement of total revenues name 2018 2019 2019 2020 dec dec march april march april bri syariah 11.58% 6.53% 14.07% 15.80% 14.00% 14.64% bni syariah 13.56% 14.71% 16.09% 12.77% 16.09% 16.01% bank mandiri syariah 32.85% 36.68% 36.37% 37.08% 40.98% 40.85% btpn syariah 14.29% 13.66% 14.54% 15.39% 16.04% 14.71% bank aceh syariah 7.53% 9.97% 12.53% 12.59% 7.44% 8.04% bpd ntb syariah 3.09% 1.24% 4.24% 4.38% 2.93% 3.10% bank victoria syariah 0.55% 0.64% 0.68% 0.68% 0.57% 0.60% bank jabar banten syariah 2.43% 3.07% 2.62% 2.71% 2.43% 2.51% bank mega syariah 4.93% 5.64% 5.15% 5.40% 5.92% 6.38% bank panin dubai syariah 2.36% 2.66% 2.76% 4.28% 2.97% 3.21% bank bukopin syariah 1.66% 2.70% 1.84% 1.90% 1.80% 1.81% maybank syariah 3.01% 0.36% 0.38% 0.33% 0.34% 0.09% bca syariah 2.15% 2.14% 2.79% 2.48% 2.47% 2.69% table v. types of social involvement name the type of social role bri syariah providing the vehicle of ambulance providing self-protection assistance tools providing nutrition product, mask, and sanitizer giving staple food to the poor bni syariah providing disinfect fluids for cleaning the public place providing self-protection assistance tools for hospital giving staple food to the poor providing nutrition product, mask, and sanitizer bank mandiri syariah giving staple food to the poor providing nutrition product, mask, and sanitizer providing self-protection assistance tools for hospital providing disinfect fluids for cleaning the public place btpn syariah providing self-protection assistance tools for hospital providing nutrition product, mask, and sanitizer bank aceh syariah providing self-protection assistance tools for hospital providing nutrition product, mask, and sanitizer giving staple food and cloth to the poor bpd ntb syariah providing face mask and sanitizer donating money of 25 million rupiah to local government for being distributed to society bank victoria syariah providing self-protection assistance tools for hospital bank jabar banten syariah providing self-protection assistance tools for hospital building the evacuating place for the infected victims giving staple food to the poor providing mask and sanitizer for society bank mega syariah providing self-protection assistance tools for hospital giving staple food to the poor bank panin dubai syariah providing self-protection assistance tools for hospital bank bukopin syariah providing self-protection assistance tools for hospital giving staple food to the poor maybank syariah providing self-protection assistance tools for hospital bca syariah providing self-protection assistance tools for hospital providing disinfect fluids for cleaning the public place ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4914 5 the concentration ratio is the percentage of the total both assets and revenues represented by some the highest banks in the same industry. based on table iv, the four-firm concentration ratio (cr4) showing the market share of the four largest firms are above 70% indicating oligopoly structure. the concentration ratio engages with competition [22]. the level of the competition depends on the number of islamic banks in an industry. the competition can increase when the market share increases. based on the table iv, the market ratio was more concentrated to bank mandiri syariah, bni syariah, and bri syariah having fixed magnitude each period. it was leading market power into a greater profit. this result indicates that the three banks can maintain their market share at the pre and along pandemic period. we further identify the role of the sample. based on table v, all banks have taken part of aiding the nation. they are involved socially in providing the donations. various donations given by the banks describe the types of social involvement. we summarize six kinds of the donations implemented by islamic banks during the pandemic of covid-19 as follows.  providing self-protection assistance tools for health workers  giving staple food to the poor  providing nutrition product, masks, and hand sanitizer  providing disinfect fluids for cleaning the place  providing the vehicle of ambulance  donating money all samples of this research have played their role in implementing social performance. a self-protection assistance tool for health workers is a primary donation. all banks put their concerns to hospital. health workers are people working at the front line. they are the initial goal in the pandemic. in the report of bank mandiri syariah [45], its director said that “this is the appreciation and the esteem to doctors, health workers, and all medical teams serving as the front liner battling covid-19” the lack of medical supply and the increasing number of patients are the factors leading them to provide same donation. beside the hospital, society also becomes the most urgent donee. most of banks give staple food to the poor. during the outbreak, the social distancing and stay at home are the policies established by the government influencing the increase of unemployment in indonesia. for instance, land transportation services and small traders, they suffered loss due to the emerging impact of government policy. such cases encourage the banks to focus on the poor. bni syariah as one of banks of the sample in this research concerned with the impact of the policy creating the loss for most to poor people particularly driver and street vender. it is disclosed that “taxi bike drivers and street vendors are chosen because they are regarded as vulnerable profession on the effect of coronavirus. as we know, this pandemic impacts on the income for daily workers”[46]. daily workers are an emphasis on the text implying the concern. they live relying on the daily income. the social role of banks is by providing food and nutrition product, mask, and sanitizer. these ways can make them survive in the midst of coronavirus. the social involvement of islamic banking area tends to reflect the magnitude of market share. based on the result of this research, bank victoria syariah and maybank syariah as two islamic banks with the magnitude of the lowest market share play the role with the type of the fewest social involvement. on the other hand, three banks consisting of bank mandiri, bni syariah, and bri syariah can play their social role aligning with the magnitude of their market share. this research underlines that all islamic banks have put their concern in the midst of pandemic. however, this result may be a tendency and cannot indicate the greater the level of market share, the higher the types of social involvement. b. social responsibility and tenet of legitimacy as reported in tribunnews.com [47], bank aceh syariah has recognized that its donation is a realization of csr program. it is shown as follows. “rema yusnita as the branch manager of bank aceh syariah says that csr is a concept or action implemented by the bank as the form of corporate responsibility on the social and environment in which the bank operates, such as performing the activities that can increase the welfare of society and maintain the environment”. the practice of csr is a way to support social welfare and becomes a tool to lead going concern. some banks distribute their donation through local government. as reported in ayopurwakarta.com that “bank jabar banten syariah gives its donation to local government of west java through the officer unit of tgpp covid-19. this donation is given by president director of bank bjb, indra falatehan, to secretary of west java, setiawan wangsaatmaja, serving as the chief of tgpp, in the state building of pakuan”[47]. the process of such donation is a strategy to enhance business legitimacy. the response of government as a stakeholder implies that csr provides the recognition expected by the bank. the meaning of the context was disclosed by amran serving as a regent of aceh selatan as follows, “……i say thank you and appreciate bank aceh syariah tapaktuan for the assistance of csr”[47]. appreciation is a recognition addressed to someone meritorious. this aims at legitimizing the action. the company understands that the role of stakeholder impacts on the business. the going concern relies on the support of stakeholders. when banks obtain feed-back deriving from local government, their business is regarded to be more legitimate. the implementation of csr can be considered as a meeting of the need between society and banks. this result connects the previous finding revealing that csr boosts better brand perception and improve competitive advantage[40]. the appreciation given by government creates good perception to ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4914 6 banks and it finally posits that firm performance engages with stakeholders and social responsibility [48]. social donation has been recognized as part of csr. it aims at legitimizing the business. the tenet of legitimacy relates to the stakeholders. it demonstrates the interaction between the company and people. amidst covid-19 pandemic, health workers and the poor are primary donee. banks put most of csr programs for them. organizations under the tenet of legitimacy seek to ensure that they operate with the bound and norms of their respective society. the attention deriving from the society through a feed-back is required to meet the value of firm. this pandemic encourages the banks to play their social roles recognized as csr. the disclosure of such program in online media is the output of the social practice containing the legitimacy. islamic banks provide information to stakeholders relevant to the latest social problem. by disclosing it, the bank can take an increasing position on the level of market share. the implementation of csr and the decision of banks to disclose the donation are the signal on the social performance. this is a part of accountability. the disclosure is a business communication given to stakeholders. it can yield the positive response for them such as investor making the decision on the purchase of company stock. all the time, social problem may arise. it makes the banks should be ready with the social performance. they must act responsively to the environment in which they operate. this pandemic is an instance that they should act suitable for the problem occurred in the field. v. conclusion all islamic banks have played their role by implementing csr program in the midst of pandemic. they have instilled social involvement by putting various donations so as to mitigate the emerging impact. the finding of this research discloses that the donations aiming at helping people survive amidst coronavirus outbreak indicates the practice of banking social responsibility. it becomes the means of communication to stakeholders leading the business legitimacy. the banks yielding a greater market share tend to provide various social donations. we posit that csr is a value creator for society providing the legitimacy for the business. all banks with varying market share have shown various types of their social involvement during the coronavirus outbreak. a self-protection assistance tool is the type of donation provided by all banks as well as 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[48] j. s. harrison and r. e. freeman, “stakeholders, social responsibility, and performance: empirical evidence and theoretical perspectives,” acad. manag. j., 1999, doi: 10.2307/256971. ejif – european journal of islamic finance islamic finance role in the time of covid-19 pandemic, no 16, december (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/4914 8 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7221 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 16 a conceptual framework of the blockchain technology adoption for zakat institution in indonesia zulfikri zulfikri1*, salina kassim2, anwar hassan abdullah othman3 1* contact author iium institute of islamic banking and finance, international islamic university malaysia, kuala lumpur, 53100, department of management, faculty of economic and business, universitas muhammadiyah sumatera utara, medan, indonesia zulfikri@live.com 2 iium institute of islamic banking and finance, international islamic university, 53100, selangor malaysia ksalina@iium.edu.my 3 iium institute of islamic banking and finance, international islamic university, 53100, selangor malaysia anwar315a@yahoo.com received: 26/12/2022 accepted for publication: 15/02/2023 published: 21/04/2023 abstract the adoption of blockchain technologies necessitates the consideration of a wide range of factors far beyond the technology focus of most current research. blockchain technology's ability to record transactions on distributed ledgers opens new possibilities for zakat institutions to improve transparency, prevent fraud, and build trust in the public sector. even though academic research on blockchain technology is still in its infancy, most academics focus on the technology itself and overlook the zakat institutions adopting it. this paper drew on a comprehensive literature review to propose a conceptual framework for blockchain technology adoption. zakat institutions can use the proposed framework as a reference point for adopting blockchain applications and for scholars to expand, refine and evaluate research into blockchain technology. keywords: blockchain technology; adoption; zakat, tam 1. introduction many believe that the recent appearance of blockchain technology represents the beginning of a major shift in the way organizations are structured and how they conduct business, as noted by behnke & jannsen (2020). however, blockchain adoption for zakat institutions has yet to be studied in academic literature. due to the difficulties early adopters have faced with european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7221 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 17 the new blockchain technology which is still in its evolutionary stage technical experts and researchers are now debating the merits of the technology. a blockchain can be described as a series of blocks that record data in hash functions with a timestamp and a link to the previous block, as noted by crosby et al. (2016). using a "distributed ledger," the data is spread out across a network of computers. this prevents cybercriminals from exploiting centralized points of vulnerability. tokens that can be transferred between parties without needing a trusted third party or intermediary or for the automatic execution of "smart contracts" when specific conditions are met are some of the uses of blockchain technology, as noted by marsal-llacuna (2018). the use of blockchain is growing across industry sectors, including zakat. desto fintech, a renowned company based in the us, introduced the i-zakat service, the leading global company to manage zakat companies, as ahmed & zakaria (2021) noted. it also supports the management system attractively powered by blockchains that strictly adopt transparency, efficiency, and sustainability principles. in addition, i-zakat prevents potential misuse, misallocation, loss, theft and other contributing factors to the lost fund and reduces the cost of operating a continuous work scheme that can last for generations. i-zakat also reduces the cost of collecting funds, as ahmed & zakaria (2021) noted. in indonesia, zakat is administered by two institutions: the national zakat amil agency, abbreviated as baznas, and the national amil zakat institution, abbreviated as laz. baznas manages zakat nationally and is formed by the government, whereas the community forms laz, which is tasked with collecting, disbursing, and utilizing zakat. to aid in the collection of zakat, baznas established the zakat collection unit, abbreviated as upz, as noted by andayani, hanum & zaenal (2019). baznas is not implementing blockchain technology in their management system as there are no regulations from the government to support cryptocurrency. 2. gap analysis as a country with the largest muslim population in the world, indonesia is still overwhelmed by the problem of poverty, which is now a big problem in indonesia. zakat is proven effective in reducing or eradicating poverty, with prominent examples from the era of the second caliph of islam, hazrat umar bin khattab (r.a), and of umar bin abdul aziz, who was the first caliph of islam only for over one year (99-101h) as noted by hudayati & tohirin (2010). the amount of zakat funds collected is still far from the potential amount. so that the amount of funds distributed automatically to eight asnaf (mustahiq) needs to be optimized. many factors cause funds disbursed to baznas not to the maximum. one of them is the distrust of the muzakki towards zakat institutions, as reported by baznas (2017). with its capability to trace transactions, blockchain technology can provide transparency to its users, which can be a possible solution to overcome distrust of zakat institution (baznas). besides that, implementing blockchain technology into zakat management can reduce the potential misconduct from zakat authority. there are numerous scholarly articles about the conceptualization of blockchain-based zakat, for example, zulfikri, kassim & hassan (2021) and rejeb (2020). however, there are still limited studies regarding adopting blockchain technology for zakat institutions. hence, this study proposes a framework research model to analyze the acceptance of blockchain technology for zakat institutions using the technology acceptance model (tam) by adding external constructs, namely trust, regulatory support and shariah compliance in the context of islamic philanthropy, especially zakat. 3. literature review 3.1 the technology acceptance model (tam) davis developed the technology acceptance model (tam) based on the theory of reasoned action (tra) in 1989 (davis, 1989). the authors believed that people's behavioral intention to use new technology (actual system use) is determined by their perceived usefulness and ease of use. meanwhile, perceived ease of use influences perceived usefulness, and both perceived usefulness and perceived ease of use are influenced by various external variables. tam is a prominent and modest theoretical model of technology use. explanatory capacity and ease of comprehension make it the most extensively utilized model in various disciplines. venkatesh and davis expanded tam to tam2 in 2000, adding social influence processes, cognitive instrumental processes, and a detailed account of the key forces underlying judgments of european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7221 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 18 perceived usefulness and behavioural intention (venkatesh et al., 2003) later identified and discussed eight models of behavioural intention to use information technology and proposed the unified theory of acceptance and use of technology (utaut). and in 2008, venkatesh and bala proposed tam3, which was based on tam2 but included the effects of trust and perceived risk on system use (venkatesh et al., 2003). figure 1. technology acceptance model (tam) source: author’s elaboration on (venkatesh et al., 2003) comparing the tam model with the other models (tam, tam2, utaut and tam3), tam is more versatile than the other models, which contain stricter definitions of external variables and are better suited to the study of specific information technologies, such as utaut and tam3. most of the time, tam is used in the following three types of research: task-related systems, e-commerce systems, and hedonic systems, as noted by hsiao & yang (2011). tam model has also been used in zakat management study. for example, roziq, wijayanti & irmadariyani (2020) measured the acceptance of the simba application. this research uses a qualitative study using a case study approach. meanwhile, purwanto, sulthon & wafirah (2021) used the tam model to measure the behaviour intention to use online zakat. santoso et al. (2020) studied muzakki intention to use blockchain in zakat management using the tam model. this study uses tam as the model for study acceptance of zakat institutions toward blockchain technology. tam (technology acceptance model) variables such as perceived ease of use and perceived usefulness can be used to gain a deeper understanding of the customer's desire to adopt new technology, as noted by venkatesh et al. (2003). several studies and researchers have found the tam useful in measuring technology acceptance. good decision-making tools for a system's deployment are essential. when it comes to embracing blockchain technology, there is no one-size-fits-all solution. tam must be integrated with other important constructs when considering a current model compatible with blockchain. on the other hand, blockchain technology is a relatively new and complex technology in both adoption and development. adopting blockchain technology is influenced by various factors, both directly and indirectly. according to albayati et al. (2020), five external constructs play a direct and indirect role in adopting blockchain technology: trust, regulatory support, experience, social influence and design. this study will choose trust and regulatory support to develop the research framework as it is more correlated to adopting blockchain technology for zakat institutions in indonesia. the new proposed model can be counted as a new contribution to the previous researcher and add a new perspective that engages new factors in the world of adoption technology for zakat institutions in indonesia. 3.2 tam and islamic finance the technology acceptance model (tam) has been widely used in studying islamic finance. shaikh et al. (2020) examine the determinants that influence bank users’ acceptance of islamic financial technology (fintech) services by extending the technology acceptance model in the malaysian context. this study adds consumer innovativeness and self-efficacy to the framework of tam. usman et al. (2022) proposes an extended model of tam by including sharia compliance, knowledge of shariah compliance and confidence in shariah compliance. this study aims to investigate the satisfaction of e-banking in indonesian islamic banking. another study by usman et al. (2022) proposes an extended tam model in using financial technology (fintech) in islamic philanthropy by adding trust, image and religiosity to tam conceptual framework. this study supports the theory of reasoned action and the tam. the relationship between perceived ease of use and perceived usefulness with tam is determined by trust and religiosity. shaikh et al. (2020) examine the determinants that influence bank users’ acceptance of islamic financial european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7221 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 19 technology (fintech) services by adding a new variable of consumer innovativeness into the tam model in the malaysian context. this study reveals that islamic fintech’s service acceptance is determined by perceived ease of use, usefulness, and consumer innovativeness. from previous studies, there are very few studies about the tam model for blockchain technology for zakat institutions. therefore, this study proposes a framework research model to analyze the acceptance of blockchain technology for zakat institutions using the technology acceptance model (tam) by adding external constructs, namely trust, regulatory support and shariah compliance in the context of islamic philanthropy, especially zakat. 4. methodology this study is qualitative in nature. it utilized an extensive review of the literature to identify and analyse the relevant studies to propose the conceptual model. the systematic review of the literature proposes new ideas, the discovery of new alternatives, and the development of new hypotheses and research proposals, as noted by manning (2010). to perform a systematic literature review, this study examines recent publications on blockchain technology, technology adoption, fintech adoption, tam, and zakat. the article search targeted any scholarly publications. the search uses the university’s library database, google scholar, and emerald insight database for relevant, mainly peer-reviewed articles, using appropriate filters and keywords. from 2015 to the present, the paper focuses on blockchain technology adoption, tam, fintech adoption and zakat. the analytic result of this literature review produces a conceptual framework. 5. results and discussion 5.1 tam core construct 1. attitude attitude refers to the user’s positive or negative feelings toward the new technology as noted by davis (1989). the theory of reasoned action (tra) led researchers to find the actual behaviour, the user belief system described as an attitude toward using and exploring things such as a technology system. behavioural intentions are formed by considering an individual's attitudes toward each of the options in a situation, and it appears that the attitude comparable choice procedure does not reflect the construction of an individual's estimates of whether they would conduct many behaviours as noted by sheppard (1988). to maintain strong attitude-behaviour correlations, ajzen (2012) identified a high correlation between predictors and fixed criteria. it has been shown that there is a strong association between attitude and behavioural intention, supported by other research results. it can be concluded that attitude positively impacts behavioural toward blockchain technology. 2. perceived of usefulness (pu) perceived usefulness is the degree to which a person believes that using a particular technology or system can enhance his/her job performance as noted by davis (1989). there is a large volume of published studies describing the role of perceived usefulness on usage intention. for instance, hanudin (2007) discovered that pu is a critical indicator of malaysians' desire to use mobile credit cards. blockchain is currently being used in a wide range of industries. if the users believe that blockchain is beneficial to them and can improve their productivity, they are more likely to embrace the technology. hence, it can be concluded that perceived usefulness positively impacts attitudes toward blockchain technology. 3. perceived ease of use (peou) perceived ease of use is “the degree to which a person believes that using technology will be free from effort” as noted by davis (1989). perceived ease of use refers to the degree the literature shows that perceived ease of use has a positive effect on perceived usefulness. kallanmarthodi & vaithiyanathan (2012) argued that peou measures an individual's subjective opinion of how easy it is to use a given system. the more user-friendly a system is, the more likely it is that a person will find it beneficial in the future. the easier it is to use blockchain, the more the users perceive it as useful, and therefore the more positive their attitudes towards using blockchain become. therefore, european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7221 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 20 it can be concluded that perceived ease of use has a positive impact on attitude toward blockchain technology and perceived ease of use has a positive impact on perceived of usefulness toward blockchain technology. 5.2 tam external construct 1. trust over the past decade, blockchain has been a major player in the worldwide market and threatens traditional businesses' long-term viability. it is known as a trustful technology, as albayati, kim & rho (2020) noted. trust refers to consumers' comfort, confidence, and security level when using technologies, according to mccloskey (2006). trust, security, and privacy are all elements that influence people's willingness to use technology in some way, as stated by matemba & li (2018). trust in a company's products and services can considerably impact the amount of time people spend on the internet, according to keen (1997). in blockchain technology, the first axiomatic issue from the user's perspective is the legality, followed by contextual variables such as the social effect, technology design, and user experiences, as wunsche (2016) noted. additionally, trust and risk must be considered. customers are particularly concerned about blockchain technology's potential for risk. to avoid this, the technology must have sufficient trust in the market to continue moving forward. protection against negative acts that can be anticipated in advance might provide better protection and monitoring of customer activities to improve their trust. according to mayer, davis & schoorman (1995), trust is also known as customer preparation toward the service provider. this study's most important finding is that trust significantly influences customer behaviour. when customers have confidence in a provider, they are more likely to switch from one technology or service to another. there was a need for more confidence in blockchain technology until recently. there is a widespread belief that the dangers exceed the rewards, as noted by wunsche (2016). another common misconception is that blockchain is difficult to use and maintain. to encourage trust chains, blockchain-based consensus protocols such as proof of stake (pos) could be used to build trust. the ibm hyperledger platform is specifically developed for blockchain applications and features a collaborative management system that ensures data confidentiality and user confidence, as demirkan and p (2020) noted. hence it can be concluded that trust has a positive impact on perceived ease of use toward blockchain technology, and trust has a positive attitude towards the use of blockchain technology. 2. regulatory support regulatory framework and government support refer to regulatory frameworks established by the government to monitor and ensure that service providers and consumers of technology perform their commitments and prevent infractions, as noted by albayati (2020). to deal with e-business, monitor service quality, and authorize and deploy new technologies in the country under the control of the government, regulations are essential, according to peters & panayi (2016). these regulations ensure that everything goes off without a hitch and that everyone gets treated fairly. the same holds for blockchain technology and cryptocurrencies regarding client behaviour. regulators are required to prevent or reduce ambiguity from the regulations, as wunsche (2016) noted. regulations and instructions issued by the government can impact customers' trust in the technology and their willingness to use it safely. cryptocurrency growth is beset by numerous issues, such as a need for more government regulation and regulations, as noted by lu (2018). policies, laws, and regulations are critical to identifying who is authentic and who is authorized in a blockchain implementation protocol, according to viriyasitavat & hoonsopon (2019). according to previous research, this study hypothesised that regulatory support and trust are directly related. because clients are more trusting of new technology when regulated by the government, the risk is reduced. therefore, it can be concluded that regulatory support positively impacts trust toward the attitude to use blockchain technology. 3. shariah compliance muslim life is guided by shariah, which can be referred to as "the way or path" because it includes islamic norms, concepts, and parameters as noted by kasim (2012). as the muslim population and awareness of shariah compliance grow, it is imperative for businesses to adhere to shariah principles to meet the needs of their customers according to suhaimi (2008). with shariah compliance, muslims can carry out their religious obligations with banks and financial institutions while still adhering to their faith according to kassim (2012). blockchain technology can be called shariah compliance if it conforms to sharia law: share profit and loss, does not include prohibited european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7221 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 21 business (alcohol, pork, drug, etc.) does not deal with interest on lending and borrowing as noted by abdulgani & suhaimi (2014). kaakeh, hassan & almazor (2019) found shariah compliance affects attitude directly and intention indirectly mediated by the attitude towards islamic banking. hence, it can be concluded that shariah compliance with blockchain technology has a positive influence on the attitudes of zakat institutions towards blockchain technology and shariah compliance with blockchain technology has a positive influence on the behavioural intention of zakat institutions to use blockchain technology. 6. conceptual research framework based on the literature review in the previous section, the research model is then shown in figure 2. the model postulates that the tam model is used to measure the level of acceptance of zakat institutions towards blockchain technology. the framework model developed from the basic constructs of tam theory and the external constructs is regulatory support, trust and sharia compliance. source: author’s elaboration on (venkatesh et al., 2003) 7. conclusion, implications, and future research the purpose of this paper is to propose a research model of blockchain technology acceptance for the zakat institution. the research model is extended from the basic tam theory by adding external constructs, namely regulatory support, trust and sharia compliance which are from a review of the relevant past studies. this paper has several implications for theory and practice. the theoretical implication of this paper is this study provides theoretical advice for advancing blockchain technology by conducting an early empirical investigation to analyse key technical elements. the blockchain has been praised as a technology that can efficiently protect privacy. various studies in the literature on blockchain adoption focus on supply chain users' adoption behaviour. however, few studies examine the effects of blockchain’s technical features on user acceptance, especially figure 2. proposed research framework european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7221 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 22 in zakat institutions. this study fills this gap in the literature by exploring the relationship between blockchain’s technical features and the patterns of adoption behaviour by users, which are zakat institutions. another contribution is this study introduces trust, regulatory support and sharia compliance that affect zakat institution acceptance. unlike previous studies on blockchain adoption, which focus on users as an individual, this study uses zakat institutions as the users. the practical implication is other researchers and zakat institutions can utilize the information about the influencing factors to accept blockchain technology. this, in turn, would make the zakat institution management and 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(2021). proposing blockchain technology based zakat management model to enhance muzakki’s trust in zakat agencies: a conceptual study. journal of accounting research, organization and economics,4(2), 153-163 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 * this paper is the result of the research called “greentosi for unirecycling purpose between third mission and sustainability. a virtuous experimental partnership with a view to quintuple helix in the socio-ecological transition context” (ref. unique project code (cup): e86c18000500005) entirely financed by the university of rome “tor vergata” through the call for projects of scientific research of the university “mission: sustainability”. when the civic-participation play a crucial role on urban sustainability. the case study of the university of rome “tor vergata” and the project “a playground for aurora”*. abstract— the sustainability has become a priority and playing an important role in the strategic choices of all actors, which look for economical, social and environmental sustainability to preserve “well-being” for future generations. the research focus is on the new role of university as a driver for sustainable development trough social responsibility in urban scenario. the research goals are: to develop a conceptual framework on the role of education at university level in promoting sustainability, according to the third mission approach, and to define the role of high education in urban sustainability. the research is enriched by a case study called “a playground for aurora”, where the department of management and law of the university of rome “tor vergata” and the government and civil society research group (gcs) played a crucial role to built and to regenerate an inclusive playground (with games accessible to disabled children). the case study is a specific example of student engagement, the importance of partnership, co-design and civic-crowdfunding with a view of sustainable developments goals. keywords: civic-crowdfunding, urban sustainability, university, third mission, social engagement, regeneration. introduction on september 2015, the united nations formally adopted a new sustainable development agenda, the 2030 agenda for sustainable development, including a set of goals, called the sustainable development goals – sdgs. these are the most significant and unprecedented global commitment to eradicate poverty, improve the quality of people’s lives, ensure environmental sustainability, provide inclusively and equal quality education opportunities for all, building sustainable partnerships and so on. sustainable development is an important global objective to overcome the economic, environmental and societal crises in many countries. one of the main instruments to develop smart, sustainable and integrated growth (european strategy 2020) is through r&d, climate change and energy sustainability (greenhouse gas emissions 20% lower than 1990, 20% of energy from renewables, 20% increase in energy efficiency), education, fight poverty and social exclusion able to promote inclusively and sustainability (section 1). the higher education can contributing to sustainability social change (scholz et al., 2006; filho, 2000; scholz et al., 2000) in strategically level (visioning and setting long-term strategy), tactical level (facilitate the cooperation with different stakeholder) and operational level (higher education can implement change in the curricula, researches and in their campus). in doing that, alongside the traditional missions typical of italian universities (education, research and the relationships with institutions and companies operating in their reference territories). the findings of the project are inductive to develop a dynamic bottom-up model of learning and education dissemination on the sustainable development in urban areas (section 3). the model allows to: (1) sensitize students to be active and shape their future, (2) create the profile of “local ethical promoters”, (3) create and strengthen the local territorial networks, connecting the networks for local development with those for social inclusion and training. the department of management and law and gcs promoted a civic engagement campaign in the university to promote the “ethical cash mobgreat challenge fairtrade” organized by the student on 14 april 2016 in the university (section 3). the research methodology (section 2) applied to the case study, mainly qualitative, is based on the document analysis (bowen, 2009) and it is enriched by a survey of the participant of the cash mob and other people (section 4). i. literature review the civic mission is recognized by the universities as an institutional mission, which joins the traditional missions of training and research. in particular, the term of “third mission” refers to all the activities with which the universities activate processes of direct interaction with the civil society and the company, with the aim of promoting the growth of the territory gloria fiorani, irene litardi gloria fiorani, associate professor in corporate social responsibility and social reporting, ph.d. in public management and governance, department of management and law, university of roma “tor vergata”, fiorani@economia.uniroma2.it irene litardi, post doc fellow in sustainability and accountability, ph.d. in public management and governance, department of management and law, university of roma “tor vergata”, litardi@economia.uniroma2.it mailto:fiorani@economia.uniroma2.it ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 and civil society too, offering services and facilities, in this way the knowledge becomes an instrument for obtaining production outputs (novelli g. and talamo m., 2014). to the universities are asked to promote social cohesion and equality: a re-think of the role of education as a mechanism to promote social mobility and the academic environment as a model of tolerance of ethnic and cultural diversity. the concept of the third mission of the university is part of the transition from the theoretical model of the knowledge society, characterized by the “triple helix”, in which universities, industry and government collaborate for socio-economic development (etzkowitz h., 2008), to the model of “open society” (figure 1), characterized by the “quadruple helix”, where government, industry, university and civil society work together to co-design a sustainable future (european commission, 2015). to achieve this goal, universities are increasingly being asked not only to be the main driver of economic development processes (to act as “entrepreneurial university”) but also to be an active part in other areas which local communities are paying more attention, such as: sustainability, social and environmental. figure 1. the evolution of knowledge society. the origin of university's third mission in europe start in 1963 with clark kerr, rector of the university of california, who, during a class at harvard, replaced the word “university” with “multiversity”, meaning a community university able to value the differences of society and to respond to the changing cultural and economic needs of a given period without forgetting the future perspective. the word “multiversity” wanted to urge american universities to take in consideration the responsibility of “saving society”. it is now possible to distinguish two configurations of the third mission: a) the first is represented by the third mission of economic valorization of knowledge, in which the third mission aims to promote economic growth, through the transformation of knowledge produced by research into knowledge useful for production purposes (third party research, relationships research-business world, management of brokerage and support structures, etc.); b) the second one is represented by the cultural and social mission, in whom public goods has been produce, that increase the welfare of society. these assets can be considered high cultural content through operations carried out also in 1 www.europafacile.net/formulari/politiche/ricerca/com2000_567.pdf (consulted: 09/15/2017). collaboration with the territory (museum centers, archaeological excavations, scientific dissemination, organization of exhibitions, exhibitions, conferences and readings, etc.); goods can also be considered as educational value through regional, national and international projects with schools of various types and levels. finally, goods can be considered with a more strictly social orientation through voluntary counseling addressed to the community for individuals and groups that are marginal or in difficulty. the european commission through the communication “innovation in a knowledge-based economy”1, to the european parliament, establishes the overcoming of the role played by universities, not only in training and research, but also in the promotion and dissemination of knowledge and technologies, especially in the local business environment. in italy the concept of the third mission arrived very late due to cultural and regulatory difficulties. the motivations that have determined the progressive interest of universities for the third mission can be traced to both long-term changes in the organization of scientific research and in the development of technologies, and the needs of its main stakeholders. the third mission has been fully included in the italian universities thanks to the legislative decree n. 1988/27 january 2012, which defines the principles of the “autovalutazione, valutazione periodica e accreditamento” (ava)2, and subsequently the decree no. 47/january 2013 of the minister of education, university and research (miur), which identifies the indicators and parameters of periodic evaluation of the research and of the third mission. universities must assume a more direct “entrepreneurial role” by providing investments in applied research that are functional to their economic impact, favoring institutions of excellence capable of producing innovative knowledge, assessing and measuring the cognitive performance of individual universities. in the universities there are skills, professionalism, ideas, projects, which if outsourced, they can have a huge value of “reputation”, an economic value, a value for the improvement of everyone's life. to outsource these skills outside the university borders, means to enhance and transfer the work of innovation and production of knowledge on the territory by creating new economic opportunities, work and social improvement, with a view to creating shared value (porter e kramer, 2011). ii. research methodology the assumption of the research starts from a theoretical analysis elaborated on the third mission of the university and in particular on the collaboration of multiple-stakeholder to promote the sustainable development on local territory (section 1). however, the aim of the research is to analyses what kind of sustainable development model has been created in a project in rome: “a playground for aurora”. in particular, the case study is a project that see involved different stakeholders (university, company, non-profit organization and civil society) to built a 2 ava is the self-evaluation, periodic evaluation and accreditation system of the university, established by miur the ministry of education university and research. http://www.europafacile.net/formulari/politiche/ricerca/com2000_567.pdf http://www.europafacile.net/formulari/politiche/ricerca/com2000_567.pdf ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 playground for disabled children (section 3) in a suburb area of the city close to the university of rome “tor vergata”. the principal methodology used to find the fund to finance the project is the civic-crowdfunding. the civic-crowdfunding qualifies as a collective funding of public works and projects (outside the budget of the administration), carried out by citizens, organizations and private companies, sometimes in collaboration with the same public administrations, in this specific case the promoters of the initiative in the roman university were a group of students in collaboration with the gcs research group, department of management and law, the profit (ecozema, veiogas, fairtrade) and non-profit organizations (next). the promoters used two instruments for the fundraising: a) create the campaign of civic-crowdfunding on web platform called “eppela”, thanks this campaign was possible collected the first found (€2.500,00) from the web. b) create the cause-promotion campaign thanks the ethical “cash mob faitrade” (see box1). thanks to the “world fairtrade challenge” promoted by fairtrade 3 , the students create and promote an “ethical cash mob to sell fairtrade caffee” and devote part of the money to the social project “a playground for aurora”. in particular, the cash mob has had three main objectives: b.1) support fairtrade in the sale of certified organic coffee by accepting the campaign launched by the same “world fairtrade challenge”. it is an excellent opportunity to share the following message: “choose fairtrade means supporting coffee producers in their fight against climate change all year round”; b.2) support the most disadvantaged producers in developing countries, in this case haitian farmer. climate change is already affecting millions of coffee growers with abnormal weather conditions with the emergence of new diseases and pests. by drinking, also symbolically, a certified cup of coffee, fairtrade has the ambitious goal of reaching the record number of cups of coffee drunk in three days, to help producers fight the effects of climate change; b.3) devolve part of the funds for the construction of the playground (for the project “a playground for aurora”). for this objective the price of the fairtrade coffee was €6.00, € 4.60 represents the cost of the purchase of a fairtrade certified haiti coffee package and € 1.40 the standard participation fee funds for “a playground for aurora” project, in this way with a unique action (to buy a fairtrade certified haiti coffee package) the stakeholder contribute to the two campaigns, support the haitian producers and support the realization of the playground for disable children. the research is enriched by survey that the authors have had with key stakeholders of the roman experience. in order to study the sensitivity of the participants and non-participants to the “ethical cash mob”, the authors create a survey composed of 17 3 fairtrade is an international organization that through fairtrade's certification ensures better living and working conditions for farmers and workers in developing countries (http://www.fairtrade.it/). the certification questions, structured in order to obtain information on the degree of interest on the issue of sustainability, knowledge of initiatives and their thinking administered during the cash-mob (on 14 april 2016) and online. the total of the answers obtained was equal to 230, having been found a discrepancy in the answers provided in some questionnaires, the significant sample is equal to 215. the google docs platform was used to draw up the survey (section 4). iii. case study analysis: "a playground for aurora" (rome, italy) university of rome “tor vergata” is committed to make the “sustainable development paradigm” central to all its activities, a choice fully in line also with the strategic directions developed by the italian rectors to build the “universities of the future”. the new mission and vision of the university of rome “tor vergata” aim to contribute to people’s education and training, to scientific research and technological, organizational and social fairtradeb assures the fairtrade minimum price and premium. the purpose of fairtrade minimum price is to cover production costs and provide economic support when the market price falls below the level of economic sustainability. box 1. brief-background of the “ethical cash mob”. the ethical cash mob is an initiative of animation and mobilization of citizens that takes place in a specific territory and whose goal is to relate responsible citizens and businesses. one of the most popular mobilization activities is the flash mob, created in a single action and with a purely recreational purpose. this activity differs from the cash mob, which is realized on the basis of three points: identify the deserving exercise to be supported in order to reward its work. the substantial difference lies in the fact that in italy such initiatives are both supported and gratified, on the contrary in america they are sustained independently of the merit of the activity; on the date established, the majority of people to participate in the event organized in the store are invited through the use of channels such as word of mouth and social network; customers are invited to purchase products by setting a minimum spending threshold. in this way we reward a particularly important activity for the local community, trying to bring it back into the economic circuit, feeling an active part of a change. it is important to underline the ethical dimension of cash mob, originally conceived by next (new economy for all), an association of civil society and a network of organizations with whom we have had the pleasure of collaborating for the realization of the event. all the cash mob revolves around the figure of the citizen who, taking an active part in the realization of this initiative, uses his purchasing power by choosing which activities to support. ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 innovation needed to achieve the sdgs approved by the un september 2015, with a view to third mission. the university of rome “tor vergata” aims at playing a leading role in research and education, as well as in technological, economic, organizational and social development in order to become not only a sustainable university but also one of the best european universities by 2025. the university of rome “tor vergata” has more than 30,000 students, it has ranked is among the top 100 in the world in 2017 ranking by the (times higher education) which only considers top universities founded for less than 50 years and it is the only italian university in the “qs top 50 under 50”, a ranking of the world’s top 50 universities established within the last 50 years. its aim to be a real promoter of the territorial sustainability and to straightening the collaboration with the private and public sector, third sector organization and investors, at national and international level. from 2014, was released a sustainability plan, including the actions required to reduce long-term negative externalities (with particular reference to greenhouse gas emissions) generated by the university’ activities. more recently, in february 2016, in collaboration with the unipolis foundation, proposed the creation of the “italian alliance for development sustainable” (asvis) with the intent to grow the awareness in italy of the importance of the agenda 2030 and the 17 sustainable development goals (sdgs). furthermore, the various public-commitment initiatives, intended as non-profit activities with educational, cultural and developmental value of the society, are of particular interest for the university. in fact, through its departments, it aims to develop new services for the university community and the territory, based on the needs that emerge from civil society. a case-study of public-engagement and civic-crowdfunding supported by the department of management and law of the university of rome “tor vergata” and the gcs research group was the event that generated the launch of a project strongly shared and participated at the local level, but whose resonance has also arrived overseas. the university initiative was to support the project linked to the appeal launched by two “braveparents”, who have been able to transform into “good” something that has “nothing good”: the premature death of their child, aurora. she was born on 29 april 2015, third of three children, and grew up beautiful and joyful, without problems until october 22, 2015, when the baby was rushed to the “ospedale bambin gesù” (roman hospital), with a diagnosis of a very rare form of brain tumor (atrt atypical tumor), which affects almost exclusively children (in italy there are 5-10 cases per year). aurora was operated several times and dies at the age of 7 months on december 1, 2015. the story of the troianelli family (aurora’s parents) does not end. in january 2016, they launched a fundraising campaign on internet, aimed at recovering a land of 4000 sqm abandoned (sdg 11 agenda 2030) to turn it into an inclusive public playground (sdg 10 agenda 2030), that is, accessible also to disabled children, in memory of aurora. the idea was to create this park in the suburb 4 consumer who actively participates in a moment of purchase of a responsible product, is defined as consumer + actor. theory of the “voting by the wallet”, (becchetti, 2010). of rome, in a neighborhood called “tor bella monaca”, one of the main neighborhood in rome with serious economic and social problems, very near at the university. thanks the collaboration with university of rome “tor vergata”, in particular students, the department of management and law and gcs research group, the initiative became a project promoted inside and outside the university and different stakeholder start to be involved. a. results of the case study the data related to the contributions and participation of the cause “a playground for aurora” and “the word fairtrade challenge” were collected in an excel file, structured in order to report the various quotas paid by the subjects involved (table 1). the data are divided in: internal, external and data processing. the first two indicators (internal and external) are differentiated on the basis of belonging to the faculty of economics of university of rome “tor vergata”. in particular: a) internal and external: the participation in the initiatives took place on the basis of two methodologies, individual purchases and group purchases (collective payment), highlighting for each purchase the personal data of each taxpayer and highlighting the role held by each participant within the “tor vergata” faculty of economics. then the data analysis report the number of packages purchased, the total unit cost, the actual participation in the campaign and the sums allocated to the two projects. please note that the standard contribution for the purchase of a coffee package was € 4.60, while for the support of the "un parco per aurora" initiative € 1.40. finally, the presence or absence of the contributor has been reported; in this way the value attributed to the concept of voting with the portfolio was highlighted, underlining the importance of active participation in events with a strong social impact. b) the second step is the data processing of the: participants in the initiative, a useful starting point for the analysis of the administered questionnaire; participants in the event, in relation to those who contributed and those who did not, thus enhancing the figure of the “consumattore” (consumer + actor)4; the total amount of coffee purchased, both in terms of quantity and in terms of spending, to highlight the contribution made to the realization of the great fairtrade challenge; the contribution to the "un parco per aurora" project. the survey data analysis was developed by reducing the observed sample to a significant data sample of 215. when analyzing the sample, it was important to emphasize the difference between the internal and external participants in the faculty in order to observe the value of both the marketing campaign and the collaboration with the private partners. from ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 the sample analysis, we note that 63% of the total is composed of subjects within the faculty of economics, so partnerships with private partners and marketing campaigns have been quite effective. data analysis allows us to say that the consumer of our sample is a very sensitive subject to the theme of sustainability and we see a real contribution. the feedback obtained is positive; in fact, 68% of the sample reported a high degree of susceptibility to sustainability, the 72% bought coffee and the 94% confirms the merit of the initiative (table 2). table i. results of the case study participants of the initiative (payers) of which: 159 (contributors) a) inside the faculty of economics 155 b) external to the faculty of economics 44 participant of the event ethical cash mob (payers) of which: 40 (of the 159) a) inside the faculty of economics 29 b) external to the faculty of economics 11 participant at the event (payers and not) of which: 175 a) inside the faculty of economics 145 b) external the faculty of economics 30 coffee purchased (total number of package) of which: 161 a) inside the faculty of economics single purchase 90 66 group purchase 24 b) external the faculty of economics 71 contribution of the “the world fairtrade challenge” of which: €740,60 (161x€4,60) a) inside the faculty of economics single purchase group purchase €414,00 €303,60 €110,4 b) external the faculty of economics €326,60 contribution of the “a playground for aurora” of which: €240,40 (161x€1,40=225,4, someone give some money for the cause) c) inside the faculty of economics single purchase group purchase €131,00 €97,40 €33,60 d) external the faculty of economics €109,40 the analysis of the results of the question on the utility of certification has achieved a positive result for the 59% of the total, specifically: 37% believes that the fairtrade standards are a form of protection for small coffee makers; 32% believes that the standard is useful for promoting fairer trading conditions, not just related to market trends; 16% supports its usefulness in promoting respect for ethical principles at work; 14% feels in this way safer in the purchase; 1% other. it was also decided to analyze the awareness that the consumer has about its role as a consumer, able to operate in the market through the portfolio's vote (see section 1). data analysis shows a greater awareness of the female consumer (72% of female subjects recognize the importance of “consumattore”) than male (57% of male subjects recognize the importance of the “consumattore”) table ii. relationship between age and degree of sensitivity to the theme of sustainability (1-least sensitivity to the topic of sustainability, 5-highest sensitivity to the topic). degree of sensitivity age <18 19-25 26-40 over 40 1 22,22% 1,48% 1,03% 2,44% 2 11,11% 7,35% 5,16% 9,75% 3 56,56% 36,76% 16,49% 7,32% 4 0 22,06% 41,24% 29,27% 5 11,11% 32,35% 36,08% 51,22% iv. conclusion and discussion the university actions are determined in coherence with the guidelines and strategic objectives envisaged in the field of sustainable development by the global strategy “agenda 2030”, approved five years ago. all the countries of the world and all the elements of society are called to collaborate (sdg 17 partnership for sustainability) in order to bring global ejif – european journal of islamic finance first special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 development on a sustainable path, in economic, social and environmental terms, without any distinction between developed, emerging and developing countries. the university is called to play an important role, as a privileged place for the elaboration of new kind of co-design model that see in social innovation and collaboration with different stakeholder the power of changing in a sustainable perspective. the university has a driving force for the development of the territory in which it operates and in the international country, through the collaboration with international networks. the case-study “a playground for aurora” is an example of good and proactive practice of social responsibility in the territory and collaboration for the sustainable regeneration of abandoned land in the roman suburbs, in line with sustainable objectives promoted by united nation (agenda 2030): 17 (partnerships), 11 (cities and sustainable communities), 10 (reducing inequalities), 3 (health and wellbeing) and 4 (quality education). an important aspect plays the civic-crowdfunding (section 2). the form of active citizenship sees in civic-crowdfunding a form of government-participation which citizens can be decided, through a proposal of a projects and mechanisms of voting the destination of money and funds for supporting a social project. the keys aspects of civic-crowdfunding in this case are: 1lack of funding from local governments to regenerate a public space; 2more attention to the territory, the community and the common well-being coming from civic projects; 3strengthening of ties in the communities, greater sense of belonging and ownership of public places of the citizen in order to increase respect and conservation of the same. crowdfunding is the most widespread form of financing entrepreneurial, creative and social projects. in fact, it was the main instrument used by the promoters of the playground project belonging to the university of “tor vergata”. they have adopted this tool within another tool, the ethical cash mob, thus linking a collection funds for an active moment of social action linked to responsible consumption. in addition, aurora's parents' project arrived overseas thanks to the web by extending the civic-crowdfunding campaign, create at the beginnings in the university, beyond the national borders. this has allowed the fundraising to expand to a global audience and citizens have had a tangible return on the use of contributions seeing the realization of the public work, this underlines the win-win logic of this tool and initiatives. references [1] aa.vv (2015), report trsnsforming our world: the 2030 agenda for sustainable. becchetti l., bruni l., zamagni s. (2010), microeconomia, il mulino, bologna. [2] cecere, g., le guel, f., rochelandet f. (2017) crowdfunding and social influence: an empirical investigation, applied economics, 49:57, pp. 5802-5813, doi: 10.1080/00036846.2017.1343450 [3] european commission, (2008). green paper fostering and measuring ́third mission ́in higher education institutions, bruxelles. [4] etzkowitz h. and l. leydesdorff (2000), the dynamics of innovation: from national systems and “mode 2” to a triple helix of universityindustry-government relations, research policy, 29, pp. 109-123. [5] etzkowitz h. and ranga m. (2013), triple helix systems: an analytical framework for innovation policy and practice in the knowledge society, industry and higher education, 27(4), pp. 237-262. [6] dunfee t., w., werhane p. (1997), report on business ethics in north america, in journal of business ethics, n°16, pp 1589-1595. [7] filho, w.l., (2000). sustainabilty and university life, international journal of sustainability in higher education, vol. 1 no. 2, pp. 168-81. [8] la bara, l., fiorani, f., litardi, i., (2017), responsible consumption in food sector. case study: fairtrade, shift. major challenges of today’s economy, snspa and tritonic, pp. 633-647. [9] paul langley (2016) crowdfunding in the united kingdom: a cultural economy, economic geography, 92:3, 301-321, doi: 10.1080/00130095.2015.1133233 [10] leydesdorff, l., (2012). the triple helix, quadruple helix, ...and an ntuple of helices: explanatory models for analyzing the knowledgebased economy?, journal of knowledge economics, 3:25–35. [11] litardi i., fiorani g., mititelu c. (2015), education and sustainable development: “third mission” of university of rome tor vergata", third annual international conference on sustainable development (icsd), 23-24 september 2015, columbia university, new york. [12] italian centre for social responsibility (i.c.s.r.), 2008, formazione manageriale e csr: indagine sulle recenti tendenze nell’insegnamento della csr nord america, europa, italia a confronto, pg. 83. [13] matten d., moon j. (2003), survey of teaching and research in europe on csr., nottingham university business school’s international centre for corporate social responsibility, european academy of business in society. [14] matten d., moon j. (2004), corporate social responsibility education in europe, in journal of business ethics. [15] meneguzzo m., fiorani g. (2009), scelte di sviluppo, innovazione organizzativa e rendicontazione sociale: il bilancio di mandato dell’università degli studi di roma “tor vergata, rirea, vol. 109, fascicoli n. 5 e 6, maggio-giugno 2009, pp.347-359. [16] mititelu, c., fiorani, g., litardi, i., (2017). fostering sustainable development and entrepreneurship: the new role of university, management dynamics in the knowledge economy vol.5 (2017) no.3, pp.395-414. [17] novelli g., talamo m. (2014), la terza missione dell’università italiana. una nuova occasione per crescere?, quaderni delle conferenze permanenti di medicina e chirurgia, n.61, pp.2739-2746. [18] ranga, m., etzkowitz, h., (2013). triple helix systems: an analytical framework for innovation policy and practice in the knowledge society. industry and higher education, 27(4), pp. 237-262. [19] rosenthal, r., wittrock, b., (1993). the european and american universities since 1800: historical and sociological essays, cambridge university press, cambridge. [20] scholz, r.w., steiner, r., hansmann, r., (2003). role of internship in higher education in environmental sciences, journal of research in science teaching, vol. 41 no. 1, pp. 24-46. [21] scholz, r.w., lang, d.j., wiek, a., walter, a.i., stauffacher, m., (2006). “transdisciplinary case studies as a means of sustainability learning, historical framework and theory”, international journal of sustainability in higher education, vol. 7 no. 3, pp. 226-51. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies, qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. marco meneguzzo, università degli studi di roma "tor vergata", italy prof. buerhan saiti, istanbul sabahattin zaim university, turkey prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin, italy prof. ghassen bouslama, neoma business school, campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university, uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine, france prof. federica miglietta, university of bari, italy prof. hakim ben othman, university of tunis, tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university, malaysia prof. laurent weill, university of strasbourg, france http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5056 1 abstract-the importance of women empowerment has become the central piece in numerous development agenda around the globe. in the gambia, as part of the national development agenda, the government has eye marked key priority areas to champion the course of women empowerment. in addition, the government has enacted laws and ratified several other international goals including the agenda 2030 to support this course. despite this, women entrepreneurs especially those in the agriculture value chain continue to struggle hard to access commercial loans due to exorbitant interest rate and lack of collateralswhile those with surplus get minimal returns on their savings. thus, the aims of this paper is to understand the financial contraints facing women andoffer an alternative and sustainable cheap sources of funding for women in the agricultural value chain in the gambia. the paper proposed an islamic blended finance model that have the potential to offera better return for those on the supply side and cheap source of funding for those on the demand side by minimising financial intermediation and transaction cost. in addition to this, the model will derisk investment to attract private capital, provide social safety net, skills training and most interestingly it would scale up the attainment of six (6) of the seven (7) most critical sgds. it is anticipated that this modelcan be replicated in other least developed countries. keywords: agenda 2030, blended finance, micro techakaful, retail sukuk, women empowerment. i. introduction and background funding women empowerment remains the major and overriding challenge for governments around the world, especially those in the least developed countries like the gambia.in traditional gambian society, women are supposed to be doing domestic work with limited access to basic fundamental rights compare to men. women participation in economic activities in the olden dayswas unthinkable. however, a lot has changed as women now constitute about78 percent of the economically active workforce in the agriculturalsector despite not accorded the same rights, such as land ownership, access to credit, technology, and markets as men[1]. a whole range of socio-economic, and cultural factors includingland ownership, continue to constitute a major hurdle for women to access credit due to lack of or inadequate collateral[2]. land ownership remains largelya male dominated field as only 4 percent of women own land by themself, with another15 percent mutually own, and the rest do not own any[1]. besides, limited access to agric extension services, financial services, market, storage and processing technology caused greatimpediments tothe progress of women in theagricultural value chain[1]. notwithstanding, the government of the gambia (gotg) over the years has made several attempts through policy directives, development programs, resources mobilisation, aid programs, and project interventions to boost the capacity of women in the agricultural sector.yet, 70 percent of the women involved in low productivity subsistence agricultureand cannot access financial services due to exorbitant prevailing interest rates, and financial institutions even shy awayin financing women in value addition[2].moreover, the little credits offered are embedded with riba and excessive gharar and many believe this may even force women into more financial distress. with these shortcomings, islamic finance offers alternative financing mechanism in funding women in the agric value chain in the gambia. as it provides a useful financing tool for domestic resource mobilisation, an equitable tool for resource allocations, and social financing instruments to leverage on[3]. thus, this paper looks into the financial constraints of women entrepreneurs in the agricultural value chain in the gambia and offer an islamic blended finance model that is impactful, sustainable and scalable. the paper is divided into five parts. part (i)talks about the introduction, objectives and methodology of the study.part (ii) deals with the literature review on the economic status of women in islam, the financial constraints of women in the agriculture value chain in the gambia and gambia‟s sdg status. part (iii) focuses on theoverview, concept and practice of blended finance, part (iv) provide a discussion on multidimensional sustainable and impactfulislamic blended finance model.part (5)of the paper provides conclusion and recommendations. empowering women in the agricultural value chain through islamic blended products to attain the agenda 2030 in the gambia karamo sawaneh, central bank of the gambia and fatou badjie, university of the gambia submitted august 2020, revised april 2021, accepted april 2021 ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5056 2 a. objectives of research the goal of this research are: i. to understand the financial constraints facing womenin the agricultural value chain in the gambia; ii. to easeresource mobilisationand offercheap source of funding for women in the agricultural value chain to scale up sdgs in the gambia. b. research questions to achieve these research objectives, the following research questions are crafted: i. what are the financial constraints facing women in the agricultural value chain in the gambia? ii. what alternative financing model can be adopted to provide cheap source of funding for women in agricultural value chain in the gambia? c. research methodology the researcher adopted is a mixed of exploratory and case study. to achieve the research objective, both primary and secondary sources of information were utilised. secondary sources were utilised to collect qualitative information through exploratory research by examining scholarly articles, policy guidelines, conference proceedings, academic journals, newspaper articles, books, websites, reports etc. this gave the researcher a better understanding of blended finance, financial constraints facing women in the agricultural value chain in the gambia, the economic status of women and gambia‟s sdg status. primary data was collected through case study method from two women smes in the agricultural value chain. the two smes were conveniently selected from a list of twenty (20) that were randomly selected. the quantitative data collected through this approach was used to make a justification for the model proposed in this paper by computing the potential cost reduction. quantitative approach was also utlised to compute the potential of waqf for the gambia using macroeconomic variables such total population, percentage of muslim population, number of mobile phone users etc. and zakat potential for islamic financial institutions in the gambia. ii. literature review reducing poverty and inequality through women empowerment is the fundamental principle underpinning both the sdgs and maqasid al shariah. the gotg has also made this as a priority over the years in several of its development agenda, and the most recent isthe gambia national development plan 20182021 (gndp2018-2021). however, financing women empowerment initiatives remains a challenge. therefore, the purpose of the literature review is to understand the economic status of women, their financial constraintsin undertaking economic activities and the gambia‟s sdg performance. a. the economic status of women in islam the issues of women inferiority havebeen in existence since the pre-islamic era where women faced discrimination, social exclusions and lack property rights andfinancial insecurity[4]. notwithstanding, islam treats both men and women equal and accorded women certain rights. for example the right to inheritance (quran 4:7), the right to own property (quran 4:31) and the right to earn equally like men(quran 4:32). these are clear indications that in islam women canaccumulate wealth through inheritance and from financial support given by their husbands[4]. moreover, islambestowed on women the rights not to only earn and spend as they wished but also the will to lead economic activities based on their skillset and prudence[5]. these views are consistent withthe fact that islam has given womenindependence and full potential to be financially autonomous [6]. in islam, women have the right to own a business, earn money, own property, enter into legal contracts, acquire and manages assets as they will [6]. in addition, the property and earning of women are under their full control and are not obliged to share in their husband‟s responsibilities even if they are richer [6]. in support of this view, the mamluk, safavid and ottoman literature has shown that women in islam were both involved in diverse trade activities and managed businesses on their own [7]. he stated that the prophet peace be upon him (saw)himself promoted women in various spheres of activities including trade and commerce and his wife being one of the most successful among them at the time is the testimony to that fact [7]. this means that islam has indeed permitted women to venture into and managed any kind of business provided they are within the ambit of shariah principle. b. the economic status of women in the gambia agriculture is the mainstay of the gambian economy and it employs more than 60 percent of the population[1]. crop production caters fornearly 75 percent of the household incomes, employs 70 percent of the labour force, representing 3 percent of the gdp and 40 percent of the foreign exchange earnings[1]. women made up 78 percent of the economically active population who work in agriculture despite not given the same rights as men, such as land ownership, access to credit, technology, and markets[1]. they are involved in small scale rice production to feed their families, horticultural productionpartly for consumption and for sale to earn supplementary income, livestock, and poultry for better living[1]. despite fewer inputs, and in certain contexts disproportionate limits on their authority, women of the gambia were central to the economic life of traditional gambian society, and had been agricultural trendsetters, processors, and traders of marine resources and manufactured goods[8]. however, with more women than men in the agricultural sector, their immense contribution does not translate to the desired improved social status [8]. ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5056 3 c. the financial constrain of women in the agriculture value chain women empowerment has become the cornerstone of gambia‟s development agenda. the government of the gambia (gotg) and partner institutions havecome up with some policy and strategy initiatives to enhance the productive capacity of women. among these are the social development fund (sdf), gambia women finance association (gawfa), rural finance and community initiative project (rfcip)[9]. accordingly, these institutions together are only able to meet 55 percent of the credit needs of women in the gambia[9]. with agriculture being the main occupation for gambian women especially small scale rice production, livestock, poultry and horticulture, women continue to operate at low productivity level as they are constrained by access to agricinputs, credit, and markets[10].even where women access credit, they may not be in full control of the money due to the cultural barrier[11].studies have indicated that it is even harder for provincial women to access credit and venture into business because, most financial products favour men[2]. however, this has not deterred gambian women from participating in the business. the widespread informal neighbourhood short-term savings by way of putting cash together and paying to participants throughballot is an indication of women aspiration to improve their livelihood[9]. d. the gambia’s performance in the sdgs there are good resemblance between the five (5) pillars of the sdgsand the eight priority areas of the gambia national development plan (gndp 2018-2021)[12]. for example, the gndp priority (1) poverty reduction through mechanised agriculturewill ensure that sdgs 1, 2, and 3 are achieved[12]. moreover, the sdgs and gndp 2018-2021 both envision to transform the human race, eradicate poverty in all its form, and protect the people and planet[13]. however, as shown in figure 1 gambia‟s sdg performance have been stagnating largely due to funding difficulties. table 1: the gambia‟s sdg performance source: sdg index and dashboards report 2019 it is not clear how much the gambia needs in dollar terms to achieve the agenda 2030. nevertheless, it is estimated that the gambia will need around usd235 per capita to achieve the sdgs, compare to between usd270 to usd350 per capita for other poor countries[14]. the gambia‟s needs is low because its extreme poverty rates are low relative to its income level, so the country has little need for social transfers to eradicate extreme poverty[15]. yet, the gambia is unable to meet up its sdg funding needs. therefore, this paper is expected to contribute to the countries progress in terms of funding towards achieving the agenda 2030. iii. overview, concept and practice of blended finance a. conventional practice of blended finance one concept gaining prominence in financing the sdgs is blended finance[16]. there is no specific definition of blended finance, over 30 definitions have been given so far. one such definition is the “strategic combination of public and/or private development finance flows (e.g. aid and philanthropic funds) with other public or private capital to enhance resources for investment in key areas such as infrastructure”[17]. the rationale is to leverage compassionate funds to attract private investment, develop the impact-driven skillset required to deliver the sdgs and provide risk-adjusted returns[17]. the aid element in blended finance can be utilised to de-risk investment by protectingthe investor from undue risk, and to assure investors of future repayments on their investment[17].in practices, the concept has already been utilised in so many sdg related projects across the globe. in jordan, the expansion of the as-samra wastewater treatment plant, where the blending includes public sector fund contributed by the government as a viability gap funding; a grant from the millennium challenge corporation (mcc); and private capital from a syndicated limited recourse loan provided by domestic banks in local currency[18]. in tunisia, the derisking renewable energy project was funded using a undp innovative „derisking‟ model 1 no poverty 2 zero hunger 3 good health & wellbeing 4 quality education 5 gender equality 6 clean water & sanitation 7affordable & clean energy 8 decent work & economic growth 9 industry, innovation & infrastructure 10 reduce inequality 11sustainable cities & communities 12responsible consumption & production 13climate action 14 life below water 15 life on land 16 peace, justice & strong institutions 17 partnership for the goals no data on track decreasing stagnating moderately improving ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5056 4 comprising of grant instrument; and private capital to the tune of eur935 million[17]. however, the flow of blended finance to poor countries remains a challenge due to the perceived risk. it is estimated that of total private finance mobilised for development finance interventions between 2012 and 2017, only usd 9.3 billion, or 6%, went to low-income countries, whereas over 70% went to middle-income countries[16]. this clearly demonstrates the shortfall of conventional blending in mobilising sdgs resources for poor or least developed countries to fill the sdg funding gaps, thus, the need for more hoslistic resoures mobilisation approach to attain global agenda in these countries through islamic blended finance. b. overview, definition and concept of islamic blended finance islamic blended finance is a new concept which has not been defined, one of the first attempt to define it was put forward by[13]. she define it as “an optimal mixture of islamic social funds like zakah, waqf, sadaqa and penalties from delinquency with financial instruments for the purpose of financing socially responsible and positively impactful businesses for sdgs”. however, the concept of islamic blended finance has already been utilised to provide funding for a number of sdg-related projects around the globe. for example, the national zakat board of the republic of indonesia baznas contribute zakat fund for a micro-hydro energy and leverages a undp/gef funded project and csr funds from bank jambi[19]. in indonesia, a innovative waqf based bank was created by blending government funding with private capital and philanthropic fund that attracted impact investors through crowdfunding and the funds were committed to sdgs [20]. the islamic development bank (isdb) and international federation of red cross and red crescent (ifrc) created the one wash funding model from blended financing sources, leveraging on impact sukuk, traditional donor funds and partial kafala facility mechanism from the islamic solidarity fund for development (isfd) to achieve sdg 3 (good health & well-being) and 6 (clean water and sanitation) in isdb member states[21]. c. theoretical framework islamic blending instruments the islamic blending instruments are the replica of conventional blending instruments. for example, sukuk is the replica of bond, takaful is the replica of insurance and waqf and zakat are a replica of compassionate fund. below,is a theoretical description of each of the islamic blending instruments: d. sukuk the literal meaning of sukuk comes from the arabic word sakk which means certificate, its technical meaning is an islamic bonds or securities structured in line with shariah principles[22]. according to him sukuk was first issued in february 1988 subsequent to the council of the islamic fiqh academy of the organization of islamic conference (oic) held its fourth session in jeddah, saudi arabia. in may 2003, the accounting and auditing organization for islamic financial institutions (aaoifi) published its first sukuk standard where they define sukuk as certificates of equal value representing undivided ownership shares in tangible assets, usufruct, and services[22]. the sukuk market has grown exponentially over the years in response to the growing need of shariah complaint financing to promote sustainable and equitable economic development[22]. the four basic features of sukuk that makes it distinct from conventional bondi) the sukuk certificates represent undivided shares in ownership of an asset and the holder is entitled to all rights conferred by shariah; ii) the sukuk contract must not contain any guarantee; iii) the sukuk must not contain any guarantee of a fixed profit or profit based on a percentage of the capital; iv) the sukuk must not contain any statement of obligation from the issuer‟s side that it will buy back sukuk for a nominal price[23]. e. takaful takaful was practice during the time of the of the prophet (saw) by its adoption of the doctrine of aqilah which means compensation for the decease family. shariah scholars are believed to have prohibited the conventional insurance practice since 1976 when takaful was introduced as an alternative shariah compliant insurance[24]. the concept of it is based on the mutual corporation and assistance among participants and the sector is dubbed as the fastest growing islamic financial sector[24]. the difference between takaful and conventional insurance lies in the ethical nature of the instrument and the prohibition of riba and gharar[25]. f. zakat zakat is an act of worship religious duty to give a certain amount of one‟s wealth to those in need [26]. the root word is derived from the arabic word "zakah" which literally means "cleanliness, purification, increase, growth, righteousness, blessing and praise"[27]. as mentioned in both the holy quran and sunnah of the prophet (saw) zakat is the right of the poor on the wealth of the rich and it is made compulsory at a prescribe rate for all muslim who meet the nisab[27]. zakat was meaningfully contributed to poverty alleviation in the past ad now and its impact on reducing the poverty gap is substantial[27]. zakat is a long term planning tool for poverty alleviation through building training institutions which provide technical and entrepreneurial training and provide seed capital in the form of investment to economically active poor[28]. zakat fund has now been institutionalised and integrated into the social protection system of many countries[26]. g. waqf waqf literally means tying up of an asset for some specific sharia compliant initiative[29]. it is derived from the arabic word which means to make endowment of the land and give it to the course of allah (swt). it also means to make endowment of houses and donate its proceeds in the way of allah (swt)[30]. waqf is exclusively introduce in islam to play a significant role in the socioeconomic, cultural, and religious development through islamic civilization. during the time of the prophet (saw) and the caliphs (as) waqf was able to fulfill the needs ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5056 5 of society as both charity and during jihads [31]. in contemporary society, innovative waqf have been utilise in interest free loans and debt relief in some countries[32]. cash waqf has now been utilised in countries like malaysia, singapore, indonesia, india, pakistan, the uae, kuwait, the uk, and the us among several other countries[32]. h. islamic blending instruments in the gambia the concept of islamic blended finance was deduced from conventional blended finance albeit with differences in blending instruments. the proposed islamic social financing and funding instruments such as zakat, waqf, sadaqqa and sukuk can be harmonised to promote inclusive and sustainable human development[33]. the blending instruments and their potentials available in the gambia are: i. sukuk for women empowerment in the gambia the money and capital market in the gambia are underdeveloped. the country is only at the advanced stage of launching its capital market albeit excluding the islamic component.hence, the opportunity to invest in stock and received rewards is non-existence. a market for trading in short term instruments apart from treasury bills and sukuk does not exist. the first sukuk was issued in the gambia in 2008. furthermore, there has been notable growth in the sukuk market, but since then it has been trailing the conventional bond and deposit instruments despite showing the same returns as treasury bills and better returns than retail deposit. for example, data from the cbg website shows that sukuk is seriouslyunderutilised in the gambia, accounting for only 6.2 percent of industry asset compare to 29.8 per cent for treasury bills. deposit mostly retail is 68.8 percent of total industry assets. meanwhile, one year sukuk return 7.4-22.3 range as much as treasury bills, with return on deposits only 0.25-4.0 percent per annum. to understand the potential of sukuk as a blending instrument, we conducted a mini case study of two women in the agricultural value chain. case 1: aisha is a 24-year-old postgraduate student in harvesting and transportation of agricultural goods who would want a loan of gdm250k (usd5k) to expand her business. however, she can get the loan only at 20-25 per cent from the bank. case 2: saffiyah is a 30-year-old secondary school graduate who is into poultry. she has a total savings of gmd350k (usd7k) which only returns 2 per cent per annum. let us look at how our mobile money retail sukuk model will help both aisha and saffiyah. suppose aisha borrows the gmd250k (usd5k) from saffiyah via the proposed retail sukuk at the prevailing sukuk rate of 11.32 per cent as at end april 2020. assuming aisha can get the same loan from her bank at 23 per cent. aisha will save gmd29.2k or usd0.58k and saffiyah will earn additional income gmd23.3k or usd0.47k from her investment. table 2: a case study on the potential of sukuk aisha’s account saffiyah’s account borrow from bank gmd deposit with bank gmd interestpaid 250k@ 23% 57.5k interest earn 250k@2 per cent 5.0k borrow from saffie via sukuk invest in sukuk interest 250k@11.32 28.3k interest earn 250k@11.32 28.3k total savings 29.2k additional income earned 23.3k source: authors own given the two scenarios above and the fact that sukuk has been largely underutilised despite showing similar returns as treasury bills and better returns than deposits, it will have great potential as a blending instrument in attracting private capital. j. takaful for women empowerment in the gambia the gambia has only two takaful companies, one established in 2008 and the other in 2020. according to data from the central bank of the gambia, takaful asset as atdecember 2019 represents 15.9 per cent of the total islamic finance industry assets. in addition to the various products like hajj, accidents its provide, the takaful company offer insurance coverage for smes[34]. therefore the self-help takaful scheme that is proposed in this paper can utilisethesetakaful company as a retakaful for hazards it cannot cover. k. islamic social financing (isf) for women empowerment in the gambia islamic finance market offers varieties of instrument as an avenue for suppliers and users of funds in a number of ways such as sales, trade financing, and investment (biancone and radwan 2018a)[35]. islamic finance instruments such as zakat, waqf and sukuk are been used as complementary or alternative funds to finance poverty alleviation initiatives, enhancing financial inclusion and upholding sustainable growth (biancone and radwan 2019)[36]. therefore, islamic financing anf the mobilisation of isf instruments has the potential to fund women entrepreneurs in the agricultural value chain in the gambia. l. potentials of zakah in the gambia there is no empirical evidence on how much zakat is collected and distributed in the gambia. however, [13] estimated the potential of zakat ( in the gambia from 2002 to 2021) in her masters‟ thesis using kahf model[37]. she utilises macroeconomic indicators such as gdp at ppp, total population, poverty gaps under usd1.9 and usd3.2, population under usd1.9 and usd3.2 and percentage of the muslim population.her result shows that zakat potential for z1(based on ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5056 6 classical scholars view that zakat levied on agriculture, livestock, merchandise, gold, silver, and wealth) has increased from about 1.1 percent of gdp in 2004 to almost 1.7 percent in 2018, z2 (based on views of contemporary scholars where zakat can be levied on net returns of manufacturing concerns and building rents and from net savings out of salaries) from nearly 2.4 percent of gdp in 2004 to above 3.7 percent in 2018 and z3 (based on maliki views, that zakatable item includes buildings and other fixed assets except those assigned for personal and family use) from 2.7 per cent of gdp in 2004 to 4.2 per cent in 2018. in addition to this, ifis in the gambiaexcept for takaful gambia are currently not paying zakat on their income because regulations do not require them to do so. islamic banks utilised various method to compute zakat. they include the growth model method, the working capital model, the profit loss method, average growth method and shareholders‟ funds growth method[7].the two common practices are the adjusted working capital method and the adjusted growth capital method because these two methods have no relationship with the tax computation and accounting [38]. for this paper, the profit/loss approach is used for the two ifis in the gambia. in this model, the zakat is payable at the rate of 2.5% of profit before tax and is based on the percentage of estimated individual muslim ownership [39]. table 3: estimated zakat amount of two ifis from 2016-2018 profit before tax agib islamic bank zakat@ 2.5 per cent takaful gambia zakat@2. 5 per cent gmd'000 gmd'000 gmd'000 gmd'000 2018 40,491 1,012 20,626 516 2017 30,956 774 11,047 276 2016 53,901 1,348 9,413 235 total gmd'000 125,348 3,134 41,086 1,027 total usd'000 2,507 63 822 21 source: authors own m. the potential of waqf in the gambia studies have indicated that countries with high muslim population can benefit immensely from waqf through sustainable infrastructure, education, healthcare, food security, renewable energy and water management [13] . the gambia‟s about 96 percent muslims and 3.6 percent christians are equally compassionate[13].waqf properties in the gambia are huge even though its accurate amount cannot be quantified due to improper documentation, however, it is noted that religious and educational waqf account for the greater share[13]. astudyhas suggested an integrated cash waqf micro enterprise investment model(icwme-i model)to improve the financial accessibility of micro-enterprises in malaysia by providing financing facility using a cash waqffund[40]. to model the potential of cash waqf to support funding for women enterprises in the agricultural sector, the study adopts [41] model which is based on the number of active mobile phone users andthe number of peoplewho are between the ages of 15-69years contributing x dollar per week at a 5% level of cash collection error rate. the assumption are i) there are 4 weeks in a month and 52 weeks in the year; ii) no of active mobile phone users according to public utility and regulatory authority (pura) is 2.5 million given that most gambians have more than 1 sim card, we just assume that the population living on more than usd1.9 per day each have 1sim card; iii) a high contribution error is taken to exclude the population at 16 – 17 years who are still considered minor under gambia law; and iv) the exchange gmd to usd is 0.02. the amount projected to be collected base on the cash waqf model as indicated in table 4 is gmd222.543 million or usd4.451 million. the cash waqf can be utilised to invest directly into sme business or the retail sukuk and the return can be used to provide qard hassan to those women in financial distress. suppose based on our model the cash waqf is invested at the sukuk rate, the investment will yield annually gmd25.192 million or usd0.504 million. this amount only is enough to provide funding for a number of smes in the agriculture value. table 4: projected cash inflow from cash waqf via mobile collection source: authors own computation details raw data proc ess data projected cashflow contribution per week per month per year population as at 5/2020 millions 2.32 2.32 % population 1664 years millions 0.56 1.32 living on > $1.9 per day millions 0.89 1.18 no of mobile users millions 2.58 1.18 % of muslim population 0.96 1.14 contribution rate 5 5.7 22.8 296.7 collection error rate 0.25 1.427 5.706 74.180 net collection gmd'millions 4.280 17.11 222.5 net collection usd' millions 0.086 0.342 4.451 ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5056 7 population of the gambia retrieved from https://countrymeters.info/en/gambia, gambia‟s multidimensional poverty index, number of mobile phone users from pura website, and exchange rate from central bank of the gambia website table 5: projected income from investment of cash waqf fund projected cash contribution per week projected cash contribution per month projected cash contribution per year net cash collection 4.280 17.119 222.543 invest at current sukuk yield 0.113 0.113 0.113 investment yield gmd' millions 0.484 1.938 25.192 investment yield usd' millions 0.010 0.039 0.504 source: authors own iv. propose islamic blended finance model given the two scenarios in our two case studies above, and the potential of sukuk, zakat, waqf and the underutilization of takaful products, we are proposing a blended finance model to support the funding of women in the agriculture value chain in the gambia. while zakat and waqf are mainly charitable sources of funding, sukuk is a commercial instrument that could be utilise to attract financing (biancone and radwan 2018) [42]. a. rationale for blending the aim is to strategically blend benevolent funds with private investment to mobilise the much needed funds towards impact driven sdg related women empowerment initiatives. the fact that sukuk is grossly underutilised in the gambia despite showing the same returns as t-bill and better returns than deposits, it has great potentials to attract private capital. on the other hand, isf instruments by default are meant to create value and enhance the wellbeing of the poor. in this regard, isf instruments will be of great help to derisk the sukuk investment by mitigating default risk and provide social safety nets and subsidies,and skills trainingfor the economically active poor women in the agricultural value chain. in a nutshell, the rationale is to provide an alternative source of funding by blending compassionate funds of zakat, waqf, saddaqa and crs funds with private capital, in which the compassionate funds willbe utilised to subsidise the operational and transactional cost and provide skills training for women entrepreneurs whileutilising sukuk to mobilise private capital. b. proposed islamic finance blending model as indicated earlier, blended products were utilised around the globe for sdg related projects albeit most of them are conventional blended products. [13] proposed a blending model for sme financing in the gambia, where she suggested pooling of funds from private capital with compassionate funds of zakat, waqf, sadaqah, the penalty from delinquency, donationsby providing social subsidy through islamic blended murabahah and blended murabahah credit line. this paper will take a slightly different approach by mobilisingprivate capital through retail sukuk, compassionate funds through zakat, waqf and csr funds of islamic institutions and a microtakaful to protect investors by providing respite for defaulting women entrepreneurs. figure 1: proposed islamic blended finance model source: authors own 1. the blending institution also serving as the special purpose vehicle (spv) pools blending resources utilising a mobile money platform. this stage will include the issuance of sukuk; 2. esg screening, credit screening, skills training, training on financial management and bookkeeping to determine eligible projects and women entrepreneurs; 3. fund remit to eligible and qualifying smes via the islamic contract of salam 4. micro takaful contribution for participants. the takaful fund will be utilised to protect sukuk investors from the risk of default; 5. takaful fund will both be invested and utilised to cover defaulting customer. 6. the spv deliver proceeds (principal plus profit rate) to investors via mobile money or bank account where they can access the funds. c. mobile retail sukuk model retail sukuk is one of the most important innovation in the islamic finance industry as it seeks to make sukuk available to https://countrymeters.info/en/gambia ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5056 8 small scale investors and strengthen retail participation in the market[43]. the proposed retailed sukuk structure is salam sukuk which is suitable for agricultural produce. this structure will help women entrepreneur in the value chain to access cheap source of funding (as seen in case 1) to increaseproductivity. women entrepreneur on the supply side (as in case 2), high net worth individuals, financial institutions and diasporan gambians can invest in this product. figure 2: proposed mobile money retail sukuk model source: authors own d. sukuk issuance 1. a salam and wakalah agreement executed between the originator (women in the value chain) and the spv; 2. the spv issue the prospectus via the mobile money platform, social media and local newspaper 3. spv executed the salam sukuk contract and the wakalah contract to sell the produced on behalf of the investors; 4. the retail investors invest using mobile money platform and receive digital sukuk certificate; 5. proceeds transfer to spv account via the direct credit using the payment system; e. investment proceeds of sukuk 6.spvremit funds to originator who funds women in the agriculture value chain by investing in shariah compliance project. 7. the originator sells produce on behalf of spv at the agreed price and remit funds to spv. f. sukuk maturity 8. the spv deliver proceeds (principal plus profit rate) to investors via mobile money or bank account using direct credit. investor may choose to roll over their investment. g. risk and mitigants for the issuance of sukuk i. low quality productsell products at market price and settle the difference using isf and takaful fund. ii. quantity not met sell products at market price and settle the difference using isf and takaful fund. iii. investor not able to sell produceappoints spv as agent via wakalah to sell, who may appoint beneficiary through the originator to sell. iv. default riskuse isf and takaful fund to cover for defaulting beneficiaries h. mobile microtechaful model mobile-based microtakaful utilising the insuretech concept increase efficiency reduced transaction cost and transparency. the fund belongs 100 percent to participants.the contribution will be made via tabarrru. part of the fund will be invested by the blending institution as mudarib and investment return will be shared 40 by 60 to participants. retakaful for the risk the blending institutions cannot manage. the microtakaful will be used to derisk the investment and protect sukuk investors. the women in the value chain with contribute to the fund in proportion to the value of financing. figure 3: proposed mobile microtechaful model source: authors own i. modus operandi of microtechaful 1.participants executed wakalah contract with the fund manager, remit takaful contribution and pay wakalah fee. 2. fund manager invests 50 per cent participant risk fund in a shariah-compliant investment. may invest in the salam sukuk as well. 3. remaining 50 per cent of participant risk fund will be used to settle claims, transfer to the participants' reserve fund and retakaful for the risk the fund manager is not able to cover. 4. investment proceeds received by the fund manager, 5. a percentage of the investment proceedswill be use in paying expenses and the balance added to participant risk fund and reinvested; and 6. surplus fund 100% goes to participants j. risk and mitigants for microtechaful ejif – european journal of islamic finance no 17, april (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5056 9 participant’s abusecreate incentives like reduced premium or 100 percent cashback via hibah for participants who have not make a claim. proper underwriting to ensure that participant‟s risk commensurate with tabarru contribution. k. how this models will contribute to the attainment of sdgs in the gambia this blended finance model has the potential to make the gambia reduce its dependence on the importation of rice, poultry and horticultural produce. the negotiated rate for the sukuk which is below the normal lending rate and above the normal deposit return will benefit both women on the demand side and supply side. the government will access cheaper capital to fund women in the agric value chain while making savings and the investors will earn more on their deposits. this will have great potentials to reduce poverty, attain to include other sdgs. this model, if implemented, will contribute to achieving the sdgs in the following ways: table 6: contribution of proposed blending model to sdgs source: authors own v. conclusionand recommendations the goal of this paper is to understand the financial constraints facing women in the agricultural value chain in the gambia and proposean impactful financing solution that is cheap and scalable. the findings of the research reveals that despite the women representing about 78 percent of the economically active population in the agricultural value chain in the gambia, they are not accorded similar rights as men. they continue to have limited access to agric extension services, financial services, market, storage and processing technology. the study also reveals that with more women than men in the agricultural sector, their immense contribution does not translate to the desired improved social and economic status. therefore, we are proposing a blended finance model where sukuk will be used to attract private capital and isf instrument will be utilise tomitigate default risk by providing social safety nets, subsidies,and skills training for the economically active women in the agricultural value chain. this paper has policy implication for the government of the gambia and the potential source of funding for women enterpreneur in the agricultural value chain. it is therefore recommended that the government create the enabling environment by empowering the blending institutions with sound policies, give tax breaks and encourage the utilization of isf instrument to provide subsidies to women organisations. referencing [1] ecowas fao. 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(2018). sukuk in focus: the necessity for global common practices. http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5056 12 paper title (use style: paper title) european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6025 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 09/05/2021 accepted for publication: 06/02/2022 published: 22/04/2022 15 the sharia compliance level of islamic banks in asia and its implications on financial performance and market share 1 department of accounting, faculty of economics and business, university of indonesia, depok (indonesia) corresponding author: kidod25@yahoo.com abstract— this study aims at showing the influence of the sharia compliance level of islamic banks in asia and how it affects their financial performance and market share. it analyzing whether the average level of the sharia compliance of islamic banks in asia is adequate. it incorporates a descriptive quantitative research design. the sample comprises 62 islamic banks located in asia with the observation period ranging from 2016 to 2018. however, following the analysis, the results of the study could not show whether the sharia compliance level of islamic banks in asia has an influence on the financial performance and market share. the limiting factors behind this could be attributed to the limited sample and the short observation period of this study. however, the results of this study can be considered by stakeholders when investing their funds. in this regard, the regulators in indonesia are expected to make deeper regulations for islamic banks. this study contributes to the islamic economic literature because the number of studies that look at the level of sharia compliance with one measurement in the asian region and see the implications of the level of this compliance on financial performance and market share is still limited. keywordssharia; compliance; financial; performance; islamic; bank i. introduction islamic banking operates side by side with conventional banks. it makes the competition between them very challenging [1]. the competition drives islamic banks (ibs) to work harder and be more creative and innovative in order to gain adequate market shares [2]. the main challenge of islamic banking and finance is to provide products and services that are diverse, innovative, and competitive with the conventional financial instruments while still being in accordance with sharia [3]. in carrying out its operations, ibs base their rules on the qur’an and hadith. all islamic banking activities must comply with the islamic sharia principles and regulations made by the sharia supervisors [4]. in this regard, shareholders and islamic scholars are entitled to the services provided by islamic banks in accordance with sharia law [5]. there are several studies which show that sharia compliance is the most important factor for prospective customers in choosing an ib [6] [7] [8]. sharia compliance also guarantees an ib’s credibility and inspires trust in their shareholders and stakeholders. to achieve uniformity of sharia compliance among financial institutions, the islamic financial services board (ifsb) and the accounting and auditing organization of islamic financial institution (aaoifi) were formed. their responsibilities include forming the accounting, auditing, and government standards while also implementing the ethics that are in accordance with the islamic law for financial institutions. an ib is determined by its commitment in following sharia in all aspects [9]. the compliance of ibs and financial institutions to aaoifi and ifsb standards is very important to manage the sharia compliance risk, mitigate operational risks, and ensure transparency in financial statements [10]. islamic financial institutions are exposed to islamic disobedience risk which is a unique risk for these institutions [8]. several cases of ibs and financial institutions violating sharia principles raise serious doubts about sharia compliance [7]. examples include the dubai islamic bank (dib) scandal, sunrise equities inc. case, and dana gas sukuk scandal. ibs and conventional banks are very similar in how they operate, due to which the former often ends up violating the sharia principles and hindering the achievement of a sharia principle’s goals [11] [12]. many of the financing offered by ibs have similarities with debt instruments rather than profit and loss sharing (pls) practices. these practices negatively affect public perception [7]. they make customers skeptical of an ib with regards to its sharia compliance [13]. in this regard, a sharia compliance analysis would be beneficial for prospective customers and bank customers [8]. most shareholders and investors are very concerned about the funds they invest and whether it is in alignment with sharia principles or not [14] [7]. therefore, there is an obligation on adelia nidyanti1, dodik siswantoro1 https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6025 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 09/05/2021 accepted for publication: 06/02/2022 published: 22/04/2022 16 banks to reflect islamic values in all their activities [9]. sharia compliance is also important to promote trust, as it will increase customer protection. customers trust an ib with their investment because they believe that it truly adheres to sharia principles that prohibit usury, speculation, and undue risk [7]. in this regard, ibs have claimed that they are complying with the sharia principles [15] [10] [16]. however, the fact remains that the level of sharia compliance cannot be qualified as compliant or non-compliant; there must be a ranking system that regulates compliance with the law, including levels/categories such as high, satisfying, weak, and non-compliant. the different levels of sharia compliance between banks in different countries cannot be compared because they use different measurements. there is no certain model that can describe the sharia compliance of each ib [13]. therefore, it is important to use a uniform measurement model so that the sharia compliance levels of ibs in asia can be compared fairly. the sharia compliance ranking system is very helpful in measuring the progress toward achieving the goals of the islamic financial system and in gaining the stakeholders’ trust. in addition, high compliance can help and support aaoifi and ifsb in improving improve their standards so that they can be applied by islamic financial institutions globally [15] [8]. market forces should obey sharia principles to increase the efficiency and competitiveness of the islamic banking industry [17]. a majority (75%) of respondents agree that high sharia compliance guarantees more financial benefits in bangladesh [10]. a study using five categories of financial performance, namely profitability, efficiency, risk, asset quality, and liquidity, to examine the financial performance of ibs and conventional banks in pakistan was conducted. the result shows that ibs are relatively better in terms of profitability, efficiency, risk, and liquidity management, while conventional banks are superior in asset quality [18]. on the other hand, sharia compliant companies underperform compared to nonsharia compliant companies. the sharia compliance also has an impact on a bank’s market share. the higher the level of a customer’s or prospective customer’s trust in ibs, the more people will invest their funds in these banks [19]. the aim of the study is to also expand the scope of or improve upon the previous research. the relationship between sharia compliance and an ib’s performance in asia is an interesting issue. no previous paper discussed this topic and case before. the structure of the paper starts from the introduction and then proceeds to the literature review and hypothesis development. this is then followed by the research method and the analysis, the last of which is the conclusion. ii. literature review and hypothesis development a. corporate governance theory corporate governance is a set of internal corporate arrangements that defines the relationship between managers and shareholders and is aimed at supporting financial stability, sustainable growth, and economic efficiency. the oecd principles can be adapted by islamic financial institutions so that they can conduct business according to sharia principles which are fair and honest with others. the scope of governance in islamic principles is broader, as it not only prioritizes the interests of stakeholders but also the socio-economic interests. based on the oecd principles, the only party entitled to decision making and internal business transaction participation is the board of directors (bod) and senior management. however, in the case of in islamic principles, anyone related to the organizational stakeholders is given the full right and responsibility to participate and convey their thoughts and ideas in reforming corporate governance [20]. the distribution of profit sharing is carried out fairly in accordance with the agreement of the two parties (bank and customer), which is determined at the time of the contract. disclosure and transparency are emphasized in governance according to the islamic principles. according to these principles, banks or financial institutions are not only responsible to the bod, but also to allah swt. therefore, it is important for ibs to pay attention to the sharia compliance, as it is one of the good governance principles. by complying with sharia principles, an ib has achieved certain key goals, namely carrying out activities that are free of usury and oriented to profit and social welfare. b. financial performance financial performance is a company’s ability to manage and control its resources [21]. the measurement of financial performance is carried out by looking at the profitability level of the company, such as return on assets (roa) [22] [23]. this ratio measures the company’s ability to use its assets to make a profit. financial ratios are taken from financial statements and made available to the public [24] [25]. a financial ratio analysis is useful for the management and interested parties to evaluate financial conditions expeditiously. c. market share market share is a proxy to see market power [26]. companies that have a high market share tend to have more innovation. companies with high market shares that continue to innovate also get higher valuations in the stock market than companies that do not [27]. d. sharia compliance in carrying out its operations, ibs are required to comply with laws, regulations, and islamic principles because they are fundamental factors that distinguish ibs from conventional banks. despite close supervision being carried out by various parties in this regard, various sharia principles have been violated in the banking industry. islamic scientists says that in conducting sharia banking transactions, an ib does things that are contrary to islamic regulations [28]. this is caused by ineffective governance, human resources, the role of the sharia supervisory board, and unscrupulous people [29]. the implementation of sharia compliance in islamic banks must be reported and requires standards in order to produce a systematic financial report that can be understood by all parties who need information. aaoifi has developed standards on https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6025 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 09/05/2021 accepted for publication: 06/02/2022 published: 22/04/2022 17 auditing, governance, and accounting for islamic financial institutions. in this regard, the sharia compliance can be influenced by various factors, namely bank size [10], a sharia internal audit and audit committee, profitability, board independence, and liquidity [30]. e. hyphothesis development identify applicable sponsor/s here. if no sponsors, delete this text box. (sponsors) most ibs adhere to islamic principles, such as those in bahrain and malaysia [16]. however, it is worth noting that not all banks with islamic labels follow sharia principles [7]. one reason or this is that the modern islamic banking financial system is similar to conventional banking [11] [12]. only a small portion of financing that is actually based on pls and islamic deposits is not interest free so it is as same as conventional deposits too. this certainly violates sharia and hinders the achievement of islamic principles. in addition, there are several cases of sharia violations committed by ibs that occurred during the mid-1980s. one example of this is how islamic banks in turkey have deviated from the practice of islamic banks [31]. in this context, the question on whether ibs in asia comply well with sharia remains to be answered. this has led to the formulation of the first hypothesis: h1: the average level of the sharia compliance of islamic banks in asia is compliant. increasing the competitiveness and efficiency of the sharia banking industry can be done if the market force complies with the sharia principles [17]. the greater the compliance level of ibs with islamic law, the greater the customer’s intention to get funds from these banks so that the latter can sustain their customer base [32]. the majority (75%) of respondents agree that better sharia compliance guarantees more financial benefits in bangladesh [10]. islamic banks are relatively better at profitability, efficiency, risk, and liquidity management than conventional banks [18]. on the other hand, companies that are sharia compliant perform lower than companies that are nonsharia compliant [19]. it is on this basis the second hypothesis has been formed: h2: the more compliant the islamic bank is with sharia principles, the better the islamic bank’s financial performance. the more compliant the ibs are with islamic principles and regulations, the greater the customer’s intention to continue to obtain funds from them [32]. customers will check for the islamic compliance of an ib before deciding to choose it [7]. this will certainly increase the number of customers and the market share of the bank. in this regard, the third hypothesis has been formed: h3: the more compliant the islamic banks are with the sharia principles; the market share of the islamic banks will increase. iii. research method this study follows a descriptive quantitative research design that uses secondary data, namely the annual financial statements published by islamic bank. the sample for this study comprises all the ibs of asia that are registered in orbis from 2016 to 2018. the annual reports for each ib are obtained through its official website. out of the 113 ibs in the asian region, only 62 fulfilled the sample selection criteria. following this, the researchers tested the sharia compliance with financial performance using a simple linear regression analysis with the following model. roait = β0 + β1 complianceit + sizeit + branchit + ageit +ε roeit = β0 + β1 complianceit + sizeit + branchit + ageit +ε oerit= β0 + β1 complianceit + sizeit + branchit + ageit +ε npfit= β0 + β1 complianceit + sizeit + branchit + ageit +ε ctdit= β0 + β1 complianceit + sizeit + branchit + ageit +ε carit= β0 + β1 complianceit + sizeit + branchit + ageit +ε fdrit= β0 + β1 complianceit + sizeit + branchit + ageit +ε msit= β0 + β1 complianceit + sizeit + branchit + ageit +ε descriptions: roait: return on assets of islamic bank i in t roeit: return on equity of islamic bank i in t oerit: operating expense to revenue of islamic bank i in t npfit: non-performing financing of islamic bank i in t ctdit: cash to deposit of islamic bank i in t carit: capital adequacy ratio of islamic bank i in t fdrit: financing to deposit ratio of islamic bank i in t msit : market share of islamic bank i in t complianceit: sharia compliance of islamic bank i in t sizeit : the assets value owned by islamic bank i in t branchit : number of branches owned by islamic bank i in t ageit : period years of bank operates the level of sharia compliance from ibs is measured by using the sharia compliance index developed by ashraf and lahsasna [13]. there are 14 indicators that look at this. they are grouped under five categories: support from regulators, quality of sharia supervision, business structure, composition of assets and deposit base, and capital adequacy standards. each indicator is assessed according to a predetermined score. a bank can get a maximum risk-weighted score of 150 and a minimum risk-weighted score of -138. the formula used to get the percentage of each ib is https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6025 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 09/05/2021 accepted for publication: 06/02/2022 published: 22/04/2022 18 % sharia compliance= (achieved score)/(maximum achievable score) after the ib compliance percentage value is obtained, the ib is classified as shown in table 1. table 1. sharia compliance levels achieved degree of compliance rating interpretation ≥80% sss high sharia compliance 50%–80% s+ satisfactory sharia compliance 0–50% sweak sharia compliance nilai negatif sn sharia non-compliant source: [13] the dependent variables in this study are financial performance and market share. financial performance is measured using several financial statement ratios, namely roa, roe, oer, npf, ctd, fdr, and car. the market share variable is measured using the formula from berger [26]: market share= (total assets of islamic banks/ total assets of national islamic banks) x 100% the total ib national asset is obtained from the stability report issued annually by the ifsb. in the stability report, the total ib assets in the world per region and their presentations for each country are given. based on this percentage, the total assets of the national islamic banking in each country are calculated, while the total ib assets are obtained from each ib’s annual financial statements. iv. results table 2. descriptive statistics variables average sd max min roa 0,0101 0,0294 0,1842 -0,1077 roe 0,0802 0,1347 0,3685 -0,9401 oer 0,7223 0,5764 6,2130 -0,2039 npf 0,0579 0,1079 0,8910 0 ctd 0,4709 3,9200 53,529 0,0015 car 0,1847 0,2579 1,6307 -1,2508 fdr 0,8410 0,5613 4,7373 0,0190 ms 0,2228 0,2739 1,0000 0.0156 sc 0,6982 0,0736 0,84 0,44 descriptions: roa (return on asset); roe (return on equity); oer (operating expense to revenue); npf (non performing finance); car (capital to adequacy ratio); ctd (cash to deposit); fdr (financing to deposit ratio); ms (market share); sc (the value of sharia compliance level ) source: authors’ elaboration the value of each variable in table 2 shows the effectiveness of the investment management (roa) and capital (roe) conducted by an ib, the amount of profitability of ibs (oer), the quality of financing provided by ibs (npf), the amount of ib funds used for financing (ctd), ib capital adequacy (car), and the amount of financing provided for deposits received by the banks (fdr). the highest roa value of 0.1842 is owned by the bank of punjab taqwa islamic banking (pakistan, 2018) while the lowest roa value of 0.1077 is owned by bank mega syariah (indonesia, 2017). the highest roe value of 0.3685 is owned by al-hilal bank (kazakhstan, 2018) while the lowest roe value of -0.9401 is owned by bank panin syariah (indonesia, 2017). meanwhile, the highest oer value of 6.2130 is owned by icb bank (bangladesh, 2017) while the lowest oer value of -0.2039 is owned by icb bank (bangladesh, 2018). the highest npf value of 0.8910 is owned by the muamalat malaysia berhad bank (malaysia, 2017) while the lowest npf value of 0 is owned by the abc islamic bank (bahrain, 2016). the highest ctd value of 53,529 is owned by maybank syariah (indonesia, 2018) while the lowest ctd value of -0.0015 is owned by the alliance bank (malaysia, 2016). the highest car value of 1.6307 is owned by maybank syariah (indonesia, 2018) while the lowest car value of 1.2508 is owned by the icb islamic bank (bangladesh, 2018). the highest fdr value of 4.7373 is owned by the khaleeji bank (bahrain, 2017) while the lowest fdr value of 0.0190 is owned by bank muamalat malaysia berhad (malaysia, 2018). the highest ms value of 1,0000 is owned by al-hilal islamic bank (kazakhstan), islamic bank of thailand (thailand), and the maldives islamic bank (maldives) while the lowest ms value of 0.0156 is owned by maybank syariah (indonesia, 2018). the islamic bank that got the highest value of sharia compliance (0.84) is the meezan bank (pakistan) while the one who got the lowest sharia compliance value (0.44) is the gulf international bank (bahrain). the average value obtained was 0.6982. in determining the level of sharia compliance, a scoring is conducted on the annual financial statements of ibs in asia. based on the scoring result, there are three ibs in the satisfactorily compliant category, 61 ibs in the high-compliant category, and one ib in the less-compliant category with none in the non-compliant category. the scoring results show the average sharia compliance level of islamic banks in asia is compliant. this proves h1 that ibs in asia comply with sharia principles. there are only three ibs in the high-compliant category, namely the aljazeera bank, jordan islamic bank for finance and investment, and meezan bank. these banks have very high islamic compliance because their amount of distribution of financing in the form of mudarabah and musyarakah is very high compared to other islamic banks. however, what should be underlined here is that this assessment is based on the annual financial statements of the ibs. the less compliant islamic bank is the gulf international bank (gib) because the sharia supervisory board reports the shariha compliance opinion to the ceo so its independence is less than the islamic bank reporting to the bod or directors. moreover, gib also does not have its own sharia supervisory board report although it has its own risk management report. in this regard, it is more focused on risk management compared to sharia compliance. moreover, it does not make a breakdown of the income earned (murabahah, musharaka, mudarabah or https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6025 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 09/05/2021 accepted for publication: 06/02/2022 published: 22/04/2022 19 ijarah). instead, it has a pool of funds mixed with conventional banks because it is a business unit of conventional banks. some other interesting things were also discovered by researchers in scoring the ibs’ annual financial statements. first, the separation of the islamic banking law from conventional banking law is carried out by three countries, namely bahrain, iraq, and kuwait. in contrast, other countries have one single banking law that regulates islamic bank with conventional banks. however, indonesia and malaysia— despite having a single law governing islamic banks with conventional banks—have separate guidelines and regulations for ibs. second, there are some sharia supervisory boards that are in charge of conducting sharia audits, while there are those who only serve as advisors of sharia banks. based on the scoring, most countries require islamic audits. countries that assigned sharia supervisory boards as advisors to islamic banks include indonesia, sri lanka, iraq, and brunei darussalam. third, a majority of the sample reports the opinion results to the bod, compared to the ceo and directors. the ibs, in general, also report the results of the assessment (opinion) of the sharia compliance in the financial statements very well, namely by notifying what is done. following this, further advice or recommendations are given on the basis of these findings, in addition to explaining that the ib is compliant with sharia. fourth, a majority of the sample have separate legal entities within conventional banks. in addition, certain ibs have very little profit equalization reserve, namely those in bahrain (3 islamic banks), kuwait (1), oman (2), and pakistan (1). fifth, the majority of ibs in the sample have separate but not independent charity funds (charity funds are obtained from non-halal income or obtained from zakat). only a few ibs have foundations or special programs for their charity funds such as al-bilad bank (saudi arabia). sixth, the sample mostly has 6 to 10 types of financing products. the majority of third-party fund structures owned by ibs are obtained from mudarabah and musyarakah rather than murabahah. finally, the sample in this study has a very good capital adequacy in accordance with ifsb rules which is above 12%. some even have cars above 20%. based on the scoring results, it can be concluded that ibs in asia have a level of sharia compliance at 50–80% which is 69.82%. this is in line with vinnicombe which states that political, economic, social, and geographical factors have an impact on the level of compliance with aaoifi standards [9]. in most countries, ibs are placed under the supervision of a central bank and treated the same as conventional banks. table 3. results of h2 variable model 1 model 2 coef. prob. coef. prob. constants -0,0157 0,3005 -0,2303 0,0410 sc 0,0168 0,4470 0,1052 0,2265 size 0,0008 0,7420 0,0115 0,0190 branch -0,0036 0,7440 0,0007 0,1020 age -0,0005 0,5440 0,0009 0,2310 r2 overall 0,0127 0,1930 f0,8664 0,0007 statistics model 3 model 4 constants 24,535 0,0000 0,0966 0,308 sc -10,301 0,0435** 0,0356 0,381 size -0,0487 0,0200** -0,0036 0,380 branch 0,0001 0,6230 0,0001 0,655 age -0,0073 0,0320** 0,0001 0,988 r2 overall 0,1796 0,0093 fstatistics 0,0013 0,9209 descriptions: sc: sharia compliance level of islamic bank; size: logarithm of total assets; branch: total branches of islamic banks; age: the period of bank operate coef: variable coefficient ***: significant level 1%; **: significant level 5%; *: significant level 10%. source: authors’ elaboration the result of testing model 1 shows that the independent and control variables have no significant effect on the dependent variable. the r2 overall value in model 1 is 0.0127. this shows that high or low roa value does not have a relationship with sharia compliance. ibs, especially in indonesia, have a small roa compared to conventional banks because the former bear a greater cost than the income earned. the model 2 test results show that the independent variable and control variables do not have a significant effect on the dependent variable. the r2 overall value in model 2 is 0.1930, i.e., the level of roe does not affect the level of sharia compliance. the roe shows how the more efficient islamic bank managers manage their capital to conduct financing. the results from testing model 3 show that the independent variable has a significant influence on sc at a significance level of 5%. the control variables, namely size and age, significantly influence the dependent variable at a significance level of 5%. the overall r2 value in model 4 is 0.1796. that is, the more compliant the ib, the lower the oer ratio. this is contradictory to lassoed’s findings that ibs have to bear higher costs when providing quality services [33]. this is because quality services are supported by diverse facilities and friendly services, which, in turn, require huge expenses to sustain it. qualified human resources are needed due to which, it is necessary to recruit and provide adequate training to the employees. table 4. results of h2 and h3 variable model 5 model 6 coef. prob. coef. prob. constants 0,7534 0,8250 -0,1129 0,6080 sc -62,865 0,0685 0,5109 0,0031** size 0,2426 0,1010 0,0011 0,9070 branch -0,0003 0,8310 -0,0006 0,4840 age -0,0158 0,5070 -0,0038 0,0120** https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6025 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 09/05/2021 accepted for publication: 06/02/2022 published: 22/04/2022 20 r2 overall 0,0452 0,1181 fstatistics 0,3405 0,0188 model 7 model 8 constants 0,5008 0,2950 -0,2036 0,3810 sc 0,9303 0,0585* -2,942 0,1540 size -0,0190 0,3580 0,0346 0,0010*** branch -0,0006 0,0010** 0,0001 0,2810 age -0,0064 0,0520* -0,0008 0,6140 r2 overall 0,1285 0,1452 fstatistics 0,0120 0,0058 descriptions: sc: sharia compliance level of islamic bank; size: logarithm of total assets; branch: total branches of islamic banks; age: the period of bank operate coef: variable coefficient ***: significant level 1%; **: significant level 5%; *: significant level 10%. source: authors’ elaboration the model 5 test result shows that the independent variable does not have a significant effect on the dependent variable. the r2 overall value in model 5 has a value of 0.0452. in other words, sharia compliance does not affect ctd. a large amount of cash violates the maqasid syariah principles because the cash is idle money that should be used to distribute financing to customers. the more cash in the bank, the more it implies that the money is buried in the bank. fewer ibs give financing to customers. the model 6 test result shows that the independent and control variables significantly influence the sc variable at a significance level of 5%. the overall r2 value in model 6 is 0.1181. this shows that sharia compliance has a relationship with the car. the more compliant the ibs, the higher the car value. this ratio shows the adequacy of the capital owned by ibs in bearing the risk of losses that may occur due to mudarabah, musharakah or other transactions. the result from testing model 7 shows that the fdr variable significantly influences the dependent variable at a significance level of 10%. there are two control variables that have a significant influence on sharia compliance, namely the number of branches and age of ibs at the significance level of 5% and 10%, respectively. on the other hand, the overall r2 value in model 7 is 0.1285. from this, it is quite evident that the sharia compliance affects the fdr. the more compliant the ibs, the higher the fdr. ibs which have a lot of financing are getting better because they achieves their goal of providing financing to their customers. significant control variables operate behind an ib’s size and number of branches in affecting the level of sharia compliance [10]. the model 8 test result shows that the ms variables and the majority of control variables do not significantly influence the dependent variable. there is one control variable that influences sharia compliance, namely an ib’s size with a significance level of 1%. the r2 overall value on model 8 is 0.1452 which implies that the sharia compliance does not affect market share. all in all, from the market share, one can see the development of ibs. based on the regression results above, it can be concluded that h2 was rejected. this finding is in accordance with the fact that sharia compliant companies have lower performance compared to non-sharia compliant companies [19]. although sharia compliance is a governance principle, financial performance depends on not only sharia but also the internal control systems, risk management systems, and services provided by employees. considering all this, the results of the regression test failed to prove that better sharia compliance guarantees more financial benefits [10]. however, the study supports bizri (2014) in the fact that prospective customers prefer ibs based on security, trustworthiness, quality of service rendering, and price of financing compared to sharia compliance [7]. v. conclusion the study aimed to determine the sharia compliance level of ibs in asia and its influence on their financial performance and market share. the level of sharia compliance of ibs in asia on average can be classified under the high-compliant category. this is due to the people in the sample countries upholding islamic principles in various aspects of life including banking. this opinion is consistent with previous studies that investors in the sample countries prioritize sharia bank compliance before investing their funds [34] [35]. based on the regression results, sharia compliance affects the oer, car, and fdr of ibs. however, the roa, roe, npf, and ctd are proven not to be affected by sharia compliance. the establishment of ibs in countries that do not have a majority muslim population is hindered by regulations. moreover, they also do not have the support of the central bank due to which, the level of compliance remains low. in this regard, the ibs in indonesia must emulate the ibs in asia so that the level of sharia compliance is maintained and further enhanced. this is because an adequate level of sharia compliance is the goal of ibs. the results of this study can be considered by stakeholders before investing their funds. they can find out whether ibs actually comply with islamic regulations because they are the basis that distinguishes ibs from conventional banks. the regulators in indonesia are expected to be able to make deeper regulations for ibs, as has been done in several countries, such as bahrain, iraq, and kuwait. these three countries have islamic banking laws that are separate from conventional banks. however, there are certain limitations to the study due to which, its scope can be extended further in future studies. for instance, the sample is limited and the observation period is quite short. moreover, the measurement of sharia compliance is not the best one. future research could keep these limiting factors in mind while deciding on research designs and components that would be more efficient. it is also worth noting that the results of the study are subjective as well, as the assessment is based on the annual islamic financial statements. in future, it is recommended that case studies be conducted for https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6025 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 09/05/2021 accepted for publication: 06/02/2022 published: 22/04/2022 21 each ib to better ensure a sufficient level of sharia compliance on the part of ibs. references [1] waemustafa w., 2013, the emergence of islamic banking: development, trends, and challenges, iosr j. bus. manag., 7, 2. [2] yumanita d. and ascarya, 2005, bank syariah: gambaran umum, seri kebanksentralan, 14. [3] venardos a. m., 2005, islamic banking and finance in south-east asia: its development and future. [4] archer s., karim r. a. a., and sundararajan v., 2010, supervisory, regulatory, and capital adequacy implications of profit-sharing investment accounts in islamic finance, j. islam. account. bus. res., 1, 1. [5] alnasser s. a. s. and muhammed j., 2012, introduction to corporate governance from islamic perspective, humanomics, 28, 3. [6] metawa s. a. and almossawi m., 1998, banking behavior of islamic bank customers: perspectives and implications, int. j. bank mark., 16, 7. [7] bizri r. m., 2014, a study of islamic banks in the non-gcc mena region: evidence from lebanon, int. j. bank. mark., 2, 2. [8] hanif m., 2018, sharīʿah-compliance ratings of the islamic financial services industry: a quantitative approach, isra int. j. islam. financ., 10, 2. [9] vinnicombe t., 2010, aaoifi reporting standards: measuring compliance, adv. account., 26, 1. [10] ullah m. h., khanam r., and tasnim t., 2018, comparative compliance status of aaoifi and ifsb standards: an empirical evidence from islami bank bangladesh limited, j. islam. account. bus. res., 9, 4. [11] kameel m. m. a. and larbani m., 2009, ownership effects of fractional reserve banking: an islamic perspective, humanomics, 25, 2. [12] chong b. s. and liu m. h., 2009 islamic banking: interest-free or interest-based? pacific basin financ. j., 17, 1. [13] ashraf m. a. and lahsasna a., 2017, proposal for a new sharīʿah risk rating approach for islamic banks isra, int. j. islam. financ., 9, 1. [14] chapra m. u. and ahmed h., 2002, corporate governance in financial institution. [15] sarea a. and hanefah m., 2013, the need of accounting standards for islamic financial institutions: evidence from aaoifi, j. islam. account. bus. res. [16] eddy y. and ezry f., 2010, are islamic banks in malaysia really “islamic”? munich pers. repec arch., 20901. [17] ariff m. and rosly s. a., 2011, islamic banking in malaysia: unchartered waters, asian econ. policy rev. 6, 2. [18] khan h. and bashar o. k. m. r., 2008, islamic finance: growth and prospects in singapore, high. educ., 1. [19] farooq o. and alahkam a., 2016, performance of sharia-compliant firms and non-sharia-compliant firms in the mena region: which is better? j. islam. account. bus. res., 7, 4. [20] abu-tapanjeh a. m., 2009, corporate governance from the islamic perspective: a comparative analysis with oecd principles, crit. perspect. account., 20, 5. [21] ikatan akuntan indonesia, 2016, standar akuntansi keuangan, iai global. [22] mudjijah s., khalid j., and astuti, d. a. s., 2019, pengaruh kinerja keuangan dan struktur modal terhadap nilai perusahaan yang dimoderasi variabel ukuran perusahaan, j. akunt. dan keuang., 8, 1. [23] sartono a., 2015, manajemen keuangan teori dan aplikasi, edisi 4, yogyakarta: bpfe. [24] galant a. and cadez s., 2017, corporate social responsibility and financial performance relationship: a review of measurement approaches, econ. res. istraz., 30, 1. [25] brigham e. f. and houston j. f., 2010, dasar-dasar manajemen keuangan, edisi 11, salemba empat. [26] berger a. n., 1995, the relationship between capital and earnings in banking, j. money, credit bank., 27, 2. [27] blundell r., griffith r., and van reenen j., 1999, market share, market value and innovation in a panel of british manufacturing firms, rev. econ. stud., 66, 3. [28] sjahdeini s. r., 2014, perbankan syariah : produkproduk dan aspek-aspek hukumnya, perbankan syariah. [29] mardian s., 2019, tingkat kepatuhan syariah di lembaga keuangan syariah, j. akunt. dan keuang. islam, 3, 1. [30] segarawasesa f. s., 2018, determinan tingkat kepatuhan syariah pada bank syariah di indonesia. [31] yanīkkaya h. and pabuçcu y. u., 2017, causes and solutions for the stagnation of islamic banking in turkey, isra int. j. islam. financ., 9, 1. [32] anshori a. g., 2008, sejarah perkembangan hukum perbankan syariah di indonesia dan implikasinya bagi praktik perbankan nasional, la_riba, 2, 2. [33] lassoued m., 2018, comparative study on credit risk in islamic banking institutions: the case of malaysia, q. rev. econ. finance, 70. [34] awan h. m. and bukhari k. s., 2011, customer’s criteria for selecting an islamic bank: evidence from pakistan, j. islam. mark., 2, 1. [35] komijani a. and taghizadeh-hesary f., 2019, an overview of islamic banking and finance in asia, in routledge handbook of banking and finance in asia. https://www.ojs.unito.it/index.php/ejif/index http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 the synergistic relationship between crowdfunding and corporate social responsibility: a case study mohamad kamal department of management, university of turin, italy abstract—crowdfunding is one of the new financing aspects that technology has added in the past decade and has grown significantly to become an alternative source of finance and assisting business projects and social & environmental initiatives. despite the development and spread of debt-based crowdfunding significantly, donation-based crowdfunding is also progressing, especially with the growing relationship between crowdfunding and corporate social responsibility (csr) and through which it is possible to create opportunities to attract funds by crowdfunding platforms. the aim of this paper is to analyze the relationship between crowdfunding and the principles of csr. in particular, the study examines whether the adoption of csr principles in crowdfunding platforms affects the success of funding and the ability of companies and entrepreneurs to access financial resources on the one hand and whether crowdfunding is an effective means of financing projects that are in line with the objectives of csr on the other hand. the approach is based on a qualitative research methodology formed by a case study using data from a crowdfunding platform in middle east countries to investigate the funds that are raised which are consistent with the principles of csr taking into account cultural and religious characteristics. the results of the paper show that the presence of csr positively affects the success of the funding offered and that the crowdfunding platforms are an effective and innovative tool for financing projects that are in line with the objectives of csr. keywords-crowdfunding, corporate social responsibility, social & environmental activities i. introduction recently, csr has become an inevitable priority for businesses around the world and represents a coherent tool in the business strategy of big companies, it has become more than a cost, restriction or charitable gesture. it can be seen as a source of opportunity, innovation, competitive advantage and strategic investment that creates long-term value [1]. usually, the csr activities are implemented with the knowledge that there is a strong relationship between the company and the society, [2] has argued that companies cannot be considered separately from society, and this strong relationship between business and the surrounding environment has a dimension of moral and ethics. in addition, many companies have striven to implement actions aimed at strengthening their reputation through the adoption of csr concepts which have a positive impact on the followed way in which the company is perceived and evaluated by its stakeholders [3]. this leads to a direct or indirect positive impact on the profitability of the company through increased sales and services or fundraising as part of the financing of social activities for companies. can benefit from the financing process for these activities mainly through crowdfunding, especially if they focus on social and environmental issues [4]. crowdfunding is a new way to get funding by going directly to a group of people around the world online and asking for funding to serve an initiative. this has become an alternative to traditional financing methods that rely on institutions such as banks, governments and investment companies. access to crowdfunding is through the launch of a campaign aimed at reaching out to supporters and donors to convince them of the objectives and benefits of the campaign and to encourage them to support them financially. this campaign is usually on a crowdfunding platform that receives funding [5]. crowdfunding has ethical dimensions and is an innovative and effective way to support social and environmental projects and can benefit companies to increase their csr-based activities. on the other hand, the existence and adoption of csr principles in crowdfunding activities positively reflect the success of fundraising. this harmony between the two concepts can help to change the traditional landscape of the financing process, which is characterized by a lot of complexity and give an additional opportunity in financing projects that are environmentally and socially oriented [6]. crowdfunding has many different qualities than conventional financing that can reduce transaction costs in obtaining the appropriate capital to finance a project and often creates interaction in different directions between the financier and https://www.zotero.org/google-docs/?vwucgj https://www.zotero.org/google-docs/?1zbo04 https://www.zotero.org/google-docs/?9p9n3m https://www.zotero.org/google-docs/?bhsfbw https://www.zotero.org/google-docs/?ykwjhi https://www.zotero.org/google-docs/?smbyox ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 the entrepreneur, thus increasing its success [4]. crowdfunding has gained a great deal of attention around the world, especially in developed countries, but recently, however, crowdfunding has grown in the middle east as well, and many online platforms have begun to operate and provide services in these countries [7]. currently, corporate social responsibility is intrinsically present in all countries of the middle east region. despite its development in recent years, the concept of csr has not yet received methodical awareness in the middle east. it is also evident that the concept of corporate social responsibility in the middle east has unique and distinctive criteria and connotations that do not always reflect current understanding and practice in developed countries. it is based on deep-rooted traditions of social values derived from religious texts and cultural traditions [8]. several scientific articles have talked about topics related to crowdfunding and csr, but there is a lack of addressing the extent of the relationship between the two concepts and how this synergy can be an important source of funding to achieve social and environmental goals in a particular context, for example, the middle east. this paper attempts to cover this gap. in fact, this paper aims to analyze the relationship between crowdfunding and the principles of csr. in particular, the study examines whether the adoption of csr principles in crowdfunding platforms affects the success of funding and the ability of companies and entrepreneurs to access financial resources on the one hand and whether crowdfunding is an effective means of financing projects that are in line with the objectives of csr on the other hand. this paper is organized as follows: section two is concerned with the literature review for explaining crowdfunding and its relation to csr activities. in section three the methodology where it is used the qualitative approach, using case study looking to the middle east countries. in section four are analyses and a discussion of the middle east countries case study. finally in section five the conclusion of the paper. ii. literature review a. crowdfunding crowdfunding is a form of financing born recently and today is witnessing its spread globally. this is an alternative way of raising funds from a large number of people via the internet through dedicated online platforms. thanks to this phenomenon, the crowd can contribute, through the giving of even small sums of money, to the realization of projects with social, environmental or entrepreneurial nature [6]. further explanations have been provided in the literature by several authors, among the best known is the description by [9], which was reviewed by [10] by defining crowdfunding as ―an open call, essentially through the internet, for the provision of financial resources either in form of donation or in exchange for some form of reward and/or voting rights in order to support initiatives for specific purposes‖. the birth of crowdfunding can be traced back to the late nineties. in these years, the first websites to raise funds mainly for charitable initiatives were born [11]. moreover, in the same years, the first examples of online fundraising related to the world of music appeared. the artists could count on a fan community and began to ask for funding for the production of new albums or organize their own concerts. one of the first examples of the successful online collection dates back to 2001 when the english group marillion managed to get $ 60,000 to finance a tour in the united states [12]. the evolution of crowdfunding went hand in hand with the evolution of the world wide web. with the new millennium and the advent of web 2.0, the internet has become increasingly accessible and connections were gradually speeding up. this allowed the development of the network as we know it today where the social component, of fundamental importance for the operation of crowdfunding, has assumed a pivotal role in the use of online resources. this phenomenon has led to the creation of sites like facebook and youtube and to the advent of the social web and the possibility of creating horizontal networks has allowed the development of platforms on the internet [6]. in this scenario the real crowdfunding was born; in 2008 and 2009 the two most popular platforms appeared on the web: indiegogo and kickstarter and these platforms have immediately exploited the social web and have quickly become the symbol of financing [13]. crowdfunding, as mentioned, is a financing mechanism through a crowd of supporters, according to the purposes and methods, the projects are divided into four categories: donation-based, reward-base, equity-based and lending-based. in donationbased, particularly suitable for community-oriented projects, it allows donating a specific sum to an organization that has social and environmental goals, in which case the donor is not a profit-making one and is often used to stimulate moral recognition by donation. as regards reward-base, in which a reward is received, based on the amount invested in the sustained campaign and which, generally, coincides with a product or service to those who finance the project. instead equity-based, predicts who invests does not receive a simple reward, but becomes a partner of the company. by supporting an equity crowdfunding project, therefore, you buy shares in the company that is looking for funds. finally lending-based, in this case, the money is properly lent to the applicants, who can use the crowdfunding platform to carry out their project, and return the money once the project is completed in https://www.zotero.org/google-docs/?qy66ee https://www.zotero.org/google-docs/?8ia6re https://www.zotero.org/google-docs/?2zd9cf https://www.zotero.org/google-docs/?l0g00i https://www.zotero.org/google-docs/?qyanc1 https://www.zotero.org/google-docs/?utfzec https://www.zotero.org/google-docs/?3jgbao https://www.zotero.org/google-docs/?cojciy https://www.zotero.org/google-docs/?yvq4oc https://www.zotero.org/google-docs/?mwrhlz ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 exchange for an interest rate on the loan [5]. regarding donation activities, [14] show that philanthropy promotes social standing, increases value and can be more profitable. many donors use this method to improve their institution image which also reflects their human sense and interest in the changes and needs in a particular society. crowdfunding was widespread only in the western state in the early years. however, alternative funding soon found its way to the middle east, and many of the global and national platforms began to serve in these countries. the platforms focused on small and medium businesses, providing crowdfunding services. in the middle east, alternative financing across online platforms has continued to grow. total market size showed an increase of 12% annually from $ 158.8 million in 2015 to $ 177.30 million in 2016. the most widely used alternative financing model was equity-based crowdfunding [7]. b. crowdfunding & csr activities the crowdfunding theme offers many synergies with the concept of csr. crowdfunding is a way of providing a broad scope where csr can interact with donors, beneficiaries and stakeholders as a whole. providing appropriate financing for smes and helping csr budgets is very useful when starting a fundraising campaign. crowdfunding can be a strategic tool for a company that embraces the concept of corporate social responsibility. research has shown that crowdfunding can have a significant impact on improving a company's performance and achieving its development goals [15]. the literature on crowdfunding has been categorized into two parts based on whether or not there are rewards for financiers. in either model, crowdfunding programs have social benefits [16]. the funding platform approach imposes several conditions, notably, the percentage requested at least 100% for the project to succeed within a specified time period or collected funds will be returned to donors [17]. for example, kickstarter is a platform that implements the all-or-nothing financing style. this model foresees that the person who launches a crowdfunding campaign receives the money raised through the campaign only if the amount financed by the supporters is at least equal to the minimum amount necessary for the realization of the project. on the contrary, indiegogo offers the keep-what-you-raise mechanism that provides that the amount of money that is paid by the supporters of a crowdfunding campaign, is paid to those who launch the campaign whatever the amount reached in addition to the allor-nothing option. indiegogo stated that through this mechanism, higher fees were charged for fund-raising activities that do not reach the target [18]. this approach encourages fundraising to take into account social campaigns to achieve the funding target. companies can support fundraising campaigns with a focus on csr activities. csr initiatives can help crowdfunding activities for social and environmental purposes by organizing donation campaigns. funding and / or csr may come from well-known entities such as individuals or companies to support crowdfunding campaigns, increase the potential for additional funding, and activate and engage stakeholders, particularly in the success of the funding project. activities within the crowdfunding platforms vary by objectives. donors usually have charitable initiatives for free to serve the community and try to solve their problems [4]. the donation-based crowdfunding model has acquired crowdfunding activity in developing countries through projects related to social and environmental activities due to the aggravation of these problems and the use of alternative financing means to address them and these platforms are growing at a significant annual rate [18]. the donation-based crowdfunding platforms encourage individuals or associations to provide funds to address social and environmental issues. donors make donations on the basis of philanthropy without expectation of material returns. the concept of csr is linked to the company's commitments to the community in order to receive charitable assistance to enable the company to realize its initiatives [19]. crowdfunders often donate money because they believe in the entrepreneur's goals. the success of funding will be influenced by the social and cultural values represented by an entrepreneur or company, who turn to the crowdfunding platform for solutions to different social needs. social entrepreneurship can be considered one of many institutional forms that strive for economic, social and environmental progress in a given context. it is certain that the main credential of crowdfunding will generally support the sustainability trend, it is assumed that the sustainability orientation (social and environmental) will positively influence the success of the financing [20]. carroll extended csr from the traditional economic and legal responsibility to ethical and philanthropic responsibility in response to the rising concerns on ethical issues in businesses. this view reflects a company's sense of responsibility towards the community and environment in which it operates [21]. the global reporting initiative gri is a body created with the aim of creating useful support for the report on the sustainable performance of organizations of any size, belonging to any sector and country in the world. this body has divided the csr into three macro areas concerning the economic, environmental and social performance of companies [22]. csr in the middle east depends on advantages in philanthropic philanthropy inherent in religious and cultural traditions and in many social values. there are many connotations and terms that express human sympathy and concern for the affairs and protection of society grounded from the islamic faith, including zakat (islamic tax to help the poor) and takaful (human solidarity) [8]. islamic law ( shariah) which is based on four sources, most notably the quran ( the sacred book of islam) and sunna ( the words and works of prophet muhammad) [23][24], provides for the concept of social justice, which guarantees all people equal access to their rights. islamic philanthropy provides strong rules for csr in the region and forms advantages in voluntary giving non-compulsory, which grows out of a human sense [8]. islam also urges to protect the environment; this is considered a religious duty from god. the muslim must preserve its components and resources and avoids wastes and does not neglect the right of future generations [25]. https://www.zotero.org/google-docs/?ckklwg https://www.zotero.org/google-docs/?twsezu https://www.zotero.org/google-docs/?hwymth https://www.zotero.org/google-docs/?vspwh9 https://www.zotero.org/google-docs/?90pkif https://www.zotero.org/google-docs/?bkf3ck https://www.zotero.org/google-docs/?syhfcv https://www.zotero.org/google-docs/?stxrcl https://www.zotero.org/google-docs/?crhprj https://www.zotero.org/google-docs/?hjcbdl https://www.zotero.org/google-docs/?rcril5 https://www.zotero.org/google-docs/?pzdega https://www.zotero.org/google-docs/?tdk17q https://www.zotero.org/google-docs/?teff2t https://www.zotero.org/google-docs/?gqhfrf https://www.zotero.org/google-docs/?gqhfrf https://www.zotero.org/google-docs/?gqhfrf https://www.zotero.org/google-docs/?0vwzec https://www.zotero.org/google-docs/?c3xnw2 ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 iii. methodology this study uses a qualitative research approach that is based on analysing phenomenon [26].the nature of the analysis is focused on the use of the case study method, which investigates all factors of a given case and harvests accurate and integrated information[27]. it is more likely to collect information that cannot be found by other means [28]. the case study methodology is suitable for operating when aspects of the research are based on a new situation that corresponds to the current times [29]. it is also advisable to adopt it when there is a need to analyze a study that has many variables related to each other [30]. the case study approach is, therefore, suitable for use to understand the theme and objectives of research related to crowdfunding and corporate social responsibility, analyze the relationship between the two concepts and how this synergy can be an important source of funding to achieve social and environmental goals in a particular context, for example, the middle east. the case study depends on several tools and stages. the most important of these tools is the identification of the subject and the place of analysis [30], middle eastern countries have been chosen to be the case study because crowdfunding is growing in those countries and is closely linked to the principles of csr stemming from cultural and religious factors that emphasize interest in projects and ideas that have a social and ethical dimension. peculiarly, the research uses descriptive data [31] by reading the topic and analyzing everything related to it. it is also based on numerical data indicating the close correlation between the factors being studied [31], because the factors to be analyzed are similar in the middle east as they have a lot in common: cultural, religious, legal and even technologically, the individual case study will be appropriate and produce the desired results. this study focuses on exploring the relationship between crowdfunding and csr in the middle east. initially, i have collected data on fundraising activities from the international crowdfunding platform it's called zoomaal 1 based in lebanon. i have harvested the data from 10 countries in the middle east ( lebanon, saudi arabia, jordan, yamen, egypt, palestine, turkey, iraq, oman, syria). after that, i have taken into consideration 109 crowdfunding activities for companies and entrepreneurs from 2013 to 2019 that provide synergy with csr initiatives from several countries in the middle east as units of analysis according to [22]. zoomaal allows funding to companies and entrepreneurs all-or-nothing financing style. in this analysis, the percentage was used as a criterion for fundraising for successful crowdfunding. fundraising operations reached or exceeded 100% is a successful financing activity. the higher the percentage of fundraising, the more successful it will be. the variables were taken into consideration in this analysis are social and environmental activities. after collecting all the data from each activity from zoomaal platform. i have distributed the activities in 12 categories. as regards to social activities ( education, local communities, health, human rights assessment, non-discrimination, child labour, training) and as regards to environmental activities ( 1 http://www.zoomaal.com/home environmental compliance, effluents and waste, emissions, biodiversity, energy). iv. discussion the importance of csr in the middle east is growing. the progress and growth of csr in the middle east are no longer limited to companies alone. governments and non-profit organizations have followed suit and taken many steps in that direction over the past years. compared to the middle east and developed countries, the awareness and adoption of csr practices in the region have lagged behind. but that awareness and adoption has improved significantly over the past decade and is currently on the rise [7]. regardless of the adoption and adoption of the concept, current csr practices are still deeply rooted in the minds in this region as a form of philanthropy derived from cultural and religious factors. the middle east is diverse in terms of religions. islam is the largest religion in the middle east and exists in almost all countries. csr in islam occupies a privileged position, as contained in a set of quranic verses and sunna. the islamic perspective of csr is summarized in the basic principle at the top of the pyramid is the administration of justice in the land. islamic legislation has urged the performance of csr, and the organization of how this performance in specific mechanisms, this is evident in the jurisprudence of zakat and the rights of workers and charity [8], in addition to the preservation of resources and public utilities, such as roads, forests, water and air, where this responsibility is not limited to subsidy with money, but extends to the use of all possibilities to benefit the community [25]. these forms of philanthropy sometimes do not correspond to the actual needs of the region, and thus give up much of what is desirable to achieve in reality and its impact on society due to many reasons, the most important of which is the institutional weakness of many countries in the region for lack of financial resources. therefore, some countries in the middle east suffer from social and environmental problems and thus have severe water shortages, the need to improve waste management, and concerns about poor air quality. on the social level, poverty is increasing and educational activities and medical resources in the region are clearly declining. project financing is one of the main obstacles facing new entrepreneurs, especially social and environmental ones in third world countries in general. to solve these problems has emerged for the time being with the spread of the internet and technology a new type of financing called crowdfunding among the countries of the middle east [32] and the cultural and religious factors based on philanthropic have helped to grow this phenomenon. there are many specialized platforms in the field of crowdfunding, and most of them, of course, foreign platforms. this process is conducted in a large and orderly manner in those developed countries, but there are arab platforms that contributed to the financing of many projects, including those platforms (zoomaal, eureeca, yomken) [32]. there are many worldrenowned crowdfunding platforms, but there is a problem when the idea of the project is directed to the world at large from different cultures and nationalities. the idea of a https://www.zotero.org/google-docs/?njozg0 https://www.zotero.org/google-docs/?tddmaz https://www.zotero.org/google-docs/?spexph https://www.zotero.org/google-docs/?y0bbxi https://www.zotero.org/google-docs/?gcimcc https://www.zotero.org/google-docs/?cmkpwc https://www.zotero.org/google-docs/?ngc5ga https://www.zotero.org/google-docs/?qs90be https://www.zotero.org/google-docs/?vyagd1 http://www.zoomaal.com/home https://www.zotero.org/google-docs/?nli0s6 https://www.zotero.org/google-docs/?rogsjh https://www.zotero.org/google-docs/?uololi https://www.zotero.org/google-docs/?yktd07 https://www.zotero.org/google-docs/?h6kp4f ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 crowdfunding campaign on these platforms threatens to fail. take, for example, the idea of a project that is very much related to arab or islamic cultures and customs, it is possible that launching this campaign on a western platform will not guarantee the success of the campaign. the best is to launch the campaign on an arab or islamic financing platform. for this reason, i have taken into account the zoomaal platform to analyse its data. zoomaal is considered one of the first platforms in the middle east for crowdfunding. the projects that have been financed through the platform have diversified, including cultural, social and environmental projects, as well as technical and technological projects. launched in 2012 and headquartered in lebanon, the platform has proven its efficiency in terms of its social, economic and media network. the website links projects with supporters [33]. funding is provided by those interested in international organizations, local sponsors or interested individuals, knowing that more than 60% of the support comes from arab expatriates in foreign countries. the project shall specify the amount required and determine a specific period of time to collect the amount in accordance with the management of the site, in the event that the project owner cannot reach the required amount at the end of the deadline, the project owner doesn't receive any amount, and the funds collected will be returned to the supporters, provided that the project originally belongs to one of the areas advertised in the platform. zoomaal deducts 5% of the funding if the campaign is successful, if it does not succeed, the site or the project owner doesn't receive any amounts [34]. as i mentioned in the research methodology i have analyzed 109 activities that comply with csr, including 82 social activities and 27 environmental activities taken from zoomaal crowdfunding platform from 2013 to 2019. i have distributed them in social activities including 7 categories and environmental activities include 5 categories. at the level of social activities, the categories are divided as follows: education 27 activities, local communities 24 activities, human rights assessment 11 activities, health 8 activities, non-discrimination 6 activities, child labour 5 activities, training 1 activity. as for at the level of environmental activities, the categories are divided as follows: environmental compliance 17 activities, energy 4 activities, biodiversity 2 activities, effluents and waste 2 activities, emissions 2 activities. i have harvested the data from 10 countries in the middle east. at the country level, data was taken as follows: lebanon 51 activities, egypt 23 activities, jordan 20 activities, palestine 6 activities, turkey 3 activities, iraq 2 activities, oman 1 activity, saudi arabia 1 activity, yamen 1 activity, syria 1 activity. zoomaal follows the american kickstarter platform all-or-nothing, where it is based on a percentage as a criterion to determine the success of the financing and the project must collect at least 100%. the higher the percentage of fundraising, the more successful the project will be. in this analysis, the 82 social activities have received a high success rate of about 74%, that is 61 projects have reached the specified percentage (100%) or more. for the 27 environmental activities, the result was somewhat similar, it has reached 70% of the success rate, which 19 projects have gained the specified percentage (100%) or more. these results confirm that there is a positive and synergistic relationship between crowdfunding and csr, showing that the existence of csr concepts in the projects presented in the financing platforms positively affects its success and that crowdfunding platforms are an effective and innovative tool for financing projects that are in line with the objectives of csr. thus, csr activities are not only charitable but also a source of opportunity, innovation and competitive advantage. crowdfunding gives the companies and entrepreneurs the opportunity to carry out csr activities and additional funding for social and environmental projects. csr activities can be achieved and expanded through active participation in crowdfunding. v. conclusion this study shows that the era of financial technology offers new opportunities for both crowdfunding and csr. crowdfunding is an increasingly suitable alternative financing option for development projects that can be effectively integrated into csr concepts. in particular, the possibility of increasing the visibility of csr and raising public awareness of csr commitment through crowdfunding initiatives. on the other hand, adopting a developmental approach helps to make projects successful on open platforms with increasing social and environmental problems. in this study applied to the case study method taking into consideration the middle east countries, it is noticeable that crowdfunding activities are increasing, particularly in the middle east, which is supported by cultural and religious factors derived from philanthropy, serving potential synergies with csr fundraising activities. zoomaal arabic platform was used to collect data because it is largely related to arab or islamic cultures and customs and most of its users belong to those countries which give us more realistic results. the results of the study correspond to the existing literature on the positive and synergistic relationship 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https://www.zotero.org/google-docs/?tybv7r https://www.zotero.org/google-docs/?tybv7r https://www.zotero.org/google-docs/?tybv7r https://www.zotero.org/google-docs/?tybv7r https://www.zotero.org/google-docs/?tybv7r https://www.zotero.org/google-docs/?tybv7r https://www.zotero.org/google-docs/?tybv7r https://www.zotero.org/google-docs/?tybv7r ejif – european journal of islamic finance second special issue for ejif workshop http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 mediation role of perceived benefit in the relationship between perceived government support, religiosity, awareness and the acceptance of islamic microfinancing in nigeria abstract— social exchange theory highlights the possible mediating role perceived benefit in social and economic relationships, however, extent literature falls short is validating such theoretical insights in the context of islamic microfinance. following this theoretical insights the mediating role of perceived benefit on the relationship between perceived government support, religiosity, awareness and intention to accept islamic micro-financing was examined. quantitative research design through data collected from smallholder farmers in jigawa state was employed; the data was analyzed using pls-sem. the finding revealed that perceived benefit mediates the relationship between perceived government support, religiosity, awareness and intention to accept islamic microfinancing. it implied that perceiving the benefit is one of the mechanisms through which government support, religiosity and awareness influence intention to accept islamic microfinancing. the study expands the understanding of tpb through the support of set to explain the mediating effects of perceived benefits in the context of islamic microfinancing. thus, it will benefit policymakers in understanding that perceived benefit of islamic microfinancing is a key to its acceptance, hence, the need for awareness campaigns, support services and religious preaching to that end. implementing the finding will not only solve problem of access to finance among the smallholder farmers but also ease life through employment generation and poverty eradication. to the researchers’ knowledge, this work could be first to examine the mediating role of perceived benefit in the context of islamic microfinance among the smallholder farmers with inferences from social exchange theory. keywordsacceptance intention, awareness, government support, islamic micro-financing, perceived benefit introduction despite the oil discovery and production, agriculture has been the bedrock of nigerian economy. nigerian government is still keen in continuous revival of the sector. recently, the government promised to engage 740,000 youth as part of the effort to boost the agricultural revolution, this alongside 20,000 school leavers and rural youth promised to engage in the sector as well as 18,500 graduates into agribusiness entrepreneur called ―nagropreneurs‖ [6]. notwithstanding this commitment by the government, there still the problem of access to finance in the sector, which eventually hinders farmers from investing in basic inputs covering good seeds, fertilizers and small-scale irrigation needed to raise productivity and sustainable income [30]. it is interesting that apart from conventional sources of financing, there still exist alternative sources of financing such as islamic financing which several countries explored its viability. for instance in saudi arabia islamic microfinance is moving beyond conventional counterpart to provide effective social and financial inclusion simultaneously through its twin tools that is credit lending and zakkah that is to be given directly to the extremely poor in cash or in kind to satisfy their argent and basic needs [3]. similarly, in yemen evidence abdulsalam mas’ud a , isah shittu b , and umar bello umar c a tunku puteri intan safinaz school of accountancy, universiti utara malaysia 06010, sintok, kedah, malaysia email: abdulsalam@uum.edu.my; masudabdussalam@yahoo.com b department of accounting, abu-business school, ahmadu bello university, zaria, nigeria ishittu@abu.edu.ng ; isahshittu15@yahoo.com c department of accountancy, college of administration and management studies, hussaini adamu federal polytechnic, pmb 5004, kazaure, jigawa state, nigeria mailto:abdulsalam@uum.edu.my mailto:masudabdussalam@yahoo.com mailto:ishittu@abu.edu.ng%20;%20isahshittu15@yahoo.com mailto:isahshittu15@yahoo.com ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 provided by [10] shows that 60% of these institutions provide purely islamic financial product and services. islamic financial institutions, particularly banks continue to play a significant role socioeconomic development [37]. although nigeria has more than 50% of its population as muslims [45], but utilizing islamic microfinancing as alternative funding source for agriculture has been lacking. interestingly, a study recently conducted in nigeria showed that factors such as government support, religiosity and awareness significantly influence the acceptance of islamic micro-finance [26]. however, the argument here is that no matter the government support provided, religious someone is or awareness he/she has about islamic micro-financing if the person did not perceived any benefit to be derived from it, such person may not wish to participate in this form of financing. fascinatingly, social exchange theory (set) highlights the possible mediating role perceived benefit in social and economic relationships. thus, in an attempt to provide more evidence on the smallholder farmer intention to accept islamic micro-financing, this study tends to examine the mediating role of perceived benefit on the relationship between perceived government support, religiosity, awareness and intention to accept islamic micro-financing with smallholder rice/wheat farmers in jigawa state, nigeria as case study. the study is motivated by three reasons. first, there is little evidence on the acceptance of islamic micro-finance in nigeria despite that nigeria has a very large agricultural sector with low access to finance. second, the country is also muslim majority, hence the potentials for islamic micro-financing. lastly, to the best of the researchers’ knowledge no study was conducted on the mediating role of perceived benefit on the relationship between perceived government support, religiosity, awareness and intention to accept islamic microfinancing with smallholder rice/wheat farmers, not only in nigeria but also globally, hence it is expected to add value to the existing literature on islamic micro-financing. to achieve its end result, the paper is divided into five sections with the first section as introduction and second part as review of literature. the third part is methodology, the forth part is result and discussion while the last part is conclusion in which implication to policy and theories were elaborated. 2.0 literature review 2.1 intention to accept islamic micro financing the widely applicable definition of intention has its origin from the golden work of [16] in which explained that individual’s intention is built from his/her attitude, subjective norms as well as their perceived behavioral control. this definition of intention has been the basis for the formulation of undisputable behavioral theories such as theory of reasoned (tra) [16] and theory of planned behavior (tpb) [1]. tra postulated that only two variables relating to intention and subjective norms predict behavioral intention [16]. thus, the critics experienced by tra gave birth to its extension which produced tpb by integration of perceived behavioral control in the tra. this means that tpb postulated that three variables predicts human intention including attitude towards behavior, subjective norms surrounding individuals environment as well as perceived behavioral control of such individual [1]. despite the fact that the proponents of tpb have extensively explored the possible predictors of human intention in the fields of human psychology, it has been made upon for the inclusion of any additional variable that can predict intention in other context and settings [16]. in nigeria, in relation to islamic financial product original tpb variables that predict the acceptance of islamic financial products have been studied by [26], thus, in this study other variables including perceived benefit, government support, religiosity and awareness were added as predictors of intention in relation to farmers’ acceptance of islamic micro financing in jigawa state. specifically, in line with the theoretical insights from social exchange theory, the study intents to investigate the mediating role of perceived benefit on the relationship between perceived government support, religiosity, awareness and intention to accept islamic micro-financing. it is important to note here that two studies have investigated the direct and indirect effects perceived benefit within islamic finance literature. [46] conceptualized among other variables the direct influence of perceived benefit on qardhul hassan financing acceptance in nigeria, however extant literature has not revealed its validation, hence, the need for empirical evidence from same context. even when such a study was validated there are two differences between this study and that of [46]. first, while zauro, et al focused on qardhul hassan financing which is mode of financing through sadaqa, this study focused on micro-financing offered by islamic micro-finance institutions. second, the proposed model of zauro et al has no clear sample, this study focused on rice/wheat farmers in jigawa state; a muslims dominated area with vast agricultural lands and islamic microfinance potentials. the other study was that of [14] which studied the indirect effect of perceived benefit but using different dependent and independent variables. the dependent and independent variables used by [14]vice quality respectively, while this study used islamic microfinance acceptance intention as dependent while perceived government support, religiosity and awareness as independent variables. another area of different is the unit of analysis, while [14] used organizations through smes as unit of analysis, our study use individuals through rice/wheat farmers as unit of analyses. these two reasons made the two studies extremely different thereby confirming the importance and distinctive nature of mediating effect of perceived benefit hypothesized and validated in this study. ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 2.2 perceived government support and the acceptance of islamic micro-financing [35], defined government support as any effort by the government towards increasing knowledge, capabilities and confidence of individuals and firms in such away to achieve a desired performance or goals. behavioral studies document the role of government supports and assistance influence on the intention of business individuals [35]. the study of [31] discovered that offering government support in terms of entrepreneurial policy influence entrepreneurs’ intention to participate in entrepreneurial activities. likewise, it was also found by [24] that government support is closely associated intention to participate in e-training employees. from islamic finance literature findings confirms that government support influence intention to use islamic banking products [22]. similar finding was also documented in the work of [4]. from the above evidence on the influence of governments support on intention two arguments can be deduced. first, almost all evidences confirmed the influence of government support on intention inclusion that of islamic finance. second, despite this evidence the mechanism through which government support influence intention has not been explored in islamic finance literature. thus, the argument here is that when government offers support to the participation of any product or service there is possibility for citizens to believe that such product or service is beneficial, and eventually from this belief such citizens can but intention to participate in the utilization of such product or service. adversely, if citizens despite government support to the use of a particular product or service failed assimilate the benefit from such product or service it will be difficult to participate in its application. thus, it can be argued that perceived benefits is the mechanism through which government support influence intention to accept islamic micro-financing by smallholder rice/wheat farmers in jigawa state, thereby serving as a potential mediating variable. 2.3 religiosity and the acceptance of islamic microfinancing religiosity refers to the several aspects of religious activity, belief and dedication in religious activities. it is unarguable that religion is one of the most influential and universal social institutions. due to this influence it has it exert significant control over people’s attitudes, values and behaviors at both individual and societal levels [2]. it has also been described as an important element to humans’ lives through shaping their beliefs, attitudes and knowledge [32]. through shaping human lives, religions prescribed what are prohibited and what are not in their undertakings [32]. islamic finance literature highlights the role of religious obligations in shaping human intention towards the usage of islamic products or services. in their work [2] found that religiosity has significant and positive affects which influence intention to accept islamic home financing. similar finding was also made in relation to islamic personal financing [4]. following these empirical evidence, it can be deduced that the finding in relation to the influence of religiosity on the acceptance intention were found to be positive and significant, however, the mechanism that explained such consistent relationship has not been explored by the extent literature. thus, it can be argued here that no matter how religious individuals have been they may not accept islamic financial services unless they perceived a benefit to be derived from the utilization of such product or service. in this, such benefit may not necessarily be economical rather it could be religious benefit by feeling that using islamic products or services fulfils their religious obligations, thus, rewards can be earned from such action. this eventually indicates the potential mediating effect of perceived benefit on the influence or religiosity on intention to accept islamic micro-finance by smallholder rice/wheat farmers in jigawa state. 2.3 effects of awareness and the acceptance of islamic micro-financing awareness can be described as knowledge of the existence of something in the society or understanding the nature of operation of such things at the present time based on information or experience. in relation to intention to accept islamic finance products and service, the role of awareness had been explored in relation to takaful by [23] and [26], where it was found to be of significant influence on intention. another finding indicated that awareness has significant influence on islamic financial products and services patronizing behavior in tatarstan [35]. a recent study also disclosed similar result on the role of awareness on customer intention on islamic home financing products [20]. despite the above empirical evidence, the mechanism that explained the consistent relationship of awareness and intention to accept islamic micro-financing has not been explored in the extent literature. thus, it can be argued that no matter the level of awareness, knowledge or understanding one has on islamic financial products and services, if such an individual cannot perceive any benefit to be derived from such product or service such person would not participate. thus, perceived benefit could be seen as a mechanism through which awareness influence the acceptance intention of islamic micro-financing by smallholder rice/wheat farmers in jigawa state thereby serving as potential mediating variable. 2.5 perceived benefit as a potential mediator perceived benefit has been defined by [18] as the perception of beneficial or positive outcome caused by execution of a specific action. it can also be described as beliefs about the positive consequences upon performing a behavior [11]. researchers and theorist continued to measure perceptual benefits based on the consideration that a behavior is driven by one’s confidence someone has in execution of a behavior especially when positive outcome are expected [18] social exchange theory which originated from the earlier work of [25] and [27] highlight the possible mediating role of ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 ―benefit‖ in social and economic relationships. the theory highlights that relationships between individuals tends to be anchored by the benefit that either or all the parties expect to received from such relation. it could be reciprocal where the benefit could emerge from all parties or one-side benefit where only one party to the relationship can derive such benefit [13]. based on the above discussions on the influence of perceived government support, religiosity and awareness on intention to accept islamic financial products and services as well as the theoretical postulations on the possible mediating role of perceived benefit in social and economic relationship it can be argued that perceived benefit can be a potential mediating variable in the relationship between government support, religiosity, awareness and intention to accept islamic microfinancing by smallholder farmers in jigawa state. 2.6 proposed conceptual framework. the conceptual framework of the mediation analysis of perceived benefit on the influence of government support, religiosity and awareness on intention to accept islamic microfinance is built on the premise of theory of reasoned action (tra) by [16] and social exchange theory (set) by [25] and [27] tra posits that human attitude (in this study perceived government support, religiosity, awareness) influence his/her intention, while set postulated that human relationships are shaped by the use of a subjective cost-benefit analysis. thus, argument can be made that while attitudes (perceived government support, religiosity, and awareness) can influence intention of smallholder farmers to accept islamic microfinance, however, such attitudes can lead to the perception of benefits to be derived before building intention to accept the financing. for instance, when a farmer perceived that government is supporting islamic microfinance he/she will perceive that the government will be working towards their benefits and protection, thus, the farmer will have good intention towards the acceptance of the financing. so also that a muslim religious farmer will expect to benefit from islamic micro-financing as he/she expected that it is best on islamic principles, this will eventually influence him/her to have intention of accepting this financing. same applies to awareness; a farmer having awareness of islamic microfinance will be more likely to know about its benefit thereby having intention to participate in this mode of financing. in essence, perceived benefit is a mechanism through which perceived government support, religiosity, and awareness can influence intention of smallholder farmers to accept islamic microfinancing. in line with this argument the following framework is proposed alongside its hypotheses. fig.1: model for rice/wheat farmers’ acceptance of islamic micro financing h1: perceived benefit mediates the relationship between perceived government support and intention to accept islamic micro-financing by smallholder farmers in jigawa state. h2: perceived benefit mediates the relationship between religiosity and intention to accept islamic micro-financing by smallholder farmers in jigawa state. h2: perceived benefit mediates the relationship between awareness and intention to accept islamic micro-financing by smallholder farmers in jigawa state. these mediation hypotheses were developed in line recent development in mediation analysis. there are two approaches to mediation analysis; segmentation approach and transitional approach [34] segmentation approach requires the hypotheses for direct relationship between independent variable (s) and dependent variable to be established first before the mediation hypotheses. differently, transitional approach requires the researchers to develop mediation hypotheses straight away without testing the direct hypotheses in the first instance. however, the transitional approach is the most recommended approach as it has more support to theory building [28], this recommendation is also consistent with the earlier literature documented by [25] and [33], [46] and [26]. 3.0 methodology 3.1 area, population, sample and sampling techniques the study was conducted in the highly irrigated emirates of kazaure, ringim and hadejia, these area have the largest concentration of smallholder farmers in jigawa state. the population of the study was all smallholder farmers in the aforementioned areas. the actual number of the population was not established giving the fact that intention which is in the heart, so it is not possible to establish the exact number of perceived benefits perceived government support religiosity awareness intention to accept islamic micro financing ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 population for the study. consequently, three hundred (300) questionnaires were distributed within the three emirates; one hundred (100) in each of the three emirates. in selecting these samples a non probability sampling techniques was employed. this can be justified by the lack of sampling frame from which random selection would be made. therefore, purposive random sampling was adopted which enabled the researchers to use any available smallholder farmers as a sample during the research. having administered the questionnaires, 283 usable responses were obtained which represented about 95% response rate. in an attempt to ensure whether this sample is adequate for the study, the power of the sample was estimated using g*power 3 [15] posthoc estimation method was used for this purpose. the method is commonly applied after data collection with a view of ensuring that the sampled collected is adequate and justifiable to reach a reliable conclusion using the data. thus, based on three (3) independent variables; government support, religiosity, and awareness, it was confirmed that here is 99.9% confidence that the 283 samples used are sufficient for the study. 3.2 instrument development and data collection the items used in the research instrument were adopted from the prior literature. five items which were used in measuring intention to accept islamic microfinance which were adapted and modified from [4] four items used in measuring perceived benefit were adapted and modified from [19] and [19]. three items were used in measuring perceived government support towards islamic micro-financing; these items were adapted and modified from [24] five items were used in measuring individual religiosity; these items were adapted and modified from [41] lastly, five items were utilized in measuring awareness of islamic micro financing; these items were adapted and modified from [21] data was collected using the translated questionnaire designed for the purpose. research assistant were deployed to each of the three emirates that served as the area of the study. the period of data collection was two months. 3.3 data analysis data was analyzed using partial least squares structural equation modeling (pls-sem) using smart-pls version 2.0. two step process was used in the assessment of pls path models; the measurement model and structural model, this is in line with the recommendation of [17] as noted by [16], the requirement of measurement model must be fulfilled before the evaluation of the structural model. the fact is that failure to satisfy such requirements can affect the statistical accuracy of structural model results. 4.0 analysis and results 4.1 measurement model results it can be recalled that as mentioned in the methodology that two-step process was used in the assessment of pls path models. these are measurement model and structural model as suggested by [19]. therefore, measurement model was evaluated using four criteria; (a) assessment of indicator reliability which is required to be greater than ≥.40, (b) assessment of internal consistency reliability using composite reliability of ≥.70, assessment of convergent validity using average variance extracted (ave) of ≥.50, and discriminant validity which requires that the square root of ave of each latent construct in the model should be higher than its correlation with any other [46] and [47] following these criteria table 1: indicator loadings, internal consistency reliability, and convergent validity constructs and indicators loadings composite reliability ave awareness 0.830 0.507 awn1 0.866 awn2 0.789 awn3 0.505 awn4 0.820 awn5 0.484 government support 0.907 0.765 gs2 0.885 gs3 0.897 gsi 0.840 intention 0.893 0.626 int1 0.857 int2 0.837 int3 0.744 int4 0.808 int5 0.700 perceived benefit 0.880 0.648 pb1 0.845 pb2 0.826 pb3 0.811 pb4 0.734 religiosity 0.899 0.597 r1 0.796 r2 0.834 r3 0.775 r4 0.679 r5 0.797 r6 0.747 ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 it can be seen from table 1 that the requirement of indicator reliability has been fulfilled as all the indicators have loadings of ≥.40 as required. likewise, assessment of internal consistency reliability using composite reliability of all the variables is above the required threshold of ≥.70; it ranged from 0.830 to 0.907. similarly, the requirement of convergent validity was also fulfilled with all latent variables having ave of greater than 0.50; it ranged from 0.507 to 0.765. the result of discriminant validity is depicted in table 2. table 2: discriminant validity constructs 1 2 3 4 5 awareness 0.712 government support 0.466 0.874 intention 0.397 0.389 0.791 perceived benefit 0.457 0.427 0.518 0.805 religiosity 0.478 0.506 0.464 0.530 0.773 as contained in table 2, as required, the square root of ave of each of the latent constructs is greater than its squared intercorrelation with any other constructs in the model, depicting good discriminant validity. thus, the following the results in table 1 and 2, it can be said that all the four criteria for assessing the measurement model has been fulfilled. hence, section 4.2 presents the structural model result. 4.2 structural model evaluation structural model is assessed using five basic criteria based on the recommendation of [16]. these criteria include assessment of: (a) multicollinearity using variance inflation factor (vif), (2) significance of the path coefficients (mediation effects), (3) coefficient determination (r²), (4) the effect size (f²), and lastly (5) predictive relevance (q²). the results are presented in table 3, 4,5, 6 and 7 below. table 3: multicollinearity diagnostics variables tolerance vif awareness 0.701 1.426 government support 0.683 1.464 religiosity 0.779 1.283 the result of the multicolinearity assessment is fantastic as the entire independent latent construct have tolerance values above 0.20 and vif below 5 as required [16]. table 4 presents the result path coefficients for hypotheses testing. table 4: path coefficients for hypotheses testing (mediating effects) hypotheses beta se t stats sign decision awareness -> perceived benefit-> intention 0.071 0.031 2.318 0.01 *** supported government support -> perceived benefit-> intention 0.048 0.028 1.727 0.04 ** supported religiosity -> perceived benefit-> intention 0.112 0.044 2.545 0.00 *** supported note. *significant at 10%, ** significant at 5% *** significant at 1% it can be seen from table 4 that as postulated the perceived benefit mediates the relationship between perceived government support and intention to accept islamic microfinancing by smallholder farmers in jigawa state (β=0.071, t=2.318, p=.01). it implies that perceived benefit is the mechanism through which government support influence the intention to accept islamic micro-financing by smallholder farmers in jigawa state. put differently, no matter the kind of support given by the government for the implementation of islamic micro-finance in the state if the smallholder farmer did not perceived that it would be beneficial to them, they will not participate. likewise, as hypothesized perceived benefit mediates the relationship between religiosity and intention to accept islamic micro-financing by smallholder farmers in jigawa state (β=0.048, t=1.727, p=.04). this result also implied that the perceived benefit is the mechanism through which religiosity affect intention to accept islamic micro-financing by smallholder farmers in jigawa state. in other words, despite that someone could be religious if she/he does not perceived that acceptance of islamic micro-financing could be beneficial as it is religious obligation for muslim to use what is not forbidden, and doing so could earn him/her a reward, such person may not have intention to accept islamic microfinancing. as also predicted perceived benefit mediates the relationship between awareness and intention to accept islamic microfinancing by smallholder farmers in jigawa state (β=0.112, t=2.545, p=.00). this finding also indicated that perceived benefit is the mechanism through which awareness influence ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 the intention to accept islamic micro-financing by smallholder farmers in jigawa state. this means that no matter the level of awareness, knowledge or understanding one have on islamic financial products and services, if such an individual cannot perceive any benefit to be derived from such product or service such person may not have intention to participate. these findings supported the insights from set on the possible mediating effect of perceived benefits. it also expands the understanding of human intention most especially in relation to islamic micro-financing. table 5 presents the strength of the above mediating effects. table 5: strength of the indirect (mediation) effects mediated relationships direct effect indirect effects total effects variance accounte d for strength of the mediation awarenes s -> perceived benefit-> intention 0.111 0.071 0.182 0.39 partial mediati on governme nt support -> perceived benefit-> intention 0.108 0.048 0.156 0.31 partial mediati on religiosit y -> perceived benefit-> intention 0.320 0.112 0.432 0.26 partial mediati on the strength of the mediating effect is evaluated following the recommendation of [16]. it is categorized into three; (a) less than 0.20 as no mediation, (b) ≥ 0.20 to < 0.80 as partial mediation, and lastly (c) ≥ 0.80 as full mediation. from the result in table 5, it can be said that there is partial mediation effect of perceived benefit on the influence of perceived government support, religiosity and awareness on intention to accept islamic micro-financing among smallholder farmers in jigawa state. table 6 evaluates the coefficient of determination ((r-squares) of the model table 6: coefficients of determination (r-squares) r-squares values dependent variable (intention) 0.339 mediator variable (perceived benefit) 0.349 it can be seen that the three independent variables; perceived government support, religiosity and awareness explained 34.9% of the variation in perceived benefit. the remaining 65.1% is explained by other variable not included in the research model. likewise, the perceived government support, religiosity and awareness through perceived benefit explained 33.9% of the variation in the intention to accept islamic microfinancing among smallholder farmers in jigawa state. [12] classified the r-squared into 0.02, 0.15 and 0.35 as small, medium and large respectively. thus, the r-squares of the current research models can be said to be medium and close to large category for both dependent variable and the mediator. table 7 revealed the result of the effect size. table 7: effect size (f 2 ) constructs dependent variable (intention) mediator variable (perceived benefit) (f 2 ) effect size (f 2 ) effect size perceived benefit 0.0998 small awareness 0.0106 very small 0.0522 small government support 0.0106 very small 0.0261 small religiosity 0.0348 small 0.1244 small effect-size is a further explanation to the coefficient of determination (r-squared). while r-squared explained the overall effects of the exogenous variables on one or more endogenous variable, effect size explain the effect of each of the exogenous variable on the endogenous variables. effect size has been classified by [12] into three categories of 0.02 as small, 0.15 as medium and 0.35 as large. from table 7, it can be seen that perceived benefit and religiosity have small effect on intention to accept islamic micro-financing while awareness and government support have very small effects. similarly, perceived government support, religiosity and awareness all have small effects on perceived benefit, giving clear policy insights on most important variables in those relationships. table 8 presents the results of construct crossvalidated redundancy (q2) for evaluation of model predictive relevance. table 8: construct cross-validated redundancy (q2) for predictive relevance total sso sse 1sse/sso intention 1415.0000 1123.9084 0.206 perceived benefit 1132.0000 878.2995 0.224 predictive relevance of a pls-sem model is evaluated using construct cross-validated redundancy (q2) as suggested by ejif – european journal of islamic finance no15, august (2020) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 [16]. it is required that for a model have predictive relevance the q 2 must be above zero. thus, from table 8 it can be seen that the q-squares of the dependent variable and the mediator are 0.206 and 0.224 respectively, indicating good predictive relevance of the current research model. 5.0 conclusion, implication and limitations the study examined the mediating role of perceived benefit on the relationship between perceived government support, religiosity, awareness and intention to accept islamic microfinancing among smallholder rice/wheat farmers in jigawa state. it was found that perceived benefit mediates the relationship between perceived government support, religiosity, awareness and intention to accept islamic microfinancing. it implied that perceiving the benefit of islamic micro-financing plays significant role and serve as mechanism through which government support, religiosity and awareness influence the intention to accept islamic micro-financing among smallholder rice/wheat farmers in jigawa state. 5.1 implications the study has implications to both policy and theory. for policy, the policymakers and other stakeholders need to understand that establishing good perception about the benefit of islamic micro-financing is a key to its acceptance intention no matter the level of government support, religiosity of an individuals and awareness established if individuals failed to understand the benefits they will receive from islamic microfinancing they will not have intention towards the products or service. thus, the benefits of islamic financial products and services including micro-financings should be made known to individuals through various awareness campaigns, government support services as well as religious preaching. for the theory, the study contributed to the tpb and set. for the tpb, the study expands the understanding of behavioral intention in the context of islamic micro-financing through awareness, government support and religiosity especially among the smallholder rice/wheat farmers in the context of nigeria and specifically in jigawa state. it also contribute to set through the study of mediating role of perceived behavioral control, which to the best of the researchers knowledge there have been no study which explored this possible mediating effects in the context of islamic finance. 5.2 limitations despites its immense contribution in the area of islamic micro-financing, the study is associated with number of limitations. first, the used of non-probability sampling technique is one of the limitation of the study, this happened due to the lack of sampling frame on the subjects of the study. future study should explore the possibility of obtaining a sampling frame to enable the use of probability method of sampling to enhance the reliability of findings. notwithstanding the use of non-probability sampling, the posthoc analysis conducted indicated that the findings could be reliable as the samples are enough to draw reasonable conclusion on the study’s findings. second, despite the fact that the r-squared of the model is medium which explained less than 35% of the changes or variation in the intention to accept islamic micro-financing, there is still room for expanding the research models by future researchers to optimized the r-squared as study other factor that could possible add explanation on the intention to accept islamic micro-finance among the smallholder farmers. lastly, perceived benefit has a partial mediating effect of the influence of government support, religiosity, and awareness on the intention to accept islamic micro-financing among smallholder rice/wheat farmers in jigawa state, indicating the existence of other mediating variables in such a relationship. future research should explore on the other mediating variables on such a relationship. acknowledgment the authors acknowledge the support islamic research and training institute (irti), affiliate of islamic development bank group (isdb) for granting approval to use the data which was 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2021 federica lanzara, university of turin abstract— the aim of this research is to provide, through a bibliometric analysis of the last 21 years of thematic literature, an overview on the contribution of sustainable development goals (sdgs) to the discussion in the field of islamic finance. a bibliometric method has been used to analyze the characteristics, citation patterns and content of 15 documents published in international academic journals, books review and chapters, editorial material and proceedings papers. considering the findings, the analysis has shown that there is an enormous gap on that field, with a few works on the topic with an impact on research. through the analysis of the papers, it emerges that qualitative method is the most used method to demonstrate the link between islamic finance and its relationship in the achievement of sustainable development goals. the research also shows that there is an increase on the academic interest on the topic only in the last four years. research limitations/implications – the study highlights a limitation, related to the adoption of the bibliometric method. this is due to the fact that databases include only part of the scientific papers and not all world’s sources. however, wos database, the one adopted for the research, is the world’s most complete index even if it is not complete at all. on the other hand, to have a wider landscape of knowledge on the field of research, they have been considered all kind of sources: books review, chapters, papers published in international and academic journals, editorial materials, reviews and proceedings papers. originality/value – this research shows the initial attention of the academic world toward the relation between islamic finance and sustainable development goals, however underlying that this contribution is not systematically interpreted by the different stakeholders and in the different countries. the bibliometric analysis of the literature puts islamic finance and sustainable development goals in relation but contemporarily indicates that more efforts need to be done in order to enhance this bond both from an academical and a practical point of view. therefore, with the intention of mapping all the studies that have been done in this regard, the study analyzes how research on the relationship between islamic finance and social development goals has been addressed, confirm with its qualitative approach the link between islamic finance and social impact. keywords: islamic finance, sdgs, bibliometric analysis, social impact i. introduction islamic finance in the last 30 years has been growing continuously and has provided a niche market with solutions and financial inclusion through a well-defined islamic ethos (mahomed 2017). its conformation to islamic principles however has not limited its attractiveness to non-muslim countries, customers and actors and poses this alternative finance as one of the most interesting vehicles of a financial transformation with hypothetical unlimited outputs in the real economy (ferro 2005; belouafi e chachi 2014; masiukiewicz 2017; hajjar 2019; nawaz et al. 2019). starting from that preliminary observation, in the field of the relationship between islamic finance and sustainable development goals, it has been observed that there are still gaps in our knowledge (zarrouk jamel 2015) they are principally related to a lack of academic debate and to the lack of coordination between financial actors as it will be demonstrated in the research. in fact, there is not much literature that faces the relationship between islamic finance and sdgs that, however, seems of a certain relevance for global growth. to enhance the knowledge on that topic, this paper analyzes the literature evolution from 2000 until 2021 in order to fill a gap of knowledge in the specific field. islamic finance, in fact, had been addressed as one of the key ―actors‖ for the reach of a sustainable development since it can move a huge amount of money that actually is not deployed for that purposes (oecd 2020). due to present social and economic challenges, particularly after 2008 and covid-19 crisis, it has been enhanced the knowledge of all the possible instruments which can be a real alternative for sustainable development and global growth (m. kabir hassan, aishath muneeza, adel m. sarea 2021; aam slamet rusydiana 2020; alam 2020; abbas e frihatni 2020). in this work, the research focuses on the relationship between islamic finance and sustainable development goals from 2000 to 2021. it has been systematically analyzed every article published on that field in international and academic journals, editorial materials, reviews and proceedings papers. submitted april 2021, revised may 2021, accepted may 2021 ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5765 2 the aim of this paper is to demonstrate (a) if islamic finance and sustainable development goals have a relation in literature, (b) if so, to crystallize the academic studies on this field and (c) furthermore to demonstrate the evolution of the perception of the sdgs in islamic finance in literature. this research will show how, among 21 years, the literature has underlined the relation between islamic finance and the achievement of sustainable development. therefore, with the intention of mapping the studies that have been done in this regard, the paper aims to explore how research on this field has been addressed. the originality of this paper is represented by the fact that no bibliometric studies have been published in this specific field. in order to explore the contents of the relationship between islamic finance and sustainable development goals in literature and as well to identify the main flows of the academic sector, this work is organized as follows: (i) analysis of the literature; (ii) identification of the most influential articles; (iii) analysis of the main themes. the next section presents the methodology, including a review of the literature regarding the results on the eventual relation between islamic finance and social finance. the third section explains the categorization of these findings and after describing the results of the method used, the fourth section outlines implications and conclusions. background according to previous studies which explained the existing relation between islamic finance and social finance(olanrewaju, shahbudin, e zakariyah 2020; the world bank 2017; cattelan 2018), it seemed interesting to deepen the research in order to find out the state of art of the academical research on islamic finance in relation to sustainable development goals which are, as an instance, related to the ―social aspects‖ of finance. islamic finance, as a matter of fact, could be seen as a tool for institutional and economic actors to achieve sustainable development goals (sdgs) developed by the un(oecd 2020). starting from the "independent group of scientists appointed by the secretary-general, global sustainable development report 2019: the future is now – science for achieving sustainable development, (united nations, new york, 2019)", this study aims analyze how islamic finance acts in promoting the effective functioning of the sdgs. in the motivating principles of the sdgs, the secretarygeneral stated (united nations, 2017, p. 2): ―in adopting the 2030 agenda for sustainable development, world leaders resolved to free humanity from poverty, secure a healthy planet for future generations, and build peaceful, inclusive societies as a foundation for ensuring lives of dignity for all [...] our challenge now is to mobilize action that will bring these agendas meaningfully and tangibly to life. i call on governments and stakeholders to recognize the gaps that have been identified in this report – in implementation, financing and political will – and to now join hands to fulfil this vision and keep this promise‖. the 17 sdgs developed by the un recognize and ratify the essential social, economic and environmental issues facing our society. fig. 1 sustainable development goals source: united nations development program web site governments and the public sector as well as the stakeholders and the enterprises (p. p. biancone e radwan 2019)too as a whole must use the sdgs as a basis for developing the public implementation (farneti et al. 2019). literature in the field is really limited (georgeson e maslin 2018; kharas e mcarthur 2019; attridge, te velde, e peter andreasen 2019; ziolo, bak, e cheba 2021) so an academic contribution with a deepening on that topic appears to be highly recommended in order to reach substantial progress in achieving global goals and meet the criteria of 2030 agenda for sustainable development (littlewood e holt 2018). bibliometric analysis help on the field of islamic finance do not pertain the relationship between islamic finance and sdgs. these analysis are focused on general topics such as ―islamic finance‖ and ―islamic banking and finance‖ (p. p. biancone et al. 2020; bollani e chmet 2020). ii. methodology 2.1 method the study was conducted in the form of bibliometric analysis which is often used in order to extract and manipulate data, based on content or citation analysis (wallin 2005) to determine necessary information about the literature about a specific research topic (zupic e čater 2015). bibliometric method, furthermore, had already been used in the field of islamic finance (tijjani et al. 2020; alshater et al. 2020; p. p. biancone et al. 2020) and in the field of ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5765 3 sustainable development (secinaro et al. 2021). this method benefited greatly from computerized data treatment and in the recent years there has been a huge increase in the number of that kind of publications (ellegaard e wallin 2015). according to verbeek, debackere, luwel, & zimmermann (2002), bibliometric analysis can be defined as follows: ―bibliometrics is the statistical analysis of scholarly communication through publications‖. all sources are used to perform rigorous bibliometric and network analysis (e.g., citation and citation analysis) with the function of tracing the knowledge structure of this topic. in particular, according to moral-munoz et al., ―bibliometrics has quickly evolved and technically perfected alongside with the exponential growth of science. presently, the massive amount of data published on academic journals, books, patents, proceedings, etc. required to be stored and organized into bibliographic databases. the information contained on these platforms (i.e. citations, keywords, titles, journals, authors, institutions, etc.) provides a valuable sample to perform science evaluation research using bibliometric techniques (gutiérrez-salcedo et al. 2020). as a result, bibliometrics has become in contemporary context an essential tool for assessing and analyzing researcher’s production (ellegaard e wallin 2015), collaboration between institutions (skute et al. 2019), impact of state scientific investment in national r&d productivity (fabregat-aibar et al. 2019) and academic quality (van raan 2004), among other possibilities (glänzel 2012)‖. the analysis of the network through bibliometric tools has proved useful in identifying consolidated and emerging topical areas(aria e cuccurullo 2017; moral-munoz et al. 2020) and also to give contribution towards integrating these elements in literature (secinaro et al. 2020). the keywords used to perform the bibliometric study were: ―islamic finance and sustainable development goals‖; ―islamic finance * sustainable development goals‖; ―islamic finance and sdg‖; ―islamic finance * sdg‖. a meta-search engine (web of science-wos) was used in the research, which accessed the most well-known academic databases (archambault et al. 2009). this multidisciplinary database allows researchers to identify key articles for scientific analysis (okoli e schabram 2010; webster e watson 2002). the research’s results were then aggregated into a single list for comparative purposes through the creation of a .bib file for the data analysis which has been performed with r-studio. biblioshiny tool was used for the creation of conceptual maps of the data analysis. the statistical analyses were done with the statistical software r-studio (derviş 2020)(rodríguez-soler, uribe-toril, e de pablo valenciano 2020) and the statistical software provided by web of science (wos). the above-mentioned process can be summarised and represented in fig. 2 below. fig. 2: methodology framework source: personal elaboration 2.2 identification of papers fifteen (15) documents have been identified in the wos database based on the assumptions made. despite the limited number of documents selected for the topic analysis, this research maintains its originality because it aims to start a fruitful discussion on this topic. bibliometrix quantitative variables have been helpful to analyze, mainly, keywords and main topics. all the results were then aggregated into a single list for comparative purposes. after the comparison of the four lists, it emerged that the first list, ―islamic finance and sustainable development goals‖ was the only one that included all the results generated by the researches with other keywords. articles dealing within all areas of knowledge have been included in the list. for a wider search, not only peer review journals have been selected. in order to answer the research question, documents published from 2000 to 2021 (february 2021) have been selected. this period includes the years in which millennium development goals and sustainable development goals have been operative (mdgs 2000-2015 and sdgs 2015-still on operations) due to the fact that millennium development goals principles had been substituted and absorbed by sustainable development goals 1 . in the research had been included documents published in international academic journals, books review and chapters, editorial material and proceedings papers. 1 https://www.sdgfund.org/mdgs-sdgs database web of science bibliometrics analysis  source main information  authors  countries  network analysis  keyword analysis ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5765 4 the language of publication selected is english in order to have a wider and more homogeneous overview since it is the most dominant language in social sciences articles (hamel 2007). iii. results 3.1 publication pattern main information, source growth, annual scientific production, most relevant sources, top 20 authors and top 20 universities cited had been analyzed to identify the publication pattern. in tab. i we can find the main information regarding the 788 articles included in the research. tab. i – main information description results main information about data timespan 2000:2021 sources (journals, books, etc) 11 documents 15 average years from publication 2 average citations per documents 1,667 average citations per year per doc 0,5856 references 500 document types article 11 proceedings paper 3 review 1 document contents keywords plus (id) 15 author’s keywords (de) 60 authors authors 31 author appearances 35 authors of single-authored documents 3 authors of multi-authored documents 28 authors collaboration single-authored documents 4 documents per author 0,484 authors per document 2,07 co-authors per documents 2,33 collaboration index 2,55 source: personal elaboration as it could be observed, articles (11) and proceeding papers (3) are the most relevant type of documents followed by reviews (1). on average, most articles were the result of the work of multiple authors considering that only 4 documents, out of 15, were single-authored. finally, the collaboration index which implies the total number of authors of multiauthored articles/total number of multi-authored articles, has a value of 2,55. during the period under review (2000-2021), the number of publications on the analyzed theme increased in the last four years. fig. 3: source growth source: personal elaboration from biblioshiny the most relevant scientific production refers to one journal: al-shajarah that is the journal of the international institute of islamic thought and civilization (istac) (fig. 4). it can be noted (from the figure below) that the majority of journals are related to social studies rather than to islamic finance. fig. 4: most relevant sources source: personal elaboration from web of science annual scientific production has increased particularly in the last two years (2021 has just started) (fig. 4). the data confirm what has already been said above. this field of research is evolving and the horizons are increasingly broad. ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5765 5 fig. 5: annual scientific production source: personal elaboration from web of science considering the research areas of the articles, it can be noted (from the fig. 5 below) that the articles mostly deal with management (3) and only 1 article has been published in the field of development studies. fig. 6: research areas source: personal elaboration from web of science the sample is composed of 31 authors (tab. ii). the authors with most impact so far have been: ali erae (2), gundogdu as (2), mahadi nf (2), zain nrm (2). checking their affiliation at the time of publication emerged that the most represented universities are those represented on tab. iii. most of the studies are the result of a group-work while only 4 had been the result of the work of a single author. tab. ii: top 20 authors authors articles ali erae 2 gundogdu as 2 mahadi nf 2 zain nrm 2 abduh m 1 afandi ma 1 ali km 1 azman smms 1 balqiah te 1 bazyar m 1 doshmangir l 1 ghoniyah n 1 hananto a 1 hartono s 1 hassan r 1 hati srh 1 hudaefi fa 1 kamal r 1 kassim s 1 majdzadeh r 1 source: personal elaboration tab. iii: top 20 university for scientific production affiliations articles iium inst islamic banking and finance iiibf 8 univ tehran med sci 8 int islamic univ malaysia 4 univ indonesia 4 assoc shariah advisors islamic finance asas 3 peace res inst 3 yarmouk univ 3 baznas ctr strateg studies 2 boston univ 2 disciplinary comm 2 hamad bin khalifa univ 2 inst agama islam darussalam iaid ciamis 2 ipb univ 2 istanbul sabahattin zaim univ 2 labuan financial serv author labuan fsa 2 malaysian inst islamic understanding 2 nrm (corresponding author) 2 sch business and econ ubdsbe 2 shariah advisory council 2 tabriz univ med sci 2 source: personal elaboration ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5765 6 3.2 citation analysis fig. 5 and tab. v display the country production with malaysia which tops the list (36), followed by indonesia (12) and iran (11) which are the only three countries with a production of more than 10 documents. this is due to the presence on that countries of a lot of scholars interested on the themes and with a muslim majority. in these countries islamic finance is becoming day by day a fundamental tool for growth and academic discussion on the field is continuously growing. (rammal e zurbruegg 2016; belouafi e chachi 2014). finally, fig. 5 shows a generalized worldwide interest on the topic of research. fig. 5 country production source: personal elaboration from biblioshiny tab. iv top 20 country production region freq malaysia 36 indonesia 12 iran 11 jordan 3 norway 3 usa 3 brunei 2 qatar 2 saudi arabia 2 turkey 2 bangladesh 1 canada 1 source: personal elaboration the most cited country is iran (17), the only one with more than 10 citations, followed by indonesia (3), malaysia (1), qatar (1), saudi arabia (1), turkey (1) and usa (1) (tab. iv). tab. v: most cited countries country total citations iran 17 indonesia 3 malaysia 1 qatar 1 saudi arabia 1 turkey 1 usa 1 source: personal elaboration table iv represents the ranking of the top 20 articles per number of citations from other articles. this shows that the article with the most total citations and total citation per year is a paper edited in archives of iranian medicine (doshmangir et al. 2019). at first sight it could seem strange that an article of a medical journal could be of any interest for the topic of this research, however that particular paper is really interesting in facing the problem of healthcare systems in achieving sustainable development. on the other hand, regarding the other articles it could be said that they came from a variety of journals. articles with a significant number of total citations per year are related to the role of fintech in achieving sdgs in indonesia (hudaefi 2020), the use of waqf in forest preservation and in achieving sdgs (ali e kassim 2020), the role of islamic ppps in the context of sdgs (gundogdu 2019), the different approaches of development bank of latin america and the islamic development bank in realizing sustainable development (ray e kamal 2019) and the role of islamic finance in the perspective of sustainable development goals (gundogdu 2018). according to the results, it is not possible to identify a leading journal with a higher number of published articles inserted in the top-cited documents list. tab. v: top-cited documents # authors, title and sources total citations tc per year 1 (doshmangir et al. 2019) so near, so far: four decades of health policy reforms in iran, achievements and challenges archives of iranian medicine 22(10):592-605 – october 2019 17 5,667 2 (hudaefi 2020) how does islamic fintech promote the sdgs? qualitative evidence from indonesia qualitative research in financial markets vol. 12 no. 4, pp. 353-366. 14 march 3 1,5 ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5765 7 2020 3 (ali e kassim 2020) waqf forest: how waqf can play a role in forest preservation and sdgs achievement? etikonomi: jurnal ekonomi, 19(2), 2020 1 0,5 4 (gundogdu 2019) determinants of success in islamic public-private partnership projects (ppps) in the context of sdgs journal turkish journal of islamic economy volume 6; pages 25-43; 2019 1 0,333 5 (ray e kamal 2019) can south–south cooperation compete? the development bank of latin america and the islamic development bank development and change volume50, issue1january 2019 special issue: beyond bretton woods: complementarity and competition in the international economic order 1 0,333 6 (gundogdu 2018) an inquiry into islamic finance from the perspective of sustainable development goals european journal of sustainable development, 7(4), 381. 2018 1 0,25 7 (tok e o’bright 2017) reproducing spaces of embeddedness through islamic ngos in sub-saharan africa: reflections on the post-2015 development agenda african geographical review volume 36, 2017 issue 1: from the millennium development goals (mdgs) to the sustainable development goals (sdgs): africa in the post-2015 development agenda. a geographical perspective, part 1 1 0,2 8 (ghoniyah e hartono 2020) how islamic and conventional bank in indonesia contributing sustainable development goals achievement 0 0 cogent economics & finance volume 8, 2020 issue 1 9 (azman e ali 2019) islamic social finance and the imperative for social impact measurement al-shajarah 2019: special issue: islamic banking and finance 2019 0 0 10 (mahadi, zain, e ali 2019) leading towards impactful islamic social finance: malaysian experience with the value-based intermediation approach al-shajarah 2019: special issue: islamic banking and finance 2019 0 0 source: personal elaboration topics analyzed from the considered articles are quite various, so for the purpose of this research, we will have a deepen look at the five most cited papers in the field of interest. in the most cited articles, the most relevant scientific contributions are:  (doshmangir et al. 2019) which observes the necessity of a sustainable development of healthcare system in iran, providing an interesting reconstruction of the last 30 years achievements on that field. regarding the target of this research, it appears relevant to underline the lines of the paper in which the authors of the paper state that ―to achieve sustainable health development, bold policy reforms are essential in core components of the health system, i.e. governance, delivery of healthcare and financing‖(roberts et al. s.d.)(world health organization 2010), attributing a determinant role to a joint action at all levels to achieve sustainable goals. even if in the paper there is no direct mention of sdgs, it is possible to insert that contribution in sdg number 3 ―good health and wellbeing‖;  (hudaefi 2020) examines the relationship between islamic fintech and the achievements in endorsing sdgs, finding that ―islamic p2p fintech lending in indonesia has been financing smes, agriculture sector, and conducting charity programmes for disadvantaged groups. in some degree, these findings may be synonymous of the islamic fintech efforts in endorsing the sdgs implementation in indonesia. this study is among the pioneers which substantively confirm the role of fintech firms in promoting sdgs‖;  (ali e kassim 2020) analyzes the role that a productive waqf forest will generate in tangible and intangible benefits. an important implication of the research is that ―waqf research for muslim society is essential and potential for elaborating the potentials of waqf in ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5765 8 strengthening the ummah’s economy (rusydiana & al farisi, 2016). previous research stated that waqf could be used to support environmental and forest sustainability.‖ and also that ―waqf could be introduced into forest protection and regeneration program in terms of funding (hasanah & hakim, 2017; yaakob et al., 2017). waqf is ―holding the assets and donating the yields.‖ waqf has several unique characteristics that suitable for developing forest preservation, namely: waqf cannot be sold (laa yubaa’), cannot be granted (laa yuuhab), and inherited (laa yurats) as well as-sa’di, 2002). in terms of waqf for forest conservation, a forest that became a waqf land will be sustainable, because waqf rule forbids to change the land use to another use until the end of the world.‖. finally, that kind of sustainable investment will have a dramatic impact on the achievement of a sustainable development since it complies with sdgs number 1 ―no poverty,‖ 2 ―zero hunger,‖ 3 ―good health and wellbeing,‖ 6 ―clean water and sanitation,‖ 13 ―climate action,‖ and 15 ―live on land‖;  (gundogdu 2019) examines the role of islamic publicprivate partnership (ppps) projects in bridging the huge infrastructure investment gap related to sustainable development goals (sdgs); in this paper ―islamic ppps are presented as an instrument to address sdg #7: affordable energy, sdg #9: industrial innovation and infrastructure development and sdg #8: decent work and economic growth‖. sdgs are seen as an opportunity for the growing of islamic finance industry since ―islamic financial institutions would find leeway to invest in tangible assets produced by ppp projects‖;  (ray e kamal 2019) analyse the role of southern-led multilateral development banks (mdbs) in harnessing global capital to finance specific sector such as infrastructure. they analyse mbds’ performances comparing them to those of their northern-based counterparts and focuses on ―bank operations to determine whether their governance structure impacts their internal performance, as reflected on balance sheets, and external performance — gaining relevance in development finance and particularly in infrastructure lending, including the burgeoning sector of sustainable (climate-resilient) infrastructure‖. finally, it resulted mbds’prominence as major players in the field of development finance. 3.3 keyword co-occurrences network every article published must contain keywords. these keywords are the research fields that have been involved in the respective articles. it establishes the co-occurrences of the network keywords. the purpose of the co-occurrence analysis is to design the conceptual structure of a frame of reference using a network of co-occurrence words to map and group the terms extracted from the keywords into a bibliographic collection. the following fig. 6 provides information to find out which are the most relevant keywords analyzing papers’ abstracts. the figure shows that researchers combine their scientific production with a significant number of keywords. the most involved keywords are islam, development, social, sdgs, finance, sustainable, goals, health, banks and financial. analyzing these keywords, it is clear that there is a general attention to sustainable development but there is a lack of specificity, with the exception of the keyword health that could be reconducted to a specific sdg. central appears the role of banks in islamic finance path toward sustainable development. fig. 6 most relevant words source: personal elaboration from biblioshiny fig. 7 annual occurrences of most cited words source: personal elaboration from biblioshiny the figure above helps to understand the spread of the annual occurrences of the most cited words in the last years (production starts effectively in 2017 and does not register articles in 2021, so the picture contains the period 2017-2020). ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5765 9 at the same time in tab. vi and fig. 8 below clarify the trending topics between 2017 and 2020, the years with production. tab. vi trend topics per year item freq year islamic social finance 5 2019 sdgs 4 2019 sustainable development goals 3 2019 financial intermediary 2 2019 sustainable development 2 2019 sustainable development goals (sdgs) 2 2019 waqf 2 2020 affordable housing 1 2018 agriculture 1 2019 blended finance 1 2019 cash waqf 1 2018 complementary currency 1 2018 credit distribution 1 2020 crowd funding 1 2018 crowdfunding 1 2019 development 1 2017 economic empowerment fund 1 2018 embeddedness 2 1 2017 faith based ngos 1 2017 food security 1 2019 goal and function of bank 1 2020 goals 1 2019 green sukuk 1 2019 hdi 3 1 2019 health policy 1 2019 health system 1 2019 health system framework 1 2019 ihya' al-mawat 1 2019 ijara 1 2019 indonesia 1 2020 infrastructure development 1 2018 intermediation 1 2019 international trade 1 2018 iran 1 2019 2 according to the concept of social embeddedness, economic decisions are affected by the social networks in which economic actors operate (czernek-marszałek 2020) 3 human development index islamic bank financing 1 2019 islamic banks 1 2019 islamic fintech 1 2020 istisna 1 2019 maqasid al-shari'ah 1 2019 maqasid al-sharrah 1 2019 micro finance 1 2018 ppps 1 2019 project finance 1 2019 qatar 1 2017 reform 1 2019 rem 1 2019 review 1 2020 sme financing 1 2018 social impact measurement 1 2019 social living standards improvement 1 2020 source: personal elaboration fig. 8 trend topics per year source: personal elaboration from biblioshiny the figure and the table above show that researchers combine their scientific production with a significant number of keywords. instead, the figure below helps to understand the spread of the annual occurrences of the most cited words in the last four years which implies an increased awareness on the field. to examine the content of the articles, a list of the trend topics per year had been developed. the target of the coding process is to determine whether there is a match between sdgs and the keywords in the article collection. according to undp 4, ―the sustainable development goals (sdgs), also known as the global goals, were adopted by all 4 https://www.undp.org/content/undp/en/home/sustainabledevelopment-goals.html ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5765 10 united nations member states in 2015 as a universal call to action to end poverty, protect the planet and ensure that all people enjoy peace and prosperity by 2030. the 17 sdgs are integrated—that is, they recognize that action in one area will affect outcomes in others, and that development must balance social, economic and environmental sustainability.‖ tab. vi sustainable development goals and trend topics # sdgs expected achievements most cited words 1 no poverty end poverty in all its forms everywhere agriculture and food security 2 zero hunger end hunger, achieve food security and improved nutrition and promote sustainable agriculture agriculture and food security 3 good health and well-being ensure healthy lives and promote wellbeing for all at all ages health policy, health system and health system framework 4 quality education ensure inclusive and equitable quality education and promote lifelong learning opportunities for all 5 gender equality achieve gender equality and empower all women and girls 6 clean water and sanitation ensure availability and sustainable management of water and sanitation for all 7 affordable and clean energy ensure access to affordable, reliable, sustainable and modern green sukuk energy for all 8 decent work and economic growth promote sustained, inclusive and sustainable economic growth, full and productive employment and decent work for all blended finance, complementary currency, credit distribution, crowdfunding, economic empowerment fund, embeddedness, faith based ngos, goal and function of bank, intermediation, international trade, islamic fintech, micro finance, ppps, project finance, sme financing, social impact measurement 9 industry, innovation and infrastructu re build resilient infrastructure, promote inclusive and sustainable industrializatio n and foster innovation green sukuk; blended finance, complementary currency, credit distribution, crowdfunding, economic empowerment fund, embeddedness, faith based ngos, goal and function of bank, intermediation, international trade, islamic fintech, micro finance, ppps, project finance, sme financing, social impact measurement 10 reduced inequalities reduce inequality between and among countries affordable housing, hdi, social living standards improvement, infrastructure development; blended finance, complementary currency, credit distribution, crowdfunding, economic empowerment fund, embeddedness, faith based ngos, goal and function of bank, intermediation, international trade, islamic fintech, micro finance, ppps, project ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5765 11 finance, sme financing, social impact measurement 11 sustainable cities and communitie s make cities and human settlements inclusive, safe, resilient and sustainable affordable housing, hdi, social living standards improvement, infrastructure development 12 responsibl e consumptio n and production ensure sustainable consumption and production patterns 13 climate action take urgent action to combat climate change and its impacts agriculture and food security; green sukuk 14 life below water conserve and sustainably use the ocean, seas and marine resources for sustainable development 15 life on land protect, restore and promote sustainable use of terrestrial ecosystems, sustainably manage forests, combat desertification and halt and reverse land degradation and halt biodiversity loss agriculture and food security; green sukuk 16 peace, justice and strong institutions promote peaceful and inclusive societies for sustainable development, provide access to justice for all and build effective, accountable and inclusive institutions at all levels 17 partnership for the goals strengthen the means of implementatio n and revitalize the global partnership for sustainable development source: personal elaboration from undp website keywords emerged on tab. vi and fig. 6 had been put into tab. vii in order to clarify their relation with sdgs. it emerges that literature on the field of islamic finance and sdgs deals with a number of issues that will be analyzed below. (affordable housing, hdi, social living standards improvement, infrastructure development) sdg 10 – reduced inequalities, sdg 11 sustainable cities and communities; the issue of affordable housing, according to (gundogdu 2018) can be attained through resource mobilization. it is also observed that such mobilization requires product development and successful sdg programs that will have to provide convincing results. hdi has been taken under consideration (afandi, wahyuningsih, e muta’ali 2019) to evaluate the role of islamic finance in improving quality of life of java islands’ population; it has been observed that islamic banking should encourage its financing based on social values or impact investments such as education, health, rural communities, agriculture, nutrition and renewable energies to support the improvement of hdi. social living standards improvement are, according to (ghoniyah e hartono 2020), part of the banking’s objectives in indonesia in order to improve equity, national stability, and economic growth. infrastructure development by multilateral development banks and local governments have not succeeded in reducing poverty (gundogdu 2019), however islamic finance could succeed in achieving sustainable development goals using ppps. (agriculture and food security) sdg 1 – no poverty, sdg 2 – zero hunger, sdg 13 – climate action, sdg 15 life on land; agriculture and food security are identified as key actors in achieving sustainable development goals (sdgs), particularly goal number two, ―zero hunger‖. in this sense, it is assumed that sixs islamic social finance tools namely infāq, waqf and zakat and iḥyā’ al-mawāt and aliqṭāʽ are really effective and will be very important tools ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5765 12 to sustain regionally or internationally the achievement of sustainable development, especially for developing and least developed countries. (abduh 2019). (green sukuk) sdg 7 affordable and clean energy, sdg 9 industry, innovation and infrastructure, sdg 13 – climate action, sdg 15 life on land; green sukuk is seen (hati et al. 2019) in indonesia as a viable solution to environmental problems and as a bridge between the islamic and conventional financial markets. it is assumed that, since those who invest in sukuk are mostly socially responsible, there is even more potential for countries that have muslim majorities to develop green sukuk markets because they are in greater compliance with sharia principles and they also are aligned with the achievement of sustainable development goals (sdgs). (blended finance, cash waqf, complementary currency, credit distribution, crowdfunding, economic empowerment fund, embeddedness, faith based ngos, goal and function of bank, intermediation, international trade, islamic bank financing, islamic bank, islamic fintech, micro finance, ppps, project finance, sme financing, social impact measurement) sdg 8 – decent work and economic growth, sdg 9 industry, innovation and infrastructure and sdg 10 – reduced inequalities; blended finance, ppps and project finance, are examined to shed a light on the role of islamic finance in order to achieve sustainable development goals through a blended form of finance called islamic public-private partnership (ppps). ppps’ projects, which will have the nature of project financing, in fact, could also reach a resource mobilization from islamic capital markets and are seen as an opportunity for the growing of islamic finance industry which may contribute to the achievement of sustainable development goals (gundogdu 2019) (ghoniyah e hartono 2020) assumes that an intensification in credit distribution can increase the level of banking profitability generating a very significant impact of financing or credit on sustainable development. it is also considered that, on the one hand, conventional bank has a lower orientation of credit distribution in the real sector while, on the other hand, islamic banks, which have more friendly implications than conventional banks, can be a reference in setting and applying business objectives (social objectives). islamic finance industry has contemporary products to address at least the first 11 sdgs that relate directly to islamic economics and finance. among them crowdfunding is analyzed as a useful tool for resource mobilization (gundogdu 2018). moreover, in thailand crowdfunding is seen (zain, mahadi, e noor 2019) as a useful platform to make possible the revival of waqf, which is one of islamic social finance's instruments and the most preferrable charitable tool due to its features that are perpetual, irrevocable, and inalienable. the revival of waqf may provide essential assistance in alleviating poverty and giving equal opportunity for economic participation. in (tok e o’bright 2017) the nexus of religion, space, and development is analyze, shading light on the role of faith based ngos as partners in sustainable development and key actors for achieving the sustainable development goals in sub-saharan africa (ssa). moreover, it is also stressed the concept of embeddedness, according to which economic decisions are affected by the social networks in which economic actors operate, analyzing the case study of qatari organizations in ssa. goal and function of bank, according to (ghoniyah e hartono 2020), are strictly related due to the fact that banks in indonesia have as a clear objective and target to be aligned with social goals. in fact, for islamic banks in indonesia the goals are profit-oriented or socially oriented, which align them with sustainable development goals (sdgs). it is also assumed that there are differences between islamic and conventional banks in promoting sustainable development. (azman e ali 2019) assume that there is a growing interest of islamic social finance towards social impact measurement. they also address that value based intermediation, in the continuously evolving environment of islamic social finance integration with islamic financial instruments and mainstream social finance, could be useful, along with other instruments, such as maqcisid al-shari'ah, to achieve sustainable development goals. islamic bank financing is intended to be encouraged (afandi, wahyuningsih, e muta’ali 2019) when it supports activities based on social values or impact investments such as education, health, rural communities, agriculture, nutrition and renewable energies to support the improvement of hdi, as it is demonstrated by the case study of java islands. islamic bank (razinah, hassan, e salman 2019) are addressed in order to stress on the one hand their relevance to achieve of sustainable development goals (sdgs) through their financial intermediary roles and, one the other hand to highlight the positive impacts of sustainable development goals (sdgs) in expanding the financial intermediary roles of islamic banks. moreover, it has been underlined that islamic banks may implement sdgs in their policies and may realize more transparent reporting on their activities. (hudaefi 2020) explores the indonesian market in order to clarify how islamic fintech firms have been promoting the global movement of sustainable development goals (sdgs) in the that context. of the 17 sustainable development goals (sdgs) of the united nations, the first 11 have a perfect fit with the ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5765 13 purpose and principles of islamic finance. it is highlighted (gundogdu 2018) that islamic finance industry has contemporary products to address these sdgs. in this context, cash waqf, complementary currency, economic empowerment fund, international trade, micro finance and sme financing must be seen as useful tools to achieve sdgs also because they are employed as resource mobilization tools. (health policy, health system and health system framework) sdg 3 health and well-being; health policy, health system and health system framework are analyzed (doshmangir et al. 2019) in order to reach a sustainable development of healthcare system in iran. sdg 4 quality education, sdg 5 gender equality, sdg 6 clean water and sanitation, sdg 12 responsible consumption and production, sdg 14 life below water, sdg 16 peace, justice and strong institutions e sdg17 partnership for the goals do not match with the considered literature. furthermore, there are some keywords, typical of islamic finance framework, which has not been possible to insert in the sdgs framework (waqf, cash waqf, ihya' al-mawat, ijara, istisna, maqasid al-shari'ah). these keywords, however, have a certain relevance in the islamic finance discussion on sdgs since all of them refer to particular financial tools that could be deployed to reach them. iv. discussion and conclusion 4.1 contributions to the literature the relationship between islamic finance and sustainable development goals has been proven according to literature, however the academic debate is still at the beginning. in order to develop the contribution of islamic finance to the debate of sustainable international growth, a hard work must be done from both an academical and practical point of view. that is particularly true also taking on account the enormous chances of expansion of islamic finance both in muslim and non-muslim countries (al-khazali, lean, e samet 2014; alharbi̇ 2016; belouafi e chachi 2014; grassa e hassan 2015; kalimullina 2020; pepinsky 2013; uddin e mohiuddin 2020). in fact, according to nawaz et al. (nawaz et al. 2019), ―numerous market trends suggest a rising use of islamic financing as a financial sector development. it is an increasingly visible substitute for conventional banks in islamic states (cihak e hesse 2008) and in a growing number of countries with large muslim populations, such as the uk, usa, italy, france, china, singapore, korea, and japan. in some countries, such as pakistan and malaysia, islamic banking activity runs in parallel with the conventional banking system. globally, the assets of islamic institutions have grown at two-digit rates for three decades and some conventional banks have opened islamic finance divisions.‖ due to the need to boost the participation of islamic finance to the world’s growth and sustainable development, it has been considered that a bibliometric analysis of the relationship between islamic finance and sustainable development goals could have been the right way to contribute to the academic debate for further systematic studies on this field. through the coding activity, emerged that only 10 out of 17 sdgs have connections in literature to islamic finance. some keywords, as emerged by the coding activity, cannot be inserted in particular sdgs categories because they are specific islamic finance instruments. among them, a particular mention must be done regarding zakat, sukuk and wakq (awfq) which appear to be the most effective instruments for an islamic financial contribution to sustainable development. according to (ismail, shaikh, e mohd shafiai 2017) waqf ―can be used to provide a wide range of welfare services to muslims as well as non-muslims, and the beneficiaries could also be other living beings. for instance, animal protection programmes and environmental preservation expenditures can be provided more flexibly through waqf. the institution of waqf can transform social capital into social and public infrastructure. it provides a permanent social safety net in the case of perpetual waqf to the beneficiaries.‖. on the other hand, zakat, which is a ―payment made annually under islamic law on certain kinds of property and used for charitable and religious purposes, one of the five pillars of islam‖ 5 , according to (ismail e shaikh, 2017), seems to be another important instrument to achieve sustainable development, particularly due its attitude to ―help in scaling up the benefits in terms of strengthening institutions to create synergistic effects‖. finally, sukuk has a high potential to be an innovative financing mechanism for islamic microfinance also because well-developed sukuk markets would enhance access to financial services, deepen capital markets and create sharia-compliant alternative for small and/or risk-averse investors (khiyar, 2014). moreover, socially responsible investment (sri) sukuk has demonstrated (khouildi e kassim 2018) a relevant attitude and ―potential to be developed as innovative shariah-compliant mechanism as shown by malaysian experience in issuing the sri sukuk to develop socially-related projects including the educational and green energy sectors‖. in this respect, a particular mention can be done in relation to green sukuks (aassouli et al. 2018) since ―mitigating climate change and achieving the sdgs by 2030 requires national, regional, and international partnerships and collaborations, as well as the development of alternative segments of modern finance.‖ to that extent, it is important to underline the importance of developing green sukuks for islamic finance. in fact, that particular instrument could be a booster for an international mobilization of funds both from muslim and nonmuslim investors in order to create social outcomes and a relevant contribution to social development and to reach the goals of 5 https://www.lexico.com/definition/zakat ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5765 14 sdgs 7-9-13-15. this study presents the results of research in the field of islamic finance and sustainable development goals and could be a starting point for further studies on the fields of knowledge that emerged from this bibliometric analysis. a bibliometric method was used to analyze the characteristics, citation patterns, and content of 15 documents published in international academic journals, book and chapter reviews, editorial materials, and proceedings papers. by adopting this scientific method, the analysis presents the state of art of the research on the field of the relation between islamic finance and sustainable development goals. the main findings have to be linked with the keyword analysis which helped to understand what are the present themes in literature in regard of islamic finance and sustainable development goals. another important finding is that the researches on this field are mostly related to muslim countries. it also emerges that academics of non-muslim countries may contribute with researches related to possible applications of islamic finance to contribute to the achievement of sustainable development goals in their countries (corvo e pastore 2019). that gaps on literature suggests that a lot of work can be done on that field, particularly observing the potential outputs of that relationship. the bibliometric analysis showed that the most cited articles explore very interesting themes: the link between social development and sustainable health systems; the relationship between islamic fintech and its achievements in endorsing sdgs; the relevance of waqf forest investments in climate and environment protection; the role of islamic public-private partnership (ppps) projects in sustaining infrastructure investment. 4.2 implications for institutions, banks, enterprises and customers based on the study's preliminary evidence and if supported by further research, islamic finance and sustainable development goals have a proven relation that can be enhanced by all levels of stakeholders, from governments, to banking institutions, to social enterprises (iannaci e mekonnen 2020), ppps and smes that have to coordinate their actions in order to generate a positive impact and effective sustainable development. the use of islamic finance to achieve sustainable development goals is a reality and the academical and economic discussion on that field has just begun and could benefit of an indefinite growth. it implies that it is time to enhance the role of islamic finance toward 2030 agenda’s targets through ethical investments that will generate social impact and sustainable growth. however, a part from the above mentioned 10 sdgs that had been found in relation with islamic finance, a particular effort must be done in integrating that kind of ethical finance also in regard of the other sdgs, particularly those related to sdg 4 quality education, sdg 5 gender equality and sdg 16 peace, justice and strong institutions. these sdgs, particularly in muslim countries, which have a deeper relation with islamic finance, need to be taken under serious consideration and may attract social investments to grant to the involved citizens better life conditions which, for those countries, are not actually at an acceptable level (oecd 2020). as already underlined in previous studies, muslim countries particularly suffered a lack of coordination between banking and social institutions and often failed in the past to convey money in social projects (olanrewaju, shahbudin, e zakariyah 2020). in non-muslim countries, on the other hand, as already said, there is a higher awareness on the field of social finance (p. p. biancone e radwan 2019)and toward the achievement of sustainable development goals, but the countries usually fail to attract islamic finance investments, due to their legislation which is not completely ready to welcome islamic finance tools (p. p. biancone 2014; p. biancone, secinaro, e radwan 2020; masiukiewicz 2017; kalimullina 2020; grassa e hassan 2015; alharbi̇ 2016). at this point and considering the actual period of deep crisis, from an economic, environmental and social point of view, it seems very important to invest on sustainable development also through islamic finance. 4.3 limitations and future research the study shows a limitation, related to the adoption of the bibliometric method even as it considers books, chapters, articles published in international and academic journals, editorial materials, reviews, and proceedings papers. the purpose of this study is to provide insights that other scholars can draw upon and explore further in the process of theory development. therefore, this study invites scholars to increase their efforts to provide further researches on this field. these findings suggest that there is an initial awareness on the specific area of research, as demonstrated by the analysis of the literature that puts the basis for a general reflection on the possible opportunities and challenges coming from the match between islamic finance and sustainable development goals. the originality of the research is the application of a quantitative approach to discover the relation between islamic finance and social impact which could hopefully generate further empirical studies investigating the impact of this relationship. to this extent, it must be underlined the lack of academic awareness in the field of sdg 4 – quality education, sdg 5 – gender equality, sdg 6 – clean water and sanitation, sdg 12 – responsible consumption and production, sdg 14 – life below water, sdg 16 – peace, justice and strong institutions e sdg17 – partnership for the goals, which are not mentioned at all in the papers considered. these sdgs, however, are particularly ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5765 15 relevant for a sustainable development proving that higher attention must be put 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http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5765 19 paper title (use style: paper title) 39 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6257 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 21/11/2021 accepted for publication: 07/04/2022 published: 22/04/2022 mapping islamic finance and new technologies: research and managerial perspectives 1. university of turin, department of management, italy 2. university of pavia, department of economics and management, pavia, italy 3. georgetown university, mccourt school of public policy, usa corresponding author: davide.calandra@unito.it abstract— new technologies promote radical changes in how banking services are delivered. the field of islamic finance is not exempt from radical changes and is gaining increasing attention from academics and practitioners. although several scientific studies have been conducted on the impact of technologies on specific islamic finance instruments, no research has examined bibliometric variables in this area. this study aims to cover this gap by conducting a bibliometric and open coding analysis on 170 sources of published studies on islamic finance and technology. our study detects the most influential authors, journals and countries of publication that currently prioritise research in this field. in addition, the thematic analysis reveals that among the niche themes are applications of technology to takaful. among the motor themes is the opportunity for technology to facilitate decision-making in islamic banks. finally, in terms of originality, this study highlights the field's current state by combining methodological approaches and providing valuable insights for future research. moreover, it is also a starting point for practitioners to fully understand the characteristics and potential of technology in islamic finance. finally, the article provides researchers with a research agenda to guide future research ideas. keywords: islamic finance; blockhain; cloud; artificial intelligence; fintech; business implications; future research agenda i. introduction new technologies are gradually changing various businesses and activities. [1], [2]. islamic finance is also looking with interest at critical global trends. in fact, among the most-watched developments today are cloud, blockchain and artificial intelligence [3]–[5]. according to several international authors, these technologies could change the business models of islamic banks and promote new virtuous economies to make them more attractive from the economic point of view than traditional finance banks. [6]–[8]. therefore, this literature sees a decisive advantage for islamic finance from applying new technologies. alongside the technologies applied to the business of islamic financial institutions, numerous publications are dealing with islamic fintech and its compatibility with sharia'h [9]. today, the main areas of study in the business sector are undoubtedly sukuk with process robotisation applications [10], takaful with automatic management applications and fraud reduction thanks to the blockchain [11] and fintech [12]. despite the widespread interest shown by the growth in publications, as defined by delle foglie et al. (2021) and uluyol (2021) [13], [14], more research will be needed in this initial area to systematise publications and identify any increased scope for global competition. this can only be the case if the level of knowledge on the subject is precise. therefore, precisely on this point, as suggested by zupic and cater (2015) and secinaro et al. (2021) [5], [14], timely analyses of knowledge flows with bibliometric and open code analyses could provide researchers and practitioners with a state-of-the-art on what has been published so far. all these premises give us the idea of an embryonic stream of knowledge with few authors and citations looking for its own space within the more significant strand of research on islamic finance. therefore, this paper proposes a broad investigation, including studying primary bibliometric data on peer-reviewed sources in the international scopus database [16], [17]. the main findings denote a multidisciplinary view of the research field studied. the literature includes an interesting discussion on possible new technological tools for islamic davide calandra1, roberto marseglia2, vincenzo vaccaro3, federico chmet1 https://www.ojs.unito.it/index.php/ejif/index 40 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6257 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 21/11/2021 accepted for publication: 07/04/2022 published: 22/04/2022 finance, the development of new technical processes to increase the operational efficiency of the islamic financial system, and the presence of alternative payment and investment methods based on fintech. furthermore, we note that the strand of research looking at technological solutions consistently looks at cost reduction as a sign of operational efficiency vis-à-vis traditional type banks. our analysis is innovative for the topic of interest. it applies a hybrid methodology that includes, without distinction, new technologies and not only a specific tool such as sukuk or takaful or fintech as a financial innovation [12], [18]. therefore, our article aims to map, discuss, and critique the research debate on these issues by answering the following questions: (1) what are the main characteristics of these research streams considering authors, citations, and geographical interest? (2) what are the most frequent topics in this literature? (3) what are the possible implications for future research in this field? the rest of the article is structured as follows. section 2 sets out the methodological flow. section 4 shows the results of our research. section 5 provides an in-depth interpretation of the data, commenting on and critiquing the main results. section 6 concludes this article by considering the current implications and limitations and building on these by suggesting future research paths. ii. methodology this paper uses a hybrid method joining the bibliometric analysis and the available coding analysis [5]. as the first research step, we create the review protocol. according to massaro et al. (2016) [17], authors should include clear and direct data replication processes. additionally, as tranfield et al. (2003) [19], in wide-ranging literature reviews, research teams should put transparency measures to allow for high reliability and replicability of the research, even at different times. we implement a six-step research protocol from other published papers with known elements, motivation in conducting this research paper, the topic under discussion, the research limitations, tools used, and the research framework followed. the following table i shows the research protocol followed by the researchers. finally, the next sub-paragraphs describe the dataset creation phase, all the tools used to implement the analysis, and the open coding analysis protocol. table i. research protocol review protocol elements author's considerations what is already known? (step 1) technologies promote a change in islamic financial institutions' working and business models [20]. more and more researchers are fostering research in this area because of the opportunity for cost reductions and operational modifications [5], [21]. motivation (step 2) a rising research stream analyses how new technologies will impact islamic finance. there is currently no unified mapping in the literature despite numerous research studies. this creates fragmentation and difficulty in interpretation for researchers who must verify multiple sources of knowledge. review protocol elements author's considerations research topic (step 3) fragmentation promotes possible bibliometric analyses in this emerging research area [15]. research limitations (step 4) following massaro et al. (2016) and secinaro et al. (2021) [5], [16], we decided not to limit the search to a single scientific journal. moreover, as dumay and cai (2014) [20], we included peer-reviewed journal articles, book chapters, and conference proceedings in the analysis. finally, book chapters and white papers were excluded as nonpeer-reviewed sources. research tools (step 5) scopus database, bibliometrix r package and atlas. ti cloud. research framework (step 6) years, documents' information, sources, authors, keywords, citations, countries, theories analysed, methodologies used and technologies under discussion. source: author's elaboration a. dataset creation the critical sources under analysis were collected, starting with studying the keywords. according to chen and xiao (2016) [23], keywords selection can be made using different methods. the first is to use wide-ranging words that encompass a large, high-level search domain. the second is to analyze smaller and perhaps rising search domains. therefore, this study utilizes the second mode of research by analysing the micro-domain of new technologies and their use in islamic finance. additionally, starting from the analysis conducted by massaro et al. (2020), de mem machado (2021) [24] and rosa et al. (2020) [25], we have selected which keywords: "islamic finance" and "tech*" or "blockchain" or "artificial intelligence" or "cloud" or "smart". as shown in table 1, we used the multidisciplinary and international scopus database for data collection [26]. indeed, several studies published in leading international journals use this database as it also includes data from other registries such as web of science [5], [27]–[29]. despite the certainty of the previous studies, we decided, in any case, to compare the results of the two databases to avoid the loss of relevant data. in the outcome, we can confirm that the coverage of articles was more excellent on scopus. the dataset's creation includes only documents published until 2021 [30]. the application of the search requirements returned 179 documents. however, the research team could not access pdfs of 9 documents, so the final sample analysed was 170 documents. figure 1 below, using the methodological paper by liberati et al. (2009) [31], shows the research steps used by the authors. https://www.ojs.unito.it/index.php/ejif/index 41 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6257 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 21/11/2021 accepted for publication: 07/04/2022 published: 22/04/2022 figure 1. prisma workflow. source: author's elaboration using liberati et al. (2009) [31] b. tools of analysis the research used several analysis tools. first, the quantitative and qualitative data analysis was done using the bibliometrix and biblioshiny package through the r studio application [32]. similarly, as evident from the research gap, few studies deal with providing a map of the theories and, at the same time, systematising the technologies that to date are applied to islamic finance. therefore, our research uses atlas. ti cloud software will provide valuable insights regarding technologies applied by researchers in this research area [33]. iii. results this section aims to illustrate the bibliometric and open code analysis results. in the following sub-sections, the reader will see the research variables such as types of documents, years of publication and scientific production, scientific reference sources, growth of sources, number of articles per author, author productivity and the area related to keyword analysis. finally, the section will end with a specific analysis of the theories used by researchers and the study of methods and technologies. a. main information table ii shows the information of the 170 papers selected between 1997 and 2021. the research topic appeared in 112 scientific sources with an average annual publication rate of 3.7 articles. however, as shown in figure 2, the figure could be misleading as most published papers are after 2013. further on, the most published type of document is the scientific article in a peer-reviewed journal (119), followed by books (15) and peer-reviewed book chapters (14). finally, the analysis of authors and collaborations is also interesting. what emerges from these first data is a research field with a still low level of collaboration and single authors or an average number of authors equal to 2.28, a symbol of a growing area that is still little explored by researchers worldwide. table ii. main information data results timespan 1997-2021 (september) documents 170 sources 112 average years from publication 3.7 average citations per document 7.3 average citations per year per document 1.224 number of references 10.367 document types articles 119 books 15 book chapters 14 conference papers 13 conference review 1 editorial 1 review 7 document contents keywords plus 183 author’s keywords 515 authors authors 387 author appearances 435 authors of singleauthored documents 38 authors of multiauthored documents 349 authors collaboration single-authored documents 44 documents per author 0.439 authors per document 2.28 co-authors per documents 2.56 collaboration index 2.77 source: author's elaboration https://www.ojs.unito.it/index.php/ejif/index 42 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6257 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 21/11/2021 accepted for publication: 07/04/2022 published: 22/04/2022 figure 2. annual scientific production. source: author's elaboration using biblioshiny b. sources' analysis table iii identifies the top 10 sources of publication. interestingly, the unitary distribution of the sources published both in reference and monothematic journals on islamic finance and journals with a wide range of topics. for example, the journal of islamic accounting and business research is one of the most critical publications (21), followed by the international journal of islamic and middle eastern finance and management (9). on the other hand, among the journals with a broader subject matter is qualitative research in financial markets (6), aiming to publish contemporary research on corporate and international finance issues. table iii. relevant sources sources number of publications journal of islamic accounting and business research 21 international journal of islamic and middle eastern finance and management 9 qualitative research in financial markets 6 islamic fintech 4 al-shajarah 3 borsa istanbul review 3 journal of islamic marketing 3 research in international business and finance 3 arab law quarterly 2 contemporary studies in economic and financial analysis 2 source: author's elaboration using biblioshiny figure 3 identifies the cumulative frequency distribution of articles published by journals. therefore, the names of the journals that have published research contributions on this topic to date are shown. interestingly, the publication flow in the most relevant scientific journals began in 2009, a year that is also relevant for technologies such as blockchain [5]. these results align with the growth shown in figure 1 and the interest in economic research approaches. figure 3. source growth. source: author's elaboration using biblioshiny c. authors' analysis table iv shows the top 10 most relevant authors. the authors with the most publications are rabbani mr. from the university of bahrain, a very active centre for publications on technology, and professor hassan m.k. from the university of new orleans and editor-in-chief and editorial member of several journals on islamic finance. his research has helped broaden the research horizons of islamic finance by providing interesting and up-to-date ideas and research objectives for other fields. finally, khan s. and saiti buerhan follow with 6 and 5 publications. finally, what emerges from the analysis is a research topic trying to find its place within the macro-discussion on islamic finance. the first authors per publication indicated here are experts in the field who, with their pilot research projects, are promoting an open and unconditional discussion on the topic. table iv. most relevant authors sources number of publications rabbani m.r. 8 hassan m.k. 8 khan s. 6 saiti b. 5 rudnyckyj d. 4 alam n. 3 calder r. 3 morea d. 3 ahmad k. 2 ahmed a. 2 source: author's elaboration using biblioshiny table v shows the analysis of the most promoting research on islamic finance and new technologies. the international islamic university malaysia is the leading institution in the number of articles published (17). next, we discover how the significant universities in the world dealing with research in this field reside in the middle east. a clear vision can explain these results that states like bahrain promote funding for new technologies [34]. https://www.ojs.unito.it/index.php/ejif/index 43 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6257 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 21/11/2021 accepted for publication: 07/04/2022 published: 22/04/2022 table v. most relevant affiliation sources articles international islamic university malaysia 17 kingdom university 8 university college of bahrain 6 university of bahrain 6 university of malaya 6 universitas islam indonesia 5 universitas indonesia 4 university of new orleans 4 university of victoria 4 al-farabi kazakh national university 3 source: author's elaboration using biblioshiny d. citations' analysis the analysis of citations can yield interesting drivers of observation (table vi). we will first use concerns by studying the most cited sources at the local level, i.e., within the research area under study. this approach is beneficial in omitting references with greater scientific relevance [28], [35]. in particular, one of the most cited sources is a literature review by rabbani, khan and thalassinos [32], which aims to identify the level of knowledge of islamic finance within fintech, cryptocurrency, and blockchain. furthermore, the study classifies islamic financial instruments that are shari'ah compliant. another interesting study is khan et al. (2020) [10], which introduces the concept of sukuk tokens by showing that blockchain can decrease managing costs'. table vi. most relevant local citations author total citations gheeraert l. (2015), econ model [36] 54 rudnyckyj d. (2014), am ethnol [37] 31 syed mh. (2020), int j econ bus adm [38] 17 rabbani mr. (2020), int j econ bus adm [18] 16 diaw a. (2015), j islamic account bus res [39] 14 hassan mk. (2020), j econ coop dev 9 rabbani mr. (2020), int j sci technol 4 khan n. (2020), global financ j [10] 4 salim bf. (2016), int j econ financ issues 2 khediri kb. (2015), res int bus financ [8] 2 source: author's elaboration using biblioshiny e. keywords' analysis analyzing keywords allows us to study the concepts most frequently addressed by researchers [23]. as shown in figure 4, we do not find uniform examples of technologies except for blockchain and fintech. we also see that sukuk is one of the most used tools applied. finally, a geographic fact that will be confirmed later in the analysis is that malaysia has the highest level of research in this area. figure 4. trend topic. source: author's elaboration using biblioshiny figure 5 below illustrates the thematic map of trending topics based on keywords plus analysed. these are words or phrases that often appear in the titles of article references but not in the primary title of the article itself. such extractions are possible thanks to an algorithm developed by clarivate analytics that allows extending the scope of information by looking at the article's content and not only at the title, abstract and external keywords [40]–[42]. applying the data reading to the bibliometrix package makes it possible to obtain a graph by relevance and development. inside it is possible to notice a distinction by topics: • niche themes; • motor themes; • emerging/declining themes • basic themes. starting with the first one above, we find that the topic of blockchain is applied to the takaful insurance industry among the niche themes. we see interest from researchers in this topic, especially for data management between different insurance locations and fraud prevention by policyholders [11]. despite the interest and potential, this topic is not yet widely developed. the second quadrant of the graph shows the motor themes. they represent the topics on which the scientific discussion is based today. we discover how technology can support the decision-making processes of islamic financial institutions. among the most curious applications is pioneering research that identifies technology as an opportunity to increase the economic sustainability of islamic banks in case of banking disputes and controversies [43]. the third quadrant of the graph identifies emerging issues in which researchers may have future interests. these include climate change. although widely developed in several businesses and traditional finance [44]–[46], its treatment is still far from widespread in islamic finance. https://www.ojs.unito.it/index.php/ejif/index 44 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6257 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 21/11/2021 accepted for publication: 07/04/2022 published: 22/04/2022 finally, the last part of the graph shows the basic themes, including islamic fintech, which has had its scientific history with numerous contributions investigating its compatibility with sharia'h [7], [9], [47], [48]. figure 5. thematic map. source: author's elaboration using biblioshiny f. open coding analysis the objective of this brief section will be to show the results of the open code analysis conducted by the researchers on the selected documents. the research uncovers several interesting points. first, the most addressed technologies that meet the definition of adomavicius (2006) [1] are only blockchain and artificial intelligence. second, documents that deal with fintech do not focus on technology but rather on the applications it allows concerning means of payment. third, although reported in the sample, we find data noisiness as many papers use the word technology without going into detail but only into hypothetical applications. figure 6. coded technologies. source: author's elaboration using atlas.ti cloud g. geographical and collaboration analysis table vii identifies the frequency of publication and the countries with the most significant interest in technology in islamic finance. malaysia (79) is the country with the highest scientific output on the topic, followed by bahrain (26), indonesia (26) and the uk (21). the analysis shows that muslim countries primarily analyse the research topic. however, the topic is also of interest in countries whose financial sector is traditional, such as italy, the usa, and the uk. finally, interesting research insights can be derived from the analysis of figure 5, which identifies collaborations between academics worldwide. as can be seen, there is a strong cluster of collaboration between indonesia and australia with the usa and between, turkey and brazil. these results also represent active research collaborations and discoveries in other research topics such as halal food or waqaf [27], [29] and reflect faculty teams currently working to increase knowledge in this interesting area. table vii. country scientific production country frequency malaysia 79 bahrain 26 indonesia 26 uk 21 usa 21 italy 19 pakistan 10 turkey 9 nigeria 8 saudi arabia 8 source: author's elaboration using biblioshiny figure 7. thematic map. source: author's elaboration using biblioshiny iv. discussion and conclusion our study used bibliometric analysis to investigate the broad literature about technologies and islamic finance. we conducted a bibliometric analysis using bibliometrix rhttps://www.ojs.unito.it/index.php/ejif/index 45 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6257 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 21/11/2021 accepted for publication: 07/04/2022 published: 22/04/2022 package and an open coding analysis using atlas to answer the three research questions ti cloud accurately. starting from the gap in the literature with numerous studies in this direction but without a systematisation [7], [49], this article provides an in-depth qualitative and quantitative analysis of bibliometric variables. some valuable theoretical insights can be made. firstly, although sustained in the last three years, the scientific production in this field has not had constant levels so far. moreover, the increase in interest by researchers is primarily sanctioned to seek solutions and answers to the compatibility of fintech with shari'ah [9], [48] and to understand the relationships between blockchain and artificial intelligence in the business of islamic banks [8], [21], [50]. this evidence is demonstrated, for example, in figure 5, which shows the primary topics of discussion. secondly, from a theoretical point of view, the analysis aims to criticise what is reported in the literature constructively. the research shows noisiness in the data collected, which is to be outlined in the scopus analysis conducted. however, what is noticeable in the study is a homologation of possible technologies for islamic finance. for example, according to adomavicius (2006) [1], understanding the dynamics of technological evolution is the first point of reference for verifying the state of cyclicality and application of many technologies. in the context of islamic finance, we have observed a stage of embryonic development on a purely scientific level. moreover, it is unclear what evolutionary state we are in many works, and applications such as fintech are likened to technologies like blockchain and artificial intelligence. therefore, this evidence confirms the novelty of scientific literature and the great space it may have for future researchers. moreover, our analysis also contains some practical insights. first, islamic managers and banks should increasingly open up to the technological wave by aspiring, as demonstrated in the literature, synergies to improve and evolve their business models [47], [50]. second, despite the expansion of technology, as admitted by adomavicius, the wave of new technologies needs to be managed and controlled in its life cycle. therefore, financial managers should understand to what extent a technology in use is in its initial or final life cycle. this is instrumental in activating, if necessary, further developments to remain competitive. like all research, this one has some limitations. first, the current work does not consider the technical issues of the technologies analysed. future research could combine a more careful analysis of recent technological problems and variables. second, the study might be biased using a single research database. therefore, future research stimuli could conduct integrated, multi-database analyses. the following table viii aims to provide researchers with new avenues of research for the future. table viii. future research perspectives macro-themes future research perspectives blockchain (1) how can blockchain be used to limit the economic impact of costs in islamic banking and insurance? (2) how can blockchain features enable the development of the islamic financial system? artificial intelligence (1) how will artificial intelligence stimulate islamic banking processes? (2) to which administrative processes can artificial intelligence be applied? (3) how will artificial intelligence support sukuk, takaful and waqf? fintech (1) how will fintech improve islamic banking processes? (2) is there compatibility between fintech and islamic law? (3) how can fintech relate to other technologies such as blockchain and artificial intelligence? source: author's elaboration using biblioshiny references [1] g. adomavicius, j. bockstedt, a. gupta, and r. j. kauffman, "understanding patterns of technology evolution: an ecosystem perspective," in proceedings of the 39th annual hawaii international conference on system sciences (hicss'06), jan. 2006, vol. 8, pp. 189a–189a. doi: 10.1109/hicss.2006.515. [2] v. jafari-sadeghi, a. garcia-perez, e. candelo, and j. couturier, "exploring the impact of digital transformation on technology entrepreneurship and technological market expansion: the role of technology readiness, exploration and exploitation," journal of business research, vol. 124, pp. 100–111, jan. 2021, doi: 10.1016/j.jbusres.2020.11.020. [3] d. calandra and m. favareto, "artificial intelligence to fight covid-19 outbreak impact: an overview," european journal of social impact and circular economy, vol. 1, no. 3, art. no. 3, dec. 2020, doi: 10.13135/2704-9906/5067. [4] s. secinaro, d. calandra, and p. biancone, blockchain, trust, and trust accounting: can blockchain technology substitute trust created by intermediaries in trust accounting? a theoretical examination,” ijmp, vol. 14, no. 2, p. 129, 2021, doi: 10.1504/ijmp.2021.113824. [5] s. secinaro, f. dal mas, v. brescia, and d. calandra, "blockchain in the accounting, auditing and accountability fields: a bibliometric and coding analysis," accounting, auditing & accountability journal, vol. ahead-of-print, no. https://www.ojs.unito.it/index.php/ejif/index 46 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6257 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 21/11/2021 accepted for publication: 07/04/2022 published: 22/04/2022 ahead-of-print, jan. 2021, doi: 10.1108/aaaj-10-2020-4987. [6] n. m. ariffin, s. archer, and r. a. a. karim, "risks in islamic banks: evidence from empirical research," j bank regul, vol. 10, no. 2, pp. 153–163, mar. 2009, doi: 10.1057/jbr.2008.27. 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[51] f. h. l. chong, "enhancing trust through digital islamic finance and blockchain technology," qualitative research in financial markets, vol. 13, no. 3, pp. 328–341, jan. 2021, doi: 10.1108/qrfm-05-2020-0076. https://www.ojs.unito.it/index.php/ejif/index paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif 1 evolution & development of islamic banking – the case of pakistan *international islamic finance & insurance institute, email_aqib@yahoo.com / aqib@iifii.org abstract— the paper attempts to explore the roots of islamic banking in the world in general and in pakistan in particular to assess the evolution and development/growth of islamic banking worldwide and especially in pakistan. the paper highlights the chronology of islamic banking globally and in pakistan and also traces the progress of islamic banking internationally with special reference to pakistan. the facts reflect an encouraging global islamic banking outlook. the findings also show that the progress of islamic banking in pakistan has been consistent and quite encouraging. as the time passed the quantum of islamic banking in the country expanded and is continuing to move in the right direction. from a new initiative in the 1970s, islamic banking is now a force to reckon with, the annual growth rate of more than 16% proves this fact. keywordsislamic banking, islamic finance, pakistan, evolution, development, growth i. introduction & overview of islamic banking islamic economic and financial system is based on the idea of collective welfare which is driven by virtue and goodness of both worlds. this idea of islamic economic system is greatly in contrast to the modern interest based economic system which is driven by the principles of capitalism, unbridled resource consumption and materialism. islamic system of finance emphasizes risk sharing which provides islamic financial methods like murabaha, mudaraba, ijarah, musharakah, salam and istisna – guided by the islamic principles derived from holy quran and the sunnah (sayings and acts) of the holy prophet (saw) to eventually facilitate trade and business in the society and to consequently bring economic well-being and prosperity. this is incredible to note that islamic sacred texts from the times when paper money was not even invented offered guidance on intricate financial issues. besides this, islamic principles also provide guidance on the architecture of a system that is economically just and fair and is based on the schema of socio-economic welfare of all and not just certain wealthy individuals or groups. (zaman 2013) whereas, the conventional economic system, emphasizes on the principles of time value and money. this is explicitly mentioned in the second chapter of the glorious quran that dealing in interest is tantamount to waging war against god and his messenger pbuh. islamic mode of business financing is laid on the tenant that the use of riba (interest) is forbidden in all transactions (gerrard and cunningham, 1997). this prohibition is based upon sharia guidelines and laws which are derived from two divine sources i.e. quran & hadith. according to the fundamental divine rulings of islam, muslims can neither collect nor disburse riba (interest), so they are incapable to deal and transact with conventional financial institutions and including both banking and non-banking financial organizations. (jaffe, 2002). to cater to the needs of this segment that represents those muslim clients, who avoid interest because of their religious beliefs, which forms a massive market, islamic banking and non-banking organizations have developed a diverse group of shariahcompliant and riba-free banking and financing products that fulfill the relevant shariah rulings, and hence, are suitable to their muslim customers. (rammal, 2004). ii. tracing the roots of islamic banking in the world the islamic system of economy – long established approximately 1400 years ago is a broad structure of principles, institutions and clearly defined injunctions. holy prophet muhammad pbuh himself was a trader by profession and hence he knew the importance of trade and business along with other economic issues. islamic mode of partnership finance i.e. mudarabah was one of the driving forces of business and trade in the medieval times. with the passage of time, industrialization and institutionalized commercial banking reached the muslim populations, where at that time; it was not somehow practically possible for the muslims to reject the interest-based banking system, as there was no pragmatic and concrete alternative available. islam forbids interest or riba in all its facets and warns those who deal in interest. (aqib ali 2012) it was in the 19 th century that muslims started to realize that the current system of banking and economy was based on riba that is interdicted in islam and is categorically forbidden in all its shapes whether commercial or non-commercial; and there should be an alternate system which conforms to the muhammad aqib ali * mailto:email_aqib@yahoo.com mailto:aqib@iifii.org ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 2 principles of shariah. the primary project that paved way for a promising future of islamic banking was “mit ghamr” in egypt. in the meantime, another initiative was taken in the shape of “tabung haji” in malaysia (laldin 2008). a major challenge in the establishment of islamic banking set-up was to develop shariah compliant products and services, for which islamic banks established shariah advisory committees and religious boards, who authenticated the products and services of the islamic banks and whose main objective was to judge, whether these products and offerings conform to the tenets of shariah. these boards comprised of islamic scholars who came from diverse backgrounds and belonged to various schools of thought. this was a positive prospect as banks could benefit from the vast knowledge and innovative ideas of these scholars. there was also difference of opinion among these scholars but mutual consultation was the guiding force to finalize the decisions. as the time passed, islamic financial institutes grew in numbers and magnitude. the first international islamic financial institute was the islamic development bank (idb) in 1975. this was a landmark in the history of islamic banking. some countries including pakistan, iran, sudan, malaysia and bahrain initiated efforts to implement islamic banking at larger scales in their respective countries during 1980s. in the next decade some of the conventional banks also introduced islamic banking products and services by operating separate islamic banking units and divisions. after the foundations of islamic banking in countries like egypt and malaysia, it became evident that islamic banking will have a vivid future. swiftly after the introduction of islamic financial services by the conventional banks, islamic banking started to make its mark on the global financial landscape. (khan & bhatti 2008) several islamic investment and holding companies were established and many international and large-scale financial institutes introduced islamic financial services. with the passage of time, islamic finance flourished, innovative and diverse products and services like sukuk, islamic mutual funds, and takaful fortified islamic finance at international level. the rapid expansion of islamic finance and the discovery of new and innovative sharia compliant products and services facilitated islamic finance to compete at a global scale with the competitive interest based banking and financial set-up. a number of international and large-scale entities like islamic development bank, the islamic finance services board (ifsb), accounting and auditing organization for islamic financial institutions (aaoifi), and international islamic rating agency are making their due contribution in the growth and development of islamic finance at a global scale. today islamic finance is a thriving and dynamic force in the global financial setup. islamic development bank established in 1975, being the first international islamic financial institution played a role of a pioneer to make islamic banking and finance a global phenomenon. the bank played a vital role in the economic growth and development of its member countries keeping in view its primary objective of narrowing the gap between the rich and the poor member countries. the idb is distinguished from other similar institutions like the world bank or the asian development bank in a way that it is committed to follow the tenets of shariah in all its operations and is dedicated to avoid riba or interest in all its dealings. the idb plays a crucial role in the economic development of member countries and muslim communities around the world by performing key functions like financing the public and private sectors of member countries; raising, operating and maintaining various funds like trust funds, special funds and other specific funds; accepting deposits and capital contributions; making investments and trade financing; providing technical assistance, co-operation and training facilities to member countries; promoting and assisting foreign trade among member countries; insurance, information and other ancillary services; facilitating research and training in areas of islamic economics, banking and finance by providing scholarships etc. other functions which guarantee the idb, a distinctive islamic character, are the participation in the equity capital of projects in member countries and the investment in social infrastructure projects in member countries. the idb has proved its mettle at the international level as the first developmental-aid institution operated in accordance to shariah principles. the role played by the bank in the economic development of its member countries has been momentous. the idb has transformed from a single unit into a group of five entities, its capital has increased manifold and the credit ratings and financial position of the bank, even during the recent global economic and financial crisis, has been phenomenal. today the idb is one of the few multilateral development financial institutions with excellent credit ratings, which confirms its financial stability and progressiveness. the idb continues to play the critical role in its member countries, by reducing poverty and fostering economic development. islamic finance industry has expanded swiftly in the past thirty years expanding its horizon in terms of operations and territory by reaching out to many parts of the world from arab countries to middle-east to asia and europe. the dynamics of islamic finance industry as discussed earlier emerged with the establishment of the small savings association of mitghamr (egypt) in 1963. the capacity and vigor of the industry has now reached to more than 500 banking and financial entities having operations in over 90 countries with the aggregate gross assets approximately more than 1.6 trillion us dollars which is likely to double by 2016. (humayun 2013). the growth rate stands at a staggering more than 16% a year. according to kapur (2008), most of the large islamic finance entities including islamic banks have outperformed and outpaced their conventional counterparts – the conventional interest based banks with the assets growth rate of more than 26.6 per cent with assets growth standing at an amazing 350 billion us dollars approximately, as compared to the mainstream banks who stood at an asset growth rate of 19.3 per cent. this performance as reflected in the growth rates shows the great potential and amazing progress of islamic finance institutions when we match these rates with the estimated rates of 15-20% ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 3 per annum, which were forecasted by most of the analysts globally. nearly all of the major interest based conventional banks have either already developed their islamic banking units and divisions or are in the process of establishing their islamic banking groups to tap the new and great emerging market. the greatly speedy and encouraging increase in the growth rate of islamic banking and finance around the world, beyond any doubt proved to be a wave of fresh breathing air for those who wished to be a part of modern banking and economic organizations including both banks and non-bank institutes, to participate in the economic process and to reap the benefits in shape of shariah compliant returns and profits. the industry growth provided a great opportunity to muslims to be a part of modern market economy while also being in conformity with their religious beliefs by not dealing in interest and speculation businesses, directly or indirectly. (usmani, taqi, 1999). it was in the year 1973 that a meeting of foreign ministers and delegates of almost all the major muslim states decided to setup an islamic monetary authority in shape of islamic development bank with the purpose and intentions of nurturing financial prosperity and socio-economic development of muslim countries in consonance with the tenets of islamic shariah. the event actually signaled the major initiative collectively taken by muslim countries to facilitate islamic finance sector (saad, 1998). as time passed, many muslim countries strengthened their own islamic banking and finance structures. the magnitude of success in this regard differed but progress on this account was surely made by many countries particularly by bahrain, oman, malaysia, egypt, pakistan, saudi arabia & uae. iii. origin of islamic banking in pakistan the islamization process in pakistan concurred with the movement of islamic finance in the world in the second half of 1970s. but it had its genesis in the very creation of the country. pakistan came into being by partition of the india in 1947 in response to the demand of the indian muslims to establish an independent homeland where they could practice islamic teachings. as a result, successive constitutions of the country have reiterated the intention of implementing the law and culture of islam in true spirit. the foremost expression of the will to practice islam had been to find a viable solution to refashion the financial institutions of the country on interest-free basis. it had always been in the subconscious of the ordinary muslims that islamic way of life naturally meant an interest free economic system; though very few even understood the vast implications of such a belief. but the intelligentsia of the country had a sizeable number of such people who sincerely believed that the prevalent commercial interest was not the riba prohibited by the qur'an. the main conclusions of the islamization were as follows. first, the islamization of banking in pakistan had not met with a success. most of the finance are still being provided by the savers and the bankers on interest although different terms were being used to camouflage it. second, the early days of islamization did see some genuine but inadequate efforts to eliminate interest from the economy but in a period of less than five years most of these efforts had either been reversed or, at least, further progress on them had been halted. third, a genuine attempt to eliminate interest from the economy would require plugging in all holes for interestbearing finance. so long as avenues for interest-bearing investment were open, the possibility of a successful transition to islamic system of finance would be well-nigh difficult. four, a true islamic system of finance would require the savers desirous of earning a return on their savings to assume risk as well. the principle of no-risk-no-return will have to be strictly enforced. this will mean a structural change in the role of financial institutions. five, the macro-economic management of the economy will also need to be in conformity with the islamic principles to make the experiment of islamic finance a success. the conceptual debate on the meaning of riba in pakistan revolves around two important points of view. the first, and by far the most influential, is the one propagated by the religious scholars and commonly believed by the general public. according to this, the prevalent commercial interest in financial institutions is the riba prohibited by the islamic law. the other view propagated by some modernist scholars such as fazalur rahman, ja'afar shah phalwarwi, mirza ahmad ali, syed yaqub shah in sixties of this century argued that the prohibited riba pertained to interest on consumption loans and not on commercial loans as in vogue in the financial institutions. the council of islamic ideology of pakistan (formerly advisory council on islamic ideology) is a constitutional body and consists of scholars of all shades and schools of jurisprudence. the council in its historic decision of 23 december 1969 categorically pronounced that all forms of interest were riba, irrespective of the purpose, parties, rates and duration involved. it also declared that discounting of bills of exchange, prize on prize bonds, interest on provident funds, and interest on loans to employees of the government, all fell within the purview of riba. the federal shari'ah court of pakistan, in november 1991, decreed that riba included all forms of interest including the prevalent system of mark-up. the decision struck from the statute book all those clauses of various laws which had a mention of the term "interest". it asked the federal government to devise new laws to replace the existing ones in the light of the islamic law by 30 june 1992 beyond which date the existing laws will cease to have effect, so far they are related to payment and receipt of interest. but the federal government, instead of implementing the decision of the federal shari'ah court, filed an appeal in supreme court of pakistan‟s shariah appellate bench. in the meantime, the supreme court had issued a questionnaire to solicit opinion of scholars and practitioners on various issues involved in transforming the existing financial system. the questionnaire showed that the supreme court would, in all probability, re-examine the whole issue once again. in june 1992, the commission for islamization of the economy issued its first report. the report on banks and financial institutions was based on the work done by a working group appointed by the commission and consisted of senior bankers and an islamic scholar. the report also categorically took the position that all forms of interest were riba and prohibited by the islamic law. ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 4 akram khan 1994 states that besides all these authoritative decisions and the earlier writings of the scholars and overwhelming opinion of the muslim ummah all over the world that all forms of interest were riba, there still remained a powerful lobby in the bureaucracy and financial circles which tried to confuse the issue. on and off, one could see articles being published in the popular media that the prevalent interest was not prohibited and that there was nothing wrong in the existing financial system. there was a strong need for disseminating the various aspects of the debate and to argue out the whole case in the popular media. the council of islamic ideology gave the conceptual lead and the islamization of financial institution was initiated with an order by the then president to the islamic ideology council on 29 th september, 1977 to design a plan for a riba-free islamic system of economy. the council assigned this task to a panel of economists and bankers who submitted its report in february 1980. the council examined this report and with several modifications issued its own report on the elimination of interest from the economy on june 15 th 1980. this report proved to be a milestone in the endeavors for islamizing of financial institutions in pakistan. it set out in sufficient detail a complete blueprint for elimination of interest from pakistan‟s economy. another landmark was achieved when the state bank of pakistan prescribes banking operations on islamic lines. based on the report of the council of islamic ideology the state bank of pakistan started issuing circular to the banks for transforming their operations on the islamic lines. from 1st january 1981, islamic windows were opened in all nationalized commercial banks. during 1981-85, the state bank of pakistan issued several instructions. very briefly, it prohibited the banks to accept any interest-bearing deposits and provide finance by interest-bearing lending. for deposits, it introduced the concept of profit-loss sharing (pls) for various durations, besides current accounts as already practiced. the pls depositors were now to share in the profit or loss of the banks. the state bank prescribed maximum and minimum ranges of this sharing and also the formula to work out the banks' management fee. for financing, the state bank prescribed twelve modes of finance. these modes of finance included musharaka, mudaraba, ijara, ijara wa iktina, equity participation, rentsharing, mark-up financing for purchase of goods, purchase of property with buy-back agreements, purchase of participatory term certificates, purchase of trade bills, and interest-free loans on the basis of service charge. these modes of finance provided a wide variety of menu to the banks. other financial institutions also introduce islamic schemes. simultaneously, other financial institutions also started transforming their operations. for example, the investment corporation of pakistan (icp), an investment bank, introduced a profit-loss sharing investment scheme. under this scheme, the icp accepted deposits and added its own share in proportion to 40:60. the funds thus collected were invested on the stock exchange and the profit was shared with the depositor in proportion to 60:40 but the loss was shared in proportion to capital invested by both the parties. similarly, the house building finance corporation started providing finance on the basis of rent-sharing. the national investment (unit) trust was also advised by the state bank to invest its funds on interest-free basis. in brief, during early days there was a lot of enthusiasm for islamization of the financial institutions. in the beginning the banking entities were reluctant to an extent, to adapt with the newly established interest-free system and endeavored to devise some ways to eliminate interest from their dealings. but very soon they started operating on the basis of mark-up and buy back arrangements. the mark-up and buyback transactions, as practiced in pakistan were two very similar techniques. these techniques were in fact camouflaged forms of interest. in the garb of fresh terminology and slogans, the banks kept on operating on the lines of old ways of interest bearing finance. the islamic forms of finance such as mudaraba, musharakah, ijarah, ijarah wa iktina,etc were not embraced by most of the banks and financial institutions. but even in those cases where, these islamic modes of finance were adopted, the banks introduced such changes in their application that the matter became dubious and some form of interest was introduced. (akram khan 1994) iv. growth/development & quantum of islamic banking in pakistan islamic banking initiative in pakistan in a true sense was categorically taken in 1979 when the government preliminarily decided to transform interest based non banking financial organizations like; investment corporation of pakistan (icp), bankers equity, house building finance corporation (hbfc) on riba free basis. at the same time the government also approved and encouraged commercial conventional banking institutions to provide depository accounts on the basis of profit and loss sharing, these were termed as pls accounts. from the mid of june 1985, the government barred all the banks from offering interest-based services and products. nevertheless, all interbank dealings and government linked dealings and the foreign currency accounts were permitted to continue operations on present basis i.e. on interest basis. (ahmad & abdul wajid, 2009). this signaled a new era of islamic finance in the country as the supreme court also issued a ruling against riba-based transactions and islamic ideological council of pakistan proposed a system of economy without interest. after the islamization steps by the zia regime in mid to late 1980s, strong footing was laid for the enactment of islamic finance entities in the country. the gradual and steady progress of islamic banks continued and the industry of islamic finance thrived as time passed. islamic banking is among the swiftest progressing components in the world‟s financial systems; the market distribution of assets in the islamic finance industry has risen from 2% from the late 1970s to an astounding 15% up to the middle of 1990s (yousef, 1996). presently, according to estimates, over 500 (sania & shehla 2012) islamic financial institutions, in more than 90 countries are involved in the funds management of more than roughly 500 billion us dollars in assets. moreover, over the last decade, the islamic finance and banking industry achieved an amazing growth rate of 15 to 20 percent per year (bose & mcgee 2008). the islamic finance ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 5 entities are not only functioning in the muslim countries but these are also playing their vital role in other countries where muslims are a minority, for instance, in the major countries of the world including the united states of america, the unite kingdom, china, australia, and france. furthermore the products and services offered by these islamic finance institutes are not only accepted and availed by the muslims but as well by the people from other religious beliefs and backgrounds. the reason behind the acceptability and attraction towards these islamic banking products and services is the compliance of shariah principles that prohibit ambiguity, confusion, exploitation, deceit and fraud and hence these have a great appeal to numerous non-muslims as well (venardos, 2006). islamic banking industry experienced a large-scale boom in many countries around the globe in the last 30 years (from 1980‟s). the performance and this encouraging growthrate was dominated and driven by the variables such as the introduction and effective implementation of large-scale macroeconomic reforms; refined and systematic framework policies in financial structure and systems, the global-scale coordination, integration and liberalization of financial and capital markets, privatization and the presentation of creative and diverse islamic finance products. all these factors now see islamic finance attaining new levels of sophistication and making it a reckoning force against the powerful conventional and interest based systems and markets. (cornelisse and steffelaar, 2008). as islamic finance has been able to win worldwide acceptance generally and in muslim majority regions particularly; by the early 2003 the number of islamic banks around the globe was 176 with deposits of more than of 147 billion us $. (ghanadian & goswami, 2004). besides many hurdles, islamic banks in pakistan grew progressively driven by the motives of shariah compliance, higher returns and service quality. the role of all the stakeholders including the central bank – the state bank of pakistan has been very positive. for this reason pakistan has been one of the fastest growing islamic finance industries in the world having superior statutory and legal framework, shariah governance experts and governmental support to a reasonable extent. according to kabir (1999), pakistan has an effective framework for better islamic banking regulation and control. the number of fully dedicated islamic banks operating currently in the country is five with branches in all the 16 major city-centers of the country. they include meezan bank (313 branches) topping all others in terms of branch network; al-baraka islamic bank, burj bank, bankislami pakistan and dubai islamic bank pakistan. in addition to these islamic banks having a total of 660 branches, there are fourteen non-islamic banks (conventional banks) that have fully operating islamic banking branches across the country numbered 440, taking the total number to an amazing figure of 1100 branches nation-wide as stated by the banking policy & regulations department, state bank of pakistan. the growth of ibds (islamic banking divisions) of conventional banks is also rapid and they are making strides to vie with the dedicated islamic banks to win maximum customers. the maximum progress banks include bank alfalah & standard chartered among other foreign conventional banks. according to a report, up to 2006, registered islamic banks in pakistan were six with 99 branches nationwide. (state bank of pakistan islamic banking bulletin 2007) the amount of assets held by these islamic banking institutions was approximately estimated at 1.3 billion us dollars with the total operations at an estimated 2.2% of the aggregate financial and capital markets of the country. the recent statistics of islamic banking industry in the country speak volumes about robust growth of the system as depicted by the amazing facts and figures in the latest sbp islamic banking bulletin (2013) which states that the total number of islamic banking branches in the country is 1100 (till march 2013) as compared to only 99 in february 2006; the total deposits of islamic banks stands at an encouraging figure of 9.7% out of total bank deposits and net finance and investment operations percentage is 8.5%. the trend was accurately forecasted in 2006 by al-refai who projected that the aggregate islamic banking deposits will be estimated to be at staggering 13 billion us$ approximately 10% of the total bank deposits in the country by 2014. the progress is still taking place as all the industry stakeholders are playing their role in the strengthening of islamic finance including the central bank of pakistan, the state bank of pakistan (sbp). sbp recently started a massive media campaign in the country to enhance awareness and to promote acceptance of islamic finance, its products and services. the campaign is part of an initiative that also includes a proposal to establish a country level shariah board to supervise the activities of islamic financial institutions and to ensure greater levels of shariah compliance in the products and service offerings of islamic banks and other islamic financial institutions. (bernardo 2013) v. conclusion islamic banking has shown an outstanding potential and has gradually grown from strength to strength in the last five decades, globally. an annual growth rate of over 16% demonstrates the phenomenal expansion of islamic banking and finance paradigm in the world. when we specifically survey the progress of islamic banking in pakistan, this can be said that it has been quite encouraging and consistent. the facts and statistics support the splendid growth of islamic banking initiative in the country; for instance in the initial years of islamic banking in pakistan i.e. from the late 1970s to 1990s, a growth rate of 13% was observed while it has been more than 30% according to the latest estimates (dawn 2014). apart from the positive progress, there are also some challenges and issues like shairah compliance, negative perceptions of people towards islamic banking, and mighty conventional/interestbased system ,that act as hurdles to the overall expansion of islamic banking in pakistan. these issues must be addressed discreetly and effectively to make sure that islamic banking keeps on the right track and continues to progress in the right direction. the potential and vision of islamic banking can only be realized if it favorably impacts all of the relevant stakeholders, principally its customers, and this can be ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 6 achieved through greater focus on research, innovation, product diversity, customer satisfaction & awareness. references [1] ahmad kaleem, rana abdul wajid, (2009), “application of islamic banking insturment (bai salam) for agriculture financing in pakistan”. british food journal, vol. 111 issue: 3 pp.275-292. [2] akram khan, muhammad (1994), “islamic banking in pakistan: the future path”, all pakistan islamic education congress; lahore, pakistan. [3] aqib ali, muhammad (2012), the concept & categories of riba (interest) and the rationale for its prohibition in the islamic economic framework, pipfa quarterly journal april-june 2012, volume 7, reg. no.: ss 1112. [4] ar-refai, m.a.b. (2006), „„unicorn investment bank enters pakistan‟‟, media release, unicorn investment bank, bahrain, 20 june, 2006. [5] bernardo, vizcaino, (2013), “pakistan launches media campaign to boost islamic finance”, reuters india edition, 19 th july 2013. [6] bose, s. and r. w. mcgee (2008). “islamic investment funds: an analysis of risks and returns”, florida international university chapman graduate school of business. [7] cornelisse, p. and steffelaar, w. (2008). “islamic banking in practice: the case of pakistan”. development and change volume 26 issue 4, published online: 22 oct 2008, 2009 institute of social studies. [8] council of islamic ideology (1980), “report on the elimination of interest from the economy”, published on june 15 th 1980. [9] dawn (2014), “islamic banking growing at 30%”, the dawn e-paper, january 16 th 2014, available at: http://www.dawn.com/news/1080554/islamic-banking-growing-at-30pc (accessed on: 16 january 2014) [10] gerrard , p . and cunningham , j . b . (1997) “islamic banking: a study in singapore” , international journal of bank marketing , vol. 15 , no. 6. [11] ghannadian, farhad f. and gautam goswami, (2004),"developing economy banking: the case of islamic banks", international journal of social economics, vol. 31 iss: 8 pp. 740 – 752 [12] humayun dar, (2013), “pakistan as a global leader in islamic banking and finance”, the express tribune, 24 th march 2013. [13] jaffe , c . a . ( 2002 ) “financial forms tailor products to lure muslims” , boston globe , 20 january 2002. [14] kabir, m. hassan, (1999),"islamic banking in theory and practice: the experience of bangladesh", managerial finance, vol. 25 iss: 5 pp. 60 – 113. [15] kapur, s. (2008), “islamic banks post 26.7 percent growth rate”, available at: www.zawya.com/story.cfm/sidzawya20080325033525. [16] khan, m. mansoor, m. ishaq bhatti, (2008),"islamic banking and finance: on its way to globalization", managerial finance, vol. 34 iss: 10 pp. 708 725 [17] laldin, mohamad akram, (2008),"islamic financial system: the malaysian experience and the way forward", humanomics, vol. 24 iss: 3 pp. 217 – 238. [18] rammal , h . g . (2004) “mudaraba in islamic finance: principles and application”, business journal for entrepreneurs , vol. 4. [19] saad a. metawa, mohammed almossawi, (1998),"banking behavior of islamic bank customers: perspectives and implications", international journal of bank marketing, vol. 16 iss: 7 pp. 299 313 [20] sania khalid, shehla amjad, (2012),"risk management practices in islamic banks of pakistan", the journal of risk finance, vol. 13 iss: 2 pp. 148 – 159 [21] state bank of pakistan (2006), islamic banking bulletin february 2006. [22] state bank of pakistan (2013), islamic banking bulletin march 2013. [23] usmani, muhammad taqi (1999), islamic finance, new steps, darul uloom, karachi. [24] venardos, a. m. (2006). islamic banking & finance in south-east asia its development & future. world scientific publishing company, singapore. [25] yousef, t. (1996), „„islamic banking and financial development and growth‟‟, forum, vol. 3 no. 3. [26] zaman, dr. asad, (2013), “islamic economics and the global financial crisis”, islamic economist, 18 th july, 2013. http://www.dawn.com/news/1080554/islamic-banking-growing-at-30pc ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france http://www.ojs.unito.it/index.php/ejif 1 waqf as a socially responsible investment instrument: a case for western countries mujtaba khalid* *center of islamic finance (cif) comsats ciit abstract — in light of the progression of islamic finance in non-muslim countries and the design of innovative financial products, the next frontier for islamic finance is to attract customers and investors from beliefs other than islam. this paper examines and discusses the case of a specific islamic contract, waqf and highlights its possible use as a (socially responsible investment) sri offering which is not only attractive to the non-muslim investor, but also in-line with the actual spirit of islamic teachings. the methodology is an examination of the waqf contract through different sources of islamic law as well as an evaluation of mainstream secondary literature on the link of corporate social responsibility and investor prospection in non-muslim countries. the ultimate result is a proposed viable waqf product which is in-line with the spirit of islamic teachings and can be an attractive proposition to the socially conscious investor. keywordswaqf, socially responsible investing, islamic finance evolution, islamic finance and non-muslim countries introduction the social development of poor countries has become a foremost issue in major economies of the world. the past fifteen years or so have seen a shift among the psyche of consumers, especially in western countries, that prefer products and services which are “environmentally friendly” or “socially responsible”. firms which are genuinely committed to the welfare of society be it environmental issues like reducing its carbon foot-print (the amount of greenhouse gases released in the atmosphere directly or indirectly by a firm) or working for the social uplift of rural communities in under-developed countries are favored. such firms promote themselves as having a unique selling point and in certain cases charge premiums on their products and services which consumers are willing to pay. a growing section of the financial sector is also beginning to reward businesses which identify the link between doing business and being environmentally friendly. this is evident from the increase in what is known as socially responsible investing (sri). islam as a religion emphasizes the betterment of society and goodwill among humans; therefore all activities of muslims are to be centered on upholding the highest ethics and social responsibility. shari‟ah are a the set of rules derived from the primary and secondary sources of islamic jurisprudence and cover areas relating to all aspects of a muslim‟s religious, political, social, domestic and private life. on many occasions islamic teachings emphasize the duties of muslims towards humanitarian and social welfare. many examples such as the quranic verse below can be found in the teachings of islam; indeed, allah orders justice and good conduct and giving to relatives and forbids immorality and bad conduct and oppression. he admonishes you that perhaps you will be reminded. surat an-naĥl (16:90) it is interesting to note from the verse above that muslims are not only forbidden from bad conduct and immorality but are ordered to actively do good. problem statement ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 2 although islamic financial assets worldwide have shown phenomenal growth, there has been considerable resentment from certain quarters that these products lack the actual spirit of islamic teachings. moreover, as the islamic finance industry starts to expand, especially in non-muslim countries, there should be a strategy shift to make islamic financial products more appealing to the non-muslim demographic. objectives in light of the above, the islamic finance industry can address both these issues by structuring an alternate product which is in line with the spirit of islamic teachings and therefore shall lead to societal benefit. this would a win-win for the industry as the next section shows that being socially beneficial leads to a positive impact on a firm‟s earnings. this paper will look to: 1. assess conventional secondary western literature linking social responsibility and firm profitability 2. analyze the implications of the waqf contract for non-muslims 3. propose a workable waqf investment structure that can be marketed to both muslims and nonmuslims. literature review social responsibility and investor perception investigating different studies and papers it was discovered that even though there is a wealth of papers that look in to corporate social responsibility or socially responsible investing on one hand and waqf on the other, but there were no studies that actually made a connection between the two. the literature review will therefore be in two parts, first looking at socially responsible investments followed by studies looking into the waqf structure and its implications for non-muslims. we start off by looking at studies that underlie social responsibility being rewarded by investors. for example king and lenox (2001) [1] show that an increase in the value of us firms is directly related to a firm adopting environmental standards. dowell, hart and yeung (2000) [2] share a similar view that firms following a single stringent environmental policy tend to have higher market value. feldman, soyka, and ameer (1996) [3] from their analysis find that improvements in a firm‟s environmental performance results in the stock price being less susceptible to market movements, which in turn leads to an increase in a public company‟s stock price thus making it a better investment. russo and fouts (1999) [4], establish that firms that follow an environmentally friendly policy benefit from having intangible assets such as goodwill which increases a firm‟s profitability. in abramson, lorne, chung and dan (2000) [5], the authors „findings state that socially responsibly screened portfolios offer competitive returns both in the short and long run, compared to the benchmark return. there are also studies that shed light on the type of consumer that opts for socially responsible investing and how ethical investing affects consumer decision making. rosen, sandler, and shani, (1991) [6] finds that socially responsible investors belong to a demographic that is younger and better educated than to their conventional counterparts. owen and qian (2008) [7] find evidence that demographic characteristics as well as non-financial motives influence investors to opt for sri products. williams (2005) [8] implies that the portfolio strategies of consumers are linked with their behavior and attitudes toward social aims.webley,lewis and mackenzie (2001) [9] provides evidence that ideology rather than financial return is the main motive for socially responsible investors as they were found to keep or even increase their ethical holdings when such investments underperformed the market. waqf even though there is no direct reference in the quran about waqf but the contract is derived from the traditions of prophet mohammad (pbuh). for example: umar bin khattab got some land in khaibar and he went to the prophet to consult him about it saying, "o allah' apostle got some land in khaibar better than which i have never had, what do you suggest that i do with it?" the prophet said, "if you like you can give the land as endowment and give its fruits in charity." so umar gave it in charity as an endowment on the condition that would not be sold nor given to anybody as a present and not to be inherited, but its yield would be given in charity to the poor people, to ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 3 the kith and kin, for freeing slaves, for allah's cause, to the travelers and guests; and that there would be no harm if the guardian of the endowment ate from it according to his need with good intention, and fed others without storing it for the future." narrated by ibn 'umar sahih bokhari volume 3, book 50, number 895 the word waqf in arabic refers to the “stopping” (one basic meaning of the arabic root verb, waqafa) of some piece of property. according to sheikh saleh al-fawzan [10], a waqfcan be made to benefit the family of the donor or the public for charitable purposes. the charitable purposes could be general or specific (e.g. for the purpose of education only). certain conditions apply in order for the waqf to be valid. these include: 1. that the person who is setting up the waqf is one who has the authority to dispose of his wealth. 2. that the property given as a waqf should be something from which ongoing benefit may be derived whilst its original essence remains. things which can be depleted cannot be given as a waqf, such as food. 3. that the property given as a waqf should be something specific. a waqf consisting of something unspecified is invalid. 4. it is not permissible to set up a waqf for purposes that are not good, such as helping people to commit sin. 5. in order for the waqf to be valid it must be executable with immediate effect. among the rulings on waqf, is that it is obligatory to act in accordance with the wishes of the one who set up the waqf, so long as it does not go against shari‟ah.there is consensus among shari‟ah scholars that it is permissible for non-muslims to both start a waqf and also be considered for receiving benefits of a waqf endowment. according to b.ali (2009) [11]even non-muslims in muslim countries established waqf for the benefit of their communities. waqf can also be in the form of certificates as implemented by social investment bank limited (sibl) bangladesh. hasan, samiul (2007) [12]. mannan (1998) [13] summarizes the objectives of cash waqf certificate as: 1. to provide liquidity to banks and waqf institutions by helping to channel social savings through the cash waqf certificate. (names of family members can be nominated to strengthen integration among rich families 2. for the development of a social capital market and increase social investment 3. to increase rich communities‟ awareness on their responsibility for social development 4. to stimulate integration between social security and social welfare. considerations as a waqf is to continue till no more economic benefit can be taken from the asset, we have to structure an investment product for perpetuity; this means that we have to look at an investment strategy that gives preference to capital preservation. we also have to take into consideration the time value of money for the capital fund and have to plough part of the income generated (depending on the inflation factor) back to the capital fund. another important aspect to be considered is that the actual capital amount cannot be used for either charitable purposes or as investment returns to the person(s) nominated by the waqif (capital provider or investor). it should be noted here that it is widely accepted by shari‟ah scholars that the waqif cannot nominate himself as the benefactor of the waqf income but can nominate his or her family members for example spouse or children. according to marzuki, shahimi, ismail and zaini (2012) [14] immediate disbursement is not necessary as there is already the charitable instrument of zakat for that. the paper also states that the cash waqf model has advantages over conventional microfinance which can act as a unique selling point in attracting non-muslim ethical investors; due to the structure of the cash waqf model (discussed later on) sustainability is ensured. this is because the capital collected is not to be dispersed and only proceeds of investments are to be used for disbursement. unlike the waqf, microfinance institutions have to balance deposits and loans for liquidity management. ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 4 another criticism of microfinance institutions is that due to the higher probability of loan default, they charge high interest rates which require weekly payments. it is also sometimes stated that microfinance institutions sometimes have to turn away the really needy as they may not be able to find guarantors or because the credit risk it very high. this is not the case for cash waqf as their survivability is not dependent on the repayment of borrowers. moreover, due to the islamic nature of waqf, borrowers can either be given a benevolent loan or a capital investment (mudarabah contract). proposed structure to start off, an investment firm will float waqf certificates in denominations of whatever value suits the specific jurisdiction. these certificates will be of two types both aimed at different type of social investor: 1) general waqf certificates: these will be aimed for people more inclined towards using the waqf as a purely charitable instrument i.e. they leave it to the discretion of the waqf institute to disburse the investment returns to whomever it deems worthy or invest in whatever social project chosen in accordance with the rules set-out by the institute. nominee waqf certificates: this certificate will give the investor the choice to have a specific nominee(s) receive the returns of the capital invested. as discussed earlier, the waqif cannot nominate him or herself. it should be made clear to specific waqf certificate holders that a certain percentage of their investment returns will be used for socially beneficial projects before being disbursed to their specific nominee(s). the investment strategy should be structured in a way that not only preserves the capital but also leads to capital appreciation and income generation. an advantage to conventional investment funds is that as the waqf certificates are non-redeemable, almost all of the capital can be invested. as the waqf structure has a very long term horizon, investments can be made in illiquid assets such as real estate which can lead to capital appreciation. these properties can also be income generating i.e. through rent. for stable cash flows, investments can be made into islamic or shari‟ah compliant fixed income instruments such as sukuks. investments can also be made in shari‟ah compliant equities but after considerable due diligence. a percentage of the income generated can be used to invest in socially responsible, shariah compliant businesses using a mudarabah contract. this can act as both income generating and helping entrepreneurs looking for seed capital. the reason why generated income rather than waqf capital is used for the mudarabah contract is to minimize risk as much as possible. a percentage of the generated income can also be used to give out interest free loans to needy people using the qard hasana contract. (figure 1 for graphical representation of structure) conclusion we started off by stating the problem that current islamic financial products are more inclined towards compliance as a box ticking exercise rather than actually being islamic in nature and spirit. another issue was that islamic finance picks up globally, islamic financial institutions especially in non-muslim countries should expand from a muslim majority consumer base to a more diversified one. this paper proposed the use of the islamic social contract of waqf as a possible solution for both the issues. this study was mainly an investigation of: a) the positive relation between social responsibility and increased firm value b) the waqf contract – its implications and different considerations using secondary literary sources, the paper proposes a viable shariah compliant alternative socially responsible investment (sri) certificate. ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 5 qard hasana – benevolent loan figure 1. structure of waqf income generated investments capital preservation/ appreciation capital investment share of profit benevolent loans paid back original waqf capital disbursement fund general waqf certificate nominee waqf certificate investment strategy: 1) capital preservation – long term e.g. real estate 2) capital appreciation – shariah complaint equity investments, real estate 3) regular income – shari‟ah compliant fixed income/ sukuks nominee payout mudarabah – equity partnership ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 6 references [1] king, a.a and lenox, m.j. 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[7] owen, ann l. and qian, yejun. (2008) "determinants of socially responsible investment decisions," hamilton college sustainability working paper #2008-2 [8] williams, g.a. (2005) “some determinants of the socially responsible investment decision: a cross country study” journal of behavioral finance, 8(1): 43-57 [9] webley, p., lewis, a., and mackenzie, c. (2001): “commitment among ethical investors: an empirical approach” journal of economic psychology 22: 27-42. -alصالح به فوزان الفوزان قراءة صوتية الملخص الفقهي [10] mulakhas al-fiqhi – shaikh saleh al-fawzan a summary of islamic jurisprudence [11] ali. b, imtiaz. (2009) “waqf a sustainable development institution for muslim communities” takaful trinidad & tobago friendly society booklet [12] hasan, samiul. (2007), philanthropy and social justice in islam, principles, prospects, and practices, a.s. noordeen, gombak, kuala lumpur, malaysia. [13] mannan, m.a.abdul, (1998) “cash waqf; enrichment of family heritage generation to generation”, social investment bank press, 1st edition. [14] marzuki, m., shahimi, s., ismail, a. and embong, zaini (2012) “tackling poverty: a look at cash waqf”prosiding perkem vii, jilid 2 (2012) 1611 – 1623issn: 2231-962x ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6901published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 08/06/2022 accepted for publication: 18/11/2022 published: 29/12/2022 21 the potential and challenges of decision support systems for islamic banking and finance othman bin abdullah1, amir bin shaharuddin2, muhamad azhari bin wahid3, mohd. shukor bin harun4 1,2,3,4 universiti sains islam, malaysia contact author 1*: othman_249@yahoo.com contact author 2: amir.ywm@gmail.com contact author 3: azhariwahid@usim.edu.my contact author 4: shukorharun@usim.edu.my abstract a decision support system (dss) is a computer system designed to help with decision-making processes. dss usage is now commonplace in personal and commercial decisionmaking – including decisions related to the islamic faith. simple applications (apps) that help with simple decisions – such as ascertaining the halal status of products and proprietors are prevalent. to what extent can dss facilitate more complicated islamic decision-making, such as fiqh rulings, hadith classifications, and zakat or faraid computations? this paper aims to review dss initiatives (academic and commercial) intended for these more complicated islamic or shariah decisionmaking processes, and to identify the potential and challenges – particularly in the contemporary ijtihad of reviewing and certifying shariah-compliant status for islamic finance products and services. the new digital mindset incited by ir 4.0, and accelerated by the covid-19 pandemic, has paved the way for the potential for islamic dss – particularly for the islamic banking and finance industry. artificial intelligence (ai) technology makes it possible to represent islamic knowledge in a computerprocessable format and to enable complex shariah decisionmaking. the main challenge is getting a human shariah expert who can translate his/her knowledge into said computable format. this has thus far led to a lack of islamic dss in the market, which can be utilized to support shariah-related decision-making. keywords islamic decision support system; islamic banking and finance; shariah robo-advisor i. introduction the use of computer applications (apps) that provide decision-making recommendations has become increasingly popular. such “recommender systems are software tools and techniques providing suggestions” to a user which “are aimed at supporting their users in various decision-making process, such as what items to buy, what music to listen or what news to read” [1]. an example is google maps or waze, that recommend the best routes to a destination, foursquare that recommends places to dine and tripadvisor that recommends travel destinations. systematic decision making driven by computer systems has also helped commercial organizations to operate more efficiently. for example, business data analytic (bda) tools enable data driven decision making to predict sales, maintain healthy inventory levels, and to enhance customer relationships – which ultimately leads to increased revenue and profits. according to lim kim heng, the executive chairman of seng heng (one of the largest electrical appliances chain stores in malaysia), in his book sengheng digital journey, “bda goes beyond just looking at numbers to see what has happened; it also endeavours to give insights into why things happen and suggests what actions to take next” [2]. muslims have some unique decisions to make which are related to the religion of islam. familiar examples of simple islamic dss apps are those that often used to determine qiblah (prayer direction), locate halal restaurants and/or determine the halal status of consumer products. a few popular apps that provide such services are muslim pro, verify halal, and zabihah (the original halal restaurant guide). there have also been numerous efforts to incorporate shariah knowledge into dss providing some form of technological assistance in decision making for more complex shariah matters, such as fiqh rulings, faraid computations, zakat computations, and hadith classifications, etc. such innovations have been given various names such as islamic expert systems, islamic decision support systems, and islamic intelligent tools. while islam has provided the methodology and the formula for these decision-making processes, some are more complicated than others. for example, zakat and faraid computations are quite straight forward, however the fiqh ruling process requires qualified scholars to perform ijtihad, following a prescribed methodology of usul al fiqh in order to arrive to certain decisions. one of the contemporary ijtihad is the shariah approval process of islamic banking and finance products and services. this serves to certify that these products and services are shariah compliant, before they can be offered to the public. there have been a few attempts to develop decision support systems intended to assist fiqh ruling processes. for example, el bayane (to assist a mujtahid in generating fatwas for new situations by using fatwas issued in past situations) [3], and al european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6901published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 08/06/2022 accepted for publication: 18/11/2022 published: 29/12/2022 22 usoly (to automate the very complicated process that usually requires a human mujtahid). unlike the el-bayane that can only be applied in the field of drinking, the al-usouly system can be applied to any field in shariah [4]. dubai has launched its “world’s first artificial intelligence fatwa service” [5]. “skil shariah robo-advisor (rsa) is claimed to be the first expert system for islamic finance, whereby users can ask intelligent questions, conduct comparative analyses, deduce from legal maxims, and consult an automated legal advisor, about complex scenarios” [6]. in the study of the technology applied in ijtihad process – particularly artificial intelligence (ai), ahmed concludes that ai has not reached a level that can replace human shariah scholars, but that ai can help a human mujtahid [7]. the purpose of this paper is to review decision support system initiatives (both commercial and academic) related to these complicated “islamic” decisions, and to discuss the potential and challenges therein. this discussion is crucial because the world is going through the 4th industrial revolution, where technology and automation have become a major part of everyone’s life. humans increasingly depend on smart assistants incorporated with various technologies that could assist them in making guided decisions, in order to be more efficient in this fast-moving digital era. the financial services industry in particular has been going through a digital transformation facilitated by financial technology. islamic financial institutions (ifis) have unique requirements for ensuring that their products and services are shariah compliant. to be competitive, these ifis have no choice but to embrace new financial technologies with additional efforts to explore digital innovations, such as decision support systems for shariah related matters in ifis’ operation. currently the use of systems or tools in shariah review processes in islamic financial institutions is still limited. an interview with mr. mazrul shahir md zuki, a member of shariah committees (sc) of malaysian industrial development finance berhad (midf) reveals that at the moment, the fiqh ruling process in ifis are largely manual – except for using simple computer software such as jami’ fiqh that contains database of 100 books in the islamic field, to locate references related to juristic opinions and resolutions. other than this, sc members will have to read, digest, analyze, and synthesize the reference materials by themselves. this necessitates greater efforts to develop and promote the usage of decision support systems for islamic banking and finance, in order to help speed up the decision-making process. this paper will review relevant literature and media on contemporary digital innovations, including published journals, technical reports, blog posts, online newspaper articles, and youtube videos. the content of this literature and media will be analyzed to identify the potential and challenges therein. it is expected that the stakeholders of islamic banking and finance (ibf) will be optimistic about the potential for decision support systems to help make ibf operations more efficient, and any technological innovations available for such systems or tools. however, the supply of these systems or tools are limited because they are challenging to develop, due to the need to not only be well versed in shariah ruling processes, but also be able to represent this knowledge in a computer processable format. the remainder of this paper comprises a literature review, a methodology, and discussions of the potential and challenges of islamic dss solutions, followed by a conclusion. ii. literature review 1) overview of decision support system 2) general shariah related dss initiatives 3) general fiqh ruling or fatwa related dss initiatives 4) islamic banking and finance related dss initiatives a. overview of decision support systems some scholars define decision support systems as “computer technology solutions that can be used to support complex decision making and problem solving” [8]. “knowledge-based decision support systems are systems designed to ensure more precise decision-making by effectively using timely and appropriate data, information, and knowledge management” [9]. these systems apply artificial intelligence techniques and other applications of information and communication technologies. a dss can also be understood as “an information system that aids a business in decision-making activities that require judgment, determination, and a sequence of actions” [10]. a dss can be employed in various knowledge domains such as medical, dietary, pollution detection, drug reaction, and credit scoring, etc. the “knowledge” that drives the decision making can be models, documents, data, or any predefined procedures or rules. in some cases, a dss can analyse real time data – making the decision-making choices more relevant and up to date. the most obvious advantage of using a dss is speed and efficiency in decision-making, leading to better quality and more accurate decisions. other advantages include more systematic ways of making decisions – particularly for structured types of problems that can be automated based on past decisions, or those that are data driven. where part of the decision-making process is automated, human managers will have more time to focus on tasks that require real human intelligence. simpler dss solve structured problems and make use of explicit knowledge to facilitate decision making. “dss uses explicit knowledge, stored in digitalized environments to solve the structured part of the problem, meanwhile tacit knowledge is utilized by decision makers to solve the unstructured part of the decision problem” [11]. explicit knowledge is codified knowledge, such as that found in documents, whereas tacit knowledge refers to non-codified knowledge, which is often personal, or experience based [12]. more sophisticated dss which apply ai techniques (expert systems, artificial neural networks, intelligent agents, etc.) in their algorithms, incorporate both explicit and tacit knowledge, and have the capability to solve more complex and less structured problems [13]. the motivation to adopt knowledge management and dss systems in the business world is the potential to achieve european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6901published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 08/06/2022 accepted for publication: 18/11/2022 published: 29/12/2022 23 superior performance. dss enhanced by the concept of knowledge management is essential for the success of organizational strategic management. alyoubi illustrates how data, information and knowledge can be combined, filtered, and understood to formulate strategic knowledge for growth, competitiveness, and objective strategies that can guide decisions and actions, which will lead to superior organizational performance [14]. b. general shariah related decision support system initiatives this section reviews islamic dss initiatives that are generally associated with the shariah domain – such as zakat, waqaf, faraid, hajj, and hadith classification etc., but excluding those related to fiqh ruling and islamic banking and finance, which will be discussed in the following two subsequent sections respectively. a summary of general islamic dss initiatives follows: • a cash waqaf distribution system using a decision tree (supervised machine learning) algorithm that can generate a list of beneficiaries. the proposed system is a web-based system that helps in the distribution of waqaf funds, which allows users to choose the type of waqaf that they would like to apply [15]. • an arabic ontology-based inheritance calculation system that can reduce the time needed to process family data and reduce human efforts in the search for family relationships throughout the process of calculating islamic inheritance. the system has the capability to automatically identify heirs’ information, such as how many there are, their genders, and their relationship(s) to the deceased [16]. • a mobile app decision support system that allows users to ask simple and advanced questions related to hajj rituals. the proposed system makes use of a dynamic knowledge-based approach that can capture problems and find solutions, preprogrammed by an expert [17]. • an expert system for zakat application that can assist in the decision-making process, the identification of the relevant rules, and in doing the calculations. the specific objectives are to determine: if someone is required to pay zakat, the unique conditions applied, and the amount applicable for the zakat types to be paid [18]. • a system called muhadith was designed to enable a computer to imitate human hadith experts, in order to discriminate authentic ahadith from unauthentic ones. muhadith also includes reasoning capability, that can enable users of the system to look into the classification details. users can enter the hadith using a web interface, and the inference engine will return the results, along with the explanation [19]. • an expert system on “islamic punishment”. the proposed system derives the recommended punishments from a knowledge base created from the quran and hadith. the three motives behind the system includes: to distribute human expertise to this science, to prevent injustice in punishment by applying islamic laws to this science, and to preserve the punishment laws in islam from becoming lost or forgotten [20]. • a rule-based expert systems on islamic medication that runs on a mobile platform so that “patients can get treatment anytime and anywhere”. the system focuses on both physical and inner illnesses, to derive the recommended cures, treatments, or therapies, from a knowledge base created exclusively from the quran and hadith. the proposed system would have the capability to recommend the most suitable treatment for an illness, with reference to the relevant verses cited in the quran or hadith. it will also recommend the related bodily actions, gestures or acts, to be performed by the patient, in order to treat his/her particular ailment [21]. the examples above covering dss for waqaf, faraid, hajj, zakat, hadith classification, “islamic punishment”, and “islamic medication”, demonstrate the extent of how diverse dss can be implemented to assist in various shariah domains. as observed in these examples, the possibilities are seemingly endless, so long as there is enough creativity to leverage the latest technologies to innovate solutions that can (at least) guide in making shariah related decisions – or potentially fully automate them. mobile apps related to waqaf, zakat, and faraid calculations are already commonly used by muslims globally. c. general fiqh ruling decision support system initiatives this section reviews fiqh ruling dss in general. fiqh rulings or fatwa are a very serious subject in islam, which can only be decided by qualified scholars. fiqh rulings may change under different circumstances, and therefore muslims require continuous guidance. the number of queries typically increase during peak seasons – such as hajj and ramadan. various attempts have been made to explore how technology can help to address muslims’ fiqh ruling needs. the following contains a summary of initiatives that are either related to, or have attempted to come up with, a computerized system for storing and smartly processing islamic law, which users could access as a reference for deciding upon fiqh ruling related matters: • the saudi arabian ministry of islamic affairs launched a robot-assisted service that can provide fatwas for pilgrims that are performing hajj. the service is available in arabic, english, french, hindi, turkish, hausa, indonesian, bengali, and amhari [22]. • dubai launched ‘virtual ifta’, an artificial intelligence (ai) fatwa service. the ai-powered virtual ifta is able to take live questions via internet chat, and replies accordingly. the service is available 24 by 7 [5]. • munshi, al sabban, farag, rakha, alsallab, and alotaibi proposed an automated islamic fatwa system that provides rapid responses to fatwa related questions – especially during high seasons, such as hajj and european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6901published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 08/06/2022 accepted for publication: 18/11/2022 published: 29/12/2022 24 ramadan. the authors built “the largest dataset for islamic fatwa, spanning the widely used websites for fatwa” [23]. • khan, siddiqui, siddiqui, saeed, and touheed proposed an enhanced ontological model for an islamic jurisprudence system in the form of question and answer (qa) ontology, which can simplify the extraction of unambiguous information about islamic jurisprudence (fatwa). the answers to users’ questions come with supporting quran and hadith references, so users can authenticate and understand the relevant quranic verses or hadith related to their question [24]. • mabrouk proposed a model-based semantic network for smart representation and inference of islamic law. the model comes with a smart deduction engine that provides compact codes of fiqh rules and deduces answers to queries relevant to these rules. the main functions comprise the storage and retrieval of fiqh rulings, selective browsing to obtain answers, comparative analysis for rulings of different situations, coding and deduction from fiqh rules, and fatwa assistance [25]. • harb and sharaf proposed an intelligent islamic fatawa retrieval system, as an agent-based system for information retrieval, based on ontology, that is applied to fatawa. each fatwa in dar al eftaa el mesria database “is annotated by its meaning, so the system locates fatwas based on its meaning and not just keywords”. a user looking for a fatwa can submit a new query, and the system will extract the already stored fatwas that semantically match the query [26]. • amari, atil, bounour and nouaouria proposed an intelligent tool for mufti assistance – an expert system (es) that can give fatwas for new situations by using fatwas from past situations. the es is intended to assist a mufti in generating fatwas from second principle. the system could be also used to retrieve information by any other user that may have questions about the field [27]. • elhalwany, mohammed, wassif, and hefny proposed an intelligent fatawa qa system that using textual case-based reasoning (tcbr). the proposed system will respond to fatwa related questions by referring to a knowledge base library of past cases, in order to identify cases with similar situations to that of the posed question. the fatawa qa system is for text indexing, retrieval and system learning, using a smart approach. the system is expected to be able to overcome the language and domain challenges [28]. • abdelwahab, daghbouche, and shahnan came up with a generic algorithm for deciding fiqh rulings with full transparency and complete algorithmic coverage of islamic law, to enable and further leverage rule of law (as opposed to rule by law). the objective is to provide legal security, legal equality, and full legal accountability of fiqh rulings. the steps in the algorithm involve disentangling and reinstating classic fiqh-methodology (usul al-fiqh), as represented by the expressive power of subsets of first order logic [29]. • mutawa and al-terkait proposed al usouly, an expert system in the origins of islamic jurisprudence domain. a knowledge-based expert system that can automate the generation of fatwa by applying rules deducted from quranic verses. the intended purposes of alusouly are to serve shariah scholars who are not specialists in usoul al-fiqh, for students or muslims in general who are interested to understand the intended meaning of quranic evidence, to understand a fatwa, and “as a tool or a decision support system for a mufti who generates fatwa from extrapolation which determines the hidden relationships and associations among incidents” [4]. • nouaouria, atil, laskri, and bouyaya proposed elbayane, a case based reasoning (cbr) system that can help muftis generate fatwas for new situations by using fatwas of past situations. being able to ‘reuse’ past fatwas, the system organizes its knowledge in cases which are collected in a memory, called a casebase. subsequently, through inference processes, the system will be able to find and reuse the appropriate fatwa and its argumentation [3]. from the above summary, the robot fatwa service operating during hajj in saudi arabia and the artificial intelligence fatwa service in dubai, are commercial initiatives for fiqh ruling or fatwa related ai decision support systems. the remaining summarized solutions are academic papers. generally, the authors qualify that their proposed systems or tools are to be used as complementary to human shariah experts. in addition, realizing that there are already databases of fatwas hosted by different parties, and that very often similar questions are asked, and therefore would have been answered in the past, some of these works took the initiative to consolidate fatwa databases and provide the capability to automatically retrieve similar past fatwas that match a user’s query. this may help to reduce the number of questions that human fatwa experts need to address, so that he/she can focus on fatwas related to circumstances that have not been dealt with previously. some of the works described in the above summary are more advanced than others, where the authors [4][24][25][29] propose systems that would have the capability to recommend solutions derived from islamic sources of knowledge, such as the quran and hadith. for these works, the authors elaborate upon the technical details of how to derive an ontology (knowledge representation) that can represent quranic verses and hadith in computer language, and how logics could be programmed atop these ontologies to facilitate shariah related decision making. these works have demonstrated the possibility to represent islamic knowledge in computer language. subsequently, computer algorithms could be programmed to automate the retrieval of relevant past fatwa which match a query. more sophisticated algorithms could provide recommendations for fatwa or fiqh rulings for new circumstances. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6901published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 08/06/2022 accepted for publication: 18/11/2022 published: 29/12/2022 25 d. islamic banking and finance decision support system initiatives this section focuses on shariah related decision making dss initiatives in islamic banking and finance operations. the most commonly discussed islamic dss are digital investment advisors. some literature also refers to such dss as roboadvisors – a term that started as a disruption in wealth management, whereby investors could proceed with investments following “automated advice” provided by a digital investment platform. wahed invest is known as a pioneer in robo-advisors, providing shariah compliant investment options [30]. subsequently, there are a few initiatives to develop shariah robo-advisors which refer to dss which provide recommendations related to shariah matters of islamic banking and finance. these initiatives are summarized below: • obaidullah shared about the “promise of irshad: the intelligent robo shariah advisor”. irshad is currently still under development and will be released in phases. modules in the pipeline include “zakat advisor”, “islamic wills and inheritance advisor”, and “investment advisor for socially responsible islamic organizations and financial institutions seeking to operationalize the sdgs in the light of the maqasid al-shariah”. irshad has been developed using various ai technologies such as “rule-based programming”, “ai-based text-analysis”, “nlp tools for translation and text-to-speech capabilities”, and will eventually feature analysis of real time data using “dynamic ai-based models” [31]. • salim, abojeib, and abdul hamid, in “2020/21 islamic fintech in malaysia – reality & outlook” featured a case study on skil-rsa, an online platform that utilizes artificial intelligence technology and aims to be a decision-support system for islamic financial institutions. skil-rsa has been referred to as a “mufti companion” or “mujtahid assistant” which allows users to ask intelligent questions, conduct comparative analyses, deduce from legal maxims, and consult an automated legal advisor about complex scenarios. skil-rsa has already been adopted by mbsb bank malaysia, and is hosted on the mbsb website, where it is accessible to mbsb employees and customers [5]. • benlaharche and nouaouria proposed an expert system that utilizes case-based reasoning to assist in generating fatwas related to new situations in islamic banking and finance by using fatwas from similar past situations. the proposed system can save past fatwas in a case-based memory, for which the target users of the system are “expert muftis”, and “learner muftis”. the “expert muftis” are given authority to add, update or delete fatwa, whereas both expert and learner muftis can recover a fatwa by “interrogating the system” via a user interface screen where they can enter their queries in the provided fields, following specified criteria [32]. • che mohd salleh and mohd nor proposed “a framework of intelligent information retrieval (iir) for shariah sources using support vector machine (svm) for shariah decision making in the islamic financial industry (ifi)”. svm is a machine learning technique used mostly for regression, information classification, and outlier detection. the proposed framework will provide “an efficient platform for the shariah scholars, as well as industry players in gathering sufficient information for decision making processes in order to run the islamic business and also to resolve shariah issues that they encounter” [33]. • tlemsani, marir and majdalawieh proposed a machine learning data mining technique that analyzes quran and hadith texts to validate whether all the activities and data flows in murabahah financing contracts are compliant with the shariah requirements. as part of the project, the proposed technique managed to identify some shortcomings with regards to the compliance level of existing islamic banks’ murabahah financing contracts with shariah law [34]. from the above summary, irshad and skil-rsa are commercial initiatives, whereas the others are academic papers. similar to the dss initiatives for the general fiqh rulings, there are attempts to facilitate the retrieval of similar shariah rulings from past cases that are relevant to current situations. the most advanced initiative is skil-rsa – which has already been adopted by at least one islamic financial institution in malaysia. an important observation is that these “shariah robo advisors” have not reached the level to replace a human yet. at best, they can only function as a smart assistant to a human shariah advisor, in order to speed up his/her work. literature in this area is quite limited which may indicate that there is not much work has been done in this area yet, and therefore provides great opportunity for both commercial entities and academics to explore further. iii. methodology this paper reviews commercial and academic works related to islamic decision support initiatives. since this paper deals with contemporary digital innovation – which is a relatively new subject matter, in addition to published journals, this paper also refers to other sources such as technical reports, blog postings, online newspaper articles and youtube videos. the need to refer to such contemporary digital content is aptly summarized by ahmad and buyong, who notes that in this digital era content analysis is also applied to analyzing data obtained from modern media such as websites, digital version of newspapers, blogs, facebook, instagram, and youtube videos, etc. [35]. this study has utilized content analysis methods to analyze the data collected from the reviews of these journals and media. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6901published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 08/06/2022 accepted for publication: 18/11/2022 published: 29/12/2022 26 iv. discussions of the potential and challenges for islamic decision support systems the discussion in this section is organized into the following two subtopics: 1) the potential and challenges of islamic dss in general 2) the potential and challenges of islamic dss for the islamic banking and finance sector a. the potential and challenges of islamic decision support systems in general this section discusses the potential and challenges of islamic dss in general. for the purpose of clarity, in the context of this paper, potential refers to the positive capacity for islamic dss – such as the possibilities, opportunities, available technologies, benefits, acceptance, and enthusiasm for it; whereas the challenges refer to the negative aspects – such as the limitations, practical issues, and objections or rejections, etc. this review of islamic dss uncovers two main potentials. there exists available technological approaches that can assist with shariah related decision making, and there are already multiple commercial and academic initiatives that work on such islamic dss. these innovations are not limited to those shariah domains with more straightforward methodologies with calculation formula such as hadith classification, zakat computation, and faraid determination, but also includes the most complicated ones – namely the fiqh ruling process. as far as demand is concerned, the journey towards greater digitalization in line with 4th industrial revolution (4ir) requires everyone to embrace advance technologies. during the launch of malaysia national 4ir policy science, technology and innovation (mosti), minister khairy jamaluddin said “this is because advanced technology will be the transformation that covers a wide spectrum and affects all layers of society” [36]. this digitalization initiative has been accelerated by the movement restriction order to curb covid-19 pandemic. “the rapid development and evolution of industry 4.0 and the painful covid-19, has created a new mindset focussed on the future, with a readiness to try new technologies” [1]. the new digital mindset has been amplified by ir 4.0 and covid-19 is expected to accelerate digital lifestyles globally. at the moment, most people are already comfortable using a wide variety of apps to seek recommendations and look for options that can help with simple decision making in everyday life. this goes to the extent of making decisions related to islamic faith – such as determining halal status and finding halal places. some people have already resorted to digital apps to help with more serious islamic related decision making, such as calculating zakat amounts, determining faraid portions, and even looking for some fatwa related answers to their questions. with these growing islamic digital lifestyle trends, demands towards islamic dss are expected to increase, and therefore will further encourage more commercial projects and academic research into islamic lifestyle digital applications. as is the case with many digital services, the main benefits of islamic dss are convenience, speed, and efficiency in decision making. another benefit includes the standardization of rules in the decision-making process. this may assist in addressing an inherent challenge in islamic decision-making processes inherent in multiple scholarly views on certain issues in certain matters, which may result in differing decisions. there are not many challenges with respect to islamic dss for simple decision making – such as finding qiblah direction, determining halal status, or locating halal places. such applications are quite easy to develop as long as the data is available and accessible by the systems. however, it can be extremely challenging with more complex shariah decision making – particularly with fiqh ruling matters. fiqh rulings are an extremely complicated process that requires qualified shariah experts, and which follow a strict methodology. the rulings must be deduced by a reasoning process that refers to shariah sources of knowledge, such as the quran, sunnah, ijma’, qiyas, and a few other secondary sources – such as public interest, customary practices, objectives of shariah, etc. in the computer world, shariah knowledge is classified as tacit knowledge which requires human know-how, intuition, and experience to interpret before the knowledge can be converted into a computer readable format. fortunately, an ai technology branch known as knowledge representation, specifically ontology, makes it possible to represent a human expert’s interpretation of tacit knowledge as explicit knowledge that can be codified and processed by computers. the interest in computer processing of knowledge from islamic texts such as quran and hadith has motivated quite a number of researchers [37][38][39] to work on the ontology of islamic knowledge. these works prove that it is possible for computers to process shariah knowledge and provide some kind of recommendations. the main challenge is to get a human shariah expert who is capable of translating his/her knowledge into computer readable format – which requires said person to be well versed in both shariah and information technology. unfortunately, there are a very limited number of individuals with this combined skillset. in addition, while some objective tacit knowledge from the primary sources of shariah – such as the quran and hadith can be codified, more subjective aspects such as public interest, customary practice, and the maqasid (objectives of shariah) are extremely challenging to codify into computer language. if these challenges can be overcome, it could create huge opportunities for commercial entities to penetrate this space, as there is currently a very limited supply of islamic dss on the market which can be utilized for shariah related decision making – particularly for fiqh rulings. b. the potentials and challenges of decision support systems for islamic banking and finance the general potential and challenges discussed in the previous section are also applicable to islamic dss for islamic banking and finance (ibf). this section shall discuss additional potential and challenges relevant to ibf perspectives. digital transformation of financial services has created huge demand for digital solutions in the islamic financial european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6901published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 08/06/2022 accepted for publication: 18/11/2022 published: 29/12/2022 27 services industry. digital solutions that are able to expedite shariah decision making processes in islamic financial institutions (ifis) are very much needed to facilitate speedier resolutions by the shariah committees of these ifis. as ai technology is known to have the capability to enable innovations for complex decision making, there are high hopes that ai technology could be leveraged to assist in the fiqh ruling process. a few high-profile stakeholders such as the general council for islamic banks and islamic finance institutions (cibafi), and the islamic development bank institute (isdbi) have openly shared their optimism about the application of artificial intelligence technology to help bring the ibf industry to the next level. in malaysia, there is a conscious effort to encourage more innovations with ai applications that could assist in shariah decision making processes. this initiative is known as iconnect fintech in islamic finance. one of the problem statements of iconnect fintech in islamic finance is “how might we develop artificial intelligence-based and other innovative tech-based solutions that could help with some level of automation in the shariah review process within islamic financial solutions” [40]. iconnect is a malaysian collaborative network platform for disruptive innovation programs under the ministry of science, technology, and innovation (mosti) and the academy of sciences malaysia (asm). ai enabled systems designed to assist with the fiqh ruling process are commonly identified as a shariah robo advisors. professor dato’ dr. mohd azmi omar, president and ceo at inceif, mentioned in his keynote address at the islamic fintech leaders forum 2021 that “we would like to see globally more shariah robo advisory focusing on shariah compliance, shariah decision making, shariah ruling and so on…” [41]. only limited literature can be found describing how robo shariah advisors could help in shariah decision-making in the ibf industry. for example, sa’ad, alhabshi, mohd noor and hasan are of the opinion that robo shariah advisors could help to save time and effort in the iterative shariah review process and could facilitate timely and more robust shariah opinions on islamic products and services. since these robo-advisors are allegedly speedier and more precise in supporting human judgement, this could help the design and delivery of islamic financial services to be more timely, effective, and efficient [42]. in addition, fazmi suggests that shariah robo advisors can act as “smart muftis” to evaluate the sources of shariah and provide recommendations based on past fatwas [30]. according to sultan, shariah robo advisors can help validate basic shariah requirements in islamic finance products and services, such as ensuring proper offers and acceptance. a few specific examples of how shariah robo advisors can help validate basic shariah requirements in islamic finance products and services include: (i) in sale contracts, the subject matter and price are well defined and not uncertain; (ii) in partnership contracts (mudharabah or musharakah), the psr (profitsharing ratio) is valid and therefore any partner does not get eliminated at any time from receiving profits (if there are any). capital contributions are also well defined to apportion if there is any loss; and (iii) to validate if the product meets specific objectives (maqasid) of shariah [43]. digitalization in the financial services industry, and the obvious optimism from stakeholders creates a huge potential for dss for shariah review processes in ibf. shariah robo advisors with consolidated collections of shariah rulings of ibf products and services by various authorities globally, could assist shariah committee members to speedily identify relevant pronouncements to the specific case that he/she is working on. some level of standardization is also possible with a robo-advisor’s recommendations for the relevant rulings. however, based on the review in section six above, there are huge gaps in supply. this provides a significant opportunity for those who would like to venture into this space. in order to fill this gap, human capital with skill in shariah, islamic finance, and information technology are required. the ideal scenario would be to have people with all the three skills – however such individuals are rarities. this opens up opportunities for collaborations between those with relevant skills to develop and commercialize decision support systems as smart assistants for shariah committees of islamic financial institutions. v. conclusion global societies are at a stage where a lot of decisions are guided by recommendations from purpose-built computer systems. this includes simple personal decisions such as which routes to take, or which restaurants to go to, as well as more complicated decisions by commercial organizations, such as how much inventory to keep, or what products to sell. these computer systems are known as a decision support systems (dss), which are designed to facilitate more precise decision-making by effectively using timely and appropriate data, information, and knowledge management leveraging on artificial intelligence techniques and other applications of information and communication technologies. a dss can be employed in various knowledge domains – such as medical, dietary, pollution detection, drug reaction, banking and finance, and even for faith matters – such as those related to the religion of islam. mobile apps that provide halal information are already prevalent to help users to ascertain halal status before deciding to go to a restaurant or to consume a product. there are also various dss initiatives for more complicated islamic disciplines – such as fiqh rulings, hadith classifications, and zakat and faraid computations. the most complicated islamic dss are those related to fiqh rulings. based on various studies, fiqh ruling dss could only function as a mujtahid assistant, which means the dss could provide recommendations; however the final decision must be made by a human mujtahid. at best, a fiqh ruling or fatwa dss could provide recommendations for new situations based on some similar past situations that are available in the knowledge repository of the dss. concerning the objectives of this paper, the potential and challenges for dss for islamic banking and finance (ibf) – european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6901published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 08/06/2022 accepted for publication: 18/11/2022 published: 29/12/2022 28 and particularly those for shariah decision-making aspects, the potential can be summarized as: • digital transformations of the financial services industry, including islamic banking and finance, create huge demands for such dss; • technological approaches leveraging sophisticated technology – in particular ai, are available to facilitate shariah decision-making processes; • stakeholders in the ibf industry are optimistic about ai’s capability to bring the industry to the next level; • there are already a few commercial and academic initiatives working on dss for shariah decisionmaking; • the benefits of dss for ibf include convenience, speed, efficiency, and the ability to standardize the rules in the decision-making process. while the potential is very promising, there are also challenges, which are summarized below: • the fiqh ruling process in shariah decision-making is a very complicated process that requires qualified and experienced shariah scholars’ expertise; • shariah is a tacit knowledge that requires human expertise to convert the knowledge into a computerprocessable format; • convert shariah knowledge into computer processable format requires an engineer who is well versed in both shariah and technologies; • there is a limited supply of dss in the market that can assist in shariah decision-making. in summary, the new mindset created by the evolution of industry 4.0 and the painful covid-19 has paved the way for promising prospects for digital innovations, including islamic dss. with more research applying ai technologies in islamicrelated use cases, the future is bright for more sophisticated islamic dss – particularly in islamic banking and finance. the main challenge remains to get shariah expertise who can transform shariah knowledge into a computable format, which can solve more complex shariah issues, where there is currently a very limited number of individuals who are well versed in both shariah and information technology. this challenge leads to a lack of available market solutions (a large gap in supply) that can be utilized for complex shariah-related decision-making, especially for the fiqh ruling process. further research is required to develop commercially viable shariah robo advisors for islamic financial institutions (ifis). a more coordinated collaboration among academics and ibf industry players with respective shariah and technology backgrounds is crucial to unleash the potential of dss usage and 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[40] inceif, “about i-connect fintech in islamic finance, iconnect, 2021. accessed 25 july 2021 https://www.inceif.org/i-connect.islamicfintech. [41] a. omar, “artificial intelligence in islamic banks: a looking forward vision”, bm fintech solutions, 2021. accessed 28 july 2021 https://www.youtube.com/watch?v=4hj8le6715s [42] a. a. sa’ad, s. m. alhabshi, a. mohd noor and r. hasan, “roboadvisory for islamic financial institutions: shariah and regulatory issues”, european journal of islamic finance, first special issue for ejif workshop, 2020. [43] y. sultan, “will shariah robo-advisors replace the human shariah advisors?”, linkedin, 2017. accessed 31 july 2021 https://www.linkedin.com/pulse/shariah-robo-advisors-replace-humanadvisors-yousuf-sultan http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5465 1 pricing of islamic banking and conventional banking: an empirical study stefano prandi*, daniele colecchia** (*)ordinary member of the italian association for financial analysis (aiaf) , milan, italy. email : s.prandi@isorf.org (**)ordinary member of the italian association for financial analysis (aiaf), milan, italy. email:d.colecchia@isorf.org abstract— this paper examines and assesses the extent to which pricing of islamic banking and finance (ibf) worldwide is correlated to conventional finance. the data used were obtained from the islamic finance country index (ifci) and the cbonds platform. the ifci is a methodology developed by edbiz consulting to measure the growth of ibf. the ifci has been gathering data for nine years, sufficient time to yield meaningful results. cbonds is a financial-data vendor highly specialised in the analysis of bond markets. this study provides both a qualitative analysis in the form of a tile map chart and a statistical test aimed at generalising the correlation between ibf expansion and interest rates to all countries where ibf banks might locate. this correlation is estimated by dividing the analysed countries into tertiles according to their interest rate and comparing the mean ifci scores. the difference between the lowest tertile and the others is statistically significant. this appears to be the first empirical study to incorporate the whole geographical scope of the ifci and analyse the interest rates of all countries to which ibf expansion metrics apply. emerging markets represent an important growth opportunity for islamic banks. in fact, the presence of zakat as a mandatory tax to reduce poverty and the idea of a system based on distribution of wealth are important factors for developing economies. this study is consistent with previous findings: the ibf pricing system is correlated to the conventional banking system, and there is a positive correlation between the ifci and countries with high yields. the main limitation of this study is the difficulty in obtaining the 10-yearyield to maturity (ytm) of countries for which no data was available. keywords: islamic banking and finance, interest rates, murabaha, mudarabah. i. introduction the concept of modern islamic banking and finance (ibf) was developed in the 1960s and 1970s to address the unique islamic economic philosophy. ibf market growth into the western world has been impressive. the philosophy of ibf is premised upon social justice, risk and profit sharing, and distribution of wealth, as well as a rejection of interest rates, gambling, speculation, and investments that are not sharia compliant. ibf’s original goal was to offer a harmonious financial and ethical model based on partnership finance [11]. however, with the development of the islamic banking sector, this view has shifted into a more sales-based financial model [11]. unlike conventional banks, islamic banks should not charge any interest – rather, they should operate according to a profit–loss sharing (pls) system. several studies have compared pricing in islamic banks against that of conventional banks. ahmed, rahman, ahmed, and ullah [1] analysed 106 banks in bangladesh to measure the pricing linkage between conventional and islamic banking. the findings suggested that the lending interest rates of conventional banks and the investment rates of islamic banks are highly correlated. a similar study was conducted by kader and leong [6], who examined the relationship between the variation of basic lending rates and the demand for ibf products; they found that islamic banks are significantly affected by changes in basic lending rates. likewise, uddin, ali and radwan [21] stated that the two pricing systems are similar. in their study they found that islamic and conventional money markets rates are significantly correlated. thus, to remain competitive and attractive compared to their conventional counterparts, the pricing mechanism of islamic banks induces them to structure their financial products like conventional banks. for example, the mark-up of murabaha is often linked to the london interbank offered rate (libor) 1 ; the latter is strictly prohibited in islamic finance [10]. as the murabaha instrument moves closer to conventional loans, it is considered less aligned with the sharia perspective. 1 libor is the benchmark interest rate for short term unsecured borrowing in the interbank market submitted december 2020, revised july 2021, accepted july 2021 ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5465 2 the prohibition of interest rates is specifically based on verse 2:275 of the quran: “those who consume interest cannot stand [on the day of resurrection] except as one stands who is being beaten by satan into insanity. that is because they say, „trade is [just] like interest.‟ but allah has permitted trade and has forbidden interest. so, whoever has received an admonition from his lord and desists may have what is past, and his affair rests with allah. but whoever returns to [dealing in interest or usury] – those are the companions of the fire; they will abide eternally therein.” in relation to this current debate, many questions arise regarding the extent to which the islamic banking system is unique in its ideology and can be considered free of interest rates. the purpose of this research is to fill the gap in the current literature by incorporating a wider geographical scope when measuring the correlation between interest rates and islamic finance. the following section discusses the main academic theories developed by islamic scholars and experts regarding the pricing system of islamic and conventional banks. the second section presents the research methodology aimed at assessing, on a global geographical scale, whether islamic banks’ growth potential is correlated to interest rates, which in turn hints at a correlation between interest rates and islamic banks’ pricing and profitability. the third section analyses the main findings and compares them with the current literature, showing that the results are aligned. this is followed by the last section of this research, where we provide a summary of our findings and the main limitation of this study. ii. literature review a) the development of islamic finance: from a partnership model to a sales-based model with the islamic banking sector’s worldwide rise to prominence, numerous studies have attempted to analyse the pricing relationship between ibf and conventional banks. however, islamic scholars have voiced significant concern regarding the use of certain financial products and the lack of shariah experts [20]. according to warde [11], the original idea of islamic banking was to offer a model based on partnership finance and not on interest rates. an example of partnership finance is mudarabah, which is a contract between two parties, the rabb-el-maal (financer) and the mudarib (entrepreneur), who share profits and losses based on a ratio agreed upon by both parties [11]. with the establishment of the first islamic bank, the guiding principles of ibf shifted from a profit–loss sharing model to a mark-up transaction model. an example of a mark-up contract is murabaha, where a buyer agrees to purchase an asset, which is acquired by the bank and then sold back with an agreed-upon markup [11]. today, many islamic banks are adopting murabaha as a financing technique. however, since the ibf world has shifted to a more sales-based model, many scholars have begun to criticise murabaha. warde [11] and alkhamees [2] argued that murabaha does not bring significant social and economic benefits to society, as it tends to replicate conventional, interestbased finance instruments [11]. therefore, even though several islamic banks claim to follow an interest-free banking system, several studies have proven that interest rates are strongly correlated to islamic loans and deposits. for example, redzuan and kassim [19] argued that the existing islamic pricing model for home financing relies on interest rates. b) islamic banking products: murabaha andmudarabah azmat, azad, bhatti, and ghaffar [16] argued that the strong competition between islamic and conventional banks creates highly correlated pricing systems. a financial instrument that raises a seriousconcern amongst scholars is murabaha, which accounts for 70–80% of islamic banks’ total financing. murabaha shares a risk profile similar to that of loans of conventional banks. this agreement involves the purchasing of an asset by the bank which is then sold with an agreed mark-up to the customer. this asset goes under the ownership of the bank before being transferred to the client. thus, islamic banks carry an additional risk related to the temporary ownership of the asset. in fact, if the asset is destroyed, the islamic bank will bear the entire loss. azmat, azad, bhatti, and ghaffar [16] developed a theoretical model for islamic banks to find an optimal lending and deposit rate using murabaha on the asset side and mudarabah on the liability side. murabaha is the islamic deposit, which is based on a profit-sharing ratio. the customer places the fund in an islamic bank seeking capital growth without interest rates. the bank is the ―mudarib‖or ―entrepreneur‖, and its main objective is to invest the clients’ money through a full or restricted discretionary mandate. both parties agree on a profit–loss sharing ratio, which is disclosed before entering a mudarabah agreement. profits generated by the bank are shared with the rabb-el-maal (financer). the rabb-el-maal is exposed to the underlying bank risk due to the fact that deposit insurances are not allowed in the islamic banking system. ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5465 3 c) pricing of murabaha and mudarabah the model developed by azmat, azad, bhatti, and ghaffar [16] showed that there is a convergence with conventional loans and deposits. the following proposition demonstrates the optimal deposit and lending rates for conventional banks. 𝑅𝐷𝑐 = ⩂ 𝑃𝐷 + (1 −𝑃) 𝑃 𝑅𝐿𝑐 = (1 −𝑃) 𝑃 − 𝐿(𝑅𝐿𝑐) 𝐿(𝑅𝐿𝑐) the model assumes that rlc is the rate that banks charge to customers for conventional loans, and rdc is the rate that banks pay to conventional depositors. p is the probability of success of the project funded by the bank, for which the bank will get back the loan issued plus the rlc. on the other hand, 1−p is the probability of failure of the project, and in the case of a default event, the bank will lose the principals and rlc. likewise, if the bank’s project succeeds, the customer will receive d (face value of the deposit) plus the return rdc. the reservation utility 2 of conventional depositors is expressed with ⩂.islamic banks face an additional risk compared to conventional banks. in the case of murabaha, the purchased asset goes under the ownership of the bank for a specific time (t) before being transferred to the customer. therefore, if the asset is destroyed while under the ownership of the bank, the customer is not liable. azmat, azad, bhatti, and ghaffar [16] evaluated t as a continuous random variable with a density function given by f (t). 𝑃𝑑 = 𝑓 𝑇 0 (𝑡)𝑑𝑡 on the liability side, the islamic bank is assumed to have mudarabah. the bank pays a βrli, where β is the mudarabah profit-sharing ratio. this ratio must be proportioned to the depositors’ investment ratio and it cannot be negotiated. the depositors will receive the face value of their deposit d plus the βrli only if the asset is protected under the bank’s ownership and if the funded project succeeds. similarly to a conventional bank, the reservation utility is given by ⩂. therefore, the optimal lending and deposit rate of islamic banks is given by the following equation: 𝛽 = ⩂ +𝑃𝑑𝐷 (1 −𝑃𝑑)𝑃𝑅𝐿𝑖𝐷 + (1 −𝑃) 𝑃𝑅𝐿𝑖 𝑅𝐿𝑖 = 𝑃𝑑 (1 −𝑝𝑑)𝑃 + (1 −𝑃) 𝑃 − 𝐿(𝑅𝐿𝑖) 𝐿′(𝑅𝐿𝑖) = 𝑓(𝑡)𝑑𝑡 𝑇 0 (1 − 𝑓(𝑡)𝑑𝑡)𝑃 𝑇 0 + (1 −𝑃) 𝑃 + 𝐿(𝑅𝐿𝑖) 𝐿′(𝑅𝐿𝑖) 2 the central bank sets a minimum amount of reserves that must be held by a commercial bank. this amount is based on the deposit liabilities owned by the commercial bank to its customer. to remain attractive to customers in a competitive environment, islamic banks will have to price their loanscomparable toconventional banks. azad, azmat, chazi, and ahsan [17], similarly to that stated by azmat, azad, bhatti, and ghaffar [16], pointed out that as islamic banks are competing and operating in a global context, their rates cannot diverge from conventional benchmarks. their study aimed to explore the relationship between the islamic interbank benchmark rate (iibr) and the london interbank offered rate (libor),revealing a strong correlation between the two pricing systems. kafder and leong [6]conducted a study to measure the impact of interest rate change on ibf. using monthly data from 1999 to 2007, they revealed that increases in the base lending rate encourage people to seek financing from islamic institutions. the study also concluded that islamic banks are influenced by interest rate fluctuations. a similar study was conducted by khalidin and masbar [8],who explored the influence of interest rate fluctuations within the malaysian ibf system, analysing the following variables:  islamic banks‟ total financing (ibfintot)  murabaha financing (murafin)  profit-sharing rate of ibfintot (psribfintot)  profit-sharing rate of murafin (psrmurafin)  commercial banking rate consumption (cbr)  commercial banking rate for working capital (cbrwc)  interbank money market rate (immr)  consumer price index (cpi)  industrial production index (ipi) two models have been used to assess total financing and murabaha financing in respect to islamic banking. model 1. ibfintot = f (ibdeptot, psribfintot, cbrwc, immr, cpi, ipi) model 2. murafin = f (psrmurafin, cbrc, immr, cpi, ipi) the result of a pearson correlation test using both models suggests that in model 1, all variables are significantly correlated except for cpi and ipi; in model 2, all variables are correlated except for ipi. the ibfintot correlates significantly with total deposits, profit-sharing rates, commercial banking rates for working capital, and interbank money market rates. in addition to the person correlation, a granger causality test 3 was employed to evaluate the causality among the variables. both studies showed that there is a correlation between interest rates and islamic bank activities in malaysia [8]. a slightly different result was 3 the granger causality is a statistical hypothesis test based on prediction. the method helps to identify the relationship between two variables for time series data. ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5465 4 found by sukmana and ibrahim [13], who performed a nonlinear assessment of islamic and conventional banking rates in malaysia. they found that deposit rates of islamic banks are not pegged to conventional deposit rates. wali, sarwar, rahman, and samiul [14], similarly to that stated by sukmana and ibrahim [13], claimed that there is a significant difference between deposit rates of conventional and islamic banks. their study covered monthly data from 2009 to 2013 using a sample size of 53 banks in bangladesh. they assessed the association between lending and deposit rates of conventional and islamic banking through graphical time-series analysis and a correlogram. a z-test used to measure the relationship between variables showed that the null hypotheses of no difference between fixed and saving deposit rates are rejected, proving that there is a difference between the two pricing systems. this result is slightly inconsistent with the study conducted by ergeç and arslan [12],who measured the impact of interest rate variation on islamic loans and deposits in turkey. the findings showed that any shock in interest rates affects islamic loans and deposits. while most studies seem to be consistent when measuring the relation between the variation of interest rates on islamic and conventional loans, there is some divergence when assessing islamic and conventional deposits. hence, in consideration of the current debate and concern amongst islamic scholars and experts, this paper attempts to further assess the relation between interest rates and islamic banks by incorporating a large geographical scope. iii. research and methodology a) collected measures the extent of ibf development in each country included in this study is estimated through an ad-hoc metric: the ifci score, which is the result of a factor analysis conducted by edbiz consulting in 2017 and revised in 2019. table i.a (appendix a) reports the annual ifci scores by country, whereas table ii reports the average value of said score over the whole observation period. the ―yield‖ column in table ii reports the average yield to maturity (ytm) of the 10year bond emissions 4 on a country basis. both columns provide averages representing the mean value for the country in question, from 2011 to 2019, to correspond with the nine-year availability of ifci scores. the ifci was developed with the purpose of tracking the growth of ibf for 49 countries and is now considered a 4 a bond ytm is the internal rate of return required in order to obtain the current bond price when summing all future cash flow of the bond and the principal. the 10-year bond emission is the current rate that government treasury pays to investors if they purchase the bond today. this yield is a significant benchmark for commercial banks when pricing mortgages and borrowing rates. reliable index to measure the presence of islamic finance in a specific country. b) scope of analysis all countries for which both ifci scores and ytm data are available, except the gulf cooperation council (gcc) countries—bahrain, kuwait, oman, qatar, saudi arabia, united arab emirates, and yemen— have been evaluated in this study. ibf originated in these gcc countries, making them irrelevant to an exploration of development dynamics across the world outside this ibf birthplace. c) data sources the present study relied on cbonds, an independent information agency specialised in fixed-income securities, for information on kazakhstan, azerbaijan, iran, and brunei. for these countries, the ytm was estimated by averaging the bond emissions for which data were available. bloomberg supplied the ytm data for the remaining countries. d) model the scope of the present study is the largest possible, in that it encompasses all the countries where the scale of ibf development can be measured at present by means of the adopted metric (ifci score). this constitutes a sample that includes all the countries where ibf banks might locate in the near future; in this respect, the findings related to the group of countries covered by the present study can be generalised through inferential statistics. the present observational study aims to test the significance of low yields as a factor that does not favour the settlement and development of ibf based on the characterisation of business models such as murabaha linked to interest rates. for this purpose, we divided the countries for which both ifci and yield data are available into tertiles according to the cut-off values reported in table iii (appendixa), introducing the following naming scheme: t0 = 1st tertile = low-yield tertile t1 = 2nd tertile = medium-yield tertile t2 = 3rd tertile = high-yield tertile subsequently, we established the following alternative hypothesis, which states that a correlation exists between low yields and low ifci scores. hypothesis: the mediumand high-yield tertiles have ifci values significantly higher than those of the low-yield tertile. ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5465 5 to test this hypothesis, we classified the countries into two macro-groups: group 0. g0 = {t0}  low-yield countries group 1. g1 = {t1, t2}  medium-yield and highyield countries we conducted a one-tailed t-test to compare the ifci value of group 1 against the mean ifci value of group 0, and examined whether the former is higher than the latter and whether this difference is statistically significant. the difference of mean (―diff. 1–2‖) confidence interval was above zero, which proves that the alternative hypothesis holds, meaning that the ―group 1‖ mean is significantly higher than the ―group 0‖ mean. the confidence interval computation refers to the standard confidence level (cl): confidence level = 95% the standard error estimate was based on pooled variance on the grounds of the outcome of the equality of variance test (equality of variance hypothesis not rejected). table iv (appendix a) reports the mean value of the dependent variable for group 1 and group 0, providing the mean difference – i.e., the difference between mean 1 (―mean of group 1‖) and mean 0 (―mean of group 0‖), along with its respective confidence interval (ci): difference of means = 1.0880 ci = [+0.01257; infinity] the alternative hypothesis holds p-value (pr > t) = 0.03 the ifci distributions related to group 1 (above) and group 0 (below) are plotted in fig. i for ease of comparison. the kernel plot represents a normal distribution which approximates the sample distribution. fig. i. comparative distribution: group 0 (low yield) vs. group 1 (moderate & high yields) a qualitative analysis is provided by fig. ii in the form of a tile map characterised as follows:  each tile represents a country  tile size corresponds to the ifci score  the lowest-yield tertile, t0, is coloured white, and the higher-yield tertiles correspond with darker shades of blue this qualitative analysis demonstrates the prominence of low yields (white tiles) among the lower ifci scores (smaller tiles). fig. ii. tile map of the ifci scores by countries/yield-based colouring scheme. e) dependent variable manipulation a proper pre-processing of the dataset before submitting the t-test was necessary, as the ifci scores’ distribution departs from normality, which is a prerequisite for the t-test. table v (appendix a) reports the following related metrics: distribution of log_ifci kernelnormal g0 g1 g r o u p 0 20 40 60 p e rc e n t 0 20 40 60 p e rc e n t g0 0 10 20 30 40 p e rc e n t 0 10 20 30 40 p e rc e n t g1 -4 -2 0 2 4 6 log_ifci ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5465 6 kurtosis: 2.99 skewness: 8.80 the pre-processing, aimed at meeting the normality requirement, replaced the raw dependent variable—the ifci score—with its logarithm. we thus define the following derived variable: log_ifci =𝑙𝑜𝑔10 (𝐼𝐹𝐶𝐼) this transformation applied to the dependent variable is feasible based on the monotonicity of the logarithm function: the higher the raw measure, the higher the logarithm. table vi (appendix a) shows that, for the derived dependent variable, the normality assumption is acceptable: kurtosis: 0.20 skewness: 0.32 fig. iii provides the q–qplot of the derived variable log_ifci (dotted plot), which approximates a normal distribution (a continuous line plot) characterised by the mean and the standard deviation of our sample. as a result, we adopted the derived variable log_ifci as the dependent variable in the t-test. table iv and figs. i and iii refer to log_ifci as well. fig. iii. log_ifci q–qplot iv. findings and results based on the results obtained, there is a higher likelihood of ibf growth in countries with high-yield sovereign bonds. according to omar et al. [9], islamic banks are using conventional finance as a benchmark to determine the cost of funding. the findings are in accordance with the study conducted by kader and leong [6], which determined that an increase in interest rates would induce individuals to seek financing from islamic institutions, thereby enhancing ibf growth. moreover, not all clients are sharia compliancy orientated. therefore, an islamic finance customer could shift to conventional banks if islamic banks are more expensive. similar findings were also presented by khalidin and masbar [8], who found that the interbank money market rate is significantly correlated to ibf banks’ total financing. both studies used the malaysian islamic banking sector as a benchmark for their analyses and agreed that interest rates and ibf growth are positively correlated. chong and liu [15] claimed that islamic deposits in malaysia are not interest rate free – rather, they are pegged to conventional deposits. all major studies available in the current literature have been limited to the malaysian banking sector, which is the founding country of modern ibf. this paper adds some important features to the current literature as it covers a much larger geographical scope; it is more general, and it does not rely on the assumption of a linear relation between the variables. in fact, to the best of our knowledge, this is the first empirical study attempting to evaluate the growth potential of islamic banks in countries with high interest rates. based on our findings, we can state that pricing of islamic banks is linked to conventional banks, and countries with high yields are a good market for islamic banks’ growth. v. conclusion this study illuminated one of the current issues of ibf growth: there is some contention between scholars and finance experts whether ibf should be influenced by interest rates to be as profitable as its conventional counterparts. on the other hand, if emerging markets have higher yields in general, we can also argue that islamic banks have a strong appeal to retail customers, and therefore a definite growth potential, in such markets. several studies claimed that there is a positive correlation between islamic finance growth and domestic gdp of developing countries [3]. for example, daly and frikha [4] stated that islamic banks have a crucial role in the growth of the gdp of developing economies. moreover, the core principles of islamic finance are based on ethical values, profit– loss sharing and distribution of wealth (zakat). these values are important in developing countries, especially the inclusion of zakat as a mandatory tax to support the poor population. regardless of interest rates’ influence on ibf, the islamic model remains faithfulto its ethical priorities and considerations. financial manipulations such as speculation, leverage, and short selling are all strictly banned by islamic banks. in fact, with their adherence to sharia, all islamic banks managed to successfully weather the storm of the 2008 financial crisis, which caused the bankruptcy of lehman -3 -2 -1 0 1 2 3 normal quantiles -4 -2 0 2 4 6 l o g _ if c i mu=0.89, sigma=1.45normal line q-q plot for log_ifci ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5465 7 brothers and the collapse of numerous conventional financial markets worldwide. from a macro-level perspective this study provides important tools to further develop the presence of islamic banks in developing economies. in fact, the correlation highlighted by the present paper shows a competitive advantage for islamic banks which arises in geographical contexts—namely, countries— characterised by higher interests’ rates. kader and leong[6] also hinted at the role of the base lending rate in the preference accorded to islamic banks by retailers, but the present study has confirmed this dynamic on a much wider geographical scope that is of practical relevance for targeting ibf investments on a global scale. according to this study, islamic banks can consider strengthening their presence in emerging economies in order to enhance their growth and support the local community. the positive association between islamic banks and lowand middle-income economies was also demonstrated by imam and kpodar [18] who claimed that islamic finance is positively associated with economic growth. the main limitation of the present study is the difficulty in obtaining the 10-year ytm of certain countries for which data are not available. in fact, for kazakhstan, azerbaijan, iran, and brunei, the ytm was calculated by averaging bond emissions with different maturities. moreover, exponential growth of debt continues to remain a key factor to differentiate islamic rules from conventional banks, but no empirical studies have been conducted yet due to the difficulty in accessing the data providing ample fodder for further research. references [1] ahmed, s. u., rahman, a., ahmed, s. p., & ullah, g. m. (2016). pricing linkage between islamic banking and conventional banking: the case of bangladesh. international journal of finance & banking studies 3(4), 84, (21474486).12/23/2020. [2] alkhamees, a. (2017). a critique of creative shari'ah compliance in the islamic finance industry. danvers: martinus nijhoff publishers. [3] cham, t. (2017). determinants of islamic banking growth: an empirical analysis. international journal of islamic and middle eastern finance, 11(1), 18–39. [4] daly, s., & frikha, m. (2016). banks and economic growth in developing countries: what about islamic banks? cogent economics & finance, 4(1168728). [5] islamic finance country index. (2017). retrieved from http://www.gifr.net/publications/gifr2017/ifci.pdf. [6] kader, r. a., & leong, y. k. (2009). the impact of interest rate changes on islamic bank financing. international review of business research papers 5(3), 198–201. [7] kepli (2012). islamic finance in hong kong. hong kong law journal. 42. pp 809-837. [8] khalidin, b., & masbar, r. (2017). interest rate and financing of islamic banks in indonesia (a vector auto regression approach). international journal of economics and finance, 9(7), 154–164. [9] omar, a., md noor, a., kameel meera, a., ali abdul manap, t., abd. majid, m., & raihan syed zain, s. (2010). an islamic pricing benchmark.isra working paper, 17, 1-78. doi: https://www.researchgate.net/publication/326560912_an_isla mic_pricing_benchmark. [10] visser, h. (2009). islamic finance: principles and practice. northampton: edward elgar publishing. [11] warde, i. (2009), ―relevance of contemporary islamic finance‖, berkeley journal of middle eastern & islamic. [12] ergeç, e.h &arslan b.g. (2011): impact of interest rates on islamic andconventional banks: the case of turkey. university of munich.retrieved from https://mpra.ub.unimuenchen.de/29848/. [13] sukmana, r., & ibrahim, m. h. (2017). how islamic are islamic banks? a non-linear assessment of islamic rate – conventional rate relations. economic modelling, 64, 443-448. doi:.org/10.1016/j.econmod.2017.02.025. [14] wali u., sarwar a., rahman a.,samiul a. (2014). pricing linkage between islamic banking and conventional banking: the case of bangladesh. international journal of finance & banking studies. 3. 10.20525/.v3i4.193. [15] chong, beng & liu, ming-hua. (2009). islamic banking: interest-free or interest-based?. pacific-basin finance journal. 17.doi: 125-144. 10.1016/j.pacfin.2007.12.003. [16] azmat, s., azad, s., bhatti, i., & ghaffar, h. (2020). islamic banking, costly religiosity, and competition. the journal of financial research,xliii(2), 263-303. doi:10.1111/jfir.12207. [17] azad, a., azmat, s., chazi, a., & ahsan, a. (2018). can islamic banks have their own benchmark? emerging markets review,25,120-136.doi:doi.org/10.1016/j.ememar.2018.02.002. [18] imam, p., & kpodar, k. (2015). is islamic banking good for growth? imf working paper. https://www.imf.org/external/pubs/ft/wp/2015/wp1581.pdf. [19] redzuan, n., & kassim, s. (2017). house price index as an alternative pricing benchmark for islamic home financing: evidence of malaysia. european journal of islamic finance, (6). https://doi.org/10.13135/2421-2172/1749 [20] chowdhury, m. a. m., masud, m. a. a., atiullah, m., & tanvir, j. i. (2020). contemporary responses to the criticism of islamic banks in malaysia. european journal of islamic finance, (15). https://doi.org/10.13135/2421-2172/4307 [21] uddin, m. a., ali, m. h., & radwan, m. (2019). can gdp growth link instrument be used for islamic monetary policy? european journal of islamic finance, (13). https://doi.org/10.13135/2421-2172/3543 https://mpra.ub.uni-muenchen.de/29848/ https://mpra.ub.uni-muenchen.de/29848/ ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5465 8 appendix a table i.a average ifci score over the 9-year observation period (part 1/2) france germany india indonesia iran jordan kazakh stan kenya 2011 22 46 4 3.2 2012 0.57 0.45 0.82 15.6 51.71 2.7 0.5 2.35 2013 0.83 0.66 1.04 20.22 68.31 3.6 1.08 2.02 2014 0.82 0.65 1 19.82 75.24 3.08 1.26 1.97 2015 0.81 0.59 1.73 22.45 77.93 3.98 1.13 2.32 2016 0.8 0.62 1.27 24.21 77.39 7.98 1.2 2.28 2017 0.78 0.66 1.3 23.96 78.37 10.29 1.32 2.85 2018 0.57 0.67 1.29 24.13 79.01 13.01 2.12 2.85 2019 0.67 0.88 1.88 81.93 79.03 18.33 5.71 3.39 avg 0.73 0.65 1.29 28.26 70.33 7.44 1.79 2.58 thailand philippines tunisia turkey uk usa brunei 2011 2.3 7.5 7 4.01 3.3 2012 1.17 0.2 1.79 5.21 7.84 0.11 2.81 2013 1.2 0.63 1.49 6.48 8.15 4.28 3.24 2014 1.57 0.62 0.48 7.23 5.94 4.26 3.03 2015 1.73 0.61 1.76 8.83 6.13 3.27 2.89 2016 1.7 0.63 2 8.95 5.96 3.28 5.85 2017 1.69 0.65 2.87 12.16 5.88 3.5 8.85 2018 1.71 0.55 3.01 13.01 6.33 3.48 10.11 2019 1.9 0.78 4.09 20.77 6.69 4.37 49.99 avg 1.66 0.58 2.19 10.02 6.66 3.40 10.01 ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5465 9 table i.b average ifci score over the 9-year observation period (part 2/2) lebanon malaysia australia azerbaijan bangladesh canada china egypt 2011 3.4 30 2.5 12 1 8 2012 2.16 32.36 0 5.16 0.24 0.01 5.7 2013 2.64 42.69 0.62 1.02 9.19 0.25 0.46 5.69 2014 2.42 49.53 0.61 1.19 9.97 0.24 0.57 5.11 2015 2.39 73.09 1.26 1.23 11.11 1.9 0.57 7.34 2016 2.67 77.77 1.25 1.11 16.14 1.87 0.56 9.02 2017 2.64 79.2 1.22 1.15 16.72 1.82 0.57 9.99 2018 2.7 81.01 1.23 1.17 17.78 1.83 0.56 10.01 2019 3.3 81.05 1.22 2.01 43.01 1.99 0.67 11 avg 2.70 60.74 1.06 1.26 15.68 1.27 0.55 7.98 nigeria pakistan russia singapore south africa spain srilanka switzer land 2011 3.5 19 1 2 2.6 2012 0.67 11.27 0 1.31 1.26 0 1.33 0.5 2013 1.07 14.15 0.2 1.72 2.47 0 2 0.51 2014 1.45 11.49 0 2.1 1.66 0 1.84 0.51 2015 1.24 13.38 0.2 2.13 2.06 0.05 2.72 2.1 2016 2.35 18.89 0.19 2.05 1.73 0.05 2.96 1.97 2017 0.01 24.3 0.21 1.94 1.74 0.06 3.78 1.93 2018 2.34 24.01 0.22 1.81 1.99 0.05 3.77 1.89 2019 2.29 36.88 1.01 2.01 2.01 0.35 3.89 2.21 avg 1.66 19.26 0.25 1.79 1.88 0.07 2.77 1.45 ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5465 10 table ii. icfi scores and yields by country country yield ifci australia 1.80 1.06 azerbaijan 8.16 1.26 bangladesh 9.00 15.68 brunei 1.50 10.01 canada 1.78 1.27 china 3.26 0.55 egypt 14.20 7.98 france 0.49 0.73 germany 0.13 0.65 india 6.84 1.29 indonesia 7.08 28.26 iran 17.00 70.33 jordan 6.45 7.44 kazakhstan 7.68 1.79 kenya 12.38 2.58 lebanon 7.12 2.70 malaysia 3.46 60.74 nigeria 12.06 1.66 pakistan 10.97 19.26 philippines 4.18 0.58 russia 6.77 0.25 singapore 1.84 1.79 south_africa 8.25 1.88 spain 1.09 0.07 srilanka 10.50 2.77 switzerland -0.27 1.45 thailand 1.86 1.66 tunisia 7.10 1.73 turkey 10.11 10.02 uk 1.10 6.66 usa 2.02 3.40 ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5465 11 table iii. yield tertiles cutoff values analysis variable: yield yield tertile n obs minimum maximum t0 10 -0.2700000 1.8600000 t1 11 2.0200000 7.6800000 t2 10 8.1600000 17.0000000 table iv. mean log_ifci of group1 (moderate & higher yields) vs. mean log_ifci of group 0 (low yields) group method n mean std dev std err minimum maximum g1 21 1.3433 1.5267 0.3331 -1.3863 4.2532 g0 10 0.2553 1.3499 0.4269 -2.6593 2.3036 diff (1-2) pooled 1.0880 1.4741 0.5664 diff (1-2) satterthwaite 1.0880 0.5415 group method mean 95% cl mean std dev 95% cl std dev g1 1.3433 0.6484 2.0382 1.5267 1.1680 2.2046 g0 0.2553 -0.7104 1.2210 1.3499 0.9285 2.4644 diff (1-2) pooled 1.0880 0.1257 infty 1.4741 1.1740 1.9816 diff (1-2) satterthwaite 1.0880 0.1540 infty method variances df t value pr > t pooled equal 29 1.92 0.0323 satterthwaite unequal 19.968 2.01 0.0291 ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5465 12 table v. assumptions check (normality of ifci scores) moments n 31 sum weights 31 mean 8.62903226 sum observations 267.5 std deviation 16.5007035 variance 272.273216 skewness 2.99424285 kurtosis 8.80970842 uncorrected ss 10476.4626 corrected ss 8168.19647 coeff variation 191.223106 std error mean 2.96361383 table vi. t-test assumptions check (normality of log_ifci scores) moments n 31 sum weights 31 mean 0.99231857 sum observations 30.7618758 std deviation 1.53875967 variance 2.36778132 skewness 0.20278175 kurtosis 0.32147809 uncorrected ss 101.55902 corrected ss 71.0334395 coeff variation 155.067103 std error mean 0.27636939 ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5465 13 table vii.log_ifci and yields group (g0, g1, g2) by country country group log_ifci australia g0 0.05827 azerbaijan g1 0.23111 bangladesh g1 2.75239 brunei g0 2.30358 canada g0 0.23902 china g1 -0.59784 egypt g1 2.07694 france g0 -0.31471 germany g0 -0.43078 india g1 0.25464 indonesia g1 3.34145 iran g1 4.25320 jordan g1 2.00687 kazakhstan g1 0.58222 kenya g1 0.94779 lebanon g1 0.99325 malaysia g1 4.10660 nigeria g1 0.50682 pakistan g1 2.95803 philippines g1 -0.54473 russia g1 -1.38629 singapore g0 0.58222 south_africa g1 0.63127 spain g0 -2.65926 srilanka g1 1.01885 switzerland g0 0.37156 thailand g0 0.50682 tunisia g1 0.54812 turkey g1 2.30458 uk g0 1.89612 usa g1 1.22378 ejif – european journal of islamic finance no 18, august (2021) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 doi: 10.13135/2421-2172/5465 14 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 29/10/2021 accepted for publication: 19/12/2021 published: 30/12/2021 18 financing in the islamic system and sustainable economic development of selected islamic countries 1 university of turin, department of management (italy) 2 astom university, centre for business prosperity (uk) contact author: sepideh.khavarinezhad@unito.it abstract— financial markets have the obligation to support the real economy has become the development and sustainable economic growth. capital is an indispensable tool for economic growth and prosperity, which is accelerated through the financial markets, and islamic finance tools have developed significantly in islamic countries in recent years. promoting macroeconomic objectives such as sustainability and achieving endogenous and viable economic growth are the purposes of all economic systems. increasing growth of financial methods and development of these systems drives from this reality that the sustainable development of the financial system is an integral part of economic system development. islamic financing has emerged in the world financial literature, intending to provide a new model for replacing conventional financial plans and providing financial, commercial and investment facilities and opportunities by the principles of sharia. this system has been able to identify its various dimensions. due to the benefits and advantages of islamic financing, the issue of islamic financing has become critical in the international arena. by assuming islamic financial systems, it can be concluded that they do not permit the use of current financial methods since usury is forbidden in islam. so, they attempt to create islamic financial instruments. as an islamic and non-usury financial instrument, sukuk has found a suitable position among islamic governments and companies. islamic financing has emerged in the world financial literature to provide a new model for replacing traditional and conventional financial systems and providing financial, commercial and investment facilities and opportunities under the principles of sharia. the purpose of the present study is to investigate the role of islamic financing of sukuk on the economic growth of malaysia, iran, pakistan, qatar, bahrain, turkey, indonesia, uae and saudi arabia; applying the panel data, will be analysed the variables affecting economic growth (government spending, gross capital formation, labour force, exports and sukuk). keywords: financing, islamic financing, economic growth, sustainable development, islamic countries, sukuk introduction financial markets, as the flow of financial resources from the non-productive sector to the productive sector, have a valuable role in economic growth, stabilization of monetary and financial variables, investment, increasing employment and improving the welfare of society. due to the high importance of these markets, they are referred to as the main arteries of the economy [1]. financial markets have to support the real sectors of the economy to pave the way for sustainable economic development and growth. financial markets must support the real sectors of the economy to pave the way for sustainable economic development and growth. organizations, companies, institutions need financial resources to establish, equip or expand their activities, that in conventional financial markets, this need is met by issuing interest-bearing bonds. from the islamic point of view, interest rates (usury are forbidden, and these bonds cannot be used for financing in islamic society. muslim philosophers, considering the importance of financing companies through islam, first thought of creating an islamic banking system and then launching a capital market. the role of islamic financial instruments or sukuk in the islamic financing system is significant and prominent [2]. islamic financing has emerged in the world economic literature to provide a new model for replacing traditional and conventional financial systems and providing financial, commercial and investment facilities and opportunities following the principles of sharia [3]. this system has been able to identify its various dimensions. due to the benefits and advantages of islamic financing, the issue of islamic financing has now become critical in the international arena [4; 5]. today, the benefits of islamic financing have led to its expansion and growing importance. a wide range of islamic financial institutions is active not only in islamic countries but also in some european countries [6]. in this vein, the scope of activities of financial sepideh khavarinezhad1, paolo biancone1, vahid jafari-sadeghi2 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 29/10/2021 accepted for publication: 19/12/2021 published: 30/12/2021 19 institutions and banks providing islamic financial services is increasing; today, about 150 financial institutions in more than 45 countries worldwide are developing and expanding and implementing various forms of islamic financing. islamic financial instruments (sukuk) are securities with the same financial value and tradable in financial markets, designed based on one of the contracts approved by islam, and bondholders jointly own one or a set of assets and benefits derived from them [7]. the present study investigates the role of islamic financing of sukuk on the economic growth of selected countries, including malaysia, iran, pakistan, qatar, bahrain, turkey, indonesia, uae and saudi arabia. after the abstract and introduction, the theoretical foundations of the research; in the next section, the research method is examined, the research findings are analysed, and the final part of the research result is expressed. i. theoretical framework the most accurate definition of financing theory is provided by merton: the study of the behaviour of brokers in the process of allocation and distribution of resources from both dimensions of place and time in uncertain conditions forms the basis of financing [8]. time and uncertainty are the main elements influencing financial behaviour [9]. in the economic literature, capital is a critical factor in economic growth. increasing the volume of capital, both directly as a factor of production and through increasing the efficiency and productivity of other factors, increases the level of employment, production and welfare of society. therefore, financing investment projects is critical because of the great importance of capital formation in the economy. financial development is one factor that diverts resources from savers to investors [10], and plays an essential role in financing projects for optimal resource allocation and investment risk sharing. financial development is defined through four channels: risk management, financial deepening, financial liberalization, and financial innovation [11]. diversification of financial instruments is, in fact, one of the factors affecting the development of financial markets and their efficiency. since financing encourages better savings and investment and is an objective facilitator for production and consumption, it is essential and done better through financial innovation [12]. the relationship between financing development and economic growth has been a controversial topic that has been widely analysed in the economic literature, and some experts consider financing to be an essential element of economic development [13; 14; 15]. for other scholars, financing is only a small factor in economic growth. schumpeter cognises the banking sector as the engine of economic growth that finances the production investment budget [16]. financial development implements efficiently through channels of conversion of savings into investments. this channel performance via increasing profit margins and financial intermediaries, which has led to an increase in the diversification and specialization of banks [17]. these costs are affected by inefficiency in providing financial services, redistribution of financial intermediaries' profits through taxation, and risk compensation by financial intermediaries. financial development also leads to increased productivity of capital [18]. an efficient financial system increases capital productivity and affects economic growth by selecting the most profitable investment projects, risk sharing, providing the required liquidity for investment projects [19]. financial development will also positively affect savings rates because an efficient financial system offers a better combination of returns and risk for savers, and early patterns of economic growth emphasize higher savings rates and higher economic growth rates [20]. economic growth is the primary manifestation of the performance of governments; economists try to help policymakers improve the index by accurately recognizing the dynamics and factors affecting the change and evolution of this index. in the economic literature, the accumulation and storage of physical capital have been expressed as a vital factor to achieve more outstanding production and productivity and to create a continuous flow of additional income for society [21]. to achieve the theoretical relationship between financing and economic growth, the production function should be utilised because, in the production function, the relationship between investment and economic growth is stated and investing in any institution without financing that institution is considered impossible [22]. in the 1940s, haroud and dumar used the most famous production function to analyse the process of economic growth. the central assumption of their model is that the amount of production in each economic unit, whether firm, industry or the whole economy, depends on the amount of investment in that unit [23; 24]. islamic financial instruments play a significant role in the growth and development of banking and the islamic capital market. they have an essential role in achieving the islamic goals for the economic and livelihood of islamic societies [25]. islamic financing is the best way to finance large economic projects and activities beyond the financial capacity of an individual or a private company, or even the government [5]. the main aspects of the distinction between islamic-based financing and conventional financing are based on five principles [26], three of them include the prohibition of usury, the ban of risk and uncertainty, and the prohibition of financing the illegal sectors of weapons, drugs, etc.). also, the two principles, profit and loss sharing and transaction based on an asset, are influential aspects of distinguishing between these two types of financing [27]. global banks and islamic financial institutions can expand around the world [28; 29]. this capacity is due to the capabilities of this system, as well as the structural problems and weaknesses of usurious financing [30]. the inefficiency of the conventional economic system (interest-bearing system) is not only proposed among islamic doctrines, but many economists, such as fisher, simmons, and friedman, have argued that the one-sided, interest-bearing debt system is fundamentally insecure [31]. the process of globalization, to have global scope for the activities of islamic banks and the expansion of global communications, including financial communications, has created new perspectives in islamic banks [32]. islamic financing leads to financial stability and development due to european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 29/10/2021 accepted for publication: 19/12/2021 published: 30/12/2021 20 the transparency of contracts by covering inflation and trying to reduce it [33]. the existence of non-fixed profits in islamic agreements that lead to islamic financing excludes financial repression. it leads to endogenous economic growth by preventing the increase of intermediary financial expenses. ii. literature riview goldsmith was the first scholar to point to the positive relationship between financial development and economic growth [34]. in a study based on empirical evidence and using statistical data from 35 countries in the period 1963-1860, he realised if periods of several decades are considered, an approximate symmetry between economic and financial development [35]. it can also be seen that for a small number of countries where statistical data are available, rapid economic growth has been accompanied by high financial development rates. rousseau and vuthipadadorn, has examined the relationship between financial system development and economic growth using var and vecm models for 10 asian countries in 1950-19000 . the study results confirm the longterm relationship between financial and real economic variables and show that in many countries, the causal direction is from the financial sector to the real sector of the economy. the research results confirm the weak externalization of the financial sector compared to investments in 5 countries [36]. colombages, in a study entitled "financial markets and economic performance", found that the issuance of sukuk has no effect on economic growth, but in a long time, will have a positive impact on economic growth. this relationship may be one-way, meaning that the issuance of sukuk bonds will improve economic growth. however, he stressed that the relationship between these two variables depends on the economic structure of each country [37]. lawal and imam, investigated banking and economic growth based on nigerian empirical observations; the primary purpose of the study is to examine the financial contribution to nigeria's economic growth and its direct relationship. experimental results of research using quarterly data from time series during 2015-2015 show a strong positive relationship between financing of islamic banks and economic growth in nigeria, which results in the theory of an efficient banking system leading to economic growth [38]. abdelghani echchabi, conducted a study to determine whether sukuk financing affects the economic growth of large exporting countries. the research findings show that the issuance of sukuk can affect gdp and gross capital formation if all countries cooperate; otherwise, it will not affect the growth of saudi arabia and the gcc [39]. smaoui and khawaja, studied the emergence of the sukuk market and its economic effects. they state that the lack of interest in sukuk markets is one of its essential features. what distinguishes it from other financial markets is that all developed islamic countries use sukuk but it’s also used as a financial instrument, especially in european countries and the united kingdom. the value of islamic financial assets is estimated at $ 3.2 trillion by 2020, the sukuk market share of total assets is about 10%, which is increasing every year, and this shows the importance of the sukuk market [40]. nawaz et al., examined the impact of islamic financing on pakistan's economic growth quarterly using time series data from 2006-2015. this study shows that in the long run, there is a positive relationship between islamic financing and economic growth in pakistan, and this strengthens the theory that "good performance and functioning of the islamic banking system leads to economic growth." meanwhile, in the short term, there is no relationship between economic growth and islamic banking [41]. abdelghani echchabi et al., examined sukuk financing on the economic growth of gcc member countries using the test toda and yamamoto granger. the study results indicate that sukuk financing does not affect the economic growth of these countries, which has significant consequences [42]. iii. methodology this research method is descriptive-explanatory, and the data panel method is used according to its statistical data. according to the study of the role of islamic financing of sukuk on the economic growth of selected countries, the method of collecting information and statistical data based on the library method and searching the world bank and the united nations website, testing research hypotheses and related analyses using econometric models (data panel); to estimate the model, first the f test to select the combined method or data panel, and then the hausman test is performed to determine its fixed effects, and eviews8 software will be used to test and estimate the model. the statistical universe in the current study of selected countries includes malaysia, iran, pakistan, qatar, bahrain, turkey, indonesia, uae and saudi arabia. this study aims to investigate the role of islamic financing on the economic growth of selected countries, which is analysed using data from selected countries. the model used in this study is adapted from the drissi and angade [43], and the general formula of this research is: lgdpit = β1+β2lexportit +β3lgcfit +β4llfit +β5lsukukit +β6lgeit + ε it lgdp; gdp logarithm (economic growth) lexport; export logarithm llf; logarithm of the labors lgcf; the logarithm of gross capital formation lsukuk; logarithm sukuk lge; logarithm of government expenditures first, the unit root test is performed to check the significance of the model variables. the f-limer test is performed to select the combined method or data panel, and then the hausmann test is performed to determine the fixed or random effects for estimating the model. the research variables are logarithmically entered into the model to compare the estimation coefficients with each other. all data for this study were collected from the world bank and the united nations (un) website. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 29/10/2021 accepted for publication: 19/12/2021 published: 30/12/2021 21 iv. findings a. evaluation of the reliability of research variables before estimating the model, it is crucial to test the reliability of all variables used in the model; because the instability of variables in both time series data and panel data causes false regression problems to evaluate the statics of variables, levin, lin and chu (llc) tests are utilised, which are more used to assess the reliability of variables in composite data. examination of tests is determined through the ivy 8 platform and significance based on prob at the level of 5%. given that the h0 test hypothesis indicates the existence of a unit root for each variable, if the calculated p-value is less than 5%, the hypothesis of a unit root for that variable is rejected. in other words, the probability value less than the value of 0.05, h0 is denied based on a unit root at the 95% confidence level, and the model variables at the (i0) level are stable or static. table i. testing the reliability of research variables (llc) b. estimation of research models first, are estimated the chu test and the hausman test, then the sukuk model. for the chow test, estimated the timeconstant effects model is and evaluated the panel or pool based on the f-limer test. table ii. chow test for pool and panel data the table shows the confirmation of the fixed effects against the least-squares aggregation method. in simpler terms, the validation of composite data versus integrated data, because the probability is less than 5%. after verifying the panel data, the hausman test is applied to detect the difference in the intercept of the cross-sectional units is constant or random operations can express this difference between units more clearly. in this test, we examine the h0 based on the consistency of random effect estimates instead of the h1 hypothesis based on the inconsistency of random effect estimates or fixed effect consistency. table iii. hausman test to detect the model of fixed or random effects the results of the hausman test indicate the rejection of the h0. because the probability is less than 5%. based on the results in tables (ii) and (iii), the pattern of this research for the studied countries and the sukuk variable is estimated using the design of fixed effects and the estimation results are reflected in tables (iv): table iv. table 4results of estimating the model with islamic financing variable (sukuk) variables test panel data (random effects) coefficient t-statistic prob < 0.05 y-intercept 3,475645 0,403980 0/0000 lexport 0,218808 0,059970 0/0010 lgcf 0,371525 0,031908 0/0000 llf 0,267126 0,095576 0/0091 lge 0,156678 0,066109 0/0000 lsukuk 0,007042 0,003671 0/0650 r2 = 0/99 dw = 1/63 f-statistic = 5018,505 prob (f-statistic) = 0/0000 growth studies usually use the logarithmic form of variables. this is because the model will be a constant tensile model, and the estimated coefficients will be interpreted directly as tensile. stable tensile models are also more appropriate for policy recommendations. sukuk coefficients have a positive sign and are statistically significant at less than 10% and with 94% confidence. accordingly, sukuk has a positive and significant effect at 90% on the economic growth of the studied islamic countries during this period. the outcomes of table (iv) show that the estimation model is in a good position in terms of statistical indicators. the f statistic indicates the significance of the complete regression. in other words, the hypothesis that the coefficients of the model-independent variables can be 0 is rejected, and the complete regression is significant. also, the statistical value of r2 is 0.99, which shows that the explanatory variables describe 99% of the changes in the dependent variable. the lack of autocorrelation in the remnants of the model was investigated using the durbin-watson, which is 1.63. this value is between 1.5 2.5, which is acceptable [44]. among the variables affecting economic growth in this estimation model, gross capital formation, labor, exports, government expenditures and sukuk, respectively, had the most significant impact on economic growth, and all variables had a significant effect on growth at 90%. variable statistics value level prob < 0.05 lgdp -5/24463 i (0) 0/0000 lexport -11/7279 i (0) 0/0000 lgcf -4/0137 i (0) 0/0000 llf -9/5391 i (0) 0/0000 lsukuk -4/518 i (0) 0/0000 lge -15/7984 i (0) 0/0000 chow test time-constant effects fstatistic prob < 0.05 effect 65/5511 0/0000 reject h0 hausman test statistics value prob < 0.05 effect 12/5491 0/0280 reject h0 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6158 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 29/10/2021 accepted for publication: 19/12/2021 published: 30/12/2021 22 v. conclusion in recent years, the expansion of sukuk markets has been rapid. the development and prosperity of the sukuk market depends on the standardization and coordination of the structure of islamic securities with the global securities standard. to achieve this, the basic requirements include creating a legal framework and establishing support institutions. regulations in the islamic world will undoubtedly welcome the entry of sukuk into the market, and this new product will help the market formation process by collecting private savings and directing it to investment opportunities and will lead to the deepening of the capital market. due to the advantages of these securities, diversified sukuk design with different risks and returns, has a very important role in expanding the sukuk market. just as in today's world of capital markets, investors welcome securities that have been certified by reputable international rating agencies. providing the possibility of ranking islamic securities will help in expanding its market. all companies and investors consider financing as their most important goal and plan to provide it. financing is essential for profitable projects; financial managers must attempt to give the company's financing sources and measure the company's financial risk and profit because the company's potential financing for investment and appropriate financial plans are among the factors of the company's progress. islamic financing has emerged in the world financial literature intending to provide a new model for replacing traditional and conventional financial systems and providing financial, commercial and investment facilities and opportunities following the principles of sharia [45; 46]. this system has been able to identify its various dimensions. due to the particular benefits and advantages of islamic financing, the issue of islamic financing has now become critical in the international arena. in this regard, various financial institutions and tools have been invented and used. nowadays, the benefits of islamic financing have led to its expansion and growing importance; a wide range of islamic financial institutions are operating not only in islamic countries but also in some western countries. in addition, the number and scope of activities of financial institutions and banks providing islamic financial services are increasing. this study aims to investigate the role of islamic financing of sukuk on the economic growth of malaysia, iran, pakistan, qatar, bahrain, turkey, indonesia, uae and saudi arabia. findings indicate that sukuk coefficients have a positive sign and are statistically significant at a level of less than 10% and with 94% confidence. sukuk has a positive and significant effect at 90% on the economic growth of the studied islamic countries during the period. references [1] t. hua, “market and monarchy: economic thought and history in early modern china,” springer nature, 2021. 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[46] v. jafari sadeghi, and p.p. biancone, “ shariah compliant international entrepreneurship: a study of islamic finance in europe,” 2017. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6114published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/10/2021 accepted for publication: 26/12/2021 published: 30/12/2021 54 role of the central bank in implementation of valuebased islamic banking and reporting in bahrain – exploring the challenges 1* phd student, university of malaya, department of shariah and management (malaysia) akhtar.sm@gmail.com 2 professor, university of malaya, department of shariah and management (malaysia) fadillah@um.edu.my *contact author: akhtar ali saeed mohammed abstract— this paper aims to explore the role of the central bank of bahrain (cbb) in the implementation of value-based islamic banking (vbib) and reporting in bahrain, explore the related challenges, and provides suggestions that how the central bank can encourage the islamic banks to align their operations for making a positive impact in society to translate value-based banking (vbb) fully into practice by the islamic banks in bahrain. the paper also explains the vbib, and its related principles, which is a relatively new concept in bahrain. the study employs a qualitative approach to understand the role of cbb in such implementation. the findings reveal that based on islamic principles and maqasid al-shari’ah, cbb is yet to develop a strategy paper and framework for the value-based islamic banking and reporting for the islamic banking practices towards the well-being of the society and social objectives. this article suggests what could be done by the cbb to achieve the aim of the adoption of vbib. as, there has been very little written on value-based islamic banking (vbib) and reporting in bahrain. therefore, the study also contributes to the current islamic finance literature and identifies the need for reporting standards to improve the vbib practice in bahrain in the future. keywordsvalue-based islamic banking (vbib), islamic finance, central bank of bahrain (cbb), aaoifi, cbb framework i. introduction in contrast to the traditional conventional banking system, which favours debt processes, islamic banks have a distinctive character, giving equivalent weight and priority to their social objectives and profit by focusing on real sector economic activities with a long-term objective rather than short-term risktaking decisions [5]. one must understand the maqasid al-shari‘ah (i.e., the objective of the shari‘ah to promote the welfare of human beings, which lies in safeguarding the faith, human self, intellect, posterity, and wealth) to comprehend the goals of islamic banking (imam ghazali (as cited by chapra and dusuki). however, over the years, the islamic banking industry adopted the developed form of wealth maximisation [7], just like a conventional bank, and diverted from the philosophy and ideology of islamic banking from the welfare of society towards profit maximization [4], [35], and failed to realize its embedded objectives of social-economic development as part of islamic economic principles and maqasid al-shari’ah based on which islamic banking system was built [30]. the recent global financial and economic crisis with the oil crisis and commodity prices, geopolitical conflicts, and depreciation in exchange rates has caused weaker confidence amongst consumers and investors in the global economy. this global financial and economic crisis (ifsb 2016) has brought the need for islamic banks to re-focus on the originality of their objective of being a value-based banking system [30]. the fundamental question is whether islamic banks are not only considering maximisation of the wealth of the shareholders but also providing positive impact and effects on the society, i.e., achieving the maqasid al-shari’ah with socialeconomic development in the community, which was defined by al ghazali in the 14th century [31]; [10], and how to implement such a practice. in this research paper, we have analysed the consistency of values-based banking practices of ifis with the concept defined in maqasid al-shari’ah. recently, the central bank of malaysia, with the assistance of islamic commercial banks, has developed a strategy document to work towards “value-based intermediation” [7]. value-based intermediation encourages ifis to adopt a more structured framework to create value and impact in society, particularly in response to changing economic, social, and environmental conditions. islamic finance and value-based finance had common grounds as principles of responsible investment [8];[9]. our focus in this research paper is to introduce value-based islamic banking and reporting, its principles and comprehend the role of the central bank of bahrain in adopting value-based islamic banking and reporting in bahrain by conducting akhtar ali saeed mohammed1, fadillah mansor2 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6114published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/10/2021 accepted for publication: 26/12/2021 published: 30/12/2021 55 interviews with the islamic banks’ executive management, experts, and scholars of the islamic banking industry. one could ask why central banks, for example, in this paper, the central bank of bahrain, should care about the impact on society, such as climate change and environmental sustainability. it should be noted and understood that any negative impact on society means the negative influence on corporations and households (being part of society/community), who have the services or products of financial institutions, will result in a negative impact on financial intuitions portfolios and performance. thus, illnesses (i.e., covid-19) increase the number of deaths, affect short and long-term growth and financial stability. further, financial institutions, who have lent to households and corporations are likely to have a negative impact due to such events and an increase in losses. therefore, central banks and financial institutions must consider such a negative impact on society and safeguard themselves [12]. the principles of islamic banks promote long-term sustainability, social responsibilities, interest in the business of all parties concerned with the success of the result, responsible to their shareholders, as well as oblige a fiduciary duty to society as a whole [30]. reference [26] further emphasized that the principles of islamic finance offer a fair socio-economic system with a strong commitment towards the well-being of society, social justice, and prosperity of the whole community. social issues must be critical to islamic banks based on islamic principles. the earlier studies revealed that the islamic banks were based on social initiatives to achieve social objectives [30]. al-ghazali defined the maqasid al-shari’ah as an islamic social welfare function, with specific goals and guidelines for prioritising individual and social needs [16]; [31]. besides, reference [6] has argued that islamic banks play two critical roles in the community, namely religious and financial. therefore, islamic banks have been considered a new way of representing the organisations, whose social objectives are as valuable and essential as making profit [18]. reference [28] argued that “both the society and the business will not have a long-term future” without sustainable development. ifis have to play a vital role in developing value-based banking and reporting by making a community-based investment, developing value-based islamic banking products that meet customers' business needs with social values and religious beliefs [30]. these products and investments will allow people to improve standards of living, assist in the development of a community, social services such as the development of human resources, safety of environments, elevation of human rights, help them to develop small businesses and create jobs and positive contribution in community development programs (hasan & dridi, 2011; [29];[36]; [33] [13]. a. brief overview of value-based islamic banking values-based islamic banks (vbib) manage their funds by providing facilities and services to sustainable projects through facilities to individuals and corporates based on islamic finance and economic principles [30]. they avoid investing funds for purely financial purposes rather than to support their local communities with a positive impact. these banks use resources to deliver economic, social, and environmental development [20]. value-based islamic banking can be described as illustrated in figure 1 [30]. figure 1. the concept of value-based islamic banking [30] therefore, value-based islamic banking focuses not only on pure return or profit but also realises the importance of corporate responsible banking, sustainable-focused islamic banking, and ethical and investment responsible islamic banking, which will generate a positive impact on society with sustainable development and return to the shareholders [30]. b. principles of value-based islamic banking the following six principles are mentioned in figure 2 [17], previously referred to as sustainable banking and finance principles, modified for value-based islamic banking and reporting [30]. figure 2. principles of value-based islamic banking [30]. adapted from [17]. these principles are needed to be ingrained in the culture of islamic banks to recognise them as part of the day-to-day procedures and operations. the central bank can encourage and support islamic banks in bahrain to establish such policies to reflect their values-based approach and develop such practices to help society [30]. islamic principles maqasid al shariah european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6114published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/10/2021 accepted for publication: 26/12/2021 published: 30/12/2021 56 c. practices of value-based islamic banking and reporting in bahrain bahrain has been considered the financial hub in the middle east with several governing authorities. therefore, they have the ability to make valuable contributions to theory, policy, practices and assist in significant knowledge in valuebased islamic banking (vbib) and reporting not only in bahrain but also in other parts of the world [30]. the research revealed that the scale of vbibi by islamic banks falls short of the index of 1 by most banks, as social society-related matters were not disclosed in their annual reports [30]. islamic banks have been described as having “a social face” [24]. “social activities are emphasized in islamic banks’ articles of association among their objectives and functions” (el-ashker, 1987, p. 45, cited in [24] reference [30] found that the value-based islamic banking index (vbibi) scores of three dimensions debtor, environment, and qard al-hasan, are the lowest among all the themes and raise questions for islamic banks. astonishingly, we did not find any information disclosed on debt policy in the sample of islamic banks [30]. though quran says that “and if someone is in (debtor, hardship), then postponement until [a time of] ease. but if you give charity, then it is better for you if you only knew”. (the holy qur’an, 2: 280) . however, no report on the debtor or very little information was disclosed on the environment and qard al hasan [30]. sairally (2007) reported that the social responsibility of islamic financial institutions (ifis) was not an integral part of their business policies. likewise, a study by [22] and [18] have discovered that the responsibility of islamic banks to satisfy their ideological cases has either insignificant or non-existent focus on social objectives. islamic banks need to play a positive role in economic development and community prosperity [6]. reference [18] suggested that corporate disclosure practice reflects the underlying environmental influences that affect company accounting practices in different countries. as there is no impact reporting standard for disclosure purposes, islamic banks disclose whatever they desire necessary. therefore, ifis have yet to develop such evaluating and assessing operating and reporting systems based on their operations and embedded objectives [30]. there is a need for more disclosure and reporting of valuebased islamic banking and recognised the necessity for social and economic prosperity and the responsibilities of islamic banks as part of their business and islamic principal [30]. it was stated that the main reason for such non-disclosure was the lack of aaoifi standards on value-based islamic banking reporting [30]. “governing authorities such as the central bank and aaoifi has to play a vital role in this regard. it was found that currently there was no framework from governing authorities such as cbb and aaoifi in bahrain, which could direct the value-based islamic banking and reporting, no rules, strategies, and guidelines for assessments and disclosures such as the social and environmental performance as non-financial information along with financial performance” [30]. aaoifi is yet to develop and cover such aspects of value-based islamic banking reporting in their standards, as presented in below figure 3. figure 3. the value-based islamic banking reporting aspects [30] implementing value-based islamic banking and reporting will further strengthen accountability and integrity and provide fair and transparent disclosure [15]; khan, 2019). “value-based banking (vbb) standards will enhance ifis’ non-financial information disclosure to indicate their contributions to society. such reporting and transparency will help the stakeholders in decision making and could help to build up a better future for the economy” [30] ii. research gap and aims a literature review shows that many materials and articles may be published on islamic microfinance and maqasid alshari'a and their link with islamic banking in general. however, there seem to be limited research papers explicitly addressing whether the concept of value-based islamic banking and reporting and how the central bank can help to achieve such goals. this research study aims to tap into these research gaps by introducing value-based islamic banking and its principles in the islamic banking industry in bahrain. furthermore, this research study's objective is to introduce the role of the central bank of bahrain in adopting value-based islamic banking and reporting in bahrain through interviews with senior management of islamic banks, specialists, and academics of the islamic banking sector. there is very little written on the practical side of value-based islamic banking and reporting. therefore, this article provides a valuable contribution to the literature domain, knowledge, and practical aspects of the islamic banking industry in bahrain and other parts of the world where islamic banking is being practiced without value-based banking. iii. methodology a qualitative research technique was employed through interviews with the representatives and experts of islamic banks to explore the perception of the value-based banking implementation and disclosure enhancement in reporting of european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6114published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/10/2021 accepted for publication: 26/12/2021 published: 30/12/2021 57 islamic banks with the assistance of the central bank of bahrain. qualitative research enables the researcher to comprehend how islamic banks’ representatives construe their experiences and meaning [11]. the use of a qualitative research approach can be further justified in its capability to generate comprehensive information to determine the role of the central bank in the implementation of value-based islamic banking [11]. this study applied the qualitative method to collect data. we conducted 12 in-depth semi-structured interviews with the senior executives, practitioners, specialists in the field of islamic banking and reporting, and scholars who were aware of islamic banking practices in bahrain. the selection was based on their overall knowledge of islamic banks and value-based banking, including strategic objectives which have implications for vbb. the primary purpose and goals of these interviews were to gain comprehensive understandings and insights into the role of the central bank of bahrain (cbb) in adopting value-based islamic banking and reporting. open-ended questions guided the interviews, allowing for more significant discussion and dialogue between respondents and the researcher. interviewees were requested to structure their responses subjectively based on their level of knowledge, degree of expertise, and skill. this method led the researcher to a thorough understanding of the role of cbb in the implementation of value-based islamic banking and reporting, addressing the rich context and their significance [11]. the names and contact information of the interviewees were gathered from the annual reports and the websites of the organisations. in addition to that, we also employed sequential and chain sampling. in this sampling procedure, one initial respondent leads to another, or additional respondents have obtained information from the initial respondents. in other words, selected contributors will propose additional participants that they think will provide imperative data for the project [37]; [27]. context notes regarding the research and interview were sent to interviewees in advance once they were scheduled. the interval for each interview varied from half an hour to an hour. an audio recorder was also used with the interviewees' permission to record each interview. we initiated the conversation by providing a background and general introduction about value-based islamic banking and reporting, then continued by asking interviewees further questions regarding the main concept of the topic. furthermore, participants were informed that their identity and the specifics of their organization would not be divulged when quoting them. interviews were conducted in english language, which was the same language used to write up the transcript from the recorder. the procedure generated a significant number of data pages, where no significant variations were noticed. we analysed the transcripts by organizing the interview content by establishing critical points and gathering them into groups. the analysis procedure commenced with each transcription being coded. considering the bigger picture in the interview guide, the researcher constantly read all the transcriptions and emphasised substantive statements deemed appropriate to the research. the researcher listened to the recorded interviews and read the transcripts while listening to ensure the accuracy of the data and reflection on the interviewees' meanings and intentions. respondents' identities remain confidential according to ethical norms and considerations [30]. table i. list of interviewees interviewee number position nature of organization education gender i1 senior manager ifi mba, cpa male i2 executive manager ifi mba, acca male i3 senior manager ifi mba, icaew male i4 executive manager ifi mba male i5 senior manager ifi mba, male i6 director ifi mba, ca male i7 senior manager ifi mba male i8 manager ifi mba female i9 ceo ifi phd male i10 executive director ifi phd male i11 executive manager isdb, scholar phd male i12 senior manager icd, scholar phd male after reviewing samples of ifis’ annual reports and financial statements and knowing the practices and disclosure of the value-based banking, the researcher sought to ascertain how to improve value-based islamic banking and reporting in bahrain by conducting interviews (table 1). several factors affect the implementation of value-based islamic banking; however, this research paper discusses only one of the factors related to the central bank of bahrain (cbb) in adopting value-based islamic banking and reporting [30]. the current study attempts to answer the following research questions: a) how can central bank play a role in implementing value-based banking and reporting in the islamic finance industry? b) how can islamic banks be encouraged for positive social change by the central bank of bahrain? c) do you think islamic banks need the support of an entity that brings all islamic banks under a platform and guides them for being value-based islamic banks? european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6114published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/10/2021 accepted for publication: 26/12/2021 published: 30/12/2021 58 iv. results of the interviews a. role of the central bank in implementation of valuebased islamic banking and reporting all interviewees concurred that cbb and regulators must develop a framework and guidance for value-based islamic banking and reporting. “cbb can develop a strategy or a plan, just like other central banks, where value-based banking (vbb) has been implemented”(i9). “this will encourage the ifis to deliver shari’ah based products and services with a mindset and focus positive impact to the economy and community” (i7). cbb has to motivate the islamic banks to have their plan, policies, approach, and performance on value-based banking. to facilitate the adoption of value-based banking and reporting system in bahrain, cbb can assist the islamic banks with some guidance, training materials on value-based islamic banking (vbib), and also collaborate and team-up with the concerned stakeholders of the banks, and ascertain that islamic banks have the necessary training. cbb can also support and promote the vbib by ensuring that the islamic banks align their products and services with value-based banking to reflect such values in their day-to-day transactions and performance by disclosing them in the impact report either separately or as part of the annual report. “creating awareness of vbib and reporting is vital for the islamic banks by the cbb”(i5). cbb has to create awareness of value-based islamic banking and reporting through collaboration with the bahrain association of banks (bab), cibafi, islamic banks’ ceos roundtable, islamic banking conferences of the ifis in bahrain. “cbb has been continuously enhancing the regulatory framework in bahrain to support innovation and maintain the stability of the financial sector” (kpmg, 2019). however, nonfinancial related frameworks such as value-based banking and reporting frameworks are yet to be introduced and developed for the banks by the governing authorities in bahrain [30]. european central banks have included core responsibilities as environment and sustainability as part of their goals. ifis in malaysia have commenced addressing sustainable, responsible, impact investing through ethical financing by embracing the pursuit of values beyond financial returns and motivation. an example of such investment could be sukuk by khazanah that brings social impact through promoting quality education, and similarly, green sukuk could encourage sustainable energy [15]; [9]. the responses from the interviewees are in line with literature reviews of central bank malaysia (bnm) has introduced value-based intermediation (vbi) for islamic banks to be more impactful by allowing them to have more participation in social well-being, to improve the more remarkable achievement of maqasid shari’ah in ifis, and concurrently to achieve economic growth in the community [20]. “to have impactful reporting for vbib, cbb can encourage aaoifi and the islamic financial services board (ifsb) to develop a set of guidelines for non-financial disclosure information to steer ifis for vbb reporting” (i3). value-based banking (vbb) standards will enhance ifis’ non-financial information disclosure to indicate their contributions to society. such reporting and transparency will help the stakeholders in decision-making and could help to build up a better future for the economy [30]. moreover, with the support of the cbb, aaoifi to collaborate with shariah scholars and ifsb to develop guidelines and standards to guide the shariah board not to focus only on shariah compliance but also highlight to the ifis’ stakeholders, particularly the management and board, that recognising environmental, social, and cultural issues are important factors of maqasid al-shari’ah and these subjects are an integral part of ifis operations [30]; [29). the central bank must have their separate trained division in value-based islamic banking, at the central bank level, who reviews the islamic banks' operations, reviews their financial statements and policies, encourages them to align operations, and reports the impact of value-based reporting. create a system in the central bank by asking them questions such as social development goals (sdgs) based on how islamic banks’ products and services are creating jobs. to encourage them to have 17 sdgs reporting in their annual report or separate reports. furthermore, cbb must make sure that islamic banks understand the needs, expectations, and sensitivities of the subject matters must prioritise those banks that are making a positive impact and reporting such effects on the customers in the market. therefore, islamic banks should train their staff with sufficient knowledge of islamic banking products with ethics and professionalism towards customer satisfaction [33]. b. encouragement of positive social changes by the central bank cbb to introduce the enabling environments for ifis in bahrain by helping them to adopt the value-based banking practices through encouragement. “in order to promote and courage vbib practices, cbb should provide incentives islamic banks.” (i8) the banking industry in bahrain is very competitive with islamic banks being in the same marketplace as conventional banks interviewee (i8) emphasised that to implement the valuebased islamic banking (vbib) practices in bahrain, the central bank of bahrain (cbb) has to provide some incentives, for instance, by lowering the capital reserves requirements of islamic banks as a percentage of the islamic banks’ assets with cbb, if these islamic banks make investments or transactions which will create jobs or fundings to the smes or new ideas which could bring prosperity in the society, by appreciating these islamic banks efforts of such kind of investments which make a positive impact in the community. this will lead to new business opportunities and results in sustainable banking to support the financial sector's long-term resilience [15]; [9]. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6114published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/10/2021 accepted for publication: 26/12/2021 published: 30/12/2021 59 through interviews with the experts, the researcher found that the central bank must promote the engagement in corporate governance of the islamic banks around the sdgs, encourage ifis, supervise them, create some platforms for learning, form networking to bring all the exchanging experience together, and encouraging investments in the kinds of long term sustainable projects that society needs to have, which will create positive impact. cbb has to align banking practices to the value-based islamic banks with the goals expressed in the sustainable development agenda and set benchmarks for what it means to be a value-based islamic bank in that context. cbb must determine that ifis by supervising them that ifis’ operations and goals are aligned with sdgs with the core business objectives, such as job creation, financing, health care, education, and clean energy. cbb must supervisor the ifis to ensure that this approach must be embedded in the business model of ifis. cbb ought to urge and encourage the islamic banks that the value-based islamic banking techniques could be used as a strategic tool to enhance the bank's reputation in the market to gain more customers in the long run and survive in the evolving islamic banking competitive market. it was proved that profit maximization and value-based banking are positively correlated [33]. furthermore, to develop awareness and to promote vbib in the market, cbb should appreciate the islamic banks’ efforts towards such goals, for example, by marketing such valuebased islamic banks by publishing their names in its weekly or monthly newsletter or on their website as an excellent valuebased islamic bank in terms of helping the society and making a positive impact in the community in bahrain. this should be done on a volunteer basis at the beginning to promote value-based islamic banking and reporting in the islamic banking industry [8];[9]; [25]. c. need of a leader to bring all the islamic banks in bahrain under a single platform “cbb to seek guidance and assistance from the pioneer of vbib’s such as global alliance value-based banking (gavb) and isdb group to consider the way to implement value-based islamic banking and reporting in bahrain to promote the bankable social development goals (sdg)” (i12). cbb, with the help of the government, can utilise the expertise and assistance of the world bank, islamic development bank (isdb) and collaborate with the bahrain association of bank (bab), general counsel for islamic banks and financial institutions (cibafi), accounting and auditing organization for islamic financial institutions(aaoifi), islamic financial services board (ifsb), encourage the islamic banks, develop regulations and oversight the financial sectors particularly the islamic banks, as they are assets based so that islamic banks can engage over a longer term of the society, and develop value-based islamic banks disclosure standards for stances disclosure on the environment, impactful disclosure besides the financial results. if current practices of islamic banks are shifted beyond financial consumers to broader stakeholders within the community and economy, it will create not only profit for the consumers but also achieve the bankable social development goals (sdg) for the country, such as good health and wellbeing, quality education, gender equality, affordable and clean energy, decent work and economic growth, innovation and infrastructure, reduced inequality and, sustainable cities and communities. “the collaboration among the shariah scholars, practitioners, researchers, and regulators to undertake in-depth studies and research” [19] to determine that islamic banking products are value-based, which will not only earn profits for the shareholders but also make a positive impact in the society as part of the islamic banking objectives, achieve the economic goals and related sdgs in the country, will be an essential underpinning towards the development of value-based islamic banking system. “value-based islamic banking can help in achieving the sdgs through focusing on the real economy to promote growth, through financial inclusion of providing financing to sustainable projects, through financing projects that cater for the environment, and through sustaining the relationship between the bank and its customers” (i9). one of the principles of value-based banking (vbb) is client focus with the economic objective. vbb measures and captures the essence of sustainability by measuring the impact of an organisation's activities on society. such as supporting local communities, the environment, customers, services to sustainable projects, individuals, and entrepreneurs. in order to assist ifis in bahrain, central bank, acting as a facilitator and regulator, can help in such vbb frameworks for ifis, which will help in the development of the real economy, assist in sustainability, and benefit the country. in this regard, central banks can play an essential role in maintaining the economic and financial stability of the country. their toolkit also includes maintaining price stability (i.e., controlling inflation) and promoting economic growth. if achieved, economic growth will lead to job creation and employment opportunities and, hence, improve the standard of living in society. thus, as cbb, they need to consider utilising the private sector (i.e., ifis) into yielding such objectives, while ifis perform their tasks by achieving their objectives and helping the economy simultaneously. it will be a win-win situation for both ifis and cbb as a central bank, achieving sustainability and prosperity in society. all other participants underlined that cbb should enforce such practices and reporting. moreover, the majority accord with the collective view of islamic banking being value based on a responsibility to ensure socio-economic development and improvements in its reporting. through the interview, we revealed that cbb is expected to play an essential role in regulatory reform and support ifis to direct their activities towards the well-being of society [30]. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6114published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/10/2021 accepted for publication: 26/12/2021 published: 30/12/2021 60 value-based islamic banking (vbib) is closely related to economic growth in the longer term. the vbib scheme is more stable due to the absence of debt funding. therefore, it lowers inflation in the economy and positively impacts employment, trade, economic growth, and gdp [3]. v. discussions and conclusions this research paper addressed the value-based islamic banking practices and reporting in bahrain. value-based islamic banking and reporting will help resolve the issues and bridge the gap in economic development and social prosperity between the expectations and performances of the social elements of the islamic banks. islamic banks in bahrain may find it challenging to practice and disclose non-financial information without a central bank framework and guideline or set of standards from aaoifi. the findings of this paper are in line with previous studies of researchers who have discovered that the responsibility of islamic banks to satisfy their ideological cases has either negligible or non-existent focus on social objectives. islamic banks should play a positive role in economic development and community prosperity [6],[18],[22] this research paper discovered that islamic banks in bahrain have lesser consideration. they have yet to devote more resources to value-based banking practices and disclose such practices in their reports. this is mainly due to the nonexistence of an impactful framework from cbb and such standards from aaoifi for reporting purposes [30]. this paper discovered through interviews with the expert of islamic banks and managements those governing authorities such as cbb with the collaboration of other governing bodies must create enabling environment for the ifis in order for them to achieve the objectives of value-based islamic banking and reporting in bahrain by considering the followings: • developing a strategy and planning documents with the collaboration of key ifis in bahrain; • teamwork with isdb group, global alliance valuebased banking (gavb), and the central bank of malaysia; • creating awareness of vbib through islamic banking conferences and islamic banks’ ceos roundtables; • providing incentives and appreciation to encourage value islamic based banking; • developing a set of rules for non-financial indicators and disclosure reports with the association of aaoifi and ifsb; and • collaboration with aaoifi, shariah scholars, and ifsb for the development of guidelines and standards for shariah boards regarding vbib. vbib shall help achieve the social development goals (sdgs) of bahrain. economic development and prosperity in society will result in more business for ifis in the long term. therefore, islamic banks should understand the importance of value-based banking and reporting in their daily operations. ifis should realign their operations to echo the islamic principles they claim to follow to help society achieve valuebased banking [30]. though at the same time, the implementation of vbib on the ground could be challenging and cumbersome mainly because of the competitive marketplace. unless islamic banks get special treatment from the government and the central bank, for example, incentives in capital adequacy requirements, appreciation, and special treatment for such a business plan of value-based banking, it will be tough to encourage ifis with high competition in the market for islamic products such as murabaha or tawarruq products (hurayra, 2015), which are not an ideal islamic banking apparatus for carrying out the fundamental economic objectives [32]; [25]. the study also contributes to the existing literature surrounding islamic banking and the various facets attached to it. in particular, to answer how the central bank of bahrain (cbb) can implement value-based islamic banking and reporting in bahrain. our findings in this research paper have imperative implications not only for the cbb and management of islamic banks in bahrain region but also in other countries, where islamic banking products and services are in demand. vi. limitations and future research although the results indicate the opinion of management and experts that the central bank can play a vital role for valuebased islamic banks, the study has certain limitations that should be examined in future studies. we have limited our sample to bahrain alone, and further research can be extended to ifis and traditional islamic banks in other countries. thus, additional research into these aspects 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[50] https://www.thestar.com.my/business/businessnews/2018/10/03/guidance-on-value-banking/ [51] https://www.euromoney.com/article/b19zzgy0hljjvg/impact-bankingputting-the-impact-back-into-islamicfinance?copyrightinfo=truehttps://www.cbb.gov.bh/, november 2019 [52] https://albaraka.bh/en-gb/, november 2019 [53] https://www.ithmaarbank.com/, november 2019 [54] https://ibdarbank.com/, november 2019 [55] https://www.alsalambahrain.com/ november 2019 [56] https://www.bisb.com/, november 2019 [57] http://www.khcbonline.com/en, november 2019 [58] https://www.kfh.bh/bahrain/en/corporate-banking.html, november 2019 [59] https://www.bank-abc.com/en/islamicbank/pages/default.aspx, november 2019 [60] https://www.bankalkhair.com/en/international-offices/bank-alkhair.html, november 2019 [61] https://www.citi.com/icg/sa/emea/bahrain/, november 2019 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6114published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/10/2021 accepted for publication: 26/12/2021 published: 30/12/2021 62 [62] https://1stenergybank.com/, november 2019 [63] https://www.gfh.com/, november 2019 [64] http://www.gbcorponline.com/, november 2019 [65] https://ibdarbank.com/, november 2019 [66] https://www.iib-bahrain.com/, november 2019 [67] http://www.inv-darbank.com/, november 2019 [68] https://www.arcapita.com/, november 2019 [69] https://www.lmcbahrain.com/, november 2019 [70] http://www.seera.com/, november 2019 [71] https://www.vc-bank.com/, november 2019 [72] https://www.un.org/development/desa/disabilities/envision2030.html. paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif 1 challenges sharia microfinance institutions: evidence from indonesia a bank syariah mandiri, wisma mandiri i, mh thamrin road no.5, jakarta, indonesia. . abstract—microfinance institutions and islamic microfinance institutions that do not have a body would be transformed into cooperatives (coop) or shareholder firms (shfs) company under the act no.1 of 2013 (uu no.1 tahun 2013) regarding microfinance institutions. one of islamic microfinance institutions for being baitul mal wa tamwil (bmt) that currently a majority of non-governmental organizations are required to transform to become more professional, and should be answer the challenge in the future. in this literature review there are some challenges for bmt to be transformed and can be exist in future. the challenges of bmt, are what the microfinance market that also relevant to the islamic perspective will be needed in future. this literature review is limited by three questions, (i) what is the purpose of bmt?, (ii) what are the challenges of bmt in the future?, (iii) what are the advantages bmt incorporated in?. keywords: islamic micro finance, the act no.1 of 2013 regarding microfinance institutions, baitul mal wa tamwil, transformation, microfinance challenges, islamic perspective. jel classification: g02, g14, g21 1. introduction 1.1. background issuance the act (uu) no.1 year 2013 on microfinance institutions will certainly have an impact on changes in the shape and condition of indonesian microfinance institutions including islamic microfinance institutions in the future, because the act requires microfinance institutions have legal entities or shareholder firm and also the operations of microfinance institutions will be supervised by the financial services authority. currently there are still many microfinance institutions, particularly islamic microfinance institutions that do not have a legal entity, ie baitul mal wa tamwil (bmt) which amount 60% of the total bmt (republika online.com, december 15, 2010). the number of bmt to june 2012 is estimated at 5,500 units (republika online.com, june 28, 2012), and if 60% of bmt has not been incorporated in the amounted to 3,300 units and 2,200 units remaining bmt incorporated cooperative. based on the goal of microfinance institutions have the function of providing financial services to low income communities not served by banks (unbankable) (armendariz and labie, 2011). while the definition of microfinance is to provide financial services to people who have limited access to banking services. the financial services are; financing or credit, savings, remittances and insurance (karlan and golberg, 2011). however, the implementation and operation of microfinance institutions get the challenge of mismatch between the needs of low-income people with products offered by microfinance institutions (armendariz and labie, 2011). besides that microfinance institutions should protect all clients (savers) to run its operations based on prudential principles by christen et al. (2003). under these conditions, how can islamic microfinance institutions can meet the challenges of mismatch and protect all its customers in order to implement the act no.1 of 2013?. 1.2. limitation of research a lot of bmt is still not incorporated in. based on act no. 1 of 2013, the bmt that does not have a legal entity shall be transformed into cooperatives or shfs. then the limitation of this study is how the transformation process bmt be incorporated in to meet the needs of low-income communities (the challenge of microfinance institutions) and in order to keep operations running the prudential principles. 1.3. objectives and contributions goals and contribution of this study is to provide input for islamic microfinance institutions (bmt) in order to survive in the future. bmt is also expected to play an active role in creating wealth evenly throughout society by enforcing sharia (islamic law) in order to achieve the economic goals of islam. definition of the purpose of islamic economics or maqashid shari'ah is to create maslahah ummah who became one of the important pillars of the economy and business in sharia. it is also narrated in a hadith by musnad shihab, hadith no. 1234 as follows: \ "the best man is the most useful for others." lucky nugroho a ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 2 2. research methodology the research method is based on a qualitative research, the framework of this research is defined by research questions as follows:  what is the purpose of bmt?  what are the challenges of bmt in the future?  what are the advantages bmt incorporated in? 3. analysis 3.1. the purpose of islamic microfinance institutions the characteristics of microfinance institutions, there have two roles, the first function is related to financial (commercial) and second as a social function (hudon, 2011). microfinance institutions aim is not always to maximize profits (copestake, et al., 2005) but its main purpose is to provide access services to low-income people who cannot be served by banks (morduch, 1999). bmt is micro-finance institutions that carry out activities based on islamic principles. the main factor underlying the establishment of bmt is the desire to run an economic system that is based on the values and principles of islamic justice which aims to distribute free from all forms of exploitation. in addition, the role and function of bmt is to develop human resources and to support micro and small entrepreneurs as well as a viable potential (holloh, 2001). roles and tasks bmt as follows: 1) help identify needs and business opportunities. 2) help plan and provide business consulting. 3) mobilizing funds from the public. 4) provide and facilitate access to financial services and marketing channels. 5) disseminate information and provide training. in connection with this, the bmt is a form of islamic microfinance institutions whose roles and functions in accordance with khittah (basic concepts) microfinance institutions. therefore the existence of bmt in the future is indispensable in improving the welfare of society. 3.2. challenges for the future bmt. developments and changes in the needs of low-income people is a challenge for bmt to fulfill. according mersland and storm (2012) microfinance institutions must innovate to meet the needs of low-income people so that the characteristics and objectives of microfinance institutions is maintained. however, microfinance institutions as a going concern entity must and should be transformed from idealism into business activities (commercial). the transformation is necessary because there are new clients who require access to affordable microfinance and microfinance institutions must maintain the continuity of its financial condition. innovations required by microfinance institutions, according mersland and storm (2012) are as follows: 1) making low-income communities as a target service banking products also provide finance or micro-credit services to low-income communities. however, there are still many low-income people who do not bankable but has potential and deserves to be given micro-finance. based on that microfinance institutions can develop products according to the conditions in each area. in the qur’an there are lots of explicit statements related to the poverty alleviation and the solutions to it, few of statements as follows: a. al insaan verse 8 says “and they give food in spite of love for it to the needy, the orphan, and the captive”. b. al baqarah verse 177 says “righteousness is not that you turn your faces toward the east or the west, but [true] righteousness is [in] one who believes in allah , the last day, the angels, the book, and the prophets and gives wealth, in spite of love for it, to relatives, orphans, the needy, the traveler, those who ask [for help], and for freeing slaves; [and who] establishes prayer and gives zakah; [those who] fulfill their promise when they promise; and [those who] are patient in poverty and hardship and during battle. those are the ones who have been true, and it is those who are the righteous”. c. al anfal verse 41 says and know that anything you obtain of war booty then indeed, for allah is one fifth of it and for the messenger and for [his] near relatives and the orphans, the needy, and the [stranded] traveler, if you have believed in allah and in that which we sent down to our servant on the day of criterion the day when the two armies met. and allah, over all things, is competent”. related to the issues of poverty alleviation in the islam and the target from the microfinance institutions to serve low income people, it's very relevant to become low income people as a target in an islamic microfinance institution. 2) making women as targets why women were subjected to micro-finance for the following matters: a. gender equality, of course, in the teachings of islam recognize the equal rights of men and women, regardless the nature of men and women have differences. b. poverty alleviation, by empowering women to manage the household finances will add to the household income so that their household can live more prosperously. c. efficiency, because the women who manage the finances and men who generate income (the division of the finance function in the household), then women can control their household expenses and arrange installment ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 3 payments to microfinance institutions in a timely manner. according to suratmi et. al (2011) is based on of islamic sharia either in the qur'an or hadith, does not forbid women to work in the public domain. men and women can work in both inside and outside the house and in any suitable field, which needs to be done in order to survive. but in muslim developing countries, many women like and bound to stay at home. moreover, there is no condition stating firmly that only men can be a public leader. there is some quran verse that says men are more capable physically and intelligent than women. however, if there are women as responsibilities to his family (children) feel more secure when they stay at home and avoid public activities. as well, if the daily lives of men are more opportunities than women in public activities (political, economic, etc.) that is not related to islamic sharia, but because of the perception and habits of the local population. based on these perceptions, women as target in the islamic microfinance institution also very relevant to be implemented. 3) developed a variety of methods in channeling financing to low-income communities identical micro financing by requiring collateral to clients who ask financing. it cannot be applied to microfinance institutions whose goal is to serve lowincome people who in fact have limited collateral. under these conditions, microfinance institutions need to innovate the methods of financing products and their features, such as group lending models are commonly called joint responsibility, provide financing with a short term (tenor), incentives, etc. these innovations must be adjusted to the characteristics of local communities. 4) doing organizational changes microfinance institutions to provide guidance and supervision to the customers, but who is doing the coaching and supervision of microfinance institutions?. initiatives and new paradigms non governmental organizations (ngos) in the world who care about poverty to transform the organization into a company whose shares are owned by the public (shfs or cooperatives) as an example prodem ngo in bolivia changed to banco sol in 1992 (von pischke, 1996). the impact of these changes is to be more efficient because the organization runs its operations obedient (governance) that are caused by external guidance and supervision. bmt as traditional organization, along with the growing number of bmt is followed by the emergence of various problems. this happens due to the absence of legal rules governing the protection and guarantee customer funds bmt. "we have grown a lot since bmt founded it easy. bmt alone is the domain of medium to society. but in many cases that come his way as embezzlement of customer funds by the board. related to the issues of customers' protection in islamic microfinance, the organizational changes to be more professional is very important to be carried out in islamic microfinance. 5) looking for new sources of funding microfinance institutions where it has been transformed into incorporated in may seek new sources of funding in a way; raise money by issuing shares, collect deposits from the public, and loans from other financial institutions. to serve low-income communities with a wide range, islamic microfinance also require new funding not only from investors, donors, creditors, but also islamic microfinance institutions have the opportunity to distribute zakat to the poor according to the criteria of sharia law. 6) environmentally friendly the originality of microfinance objective, it's to achieve the double bottom line. that is mean microfinance institutions are mindful not only about financial performance, but also by social indicators. econometric analysis is used to assess financial performance, and guidance is provided for extending the analysis of social performance indicators or mfis have a double aspect: financial and not-for-profit. it is, therefore, appropriate to assess their performance by means, not only of financial ratios, but also by means of social indicators. (frank, 2008; armendariz and labie, 2011; hudon, 2011; stuart, 2011; balkenhol and hudon, 2011; cinca et al, 2011). but why should microfinance should concern in environmental bottom line? allet (2013) mention the clients of mfis should be responsible for climate change because they have an impact on the environment. the clients of mfis have contributed in major environmental risk like chemical pollution, solid and liquid wastes, pollution emissions, inefficient production processes (energy-consuming, waste-producing), and degradation of natural resources. regarding this risky, there are environmental issues in the community, such as health and sanitary issues, economic consequences, risk of conflicts, increased vulnerability and food security. associated in this condition the donors in mfis and the experts in this field, believed mfis has capacity to involve in environmental concern in their activities to be third bottom line or additional from the original mfis objective double bottom line, the triple bottom line element that consist of financial performance, social performance and environmental performance (copestake, 2007; green microfinance, 2007; van elteren, 2007; fmo, 2008; schuite and pater, 2008; rippey, 2009; agier and szafarz 2013). we believe green microfinance activities will be significant contribute to anticipate the impact of climate change for livelihood, because of the small scale activities in developing countries has the ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 4 threat of environmental destruction (allet, 2013), and mfis as the institution directly contact with the grassroots community. addressing in this condition, the services of mfis could be as intermediaries, and have the opportunity for the dissemination of environmental awareness-raising information (hall et al, 2008; seep network, 2008). in line with this issue, kaushal et.al (2005) also mentions that microfinance has a positive impact on the environment, because of there is a positive link between access to micro credit and forest regeneration in 27 indian villages. in the sharia perspective, environmental friendly also as crucial issues, the quran was mention about the human activity should be not harmful for the environment. the connection between the qur’an and environmental issues as follow: a. al-a’raf verses 56 says “and cause not corruption upon the earth after its reformation. and invoke him in fear and aspiration. indeed, the mercy of allah is near to the doers of good”. b. ar-ruum verses 41 says “corruption has appeared throughout the land and the sea by [reason of] what the hands of people have earned so he may let them taste a part of [the consequence of] what they have done that perhaps they will return [to righteousness]”. based on the issues mentioned above, the process of transformation of bmt shall consider what innovations are needed in accordance with the conditions and needs of the communities in which bmt operates. 3.3. advantages of bmt transformed into incorporated based microfinance policy report reveals that most say that the ownership of publicly owned institutions (cooperatives or shfs) has many advantages over non-governmental organizations or non-governmental groups (ngos / cbos). ngos weakness is less commercial and professional due to the absence of the owner who monitor management (chavez and gonzalez vega, 1994; berenbach and churchill, 1997; greuning et al, 1998; . staschen, 1999; christen and rosenberg, 2000; c gap, 2003; holden et al, 2003;. jansson et al, 2004). the implicit message is that the benefits of microfinance institutions that are owned by the people can run its operations better and be able to access more funds to be more efficient than the ngos. this is also consistent with the concept of sharia (sharia enterprise theory) which has a social responsibility. according sudarma et.al (2010) social responsibility disclosure in islamic entity is as follows: 1) disclosure of social responsibility is a form of accountability to god and man intended to derive legitimacy from god as the ultimate goal. 2) social responsibility disclosure must have a purpose as a means of providing information to all stakeholders (direct, indirect and natural) in relation to how far the agency has fulfilled its obligations to all stakeholders. it is as part of efforts to meet accountability for human. 3) the existence of social responsibility disclosure is mandatory, views of islamic microfinance institutions function as an instrument to realize the objectives of shariah. social responsibility reports would be a report that will complement the interests of all parties that have been neglected in modern accounting systems. 4) social responsibility disclosure must include the material and spiritual dimensions associated with the interests of all stakeholders. 5) consideration of the public interest (mashlahah) will be the basis of the disclosure. 6) social responsibility disclosure should contain qualitative and quantitative information. based on the above, the concept of islamic financial institutions also supports transparency, which led the organization to be more efficient because the management of bmt will receive guidance and direct supervision by the stakeholders, which consists of: the government, the owners, the public, etc. 4. conclusions and recommendations 4.1. conclusions based on the results of the qualitative analysis concluded the following matters: 1) issuance of act no. 1 of 2013 on microfinance institutions has a positive impact on microfinance institutions and in particular for the bmt is currently incorporated in. 2) the positive impact of bmt is more professional and efficient in carrying out its operation. 3) bmt as islamic microfinance institutions that have a social and commercial purposes must be able to transform to adjust to the needs of the community in the future. 4) bmt is an islamic microfinance institutions that are characteristic of the indonesian nation and not exclusive, open to the whole ummah not just muslim ummah. 5) the government shall support and supervise the existence of bmt in order to succeed the poverty alleviation program. 6) with the guidance and supervision of the interested parties, the bmt is gradually implementing prudential principles. under these conditions, the safety of the public or customers in financial transactions in bmt protected. 7) improve the reputation of bmt in the country and even on an international scale, if the transformation process had a positive impact on economic growth and poverty reduction. ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 5 4.2. recommendations all stakeholders associated with this change must be mutually supportive for the good of humanity, so that the managers of bmt are not incorporated in does not have a prejudice against the issuance of act no. 1 in 2013, while government officials associated with the administration of the establishment and operation licenses provide a convenience (cost and bureaucracy), as well as the guidance and supervision of the presence of those who are competent in their field. 5. references [1]. agier, i. and, a. szafarz (2013). “microfinance and gender: is there a glass ceiling on loan size?,” world development, vol. 42, pp. 165-181. 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editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6312 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 14/11/2021 accepted for publication: 27/03/2022 published: 22/04/2022 31 trust enhancement in zakat institutions using blockchain technology: a qualitative approach 1 department of management, universitas muhammadiyah sumatera utara, indonesia 2 iium institute of islamic banking and finance, malaysia contact author: zulfikri@umsu.ac.id abstract— there is an indication that zakat institutions are inefficient and lack transparency in terms of distributing and managing their funds. this leads to a lack of trust between muzakee and zakat institutions; hence, they prefer to pay zakat to mustahiq directly. this means that zakat institutions may be collecting far less in zakat funds than the maximum amount that is potentially available. meanwhile, the invention of blockchain technology has disrupted the financial sector as it offers transparency in transactions, meaning intermediaries are no longer needed. the use of blockchain in zakat management is important for improving transparency in the distribution of zakat. the objective of this paper is to explore the determinant factors that influence trust in zakat institutions using blockchain technology as a mediating effect. the results of the literature review revealed that these factors are reputation, satisfaction with zakat distribution, service quality and disclosure practice. this study expects that trust in zakat institutions can be enhanced through the use of blockchain technology. keywords: blockchain, zakat, trust, zakat institution i. introduction zakat is one of the financial tools and resources used in islamic economic development. zakat funds are designed to help people or communities in need and every muslim’s responsibility to pay zakat forms part of their worship and duties. the goal of the zakat fund is to minimize economic gaps among communities, which is only achieved if zakat institutions succeed in collecting large amounts of zakat. according to act no. 23, 2011, zakat management in indonesia is carried out by two institutions, namely the national amil zakat agency (badan amil zakat nasional – baznas) and the national amil zakat institution (lembaga amil zakat – laz). baznas manages zakat at the national level and is formed by the government, while laz is formed at the community level and is responsible for the collection, distribution and utilization of zakat. to assist in the collection of zakat, baznas formed a separate organization, the zakat collection unit (upz) as noted by andayani, hanum, zaenal, asmita, damayanti, fahrudin & kardiman [1] poverty is one of the many problems facing indonesia. zakat has been proven to be effective in reducing or eradicating poverty, with prominent examples from the era of the second caliph of islam, hazrat umar bin khattab (r.a) and of umar bin abdul aziz, who was the first caliph of islam for just over one year (99-101h) as noted by hudayati & tohirin [2]. as such, zakat, along with infaq, waqf and sadaqah, is an example of islamic philanthropy that has a significant impact on alleviating poverty. as set out in law no. 23 of 2011, baznas is the agency or institution responsible for the overall management of zakat in indonesia. as the most prominent muslim country globally, indonesia has the potential to collect a large amount of zakat funds. according to the baznas report of 2017, indonesia boasted a potential zakat fund of rp 286 trillion. baznas collects many types of zakat, including from households, private companies and state enterprises, in the form of deposits and savings. however, the entire zakat operation collected only rp 3.7 trillion in 2015, thus indicating a significant difference between the actual and potential amounts collected as noted by firdaus, beik, irawan & juanda [3], meanwhile, found that the total size of the zakat fund could potentially reach rp 217 trillion (combined amount from households, industries and deposits). this figure equates to 11.45% of indonesia’s national income from 2018. however, data from baznas in 2017 show that the total zakat collection in 2016 amounted to only rp 5 trillion. currently, the amount of zakat funds collected lags far behind its potential, which in turn means that the amount of zulfikri1, 2, auwal adam sa’ad2, salina kassim2 , anwar hassan abdullah othman2 https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6312 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 14/11/2021 accepted for publication: 27/03/2022 published: 22/04/2022 32 funds distributed automatically to eight asnaf (mustahiq) is not optimized. many factors explain why baznas has not received the maximum amount of funds available. one issue is a distrust of zakat institutions among the muzakee as reported by baznas [4]. this distrust stems partly from skepticism among the muzakee concerning the ability of zakat institutions to distribute and manage their funds efficiently, due to a lack of transparency as reported by baznas [4]. thus, many muzakee continue to pay zakat directly to the mustahiq. these issues must be urgently addressed to further optimize the zakat collection. several previous studies have examined the use of blockchain in zakat management as a way of improving trust in zakat institutions. these studies include beik, nurzaman & sari [5]; rejeb [6]; nienhaus [7]; nor, abdul-majid & esrati [8]; zulfikri, kassim, & hawariyuni [9]. these studies focused predominantly on the creation of a model and mechanism for implementing blockchain in zakat management, but none measured the effect of blockchain technology on influencing trust in zakat institutions. hence, this study attempts to fill this gap by measuring the effect of blockchain technology in improving trust in zakat institutions using a qualitative approach and by developing a conceptual model. ii. literature review a. blockchain technology bitcoin is a type of digital currency based on cryptography that was developed by satoshi nakamoto in 2008 as noted by abubakar, ogunbado, & saidi [10]. however, kamaruzaman, yassin, zabidi, zaman, rizman, baharom & wahab [11] argued that satoshi nakamoto is a fictitious name. nakamoto published a paper entitled ‘bitcoin: a peer-to-peer electronic cash system’ describing a peer-to-peer version of electronic cash that would enable online payments to be sent directly from one party to another, with no need to pass through a financial institution or intermediary as concluded in crosby, nachiappan, pattanayak, verma, & kalyanaraman [12] while the bitcoin innovation was thrilling and groundbreaking, it was the mechanism behind its flawless operation that was the real story. soon after nakamoto’s paper was released, it became clear that the core mechanical invention was not the digital currency but the technology operating it. as part of the bitcoin operation, nakamoto also developed a ledger called ‘a chain of blocks’, which later became the more familiar ‘blockchain’ as noted by morkunas, paschen, & boon [13]. blockchain and bitcoin are therefore linked as blockchain is the public ledger used for bitcoin currency as note by zubaidi & abdullah [14] blockchain is essentially a decentralized transaction ledger that can be used to create, authorize and send transactions to other nodes within the same network as noted by tama, kweka, park, & rhee [15]. it combines the basics of cryptography, peer-to-peer networking and game theory. while blockchain was created to track the database underlying the cryptocurrency, which is bitcoin, it is now commonly regarded as a distributed ledger with a software algorithm to record transactions as a chain of blocks safely and anonymously as noted by laroiya, saxena, & komalavalli [16] although blockchain is often linked solely to bitcoin, many other blockchain applications have been developed since nakamoto first introduced it. despite being a ledger for digital currencies, the use of blockchain as an application has extended further to impact the economy, financial sector and beyond as noted by crosby, nachiappan, pattanayak, verma, & kalyanaraman [12]; zubaidi & abdullah [14]. according to lakhani & iansiti [17] blockchain has gained significant recognition to potentially become the new internet and is proving transformative in terms of enabling organizations to modify how they both generate and take value. since its initial development, blockchain has grown in popularity as a tool with a decentralized transaction ledger that can be used to register, confirm and send payments or contracts. the use of blockchain technology has also extended far beyond financial transactions to include a much broader range of transactions and applications such as healthcare, utilities, real estate and government as noted by christidis & devetsikiotis [18]. wang, zheng, xie, dai, and chen [19] acknowledged that while blockchain is famous for bitcoin, it can also be applied to diverse applications beyond cryptocurrencies as it enables payments to be made with no involvement from banks or any intermediary. with this in mind, morkunas, paschen & boon [13] stated that blockchain is expected to disrupt existing business models and propose new value creation. b. trust in zakat institutions trust plays a crucial role in society as noted by abdulrahman & hailes [20]. previous researchers have described trust as ‘general trust for others’. sahidi [21], meanwhile, stated that the role of zakat institutions in providing a quality service to the community is an essential factor in attracting and encouraging entrepreneurs to pay zakat. as a non-profit organization, trust is an essential foundation for baznas to achieve its objectives. handriana [22] reported that the intention of muzakee to maintain laz is influenced by their trust in the institution. yang, brennan, and wilkinson [23], meanwhile, asserted that a trustworthy charity meets the public’s expectations. hence, both laz and baznas must work tirelessly to both examine and meet the demands of the public in order to gain their trust. in this way, the presence of trust will strengthen the commitment of muzakee to pay zakat to zakat management institutions and thus maintain the sustainability and life of the programme. if they have trust in laz, people become more confident that their zakat funds will be paid to zakat institutions. an examination of the relevant past studies reveals that trust is influenced by reputation, satisfaction with zakat distribution and the quality of the service provided. zainal, abu bakar & saad [24] showed that the greater the reputation, satisfaction with zakat distribution and service quality factors, the higher the trust of stakeholders in zakat institutions, and vice versa. https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6312 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 14/11/2021 accepted for publication: 27/03/2022 published: 22/04/2022 33 c. reputation and trust in zakat institutions reputation has a significant effect on trust in zakat institutions as noted by mukhibad, fachrurrozie, & nurkhin [25]. the concept of reputation in a non-profit organization has been widely explored in the economic and sociological literature and given numerous definitions. reputation can be defined as the accumulated stakeholder assessment of an organization that develops over time and is a result of consistent performance and communication as noted by gray & balmer [26]. richard and zhang [27], in their study, defined reputation as the overall perception of stakeholders of the company’s performance over time. this is in line with the definition from the concise oxford dictionary, as cited by zainal, abu bakar & saad [24], that reputation constitutes what is generally said or believed about the character or standing of a person or thing. meanwhile, abratt and kleyn [28] identified that citizens trust a company based on past product experience and the company’s reputation. as such, the company’s reputation is the final determinant in meeting consumer expectations and demands as noted by abratt & kleyn [28]. extending this, reputation has a significant influence on trust in zakat institutions. d. satisfaction with zakat distribution customer satisfaction is the key to an organization’s success, which is especially relevant in the case of servicebased organizations. according to oliver [29], satisfaction can usually be viewed as an evaluation of the market in terms of the extent to which the preferences of the customer match the actual service rendered by an organization. satisfaction with the distribution of zakat should be improved to maintain the performance of zakat and thus encourage muslims to pay it through the relevant zakat institutions as noted by ellany & lateff [30]. according to idris & ayob [31] distrust of zakat institutions leads to non-compliance, especially when that distrust relates to transparency and inefficiencies in the management of zakat distribution. the greater the satisfaction with zakat institutions, the higher the adherence to paying zakat. in accordance with the above claims, a stakeholder who is highly satisfied with the distribution of zakat would be expected to have greater trust in zakat institutions, and vice versa. therefore, satisfaction with zakat distribution has a significant influence on trust in zakat institutions. e. service quality and trust in zakat institutions service quality is closely related to customer satisfaction. according to gronroos [32], service quality can be defined as how well a service meets the expectation of the customer. zeithaml [33], meanwhile, stated that service quality refers to a customer’s overall assessment of the advantages and value of the product or service. service quality is measured using a small number of evaluative dimensions that have met previous research expectations. parasuraman, zeithaml, & berry [34] point to the use of servqual as a measurement of service quality. in the servqual model, service quality is made up of the five dimensions of reliability, responsiveness, assurance, empathy and tangibles. to maintain the efficiency of zakat, zakat institutions must increase the amount of zakat payments as noted by zainal, abu bakar, & saad [24]. previous studies reported various findings regarding satisfaction with zakat distribution. among these, md. idris & ayob [31] found that widespread non-compliance was caused by the poor administration of zakat-by-zakat institutions in terms of their transparency and efficiency. as such, greater levels of satisfaction with zakat institutions were more strongly correlated with higher zakat compliance. in line with the above arguments, it is expected that a high level of satisfaction among stakeholders will lead to greater trust in zakat institutions. therefore, service quality has a significant influence on trust in zakat institutions. f. disclosure practice and trust in zakat institutions financial statements serve as a reliable means of assessing the success of the management and financial condition of an organisation as noted by samargandi, tajularifin, ghani, aziz & gunardi [35]. these financial statements contain information that is valuable for various people and it is therefore the responsibility of the zakat board of management to ensure their credibility as documents as noted by karim [36]. as the primary shareholders in non-profit organizations, donors and investors turn to published financial statements as their main source of information. zakat institutions must disclose a wide range of financial and other related details related to their expenditure. this information is necessary to demonstrate the credibility of the organization as noted by zabri & mohammed [37]. a significant difference often exists, however, between the size of the potential zakat fund and the amount of zakat actually received by zakat institutions in indonesia. problems with zakat funds resulted from mistrust in zakat institutions due to the quality of the financial information that they provide. this information is needed when making decisions on whether zakat institutions should be trusted to obtain, use and distribute zakat funds that have been entrusted to them by zakat payers as noted by mediawati [38]. meanwhile, jayanto, jayanto, & munawaroh [39] stated that the disclosure of financial statements is expected to enhance the public’s reasoning agility and increase their interest in paying the zakat profession. the transparency of zakat institutions has a significant effect on muzakee due to the close relationship between transparency and the receipt of zakat funds as noted by jayanto, jayanto, & munawaroh [39]. transparency entails the disclosure of information to stakeholders concerning the use of funds. schnackenberg & tomlinson [40] identified three main elements of transparency: information disclosure, clarity and accuracy. based on this, it can be concluded that disclosure practice has a significant influence on trust in zakat institutions. g. mediating effect of blockchain technology blockchain is a technology that offers the potential to significantly improve the traceability of food-related products not only for companies but also consumers and policymakers. blockchain facilitates the establishment of a distributed network that holds records of digital assets in a decentralized https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6312 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 14/11/2021 accepted for publication: 27/03/2022 published: 22/04/2022 34 manner. abojeib & habib [41] highlighted the continuous efforts being made to apply blockchain technology in the social and financial system based on the system’s good governance, low transaction costs and high transparency. given their role in building a strong zakat environment, the amil zakat (zakat officer) is critical to the collection of zakat funds. hamdani [42] asserted that at least four factors contribute to a plentiful zakat collection that can alleviate poverty and bring prosperity to the people. these factors include the amil, who must be trustworthy, professional, fair and responsible. blockchain, for its part, makes processes traceable, auditable and irreversible, which is the most important aspect of successful philanthropy. based on this, it is expected that blockchain technology has a significant influence on trust in zakat institutions. iii. research methodology this study is qualitative in nature. it utilized an extensive review of the literature to identify and analyze the relevant studies to propose the conceptual model. the systematic review of the literature promotes new ideas, the discovery of new alternatives, and the development of new hypotheses and research proposals, as noted by fiegen [43]. according to khan [44], the process of conducting a systematic literature review includes framing questions for review; identifying relevant literature; assessing quality; summarizing evidence; and interpreting findings. to perform systematic literature review, this study used google scholar and emerald insight database. the papers retrieved from reputed journal databases range from 2015 to the present, focusing on the use of blockchain in zakat management. books and book chapters also were included in the analysis. the analytic results of this literature review produce a conceptual framework. iv. results and discussion this study develops an initial conceptual framework of factors influencing trust in zakat institutions with blockchain as mediating variable. we examine the literature in the context of trust and blockchain technology. reputation reputation has significant effect on trust in zakat institutions. a non-profit organization like baznas needs such a reputation to stimulate the trust of zakat payer. furthermore, studies have found a positive relationship between reputation and consumer trust as noted by oladimeji, har sani & akhyar [45]. therefore, it is hypothesized that reputation significantly influences trust in zakat institutions. satisfaction with zakat distribution trust in zakat institutions is strongly influenced by the satisfaction of distribution zakat. mohammed dahan in saad, farouk & abdul kadir [46] argued that poor zakat distribution management leads to a bad image of zakat institutions, which in turn affects zakat collection. meanwhile, zainal, abu bakar & saad [24] stated that low confidence in zakat institutions can be attributed to a lack of transparency and inefficiency in zakat distribution. thus, satisfaction with zakat distribution significantly influences trust in zakat institutions. service quality as an institution that manages public funds, zakat institutions' credibility is also affected by how their customers perceive their services. in general, service quality can be described as the difference between what customers expect and what they get as noted by ghani, said & syed yusuf [47]. according to parasuraman, zeithaml, & berry [34], if service expectations are higher than the service performance, then the perceived quality of the service is less than satisfactory, resulting in customers' dissatisfaction. this finding shows the importance of having a good service delivery (service quality). therefore, service quality significantly influences trust in zakat institutions. disclosure practice as non-profit organization, baznas need to provide information that is useful to a variety of users including muzakee such as financial statements. the concept of disclosure refers to the perceptions of transparency exhibited by an entity. information and data produced by companies fall under this category, including financial and non-financial data, quantitative and qualitative data, required or voluntary information, and information produced through formal and informal means. information may be disclosed through different mechanisms, such as annual reports, press releases, investor relations, periodic reports, brochures, and websites as noted by hassan & marston [48]. with regard to zakat institutions, the early practices of prophet muhammad (saw) and his pious successors exhibited transparency with regard to zakat proceeds, particularly regarding their storage and distribution. according to al-njrani in sawmar & muhammad [49], zakat payers and authorities should embrace transparency hence, zakat payers are expected to disclose their wealth subject to zakat to zakat collectors. it is important that information about the activities of zakat institutions be disclosed through annual reports and verified by trustworthy auditors. by viewing the information disclosed, zakat payers may be more inclined to pay zakat in the future since they will have a sense of mutual trust. therefore, disclosure practice significantly influences trust in zakat institutions. blockchain technology blockchain technology can optimize trust in zakat institutions by offering transparency. there will only be two parties involved in a blockchain-based transaction. the transaction itself and its decentralized validation. the originality of the blockchain technology is at the level of validation, as there is no third party involved as noted by chong [50]. technically, blockchain is distributed, transparent, immutable, validated, secured and pseudo-anonymous. blockchain data enables one to create an incorruptible and resistant to censorship secure legal identity, referred to as a "trust stamp". using this technology, smart contracts cannot be https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6312 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 14/11/2021 accepted for publication: 27/03/2022 published: 22/04/2022 35 altered or removed after they are written as noted by chong [50] given the advantage of blockchain technology in term of transparency, thus, we proposed the blockchain technology as the mediating effect that could enhance trust in zakat institutions. based on the discussion above, this study proposed research model shown in figure 1. the model postulates that trust in zakat institutions is influenced by reputation, satisfaction with zakat distribution, service quality and disclosure practice. the framework also postulates that the independent variables are expected to have a direct positive influence on the dependent variable. meanwhile, blockchain technology strengthens the direct relationship between the independent variables and dependent variable. figure 1. conceptual model. source: authors’ elaboration v. conclusion, implication and future research this paper aimed to explore the determinant factors that influence trust in zakat institutions, where the use of blockchain was expected to enhance this trust. from the literature review, reputation, satisfaction with zakat distribution, service quality and disclosure practice are the determinant factors influencing trust in zakat institutions. in addition, this study suggests that blockchain technology has a mediating effect and is expected to enhance trust in zakat institutions. the proposed research model can be used to conduct further research on trust in zakat institutions’ issues, while policymakers in zakat institutions can use the findings and analysis of this study to enhance muzakees’ level of trust through the implementation of blockchain technology. this, in turn, would help to maximize the level of zakat funds collected in the near future. this paper is conceptual in nature; therefore, no empirical evidence is provided. further research could use the survey method to validate and examine the predictive power of the proposed model. references [1] 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(2021), "enhancing trust through digital islamic finance and blockchain technology", qualitative research in financial markets, vol. 13 no. 3, pp. 328-341. https://doi.org.ezlib.iium.edu.my/10.1108/qrfm-05-2020-0076 https://www.ojs.unito.it/index.php/ejif/index https://doi.org/10.22373/share.v8i1.457 https://doi.org/10.1080/00014788.1990.9728888 https://doi.org/10.1108/mf-05-2017-0189 https://doi.org/10.15294/jda.v11i1.18729 https://doi.org/10.1177/0149206314525202 https://doi-org.ezlib.iium.edu.my/10.1108/17590811311314267 https://doi-org.ezlib.iium.edu.my/10.1108/17590811311314267 https://doi-org.ezlib.iium.edu.my/10.1108/ijif-10-2018-0116 https://doi.org.ezlib.iium.edu.my/10.1108/qrfm-05-2020-0076 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6107published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 20/10/2021 accepted for publication: 29/10/2021 published: 30/12/2021 45 exploring sustainability from the islamic finance perspective 1 university of turin, department of management (italy) 2 international islamic university malaysia, institute of islamic banking and finance (malaysia) contact author: federico.lanzalonga@unito.it abstract— the article explores a sample of papers on islamic finance and sustainability to define some streams of literature on this topic. the paper aims to validate whether it is possible to interpret the multitude of contributions in three different research streams that consider environmental, economic, and social sustainability. the research conducts a structured literature review on 73 articles extracted from scopus. additionally, the bibliometric analysis revealed the descriptive statistics on this field and the main themes through the authors’ keywords. the different perspectives showed the multicultural nature of the topic, which is not only addressed by islamic countries. moreover, it made it possible to find correspondence in the theorization underlying the article and to categorize the topics covered by the authors. keywords: islamic finance, sustainability, environmental sustainability, economic sustainability, social sustainability, literature review, bibliometric analysis i. introduction the islamic banking system is based on notions of social virtue, good governance, care for the environment and ethical behaviour of individuals and organisations by islamic ontological and epistemological principles [1], [2]. the rules of islamic finance guide the islamic banking and financial system and are known as shariah principles, or maqasid al-shariah [3], [4]. according to saeed et al. (2020) [5], the basis of these rules is two fundamental concepts that separate islamic banking from conventional banking: profit and loss sharing, prohibition of interest and other prohibited elements. indeed, the literature considers islamic finance a parallel system that allows greater understanding and experience of the conventional financial system [6]. therefore, the long-term growth and sustainability of the sector depend, on the one hand, on how islamic finance interacts with the conventional system and benefits from complementing and augmenting it. on the other hand, islamic finance adapts and adheres to international rules and supervision while remaining aligned with the complexities and subtleties of islamic finance products and associated risks. as a result, the unique qualities of islamic finance through the proper flexibility and without sacrificing shariah principles, the focus on sustainability appears crucial for the growth of the industry and a hopeful future. according to keeble (1988) [7], sustainability is a process of economic development, environmental protection and social equality. mainly, sustainability is also defined as the method by which companies manage the financial risk, environmental risk, and social risk of business, as well as their duties and possibilities. thus, sustainability has three main economic, environmental, and social components. the sustainability disclosure percentage of islamic banks in south-east asia was only 26% [8]. furthermore, other authors [9] found that in the united arab emirates, sustainability disclosure of islamic banks was relatively low compared to conventional banks. further studies explored 91 islamic institutions in 13 countries, revealing that islamic banks paid less attention to sustainability practices and disclosure [10]. moreover, dhuizii [11] investigated 14 islamic banks from 14 countries for poor sustainability and disclosure practices. in addition, literature has shown that sustainability policies and disclosure of islamic banks in seven muslim nations are not the main issues for islamic banks in those countries [12]. in terms of sustainability, islamic banks use two primary models in their banking operations: institutional and welfare methods. according to mansour et al. (2020) [13], the institutional approach increases the bank’s stakeholders’ wealth. the well-being approach seeks to achieve maqasid alsharia by improving people's well-being. therefore, as a result, it is possible to say that sustainability is related and vital to the concept of islamic banking. valerio brescia1, auwal adam sa'ad2, rusni bt hassan2, syed musa bin syed jaafar alhabshi2, federico lanzalonga1 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6107published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 20/10/2021 accepted for publication: 29/10/2021 published: 30/12/2021 46 the united nations brought attention to sustainability globally by introducing the sustainable development goals (sdgs) [14]. the 17 measures to promote sustainable development provide an excellent opportunity to encompass many areas of sustainable development research. furthermore, the united nations and its member countries' commitment to achieving the sdgs by 2030 has added a sense of urgency to the need to do quality research on sustainability, providing valuable results for managers and policymakers [15]. following salam gateway’s report [16], the islamic financial system has grown tremendously over the past four decades. it is currently considered one of the fastest-growing segments of the global financial system. the $2.2 trillion global islamic finance sector is expected to grow 10%-12% over the 2021-2022 period, driven by increased islamic bond issuance and a modest economic recovery in key islamic finance markets. research by jan et al. [17] found that iran, saudi arabia, malaysia, united arab emirates, kuwait and qatar are the leaders in the islamic banking market, holding around 85% of the world’s islamic banking assets. turkey, indonesia, bangladesh, and pakistan are the second-largest islamic banking nations globally. while brunei, egypt, oman, bahrain, and sudan are the nations with the smallest percentage of the global islamic banking industry. according to jan, et al. [18], the link between sustainability practices and financial performance from an islamic perspective in malaysia from 2008 to 2017, and the results revealed that sustainability practices had a strong positive association with the financial performance of islamic banks. furthermore, the low incidence of sustainability practices and reporting in the islamic banking sector is most likely due to a lack of sustainability literature in the islamic banking sector and inadequate frameworks to measure activities. therefore, this study aims to investigate islamic finance from a sustainability perspective through a bibliometric analysis to define key research streams through keyword analysis and topic dendrogram. additionally, it explores relationships between authors dealing with islamic finance and sustainability from a geographical perspective. a bibliometric analysis of the existing literature makes it possible to determine a business model’s characteristics and basic features, whether it is related to production or service delivery [19]. furthermore, the lower riskiness of islamic banks compared to conventional banks is due to the absence of interest from the islamic banking sector [20], [21]. although there are bibliometric analyses that define islamic finance and sustainable development [22], sustainability in social finance [23], [24] and mapping waqf research [25], none of these research defining it considering three components such as economic, environmental and social perspective [7]. therefore, our study aims to answer the following research questions: rq1. what is the descriptive bibliometric information on islamic finance and sustainability publications? rq2. when analyzed from an economic, environmental, and social perspective, what elements do the keywords highlight? we followed rigorous scientific research processes [26], [27] to achieve our research intent.. the method used was a structured literature review (slr), which allows for a thorough and reliable analysis of the topic in question and identifies future advances [28]. only articles published in peer-reviewed journals and written in english were considered, resulting in a final pool of 73 articles. the authors employed bibliometrix, a statistical software accessible on r-studio, to analyse [29]. this study shows the trends of islamic finance and sustainability publications through a rigorous methodology, which will be explained in the next section. after that, the quantitative and qualitative results of the bibliometric analysis and discussion considering the literature will be shown. finally, the conclusion will bring our research to a close. ii. methodology the research is based on strict methodological steps to ensure a rigorous method [26], [27]. according to numerous authors, our choice is to follow a structured literature review (slr) through a detailed and reliable examination of knowledge in the study domain, which allows us to define flourishing fields of future research [26], [28]. the technique has benefited from several combined bibliometric analysis studies [30]. the authors coded the documents manually and independently to classify the units of the research study in the selected articles, enhancing the results [31], [32]. several researchers already use the slr methodology since its publication. despite its origins in the accounting field, analyses have been conducted in the broader management field due to its consistent research process [24], [32]. therefore, our research started by searching for the title, abstract and keywords containing “islamic finance” and “sustainability” on the scopus database. according to oakleaf [33], the database includes papers indexed and ranked by the institute for scientific information and scopus. considering only articles published in peer-reviewed, english-language journals or books [34], the authors set a limitation obtaining 81 results. subsequently, only papers in the fields of economics, econometrics and finance, economics, management and accounting and social sciences were considered relevant. the final selection of papers includes 73 results, which will be the subject of the analysis. the second stage of the study involved using the opensource statistical tool r [29] to analyse islamic financing in terms of sustainability [35]. creating the .bib file for the third phase, data analysis, was part of the data collecting procedure. the researchers used r software and bibliometrix scripts to do a descriptive bibliometric analysis and generate a matrix that included all documents throughout this period. biblioshiny was also utilised to generate a concept map and citation network. the data reduction technique was used to visualise the knowledge structure during the analysis [25]. fourth, the code analysis enabled academics to validate the scopus results. furthermore, researchers defined the structured course of investigation by utilising the research questions. the analysis will be divided into two parts: descriptive analysis to analyse author structure and thematic analysis using the topic dendrogram. finally, as advised in step five, we will discuss european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6107published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 20/10/2021 accepted for publication: 29/10/2021 published: 30/12/2021 47 the results, provide theoretical and practical implications, limitations of our research, and future study directions in the following paragraphs. iii. findings the study’s bibliometric method can assist readers in swiftly identifying the fundamental aspects of the research area and answering research questions in a complete and trustworthy manner using quantitative and qualitative variables [32]. this paragraph seeks to answer the research question by providing information on various factors derived from descriptive statistics of the paper sample generated by the research key specified in the methodology. first, the different paper types and the annual scientific output are displayed. following that, the survey considered scientific sources and the number of publications published by each author. the geographical relationships are intended to highlight the countries where the topic is most discussed and international partnerships amongst experts. in addition, the study counts the number of citations to comprehend the critical contributions recognised in the literature. finally, this section explores the principal themes addressed by research on islamic finance and sustainability using keywords and a dendrogram of subjects from the three perspectives established by the literature: economic, environmental, and social [7]. a. descriptive bibliometric analysis table i shows the information about 73 papers published between 2010 and 2021, as taken from the scopus database. moreover, this section aims to address the first research question. table i. main information main information explanation results documents total number of documents 73 sources the frequency distribution of sources as journals 148 author’s keywords total number of keywords 228 keywords plus (id) total number of phrases that frequently appear in the title of an article’s references 58 period years of publication 2010-2021 authors total number of authors 158 author appearances the authors’ frequency distribution 178 authors of singleauthored documents the number of single authors per articles 19 authors of multiauthored documents the number of authors of multiauthored articles 139 average citations per document the average number of citations in each article 4,42 co-authors per documents the average number of co-authors in each document 2,44 authors per document the average number of authors in each document 2,16 collaboration index 2,62 the number of keywords used exceeds the number of papers by three to one. at the same time, the number of keywords plus, which is the number of keywords that frequently appear in the title of an article, is lower than the number of sources, indicating consistency in the main subject examined. the first results of the analysis can be identified in 2010. however, the trend is gradually increasing, demonstrating the focus on the topic since 2018. two authors wrote each article on average (2.16). finally, the collaboration index (ci) is 2.62, calculated as the total number of authors of articles with multiple authors divided by the total number of articles with multiple authors [36]. our research examined 73 articles from peer-reviewed scientific journals, books, book chapters and conference proceedings. in 2010, the initial aim of the literature on islamic finance and sustainability was to provide a perspective of unity between monetary, financial and real economy variables [37]. subsequently, scholars have focused on the financial crisis that occurred after 2008 [38] and the growth of islamic finance [39] and sustainable development alongside conventional finance [40]. in the central part of the observation period, the literature inquired about how islamic finance is growing, complementing, and sometimes replacing its spiritual components [41]. authors have focused on how socially responsible investments and the growing importance of islamic finance are linked to the shift to renewable energy [42]. in addition, stakeholder perceptions of islamic banks’ corporate social responsibility were explored [43]. figure 1. annual scientific production the growth of literature on the subject has gone hand in hand with the increase in islamic bank financing. nowadays, the literature on the topic focuses on how islamic finance can support businesses that pursue a circular economy model [44] to achieve growth that does not harm the environment [45]. other studies have focused on how islamic finance can convert its business model into ethical finance [46], [47]. conversion presupposes positive employee attitudes and a willingness to adopt the green banking approach. table ii shows the reference journals and the number of publications in each. in particular, the frequency with which papers dealing with the topic and related concerns are distributed is described. journal of islamic accounting and business research and isra journal are the two journals that have received the most attention to this topic in recent years. the former provides a dynamic forum for promoting accounting and business knowledge based on islamic european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6107published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 20/10/2021 accepted for publication: 29/10/2021 published: 30/12/2021 48 principles, intending to influence the welfare of societies around the world favourably. the jiabr encourages innovative contributions in accounting, economics, marketing, sharia governance, islamic banking and finance, and publishes publications that promote responsibility, socio-economic equity and eternal success. the isra journal ensures that published articles in islamic finance meet high standards, guaranteeing that additional innovation and research are carried out and encouraged in the islamic finance sector and academia. table ii. journals for islamic finance and sustainability. sources articles isra international journal of islamic finance 5 journal of islamic accounting and business research 4 al-shajarah 3 energy and finance: sustainability in the energy industry 3 journal of king abdulaziz university islamic economics 3 sustainability (switzerland) 3 arab law quarterly 2 corporate sustainability: inclusive business approaches contributing to a sustainable world 2 covid-19 and islamic social finance 2 humanomics 2 international journal of innovation creativity and change 2 international journal of social economics 2 islamic fintech 2 journal of cleaner production 2 research in international business and finance 2 singapore economic review 2 academy of strategic management journal 1 accounting and the public interest 1 accounting finance sustainability governance and fraud 1 acrn journal of finance and risk perspectives 1 b. authors define abbreviations and acronyms the first time they are used in the text, even after they have been defined in the abstract. do not use abbreviations in the title or heads unless they are unavoidable. table iii shows the most prolific authors publishing in islamic finance and sustainability. there are three authors at the top of the ranking: arslan ayaydin, choudhury, and hassan. ozgur arslan ayaydin is a professor in the finance department at the university of illinois at chicago, whose research areas focus on financial flexibility, corporate investment, and performance. prof masudul alam choudhury of trisakti university has his main research field in theoretical contribution to islamic finance. at the same time, kabir hassan is a professor of finance and hibernia professor of economics and finance at the university of new orleans and focuses on developments in islamic banking. however, figure 2 shows that some publications come from these countries, but they appear more as sporadic contributions rather than a focus of research. the figure maps geographically the places where publications in this field are being published in the world: the darker the blue colour, the greater the number of publications in the country. table iii. number of articles per author authors articles arslan-ayaydin 3 choudhury 3 hassan 3 dorsman 2 dreassi 2 engku ali era 2 goud 2 karan 2 kunhibava 2 mahadi 2 table iv. number of articles published in each country region occurrences malaysia 34 netherlands 13 italy 12 usa 11 indonesia 6 australia 5 pakistan 5 bahrain 4 bangladesh 4 nigeria 4 uk 4 qatar 3 turkey 3 jordan 2 oman 2 spain 2 as for the countries, most closely associated with conventional finance, the topic is of interest in the netherlands (13), italy (12), and the usa (11). this is due to the potential of islamic finance as a more sustainable model in crises [48]. 1) country publications and collaboration map the following section analyses the number of citations for publications in each country. the top paper in our cluster is malaysia (96), followed by poland (31), qatar (26) and italy (20). however, the distribution of average citations over the years shows a different distribution. in fact, for this variable, poland has the highest number of average publications per year, due to the paper by hussain et al. [49] that sees islamic finance as socially responsible investment. this is followed by qatar, with 26 average citations per year. the number of average citations per year drops in countries where more is published, like malaysia and italy show. this is both because the higher number of publications identifies a fluctuating trend in the number of citations obtained. the topic of islamic finance and sustainability being rooted in more years shows more dispersion in terms of time. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6107published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 20/10/2021 accepted for publication: 29/10/2021 published: 30/12/2021 49 figure 2. country’s scientific production table v. number of articles published in each country country total citations average article citations malaysia 96 7,3 poland 31 31 qatar 26 26 italy 20 6,6 oman 8 8 spain 5 5 netherlands 3 3 australia 2 2 china 2 2 figure 3 shows the connections (red stripe). the primary relationships are highlighted between malaysia and indonesia (3) and the usa and the netherlands (3). although different environmental conditions are evident, the indonesian banking system, in particular, is focused on substance, whereas the malaysian banking system considers symbols and form [50]. the us and the netherlands are among the leading countries investigating the field of islamic finance without having islam as their first religion [51]. figure 3. country collaboration map c. thematic analysis this section introduces thematic analysis as implemented in the bibliometrix software [29]. by studying the authors’ keywords and topic dendrogram, the section aims to define the strands of literature that islamic finance refers to in dealing with sustainability issues. 1) keywords analysis figure 4 discusses the connection between the terms’ islamic finance’ and ‘sustainability’. in their publications, researchers use a variety of keywords to situate their papers within the literature. the main words are "finance", "islamism", "malaysia", "sustainability", and "sustainable development". the word “finance” aims to identify papers investigating islamic finance from a monetary and financial instrument perspective. the word “islamism” is used to distinguish research on islamic finance from research on conventional finance. many of the articles using this keyword deal with microfinance [52] and social banking [53] topics. “malaysia” appears among the keywords as many among the articles focus on this nation. according to the literature [17], malaysia belongs to 85% of the leading nations in islamic finance and has been the subject of numerous case studies [41], [49], [54], [55]. the words’ sustainability’ and ‘sustainable development’ are intended to identify papers investigating how islamic banking can improve performance in terms of environmental sustainability [56]. others, however, explore social finance [57] and economic sustainability [58]. in this sense, the three streams of literature as theorised are confirmed [7]. figure 4. author’s keywords in articles on islamic finance and sustainability 2) topic dendrogram analysis figure 5 shows a dendrogram of topics reflecting the order of the keywords created through hierarchical clustering and their connection. the vertical lines and the cut of the figure facilitate the investigation and understanding of the various groupings. the figure is intended to estimate the number of clusters to allow for future discussion. the first block in purple focuses on environmental sustainability and measurement systems. specifically, the focus is on environmental sustainability, measurement systems, and islamic banking. sustainability practices and financial performance from the perspective of islamic banking can be measured in a sustainability framework for islamic banking [18]. from an environmental sustainability perspective, the inclusive green behaviour of islamic bankers can positively influence the growth of green banking [16]. therefore, islamic finance institutions can be valuable tools for developing green awareness and environmental concerns through islamic banks. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6107published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 20/10/2021 accepted for publication: 29/10/2021 published: 30/12/2021 50 figure 5. topic dendrogram corporate social responsibility (csr) initiatives of companies are one of the green cluster's words and the key to success in business and modern society. the islamic perspective of csr is based on religious ethics and appears to be significant and intensified. according to khan [56], working for the betterment of the poor, ensuring the most efficient and socially desirable use of financial resources, developing their institutional structures, infrastructure, and innovative products are challenges that islamic finance can address. through the principles of justice and equity, islamic banking and finance also provides a vehicle for energy companies [42]. the issue of csr is an essential factor in the islamic banking sector and in the perception of various stakeholder groups that they can guide the strategic decisions taken by islamic banks, based on their offerings, brand identity and customer service levels [43]. this defines the strand of social responsibility, connoting islamic finance as a financial and economic model based on ethical principles and values in which sustainable development and social responsibility play an essential role [59]. islamic finance is full of main instruments to propose islamic social finance, such as waqf, a continuous charitable donation preferred for its perpetual, irrevocable characteristics [60]. the blue cluster aims to identify the economic sustainability of islamic finance. the introduction of the sustainable development goals or sdgs in 2015 led scholars to the exploration of practices of islamic banks in the application of value-based intermediation through islamic social finance and its impact [57]. several developments of economic sustainability through islamic finance for small and medium enterprises were observed based on philanthropic motives, private sector activities and public sector facilitation [61]. in this context of the discussion, islamic finance is proposed as an alternative to conventional finance to pursue economic sustainability through instruments with different economic impacts, including joint venture (musharakah), islamic bonds (sukuk) and islamic insurance (takaful) [62]. however, according to jan et al. (2019) [18], the in-depth analysis revealed that the market is not interested in banks’ environmental and social sustainability, except for their economic sustainability practices. therefore, the correlation between performance and economic sustainability of islamic finance is through sustainability practices. the fourth cluster in red does not appear to open up space for a fourth research stream. some scholars have focused their efforts on understanding the socio-economic factors that favour the spread of the islamic financial system. according to literature [63], in countries of islamic culture, certain groups of people are less likely to be included in financial transactions, especially if they involve traditional loans and accounts. moreover, there is a clear need to encourage young people, the poor and women to use formal banking services to improve their access to financial services. other papers assess the approach from a socially responsible investment perspective. studying how companies react to share price shocks based on a classification based on social pressures rather than the financial objective of maximising shareholder wealth, hussain et al. [49] classified companies in the stock market as shari’ah compliant and nonshari’ah compliant. the result is that non-compliant company do not significantly alter accounting debt ratios during falling capital prices. instead, compliant firms are more likely to increase book debt ratios during periods of declining equity values. finally, this cluster includes the theoretical frameworks related to the topic. first, some articles aim to explore the concept of social banking and to look for the possibilities of internalisation in islamic banking, given the social failures of islamic banking [53]. subsequently, a comparative study of endogenous money in the quantity theory of money revealed significant differences between the theory of endogenous money in islam and traditional methodologies. in the context of islamic finance, it has never been fully determined which model is used to explain monetary transmission and the functioning of monetary policy with interest rate-avoiding instruments that meet the requirements of islamic financing [64]. therefore, the sample of papers presents numerous theorisations. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6107published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 20/10/2021 accepted for publication: 29/10/2021 published: 30/12/2021 51 iv. discussion and conclusion a. definition of research streams the following section aims to answer the second research question based on the analysis results to outline the research strands for islamic finance and sustainability. starting from keeble’s definition [7], our paper asseverated the presence of the three different versions of sustainability: environmental, economic and social within the sample of articles analysed. according to khan [56], islamic banking can improve performance in terms of sustainability. therefore, the following section aims to define the three different streams of literature about islamic finance and sustainability. 1) environmental sustainability perspective the articles in the sample focused on environmental sustainability and measuring systems. the emphasis is on environmental sustainability, measuring methods, and islamic finance. sustainability practices and financial performance from the viewpoint of islamic banking, according to jan et al. [17], may be assessed in an islamic banking sustainability framework. from the standpoint of environmental sustainability, islamic bankers' inclusive green behaviour may favourably impact the development of green banking [46]. as a result, islamic financial institutions, such as islamic banks, may be helpful instruments for raising green consciousness and environmental concerns. 2) social sustainability perspective the second stream of study is concerned with social responsibility, precisely the islamic viewpoint of csr, which is founded on religious ethics and seems to be essential and intensified. working for the benefit of the poor, guaranteeing the most effective and socially acceptable use of financial resources, and expanding their institutional structures, infrastructure, and innovative products are all problems that islamic finance can solve [56]. islamic banking and finance, based on the ideals of justice and fairness, also serves as a vehicle for energy businesses [42]. csr is an important element in the islamic banking industry, and different stakeholder groups believe that it may influence strategic choices made by islamic banks based on their products, brand identification, and customer service standards [43]. this outlines the thread of social responsibility, referring to islamic finance as a financial and economic model founded on ethical principles and values. sustainable development and social responsibility play critical roles [59]. islamic finance is full of significant tools to offer islamic social financing, such as waqf, a continuous charitable gift favoured for its permanent, irreversible, and inalienable qualities [60]. 3) economical sustainability perspective the adoption of the sustainable development goals (sdgs) in 2015 prompted academics to investigate islamic banks' activities in applying value-based intermediation via islamic social finance and the effect of these practices [57]. several advances in economic sustainability via islamic financing for small and medium-sized businesses have been noted based on charitable motivations, private sector initiatives, and governmental sector assistance [61]. in this context, islamic finance is suggested as an alternative to conventional finance for pursuing economic sustainability through instruments with varying economic effects, such as joint venture (musharakah), islamic bonds (sukuk), and islamic insurance (takaful) [62]. in-depth research, however, showed that the market is not interested in banks' environmental and social sustainability policies, save for their economic sustainability measures [18]. as a result, the connection between islamic finance performance and economic sustainability is via the development of sustainability practices. the fourth red cluster does not seem to make room for a fourth research stream. some academics have concentrated their efforts on gaining a better grasp of the socioeconomic variables that promote the development of the islamic banking system. according to shihadeh [63], in islamic-culture nations, some categories of individuals are less likely to be engaged in financial transactions, particularly when official loans and accounts are involved. furthermore, there is a specific need to encourage young people, the disadvantaged, and women to utilize formal banking services to enhance their access to financial services. b. theoretical implications our paper acknowledges some theoretical implications. first of all, it allows ascertaining the validity of keeble’s theory [7], extending the validity of his definition of sustainability also except islamic finance. subsequently, it defines and outlines three different declinations of sustainability for islamic finance. finally, it allows highlighting that a single monetary theoretical model underlying islamic finance is not yet outlined [64]. c. practical implications our research also has practical implications. first, it allows us to understand that sustainability practices by banking institutions can foster the growth of the green economy and economic inclusion [46]. second, it highlights how in a csr context, it is a vital factor for islamic finance to channel strategic decisions in islamic banking institutions, ensuring adequate perception by different stakeholder groups [43]. third, it was shown that the market is not interested in banks’ spending on their environmental and social sustainability, but only on their economic sustainability practices [18]. d. limitations our study, like many studies, has limitations. to begin, the sample of publications was limited to guarantee a structured method. this might have resulted in our missing out on important research papers and proceedings. second, considering the bibliometric variable analysis, future research may focus on bigger literature samples by completing open code inquiry to find better scientific subjects addressed. third, the embryonic stage of the literature may provide fresh economic research that may contradict, or render outdated the current study. the sample used is more geared toward studies in the hard sciences than studies in management. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6107published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 20/10/2021 accepted for publication: 29/10/2021 published: 30/12/2021 52 e. future research bibliometric analysis, according to paul and criado (2020) [28], identifies and predicts future study areas. as a result of the analysis, we were able to determine which research areas merit further investigation. the rigorous approach used opens a plethora of possibilities for scholars to investigate. the research highlights certain aspects that do not seem to be well covered in the literature. future research will have to consider the cauldron of economic and monetary theories 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[64] m. a. choudhury, «micro-money, finance and real economy interrelationship in the framework of islamic ontology of unity of knowledge and the world-system of social economy», international journal of social economics, vol. 45, n. 2, pagg. 445–462, 2018, doi: 10.1108/ijse-11-2016-0340. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7345 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 1 an assessment of islamic banking in asia, europe, usa, and australia muhammad aqib ali1* 1 contact author international islamic finance & insurance institute (iifii), dubai, uae. email_aqib@yahoo.com received: 03/02/2023 accepted for publication: 11/04/2023 published: 21/04/2023 abstract the paper reviews the progress of islamic banking in two major regions, including asia and the western world. the paper offers an inclusive discussion of islamic banking initiatives in several countries of the globe, specifically the countries from the middle eastern region, europe, australia, asia, and north america. the discussion for asian countries includes saudi arabia, iran, uae, qatar, bahrain, kuwait, turkey, egypt, malaysia, oman, indonesia, pakistan, and bangladesh. the paper also appraises the development of the islamic banking setup in the western world. the islamic banking status in the west covers the following countries: united kingdom, italy, australia, luxembourg, france, germany, canada and the usa. the review of islamic banking in the two major world regions reflects a progressive islamic banking setup. the paper entails a qualitative approach to evaluate the islamic banking progress in various countries by extracting data from different sources, including central banks and other important financial and regulatory institutions. the study affirms that the islamic banking paradigm emerged and flourished from the asian states, specifically middle eastern and asian countries, including egypt, bahrain, qatar, uae, malaysia, pakistan and iran. the findings also suggest that the islamic banking model has progressed gradually in european and other countries like australia, the usa and canada, which warrants a promising potential for the global islamic banking sector. keywords: islamic banking, islamic finance, growth, development, shariah-compliant banking, global islamic banking 1. introduction the world economy, after the recession of 2007, has inspired us to realize that the theories and philosophy of capitalism have been unsuccessful in offering solutions to the global economic woes (zaman, 2013). national and international economic distress is principally the consequence of debt-laden and interest-based financial structures of global banking and economic system (chapra, 1985; ariff, 1988; aqib, 2012). the splendid growth of islamic banking and finance and its progress in various regions of the world (khan & bhatti, 2008) reflects its ability to deliver financial propositions that are not only shariah-compliant (in conformity to the islamic law) but also pragmatic to cater to contemporary economic and financial european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7345 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 2 needs. the resilience and progress of islamic banking are reflected by the key facts and performance parameters of islamic banks compared to their conventional interest-based counterparts (islamic financial services board, 2019). islamic banking (ib) is a comprehensive islamic economic framework subsystem. although the shariah-compliant banking system per se is a relatively young discipline, the theoretical background and basis of islamic or shariah-complaint banking and financial system are strongly pinned upon the islamic economic framework, which is as old as the religion of islam itself. as a code of life, the islamic faith guides all aspects of life, including the economic and social dimensions. the early islamic financial initiative can be traced back to the second half of the 19th century, when the roots of the islamic financial system started to grow in various forms (aqib ali, 2014). primitive islamic banking activities emerged in various parts of the world, including the arabian and sub-continental regions (wilson, 1983). the earliest venture underpinned islamic banking principles evolved from egypt in the 1960s, establishing a financial arrangement named mit ghamr. another islamic finance initiative in malaysia, tabung haji was also formalized in the 1960s (ahmad, 1987). although it was still in its infancy at that time, islamic banking gradually began to evolve slowly and steadily. it was in 1970 that the islamic banking initiative took off with the development of several islamic financial institutions (aziz, 2005), including the first international islamic financial entity in the form of the islamic development bank (wilson, 2000). currently, islamic banking has attained a global reckoning, with astounding success in both the muslim states and non-muslim countries, including the regions in europe, uk, and africa. based to the (islamic financial services board, 2019), aggregated islamic banking across the globe accounts for approximately 72% of all islamic financial offerings, with huge assets of around us$ 1.6 trillion. there are a total of 1389 islamic financial institutions worldwide (thomas reuters, 2018), operating in more than 110 countries (ayub, 2017). of these, 505 financial institutions are islamic banks, including the islamic windows of conventional banks. 2. methodology the methodology employed by the researcher is qualitative in nature. the data was gathered using various secondary sources, including reports, publications, working papers and online sources. the data, including the facts and figures, were collected from the central banking institutions and various countries' governmental and financial regulatory authorities. the paper reviews the developments and growth of islamic banking in various countries from the four major world regions, including asia, europe, australia, and north america. the paper evaluates the information in terms of descriptive and theoretical perspectives by stating the statistics and various data and information, including numbers and percentages of growth, market share, etc., precisely and exactly as provided in the available data sources. concerning the article's structure, islamic banking was reviewed in three world regions, i.e. asia, europe and north america. based on many countries in asia and due to the greatest involvement of the islamic banking paradigm in the asian regions, especially the middle east and gulf states, more detailed discussion and space is being assigned to asian countries followed by other countries in europe and other regions. the paper attempts to provide a descriptive analysis of islamic banking development in the pertinent countries from the subject global territories. 3. islamic banking in asia islamic banking origins are rooted in the asian region, especially in the middle east. the country-wise situation of the islamic banking sector in the asian states is described as under: 3.1 islamic banking in malaysia malaysia has attained the position of a leader in global islamic banking intuitive. the country has achieved remarkable progress based on a holistic strategy regarding islamic banking and financial model by attaining accomplishment at various fronts; ranging from the deployment of a potent regulatory regime to acquiring support from stakeholders; from government facilitation to ensuring smooth formulation and execution of policies, from the enactment of effective shariah governance framework to ensuring a scrupulous level of shariah supervision for ibf (islamic banking and finance) institutions, malaysia’s progress has been exemplary. since the origin of an institution named tabung haji in the 1960s, islamic finance european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7345 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 3 growth in malaysia has been systematic and stable (al nasser & muhammed, 2013). malaysian islamic banking industry has achieved the status of global islamic banking and finance hub based on the impressive growth of the sector and great contribution to the global ibf domain (alwi et al., 2019). four full-fledged islamic banks are in the country, namely bank islam malaysia berhad, mbsb bank berhad, bank rakyat, and bank muamalat malaysia berhad (asni, 2019). currently, 16 islamic banks and islamic banking windows (bank negara malaysia, 2020). kayadibi (kayadibi, 2010) stated that a master plan for the financial sector was released by malaysia’s central bank (bnm) to promote the country as a regional center of ibf. malaysia has a total of usd 204 billion of islamic banking assets, with ib having a 31.2% share of total banking assets being the third largest ib market in the world (malaysian international islamic financial center, 2018). 3.2 islamic banking in pakistan the islamic banking origins in pakistan may be dated back to the late 1970s when the global rise of islamic banking initiatives took place in the second half of the 1970s. in 1977, the ib paradigm was initially considered by the then president of pakistan, zia ul haq as a system that may be pragmatically implementable to eliminate riba (interest) in financial transactions (khan & bhatti, 2008). the first islamic bank in the country was meezan bank, and two other islamic banks, including bank islami and dubai islamic bank, were established later; six fully-fledged islamic banks were operational in the country as of 2006. another latest development that can boost the islamic banking initiative in the country is the verdict given by the federal shariah court (fsc) in 2022 to ensure the islamic financial system is implemented, and interest is eliminated from the economy by 2027 (bhatti, 2022). presently, five full-fledged islamic banks are functioning in the country, including al-baraka bank, meezan bank, mcb islamic bank, bank islami, and dubai islamic bank. the number of conventional banks islamic banking divisions/windows operating in the country is 17, and there are currently 2979 islamic banking branches (ibbs) and sub-branches, including 2850 full-fledged ibbs and out of these 2850 full-fledged islamic branches; dedicated islamic banks’ branches are 1469 and conventional banks’ ibbs are 1381 (state bank of pakistan, 2019). the market share of islamic banking assets and deposits in pakistan’s overall banking industry is 15.2% and 16.9%, respectively (state bank of pakistan, 2020), having 3250 outlets of islamic banking branches with aggregated assets of around usd 20 billion. 3.3 islamic banking in bangladesh islamic banking has been in operation since the first half of the 1980s (sarker, 1999) in bangladesh, and since its inception, it has developed positively and progressively in the country. the beginning of ib in bangladesh can be traced back to the year 1983 when the first islamic bank – islami bank bangladesh limited, was established (sarker, 2005) and is also the largest islamic bank in the country (islam et al., 2019). in 1997, bangladesh bank mobilized all islamic banks functioning in the country to conduct an “islamic banks consultative forum (ibcf)”, to bring forward the pertinent significant matters related to the islamic banking sector’s progression to address these issues aptly to warrant a bright future for the ib industry in bangladesh. although there are no separate islamic banking regulations or law and islamic banks are monitored and supervised by independent shariah boards/councils (rashid, hassan & ahmad, 2009); but to assure progressive growth, legal framework is one of the vital areas that require the attention of the concerned stakeholders (nabi et al., 2015). according to bangladesh bank (the central bank of bangladesh), islamic banking in the country has been consistently showing a steady growth (bangladesh bank, 2018) and currently islamic banking assets represent 24% of total banking assets in the country. there are currently 8 fully-fledged islamic banks while sixteen conventional banks are operating their islamic banking windows and branches totaling 1252 islamic banking branches with total staff of 34,128 (bangladesh bank, 2019). 3.4 islamic banking in indonesia indonesia is the largest muslim country in the world and has a huge muslim population, islamic banking holds good potential in the country, but this potential is still largely untapped, as reflected by the low market share of islamic banking of merely 5% of the total banking industry (maulia, 2019). the current state of islamic banking is not encouraging, yet the government resolves to gradually develop the ib sector. after the first islamic bank was established in the country – bank muamalat indonesia, in 1991 by the intuition taken by indonesian ulema council (mui), muslim intellectuals and entrepreneurs (bank muamalat, 2020). indonesia’s central bank (bank indonesia) issued a comprehensive strategy to develop european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7345 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 4 and bolster the ib sector in 2008. as per the latest information as of december 2019, released by the indonesian financial services authority (otoritas jasa keuangan, 2019), there are 14 full-fledged islamic banks in the country. in addition to the full-fledged islamic banks, 22 islamic business units of conventional banks are also operating to offer shariah-compliant banking services. in collaboration with other stakeholders and governmental support, bank indonesia is optimistic about the promising future of indonesia’s islamic banking industry (bank indonesia, 2020). some issues need to be addressed like the lack the political will and slack social attitudes towards the diffusion and acceptance of islamic banking in the country (sari, zakaria & zahri, 2016) and at state-level, the ib industry has lacked adequate regulation support (abduh & omar, 2012), if these matters among others are dealt with, the industry would certainly grow and thrive. according to maulia (maulia, 2019), the indonesian authorities plan to increase the market share of islamic banking by 20% by 2024. 3.5 islamic banking in saudi arabia ib sector in the country functions parallel to the conventional banking sector. the banking industry in saudi arabia is regulated and governed by sama – saudi arabian monetary authority. saudi arabia has the second-largest banking sector among the gulf cooperation council (gcc) states regarding the value of its assets, while the kingdom’s islamic banking industry is also among the leading ones in the region (khan et al., 2018). the saudi banking sector consists of 14 foreign and 12 local banks. three of the 12 local banks hold a joint 45% share of the total banking market. the saudi banking sector has to its credit, the second largest share of 20.6% (saudi arabian monetary authority, 2019) of the total global islamic banking assets in the world, while at the national level, the total assets of islamic banking are more than half of the total banking share, i.e., 51.3% of total banking sector assets in the country (hassan et al., 2018). of these dozen local banks, four banks are fully dedicated islamic banks, including al-bilad bank, al-rajhi bank, bank al-jazira and al-inma bank, while the remaining eight banks are providing both product offerings, i.e. both shariah-compliant as well as conventional banking services. sama, with the cooperation and collaboration of the capital market authority and ministry of finance is working meticulously to provide an effective framework for regulation and control of the ib sector to stabilize and promote it. and the view of (nichita, kagitci & vulpoi, 2013) about the saudi ib industry is that it will continue to flourish under the facilitative supervision of sama and is currently the second largest islamic banking industry in terms of assets of around usd 376 billion (thomson reuters, 2018), saudi arabian ib sector growth prospects are very much brighter. 3.6 islamic banking in iran iran introduced the implementation of islamic banking in the country at state level in 1979. the “law for usury-free banking” was enacted in 1983 and was enforced in the coming year in march 1984 by the central bank of iran (anwar, 1992). the peculiar feature of iranian banking sector in its early stages after islamic restructuring was that all banks were nationalized (ashraf & giashi, 2011) and were bound to operate on riba-free basis and hence the banking sector was based on a centralized model entailing a greater degree of regulation and control by the central bank of iran – bank markazi jomhouri islami iran. the primary private bank that started to operate in the country named bank karafarin was later followed by several other banks that were granted licenses by the country’s central bank – bank markazi. the banks in iran are largely classified into two categories i.e., government owned and private banks (parveen, zodeh & ahmad, 2015). currently, the banking sector of the country comprises thirty banking institutions including eight government-owned banks and eighteen private banks (central bank of the islamic republic of iran, 2019). the major banks in iran are bank mellat, eqtesad novin, export development bank, maskan bank, and bank pasagard. as reported by ifsb’s ifsi report 2019, iran has a staggering 32% share of global assets in islamic banking sector and in addition to this merit; iran is the premier country to implement islamic banking at the state level by transforming the entire banking setup to shariah-compliant banking and financial system. 3.7 islamic banking in bahrain the country is considered the hub of the global ibf industry. the premier islamic bank in the country, bahrain islamic bank, was set up in 1979. the bahrain monetary agency (bma), the country's central bank and financial sector regulator, played an instrumental role in fostering the islamic banking industry (al-sadah, 2005). bahrain is host to numerous ifis (islamic finance institutions) and other related institutions, including regulatory, standard-setting, academic and research european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7345 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 5 institutions that include the bahrain institute of banking and finance (bibf), international islamic financial market (iifm), islamic international rating agency (iira), and accounting and auditing organization for islamic financial institutions (aaoifi). several dedicated islamic retail and investment banks, including some off-shore banking institutions, drive bahrain’s islamic banking industry. the powerful ib initiative in bahrain is spearheaded by the central bank of bahrain (cbb), formerly the bahrain monetary agency (bma). the remarkable islamic banking growth has been one of the reasons bahrain is one of the global leaders in the islamic finance sector, with total assets of usd 27.8 billion as of november 2018 (central bank of bahrain, 2019). according to the latest facts and figures released by cbb (central bank of bahrain, 2019), the islamic banking sector grew from 24.7 billion us dollars in 2014 to 30.7 billion us dollars as of june 2019, with an impressive annual growth rate of 17% and the future potential and prospects are even more promising, keeping in context the outstanding support provided by the regulatory and other governmental agencies. 3.8 islamic banking in kuwait many ifis reside in kuwait, which also has to its credit an institution named the kuwait finance house (kfh), the oldest established islamic financial institution setup in 1977. kfh, the premier islamic bank of kuwait, is a pioneer in the global islamic banking landscape. regarding assets, kfh is the biggest islamic bank in the world. the kfh services are available in kuwait and several other countries, including saudi arabia, bahrain, turkey, united arab emirates, germany and malaysia (kuwait finance house, 2018). according to ifsb (islamic financial services board, 2017), kuwait’s impressive 39% islamic banking share in the country’s total banking assets is among the best in the world. the vigour and strength of the kuwaiti islamic banking sector are reflected by the fact that it has a total of five islamic banks, including the largest islamic bank in the world, and the average size of kuwaiti islamic banks is the largest in terms of assets (ali, 2011). the aggregated number of islamic bank branch networks in kuwait is presently 600, with an approximate staff of 12000 personnel, and consolidated ib assets are around 96 billion usd. kuwait is among the top six countries in islamic finance progression, mainly because of its powerful and ever-growing islamic banking industry. 3.9 islamic banking in the united arab emirates the country is home to dib – dubai islamic bank, which was established in 1975, and was one of the torch-bearer islamic financial intuitions. the bank is currently the largest islamic bank in the uae, operating with 90 branches country-wide (dubai islamic bank, 2019). dib spearheaded the evolution of the global islamic banking initiative by being the world’s first fully-fledged islamic bank and the second-largest islamic bank in the world (dubai islamic bank, 2020). there are seven fully dedicated islamic banks in the uae, while conventional banks also offer islamic banking services through their islamic windows (tabash & dhankar, 2014). akoum (akoum, 2017) stated that there are 47 islamic financial institutions, including islamic banks, islamic windows of conventional banks, and islamic finance companies. according to reports by thomson reuters (thomas reuters, 2018) and ifsb, uae is the fourth largest country in terms of its global ib assets. the country’s central bank started designing and devising its islamic finance development framework in 2018 to boost the progression of the ib sector. the objective of the central bank of united arab emirates (cbuae) is to develop the legal and regulatory framework for the industry to support the sector effectively and to make the uae the leading islamic financial services hub (central bank of uae, 2018). in 2018, the higher shariah authority was established to standardize and harmonize the practices of islamic banking and financial institutions by aligning them to internationally applicable shariah standards and globally recognized best practices by collaborating with pertinent stakeholders (central bank of uae, 2018). 3.10 islamic banking in qatar qatar is among those few countries where the share of islamic banking is substantial compared to the share of the conventional banking sector; the islamic bank's market share out of the total market share in qatar is approximately a quarter, 26.6% to be exact. according to ibrahim (ibrahim, 2015), there are 18 banks in qatar, with four islamic, seven local and seven foreign banks. there are currently four dedicated islamic banks operating in qatar, qatar islamic bank (qib) being the first, oldest and largest one, which was set up in 1982. qatar islamic bank holds an overall 11% share of the total market share among all banks and a 42% share of the islamic banking market in qatar (qatar islamic bank, 2020). qatar central bank (qcb) is playing a very active role in the development of the islamic banking and finance sector by devising and european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7345 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 6 designing effective regulatory reforms (tlemsani, 2015), such as the implementation of a central shariah committee for islamic banks to bring consistency in the islamic finance industry (qatar financial centre regulatory authority, 2017). according to qcb (qatar central bank, 2016), islamic banks in qatar normally function under three regulatory institutions, including the qatar central bank, qatar financial center regulatory authority and qatar financial markets authority, and to ensure the sustained development of islamic banking sector, the three regulatory institutions would be devising a common approach to various regulations and allied matters to standardize the supervisory and regulatory practices, to accomplish and ensure robust growth of islamic banking sector in the future. 3.11 islamic banking in egypt the country is credited with the oldest shariah-compliant islamic financial entity established in 1963; it was essentially a savings association, a funds pool named mit ghamr. islamic banking commenced in egypt in the shape of two models, first with the establishment of public/private fully dedicated islamic banks and secondly with the establishment of islamic banking branches of interest-based banks. the first full-fledged islamic bank in egypt was nasser social bank. egypt currently has 40 banks, of which three are fully-fledged islamic banks, including bank faisal, bank al barakah and abu dhabi islamic bank (adib). in contrast, others provide islamic banking services (mubasher, 2018). egypt has a very low islamic banking market share as the challenges for the ib sector are many, including the lack of separate laws governing the ib sector, lack of political will and dearth of innovative products and services; but the industry will certainly grow when these core issues are addressed in an and appropriate manner (fayed, 2013; smith & zawya, 2018). 3.12 islamic banking in turkey in turkey, “participation banking” is used for islamic banking (ergeç & kaytancı, 2017). although the share of islamic or participation banks in turkey is meagre at around 5%, at 4.90% to be precise (zawya, 2018) but there are strong prospects that the industry will surge in the coming years because a comprehensive law for regulating the sector shall be issued by turkey’s banking and regulatory and supervision agency – the bddk. the plans are in the pipeline to lift the share of ib to 25% in the coming years by launching a mega islamic bank in collaboration with indonesia and some other countries that have shown interest in collaborating on the project. the proposed bank shall act as a central bank and a lender for global islamic banking and financial institution (daily sabah, 2017). presently, there are two state-run and three private islamic banks, operating in turkey, namely the albaraka, kuveyt turk, ziraat katilim, turkiye finans and vakif katilim; collectively having more than 15,650 employees and 1100 branches (birinci, 2019). 4. islamic banking in europe in the western world, islamic banking emerged and has been embraced as a lucrative and alternative financial proposition transcending religions and regions. the underlying motive for introducing and offering islamic banking services in the muslim-minority european countries was to realise the financial potential by attracting muslims living in these regions (cattelan, 2013). the country-wise status of the islamic banking sector in western countries is discussed hereunder: 4.1 islamic banking in united kingdom the islamic banking history in the uk dates back to 1982 when al-barakah international bank (aib) was set up and initiated operation as a fully-fledged islamic bank in the country. still, later its license was revoked by the bank of england and till 2004, islamic banking ceased to exist in the country (abdullahi, 2016). uk has proven to be a lucrative islamic banking proposition with a large muslim population and a client-driven ib model. in 2004, the islamic bank of britain was established as the country’s premier retail islamic bank. afterwards, the ib industry progressed encouragingly and soon, the uk was positioned as one of the top islamic finance hubs outside the muslim world by anchoring many islamic banking and financial institutions (sobol, 2015). the ib setup in the country thrived because of various favorable aspects, including the attraction of ib products and services to muslims and non-muslims (lane, 2020) as well as the supportive legal and regulatory arrangements by the concerned authorities to give islamic financial institutions a level-playing field in comparison european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7345 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 7 to other interest-based financial institutions, notably the changes in stamp duty land tax (sdlt) provisions to facilitate islamic finance transactions is one prominent instance in this regard (kulshrestha & ali, 2019). there are currently more than 20 banks offering shariah-compliant financial services in the uk (firdaus, 2019). according to thecityuk (thecityuk, 2019), among these banks, five are fully-fledged islamic banks, including (i) al rayan bank (formerly islamic bank of britain), (ii) abu dhabi islamic bank, (iii) qib uk, (iv) bank of london and the middle east, and (v) gatehouse bank. the country is the largest islamic finance market in not only the european region but is also one of the top islamic banking and finance centers in the world (mckenzie, 2010). the ib prospects in the united kingdom are pretty promising, as ratified by the facts and figures. thecityuk reported that the aggregated bank assets of the uk’s top islamic banks are approximately 4.7 billion dollars, highlighting the uk as the center of islamic finance in western countries. 4.2 islamic banking in luxembourg luxembourg has a proven status as an islamic finance center in the european region (laarab, 2019), starting its islamic finance journey with the establishment of first islamic finance institution in a non-muslim country named the islamic banking system in 1978 (mausen et al., 2019). apart from this, luxembourg has also attained many firsts in the islamic finance domain by being the first european country to authorize islamic insurance in 1983 (el-galfy & khiyar, 2012), and according to lff luxembourg for finance, luxembourg’s central bank banque centrale du luxembourg (bcl) was the first european central bank to join the ifsb, and according to ey (ernst & young, 2017), the country became the first european state to join as one of the founding members of international islamic liquidity management (iilm) in 2010. tan (tan, 2015) mentioned that plans were underway to establish a fully-fledged islamic bank (eursibank) in 2014, with a proposal from various stakeholders from the gulf region, but the idea could not materialize. the plans for the bank revived as the islamic finance group (eurisgroup) pioneered the idea of eurisbank, is intending to raise the capital to establish the first islamic bank in luxembourg, which would cater to the financial needs of not only muslim but also non-muslims who are interested in transacting within an ethical banking framework in the european region (merani, 2018). 4.3 islamic banking in germany one of the largest world economies and having a large muslim population and a huge business and trade volume with the gulf and middle eastern countries (aichbichler, 2009), slate germany a positive prospect for islamic banking setup. volk and pudelko (volk & pudelko, 2010) stated that only limited islamic banking services are offered to customers in germany by the institutions that are also operating in middle eastern countries and offering a broad range of islamic finance services in those countries. according to european central bank (european central bank, 2013), it was in 2009 that the country’s federal financial supervisory authority (bafin) decided to permit islamic banking services in germany and 2015, the first islamic bank in germany named kt bank ag started its operations, and apart from it, some other financial institutions are also offering shariah-compliant services in the country including the commerzbank ag. bahrain’s al-baraka group is delivering digital islamic banking services. most germans are christian, but many people believe in no religion, approximately 37% according to volk and pudelko’s study (volk & pudelko, 2016) conducted regarding islamic banking in germany. they asserted that a lower degree of religiosity does not necessarily imply that interest in islamic banking would also be on the lower scale, as discussed in (haron, ahmad & planisek, 1994; gerrard & cunningham, 1997) that religion is not to be overemphasised for banking selection. to accelerate the ib sector in germany, soylu (soylu, 2019) recommended wooing muslims and non-muslim prospects to ensure relatively productive efforts to acquire customers from this unexploited ib market in europe. 4.4 islamic banking in italy according to iannazzone (iannazzone, 2019), opportunities might be created to explore the ib initiative in italy by contemplating the ib system with the related phenomena of ethical banking and social investing. like several other european countries, italy has also issued some guidelines regarding the comparability of islamic banking services with conventional banking mechanics to deliberate the ib initiative in the country. the subject guidelines were released by the bank of italy in 2010. yet, the supervisory challenges and regulatory matters need to be settled to allow shariah-compliant banking services to gain momentum in the italian banking system (brugnoni, 2008). biancone (biancone, 2014) discussed the negotiations european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7345 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 8 between uba (union of arab banks) and abi (italian banking association), to possibly establish the first islamic bank in italy in 2008. still, it could not materialise due to the issues created by the global financial crisis. padovani (padovani, 2016) stated that the ib setup if launched and supported, would render financial opportunities for not only the 1.5 italian muslims but would also add diversity to the country’s banking sector, attracting non-muslims to avail of ethical banking services. according to padovani (padovani, 2017), the demand for islamic banking services exists in italy, and significant islamic banking players, including the al-barakah banking group (abg) from bahrain, are considering entering the italian banking industry; padovani further emphasised the huge potential of ib initiative but asserted that the general regulatory environment and legal framework matters must be addressed beforehand to govern the operational aspects for islamic banking and financial institutions. 4.5 islamic banking in france after the financial crisis of 2008, france aimed to attract foreign funds to stabilize the economy and islamic finance was considered a vital proposition (aqib ali, 2022); this would also assist them to lure funds from investors in oil-rich middle eastern countries (hajjar, 2019). france has the largest muslim population in europe, with a huge number of around six million (hackett, 2017); france may become a key islamic banking market in the region. according to thebanks.eu (thebanks.eu, 2019), there are approximately 340 banks in france, out of which sixteen have origins in muslim countries, but only eight of these banks are offering islamic banking products and offerings, while out of the shariah-compliant services provided by the eight banks, few are for retail banking customers and most are for corporate banking customers only. french authorities have made some legal modifications to assist islamic banking in the country (schoon, 2009), but the ib setup seems stagnant to a larger extent (bi & atta, 2009). the ib sector may be boosted by addressing regulatory and supervisory issues (khan & porzio, 2010), especially in the context of huge potential with a large muslim population in the country, offering lucrative financial opportunities and prospects to the early initiative-takers in the domain of shariah-compliant banking products and services (santelli, 2016). 5. islamic banking in australia the prime initiative of islamic finance to serve the financial needs muslim community in australian can be traced back to 1989 with the establishment of mcca (muslim community cooperative australia). after the success of mcca which has financed more than $1 billion for home financing and is managing approximately $50 million of investments (mcca, 2019); another institution was established named mccu (muslim community credit union) in 1999, which primarily operated as a retail-banking services organization (mirza, 2003). in 2001, another arrangement (iskan finance) to provide islamic home financing was established (rammal & zurbruegg, 2016) and subsequently amanah islamic finance for shariah compliant home mortgages was also set up. the license of mccu was revoked by australian prudential regulation authority (apra) in 2002 owing to their limited funds to sustain business activities (ahmad & hassan, 2009). nevertheless, a promising prospect from islamic financial perspective was the operational existence of various similar elements in the already established community-based australian banks (especially those that were functioning in relatively small town) and these financial entities as pinned upon islamic banking philosophy shaped to be a favorable ib proposition in australia. the islamic banking and financial offerings are gathering momentum and moving in the positive direction slowly and steadily in australia. there are various banking and financial institutions including hsbc, citibank, and nab – national australian bank that are planning to provide islamic finance products in the country to cater to the banking and financial needs of the muslim population in the region. the latest ib venture is underway in shape of iba (islamic bank australia), that would become australia’s first full-fledged islamic bank (ahmad, 2019). this is expected that iba would very soon commence operations (islamic bank australia, 2020), islamic bank australia acquired its license in 2022 and is now working on building its products, systems and processes (islamic bank australia, 2023), to cater to all those australians who wish to deal with a shariah compliant banking entity, entailing ethical banking and financial products and practices. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7345 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 9 6. islamic banking in usa & canada the islamic finance initiative began its journey in the united states in the late 1980s, establishing a californian financial entity named lariba – american finance house in 1987 to provide shariah-compliant auto and home financing. furthermore, lariba also provided mudaraba-based financing to various small and medium business enterprises. moreover, hsbc was among the premier financial entities in the us to offer islamic financing for consumer customers to fund their house and car financing needs. as of 2006, three banks offered islamic financial services in the us, including devon bank, hsbc and university bank (tacy, 2006). university islamic financial was established as the first islamic banking subsidiary by the university bank of michigan in 2005 to cater to customers' financial needs in line with shariah guidelines. catovic (catovic, 2014) stated that the first regulatory breakthrough for the ib initiative in the us was made in 1997 when a proposal for a shariah-complaint financing transaction by the united bank of kuwait (ubk) was approved by the occ – office of the comptroller of the currency. the concentration of islamic banking and financial players in usa largely revolves around home financing arrangements. other investment and financing products are still underdeveloped owing to several factors, including low market penetration and the absence of a regulatory framework (zyp, 2009; zinser, 2017). there are currently more than 30 islamic financial institutions operating in the us (aldarabseh, 2019), albeit none of these financial institutions is operating as a nationally chartered full-fledged islamic bank, and most institutions are offering limited product assortment, mainly including home and auto financing services. the prominent names active in the ibf sector include lariba (bank of whittier), university islamic finance (uif), devon bank, and guidance residential (paldi, 2020). this is imperative for the us to address the supervisory and regulatory challenges impeding the ib progress, which not only results in a great opportunity cost but also a failure to realize financial potential worth millions of dollars (zinser, 2019; paldi, 2017). canada signals a progressive islamic financial market with promising prospects of ibf growth. various institutions include al yusr, islamic co-operative housing corp, al-ittihad investment, united muslim financial, amana auto finance canada, habib canadian bank, ijara community development corp, qurtuba housing coop, manzil bank, to name a few, which are offerings shariah-compliant financial services. furthermore, many conventional banking and financial entities plan to functionalize islamic financial windows, including the canadian imperial bank of commerce and canada mortgage & housing corp. with a growing need to fund infrastructure projects in canada, islamic banking and finance seem attractive (aqib ali & hussain, 2017; natoor, 2017). another consideration that makes ibf a viable option, as highlighted in thomson reuter’s report (thomas reuters, 2016), is that islamic finance concurs with the country’s emphasis towards socially conscious/responsible investments and financing philosophy. 7. conclusion and future prospects islamic banking is an attractive proposition not only for muslims but for everyone who is interested in a financial model with an ethical and moral underpinning along with a socially responsible perspective towards dealings and transactions. the evaluation of islamic banking model in various countries of the world revealed that islamic banking and finance paradigm has grown from strength to strength in asian regions especially in the middle eastern countries from where it spread to other parts of the globe including asian and european countries. the encouraging progress of islamic banking in both muslim as well as non-muslim states demonstrates the promising potential of islamic banking as an alternative financial system. islamic banking certainly has great future prospects in the global financial landscape. islamic banking, based upon the principles of equity and fairness in financial dealings would certainly help the countries to attain financially inclusiveness, economic stability and prosperity. however, concrete measures and coordinated efforts are required from the stakeholders like the financial, governmental, and regulatory 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(2017). usage of islamic banking and financial services by us muslims. international journal of islamic marketing and branding, 2(4), 335-344. zinser, b.a. (2019), "retail islamic banking and financial services: determinants of use by muslims in the usa", journal of islamic marketing, vol. 10 no. 1, pp. 168-190 zyp, v. l. (2009). islamic finance in the united states: product development and regulatory adoption (masters thesis, submitted to georgetown university). european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6585published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/02/2022 accepted for publication: 23/12/2022 published: 29/12/2022 30 the role of islamic finance in unlocking the potential of micro-small and medium-sized enterprises and the role of fintech sara cherqaoui1 1 hamad bin khalifa university, qatar contact author 1: sara.cherqaoui@gmail.com abstract this paper aims to examine the role of islamic finance and technology in unlocking the potential of msmes. in recent years islamic finance has enjoyed rapid growth, but several challenges remain. data show significant unmet demand for shariah-compliant financial services, particularly among microsmall and medium-sized enterprises (msmes). to fill this financing gap, shariah-compliant products offered to msmes are mostly leasing and asset resale arrangements, with very little application of profit and loss sharing contracts. this paper employs a qualitative research method to look at the role of islamic finance in unlocking the potential of msmes. in addition, the emergence of financial technology (fintech) has given the islamic financial system an impetus to compete on an equal footing with the conventional system and prove itself. this study will examine the role of islamic finance in recovery post-covid19 and how fintech can be utilized to combat the economic repercussions that resulted from covid-19. in addition to other existing articles, this paper suggests that combining the principles of islamic finance, the advancements in technology, and fintech represents an opportunity to significantly contribute to the enhancement of the entrepreneurial ecosystem in the islamic world and the promotion of msmes segment development. this paper proposes using modern technology to unlock the potential of islamic finance in contributing to entrepreneurship and msme development. the findings of this study have significant implications for policymakers and governments, notably guidance on how to apply fintech and effectively promote innovative islamic financial services. keywords islamic finance; entrepreneurship; msemes; social finance, covid-19 i. introduction islamic finance entails observing the principles of islam and those of islamic finance in carrying out business and managing resources. islamic finance originated about 50 years ago. countries with a muslim majority embraced it. investments in islamic finance assets are estimated to exceed us$3.69 trillion by 2024, and this investment amount will mark the industry's highest growth track ever recorded since 2008 [9]. the increasing popularity of shariah financing among muslim countries is mainly attributed to its ability to satisfy its thirst for capital and its ability to serve the unmet demand in the market. islamic financing provides an opportunity for investors to access financing and economic development. this is by providing shariah-compliant financial services to products, especially to micro-small and mediumsized enterprises (msmes). shariah law upon which islamic financing is adopted doesn’t allow financial institutions to charge interest to their clients [5]. thus, there is a need to develop more innovative solutions to unlock the potential of islamic finance, especially with msmes. there exists a huge potential for islamic financing if the institutions advance their operations to entrepreneurship. islamic banks can work together with financial technology (fintech) firms to introduce innovative products. these products must be shariahcompliant which increases the target customers for islamic financing. considering that islamic finance is not exclusive to muslims, introducing innovative solutions will help attract entrepreneurs. the conventional nature of islamic financing is good for investors since it is not developed to make a profit but instead on returns from tangible income. this makes it more favorable to msmes, which thrive upon favorable conditions. we find that to unlock islamic finance, msmes must be aware of the microfinance modalities that can help their businesses. investors who hail from nations such as saudi arabia, united arab emirates, and malaysia have the advantage to understand islamic banking compared to people from the united states or canada. thus, islamic banking ought to be promoted for entrepreneurs to seek these services. we argue that the islamic financial systems are playing a crucial role in the recovery process. this is by providing sharia contracts to the msmes owners to allow them to recover from the economic impact of the pandemic [3]. islamic finance should also create demand for their products by making providing an innovative solution. the paper investigated the role of technology in advancing the services provided by these banks, especially during this period when the world is recovering from covid-19 [3]. this study adds to the sparse and divergent evidence on the role played by the islamic financial system in helping msmes deal with the economic impact of covid-19 across the globe. besides, the study also explored the role of fintech in european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6585published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/02/2022 accepted for publication: 23/12/2022 published: 29/12/2022 31 providing innovative solutions that align with islamic banking requirements. a. fintech are important in financial growth and a strong enabler of innovation financial technology (fintech) is the next financial and banking sector revolution. artificial intelligence, robotics, blockchains, and other cutting-edge technologies have gradually found space in the banking world. the islamic banking sector has been affected by these revolutions [10]. for instance, fintech has introduced advanced capabilities for islamic finance that enhance the ability to serve msmes. these capabilities can be adapted to unlock and attract small businesses by providing msmes services that align with shariah requirements. islamic financing must promote their services to their client customers for them to understand the advantages of working with islamic microfinance. providing innovative solutions to customers will only be effective if they are aware of the advantages of working with islamic banking over another method of financing. msmes will likely consider financial institutions that are less friendly to their business because they need to gain more knowledge of islamic finance. thus, the first approach is to make the target msmes aware of the nature of services provided by islamic banking. this will make it possible to convince them of the concept of profit sharing and fixed payment rates which are more advantageous compared to what is offered by investment banking. also, shariah law limits the area in which islamic finance can be invested, and it is appropriate to advise entrepreneurs to adhere to the law strictly. for instance, the funds cannot be invested in businesses that deal with drugs or gambling. hence, the use of financial technology will provide new opportunities for investment that are aligned with shariah. for instance, capital markets and the use of digital payment systems are new investment approaches. these are investment opportunities for entrepreneurs that are allowed by shariah law. to penetrate new regions, it is important to introduce banking packages that attract msmes since they are the backbone of most economies. this can be achieved by creating awareness and educating investment groups on why it is more advantageous to use islamic banking for their businesses. importantly, there is a need to stipulate that islamic finance does not apply to muslims alone, but investors are welcome regardless of their religion or beliefs. the incorporation of fintech into islamic banking will help investors and the institution realize impeccable results. this is by adopting technologies that allow both the investors and the banks to interact. digital disruption is an important consideration while unlocking the potential of islamic finance. the advancement in technology will enable msmes to manage funds digitally using real-time technologies. based on the nature of islamic finance, this new technology provides a great opportunity for collaboration between the institution and the msmes. the covid-19 pandemic has disrupted msmes. islamic banking can play an active role during the recovery process. fintech allows the islamic financial system a level ground to provide financial services to msmes. therefore, fintech can be used to work with small businesses that are recovering from the economic impact of covid-19. the pandemic has created an opportunity for islamic finance to work with msmes and create a sustainable financial system [6] currently, small and micro businesses have turned to innovation as they seek to attain a place in the world. the collaboration between islamic finance and msmes will create an imperative opportunity where fintech can be applied to ensure that innovative businesses are being supported. for the innovative solution to reach the target market, the investor requires financial support from institutions providing favourable terms. compared to other finance providers, islamic finance is more favourable to support innovative solutions to its strict adherence to shariah law that is not centred on making a profit. however, awareness is important, especially among investors who are not exposed to islamic banking or are guided by misconceptions or stereotypes. the purpose of this study is to contribute to the literature regarding the potential role of islamic finance in the growth of the msmes sector. this paper also explores the impact of islamic finance on society and how the sector has managed the covid-19 pandemic. ii. literature review a. islamic finance have evolved over the years over the years, the popularity of islamic banking has been growing significantly, but statistics indicate that there remains a huge potential to be exploited. there is a huge demand for islamic financing products, majorly among msmes. if the product sold by the business is shariah-compliant, it is more beneficial to seek islamic finance. the profit-loss-sharing contract benefits small businesses due to its favorable terms. public awareness remains a significant hindrance to islamic financing because people who are not muslims or from islamic countries are not aware that their investments are shariah compliant [1]. the gap in knowledge makes the msmes seek expensive investments, whereas they can access funding that comes in favourable contracts. it is more beneficial to islamic banks to use profit and loss-sharing contracts to categorize msmes based on their debt repayment capabilities. unlocking islamic finance will help correct information that allows guides on the various investment that meets the criteria for funding. the acceleration of digitalization after the covid-19 pandemic has enabled msmes to leverage online platforms offered by islamic banks. according to a study by oecd, msmes engaged in online banking platforms following the pandemic have seen an increase in sales and revenues. thanks to islamic banks, msmes are having easier access to funding and a speedy recovery from the pandemic repercussions [15]. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6585published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/02/2022 accepted for publication: 23/12/2022 published: 29/12/2022 32 figure 1: institutions registered for shariah-compliant products source: icd report the figures above indicate the continuous growth of islamic banking between 2007 and 2010. msmes realize various contracts that are more favorable to their businesses [1]. these contracts allow them to obtain funding that is cheaper compared to what they would have gotten from commercial banks. this has attracted new entrants into islamic finance while other conventional banks are introducing shariah-compliant services. the growth in the number of institutions offering islamic financing indicates the potential growth for banks and msmes seeking their services. data also indicates that islamic finance is gaining prominence in previously unexploited regions. the concentration of islamic banks spreads to areas not predominantly occupied by muslims. this geographical expansion indicates how investors accept favorable contracts, thus helping grow the assets of islamic banks. table 1: shariah compliant assets ($m) by country source: icd report the table above indicates the top 25 countries in islamic banking. the recognition of islamic banking as an alternative to conventional banking is continuously growing and indicates a huge potential for the industry in the future. to explore this niche, the business must constantly come up with innovative solutions that meet the msmes' needs [1]. this growth was observed after the 2008 economic recession. similarly, there is room for growth as msmes are recovering from the economic impact of covid-19 that have affected and are looking for an innovative solution to their financial woes. according to a recent report from refinitiv, islamic finance has proved resilient to current global economic troubles and is projected to grow at an average annual rate of 8 percent until 2025 [21]. it is worth noting the factors that have contributed to the growth of this industry. firstly, since the principles of islamic finance are based on the values of social justice and the improvement of humanity. second, its growing use for financing msmes maintains a net positive social impact in the industry [11]. furthermore, some countries like saudi arabia have islamic finance on their top agenda. saudi arabia is one of the most knowledgeable countries in the world when it comes to islamic finance and has an impressive record of shariah-compliant infrastructure targeted toward msmes [11]. additionally, islamic finance is committed to promoting greater financial inclusion, particularly for large, underserved muslim populations. as the muslim population grows, the need for islamic funding grows, which accounts for the rise of islamic finance in muslim countries [12]. islamic finance has some characteristics that give it the potential to effectively support medium and small business financing, economic growth, and development [13]. islamic finance has certain features which give it the potential to support msmes' financing and development effectively. for example, in the gulf co-operation council (gcc) countries, smes represent more than 22% of the country’s gdp. this tendency extends to employment, with smes being the only ones to participate, around 40% of jobs. [13]. countries like saudi have been continuously supporting msmes growth and development. b. role of msmes in in the development of islamic financial institutions over the years, investors have been using islamic finance to acquire financing for their investments. investors who hail from both islamic nations and non-islamic regions use these finances to develop and grow their businesses. these are largely msmes that have invested in companies that are compliant with shariah law which is the islamic law used to regulate islamic financing. unlocking entrepreneurship is therefore possible if the business adopts this asset-based approach. the majority of the financial providers focus on interest which affects small businesses which are trying to compete with big firms. according to research, it is more sustainable to work with islamic banking because they are controlled by shariah law which is asset-based rather than profit. the majority of msmes have been adversely affected by the covid-19 pandemic and are unable to meet requirements set by financial institutions. thus, financial instruction offering favorable terms for accessing finance is much welcome. it is important to educate entrepreneurs on various microfinance modalities provided by islamic financing. based on the nature of the investment, the msmes will be able to adopt a contract that is best suited for their business. for 163 194 192 199 362 420 436 456 0 100 200 300 400 500 2007 2008 2009 2010 number of conventional banks with shariah windows number of shariah compliant insitutions rank country shariah compliant assets ($m) rank country shariah compliant assets ($m) 1 iran 314,897.40 14 pakistan 6,203.10 2 saudi arabia 138,238.50 15 syria 5,527.70 3 malaysia 102,639.40 16 jordan 5,042.40 4 united arab emirates 85,622.60 17 brunei 3,314.70 5 kuwait 69,088.80 18 yemen 2,338.70 6 bahrain 44,858.30 19 thailand 1,360.80 7 qatar 34,676.00 20 algeria 1,015.10 8 turkey 22,561.30 21 mauritius 992.20 9 united kingdom 18,949.00 22 switzerland 935.50 10 bangladesh 9,365.50 23 tunisia 770.10 11 sudan 9,259.80 24 singapore 725.00 12 egypt 7,227.70 25 palestine 612.50 13 indonesia 7,222.30 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6585published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/02/2022 accepted for publication: 23/12/2022 published: 29/12/2022 33 instance, a profit and loss sharing contract in islamic banking allows the investor and the bank to split the profit or loss made by the investment based on a predetermined ratio. this can be based either on mudaraba or musharaka contractual terms that the bank and investors agree to share the profit or loss of the venture. if the party adopts mudaraba contractual terms, islamic finance will act as the financier of the investment while the investor is the management and executor. on the other hand, musharaka both parties agree on the revenue-sharing formula before the investment is initiated. islamic law contains various contracts that allow small and medium enterprises to access funds packaged for their investment. for businesses that require funds for a specific project, it is possible to acquire an interest-free loan from the bank to meet its financing requirements. however, the biggest challenge remains access to information on the available microfinance modalities provided by islamic banks. to unlock islamic finance, msmes must be aware of the microfinance modalities that can help their businesses. investors who hail from nations such as saudi arabia, united arab emirates, and malaysia have the advantage to understand islamic banking compared to people from the united states or canada. thus, islamic banking ought to be promoted for entrepreneurs to seek these services c. impact of islamic finance on society research indicates that msmes play a crucial role in society, especially in poverty eradication and the promotion of the domestic economy. countries that promote msmes tend to achieve economic growth that enables them to achieve sustainable development goals (sdgs) [5]. this is possible when small and medium businesses are able to access financing. funding from islamic finance has increased the ability of these msmes to increase their sales, meet customer demands and employ workers [16]. access to funding also enables msmes to become more profitable and increase their competitive advantage. this is made possible by the favorable terms associated with islamic banking that allows businesses to become more productive. however, islamic finance must create demand for their products by making providing an innovative solution. research indicates that more countries are developing interests in islamic finance. still, it is the responsibility of the stakeholders to educate the msmes on various sharia contracts that are good for their business [1]. awareness is needed if small businesses adopt a new source of financing. although islamic financing provides better arrangements, the msmes must be aware of these contractual terms for them to place their investment. unlocking islamic financing entails empowering msmes to grow and adopt new technologies. the previous program that has worked can be used for benchmarking for the investors. d. islamic fintech in managing impact of covid-19 on msmes covid-19 has disrupted most businesses, with msmes being the most affected. the islamic financial systems are playing a crucial role in the recovery process. this is by providing sharia contracts to the msmes owners to allow them to recover from the economic impact of the pandemic [3]. the 2008 economic recession provided the islamic financial system with a blueprint for working with small and medium businesses during the recovery process. this can be reciprocated to help msmes that are recovering from the economic aftershocks of the pandemic. islamic finance entails corporate social responsibility that allows the institution to support businesses in society [1]. according to a study, the covid-19 pandemic created an opportunity for people to be creative and create innovative solutions. there are multiple startups that are rising and require support for them to flourish. islamic finance promotes asset financing, which is significant in the achievement of sdgs. the construct of islamic financing is designed to promote risk sharing and avoid speculations. while other conventional banking systems are linked to gambling and other ambiguous investments that expose investors to multiple risks, islamic finance does not support business activities that are prohibited. therefore, islamic finance allows easier and safer access to funding. when it comes to technology, islamic banking innovative solutions such as the use of digital currency, msmes can acquire finance without taking excessive risks. figure 2: global islamic finance assets growth (us$ trillions) source: icd report the figure above shows global islamic finance assets from 2012 to 2020. over the year, islamic financing has been gaining prominence across the globe. this can be attributed to the fact that it is not limited to muslims only but also nonmuslims, thus gaining attraction due to favorable contractual terms. also, the sharia laws allow the parties in the contract to negotiate equal rights without one party feeling exploited. unlike conventional banking, islamic finance allows equitable sharing of collected revenue. iii. methodology the study employs a qualitative research approach to understand the role of islamic finance and entrepreneurship in unlocking the potential of msmes. in the analysis process, qualitative content analysis is applied, which is then supplemented by exploratory research to assess and evaluate the potential of islamic finance among the msmes in dealing 1,76 2,06 1,98 2,2 2,31 2,46 2,51 2,88 3,69 20 12 20 13 20 14 20 15 20 16 20 17 20 18 20 19 20 24 (p ro jec te d) european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6585published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/02/2022 accepted for publication: 23/12/2022 published: 29/12/2022 34 with the impact of covid-19. this study also uses secondary data. the first source is the annual reports of selected islamic financial institutions on their respective websites. to minimize selection bias, several electronic databases were used to gather data. only full-text studies from databases providing full access to several full-text journals were considered. keywords included were islamic financial system, fintech, islamic finance, msmes, the impact of covid-19 on small and medium enterprises, entrepreneurship, social finance, and innovative solution in islamic banking. once relevant articles were identified, the authors analysed their content to obtain relevant information on unlocking the potential of islamic finance and entrepreneurship using innovative solutions [1]. to ensure the relevance of the current research, the selected articles were objectively and quantitatively analyzed through content analysis to obtain data and information to proceed with the research paper. this approach analyzes secondary data to understand the relevance of islamic finance in supporting msmes, especially post-covid-19. iv. results according to search engine findings, the impact of the covid-19 pandemic has greatly evolved from health crises to economic crises, with msmes being the most affected. most entrepreneurs are already struggling to keep their businesses afloat due to lockdowns and loss of employment imposed once during the country lockdown [3]. once the lockdown was lifted, economic activities failed to resume immediately, and some businesses could not sustain themselves due to a lack of funds. covid-19 also created new opportunities for innovators to provide solutions by providing products and services [17]. the pandemic rendered millions of people jobless, and people had to develop creative ways to make a living, leading to various businesses. firms trying to recover from the impact of the pandemic are dealing with various challenges, such as a need for more funds to sustain themselves. also, there needed to be more cash flow since most target customers lost their jobs during the pandemic. many working hours were lost during the lockdown affecting the cash flow among the working populates. with the cash flow, small and medium businesses can sustain and survive the impact of covid-19 on the economy. this creates extreme uncertainty for the msmes who depend on the availability of cash flow when the working hours are utilized optimally. for msmes to survive the impact of covid-19, there is a need to shift from the conventional financial system that does not provide favorable contracts to already struggling establishments. the existing financial systems are more focused on making profits and less interested in supporting the msmes [5]. this makes islamic financing the best-suited approach to unlock msmes' potential and access funds easily. islamic finance offers non-exploitive services that allow the business to develop [5]. through various contracts, it is possible for small businesses to access finance and benefit from favorable contracts compared to the ones offered by conventional financial institutions. islamic finance provides various service that attracts msmes. these financial services are more favorable through islamic financing compared to conventional banks, which are exploitative to their customers. the islamic banks provide services that are not interest-oriented, thus making them ideal for msmes dealing with the impact of covid-19. however, the investor needs to acquire information on the nature of investment supported by these banks. in as much as islamic financing promotes small businesses, they refrain from an investment that is against sharia law. activities such as gambling and speculation are prohibited, and investors will not receive funding for such businesses. additionally, islamic financial institutions are a good platform for increasing access to financial inclusion, including access to finance for msmes, thereby supporting growth and economic development [19]. furthermore, a lack of awareness and knowledge about islamic banking products also affects msmes [19]. therefore, information is important in promoting islamic financing, especially in non-muslim nations. recently, several countries have embraced islamic financing, including nations where islam is not the populous religion [2]. based on content analysis, people from such countries need to be more conversant with the strict requirement of shariah law. these are investors who are attracted to the favorable contractual terms of islamic banking, but they need to be made aware of the segments that they must meet to acquire funding [2]. with the outbreak of covid-19, the majority of msmes have been affected and are seeking investment from an organization that is less exploitative. however, these businesses may be locked out of acquiring funding from islamic banking because their companies do not conform to the law. in this paper, we presented several islamic financial products like mudarabah and musharakah that msmes and entrepreneurs can adopt to meet their financial needs [18] (see table below). besides, the islamic social finance tools stipulate various obligations that must be met before providing funds to businesses. the information role of islamic banks must be addressed, especially for nations that are not predominantly islamic. content analysis indicated that countries globally are exploring islamic banking [2]. for instance, western countries have greatly embraced this form of financing that offers better terms than conventional banks that are exploitative. however, the majority of the resident of these countries are not muslims, thus unaware of shariah laws that regulate islamic banking. information is, therefore, necessary for investors on the nature of services and products so that they can seek support from the government. table 2: contracts and their definitions contracts definition profit and loss sharing is a contract between two parties; one provides the capital and the other provides the labor to form a partnership to share the profits by certain agreed proportions. joint venture (musharaka) is a financial contract between two or many parties to establish a commercial enterprise based on european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6585published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/02/2022 accepted for publication: 23/12/2022 published: 29/12/2022 35 capital and labor. the profit and loss are shared at an agreed proportion according to the amount of contribution. cost plus (murabaha) refers to a sale of a good or property with an agreed profit against a deferred or a lump sum payment. there are two contracts in murabahah: the first contract is between the client and the bank, whereas the second contract is between the bank and supplier. the client (purchaser) orders a certain commodity through the bank, the bank then buys the commodity from the supplier and sells it to the client with specified profit whereby the client can make a lump sum or a deferred payment to the bank. source: characteristics of gcc islamic banks investment in malaysia, ali abusalah elmabrok mohammed v. discussions of the potential and challenges for islamic decision support systems the research focuses on unlocking the potential of islamic finance among msmes in dealing with the impact of covid19. through the application of islamic financial systems and strictly adhering to the shariah laws on which they are built, entrepreneurs can access funding for their investments and survive the economic repercussion of the covid-19 pandemic. the use of digital currency and smart contracts provide a lucrative opportunity for islamic finance to penetrate the larger market. using fintech, it is possible to solve economic challenges facing the majority of msmes. analyzing activities based on whether they adhere to shariah guidelines and then proceeding to seek financial services can help many struggling msmes. enterprises have huge potential, but they need to receive favorable financial services from conventional bank that favors their economic situation. fintech can be used to collaborate with firms dealing in blockchain financial technology, which has become more prominent post-covid-19. blockchain aligns with shariah requirements because it reduces the risks of cheating or hacking and thus does not affect financial integrity. fintech in blockchain is viable in helping islamic finance provide an innovative solution to its clients. the financial bank can access information contained in blockchain digital ledger, thus ensuring accuracy. this also allows the bank to determine if a digital currency is making a profit or loss. the world is almost concurring covid-19 with new variants promptly managed without the need to lock down the economy. with the ongoing vaccination, the focus is now on economic recovery. multiple opportunities have arisen, especially in fintech dealing with digital assets and nonfungible tokens (nft). as a result of the technological innovations described in rabbani’s study, fintech has been able to disrupt our everyday lives with innovation in finance. we are now receiving financial services through artificial intelligence systems, and it is possible to apply shariah principles in financial transactions [5]. cryptocurrency is a categorized currency; thus, it is halal for islamic finance to fund. considering that currency are properties that do not attract interest, msmes dealing with digital currencies can acquire funding with much ease. the aspect of islamic financing is to create value while conducting business in an ethical manner that does not expose the institution or the clientele to risks. all in all, the use of fintech in islamic banking is gaining attention globally, and its potential in financial services is immeasurable. thus, the adoption of fintech by msmes requires the support of islamic finance sector to help overcome the lack of funding. the recovery process against covid-19 entails both short and long-term financial strategies. short-term strategies entail msmes seeking financial support not exceeding one year. this is mostly emergency financial needs that provide financial assistance to investments. islamic finance is used to fund msmes for projects that meet zakat, sadaqah, or qaradh-alhasan stipulations. it is important that client is introduced to various financial services provided by islamic banking based on their needs. in regions where islamic banking is not popular, msmes owners require more information on how they operate, and their advantage compared to conventional banking. bridging the knowledge gap is important in determining whether the investor needs short-term emergency support, or they need long-term support. social instruments under islamic finance, such as qardh-alhasan, zakat, social sukuk, and waqf are viable options to be used by the islamic banks during and after covid to help the affected individuals, msmes, and corporations by providing direct cash transfers and giving access to the health care and education facilities [7]. islamic finance is based on the principle of social justice and equitable distribution of income and these two characteristics make it as the suitable path under crisis [8]. for instance, zakat financial support is rendered to a certain group of customers who are financially deprived, according to sharia. this can benefit poor people in a society whose enterprises have been affected by covid-19. to penetrate the financial markets, islamic finance must engage msmes that are recovering from the impact of the covid-19 pandemic. as the business recover from the impact of covid-19, it will start focusing on its growth and sustainability. thus, msmes can opt for medium-term or longterm recovery loans, which have a longer duration than shortterm recoveries. through fintech, it is possible to work with organizations to ensure they remain active and not get overwhelmed as they try to recover. a business that achieves long-run resilience is able to sustain itself and advance in other areas. this creates an opportunity for islamic finance and fintech to work on innovative financial solutions. the disruption caused by coronavirus is likely to be felt for a long period, especially with the constant emergence of new variants. therefore, msmes require partnerships with favorable financial services that will be in existence in the long run. also, incorporating digital currencies will help businesses and european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6585published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/02/2022 accepted for publication: 23/12/2022 published: 29/12/2022 36 financiers evolve with technology. with fintech, the banking world has changed, and fintech, artificial intelligence, and blockchain will re-engineer islamic banking to boost and enhance msmes access to funds and growth [20]. vi. conclusion based on the content analysis that has been carried out, the result of the study shows that utilizing islamic finance to promote entrepreneurship and the msmes sector when dealing with the impact of covid-19 offer a conducive growing environment. working together with fintech, islamic finance institutions will be able to introduce innovative products that meet customer needs. fintech has introduced advanced capabilities that allow the partnership between msmes and islamic finance. this advance aligns with shariah requirements, thus allowing the use of digital currency in transactions. the use of digital payment, like financial transactions, is easily controlled and does not entail gambling or speculations. countries such as malaysia, united arabs emirates, and saudi arabia have advanced levels of islamic banking. however, there is underlying potential across the globe, but islamic finance must prepare detailed packages that target msmes. besides educating the groups, it is important to include fintech in islamic banking. digital disruption cannot be avoided, and it is viable in managing funds using real-time technologies. the covid-19 pandemic disrupted the economy, with the most affected msmes. the economy is recovering with the ongoing vaccination and relaxation of the containment measures. fintech can be used by islamic finance to offer innovative solutions to msmes that have been significantly affected. this can be through collaboration between the two entities to create a sustainable financial system. small and micro-businesses are trying to find their place in the economy, competing with big corporations with access to financing. thus, corporation between these two entities provides an imperative opportunity where fintech can be applied to provide financial support. islamic finance is more favorable to msmes than conventional banks, whose main aim is to profit. according to research, msmes that have invested in a business adherent to sharia law have been using islamic finance to develop and grow their business. this has made it possible to unlock great investment opportunities for msmes. islamic finance does not focus on interest but is asset-based, unlike other financial providers. also, they provide various contractual terms that are more favorable compared to conventional financial organizations. many innovative solutions remain unexplored that could unlock the potential of islamic financing and msmes. many sharia-compliant businesses offer a conducive growing environment for entrepreneurs and msmes. the covid-19 pandemic caused an economic recession affecting many organizations, especially small and medium enterprises. the lockdown and strict restrictions by the department of health affected the business's cash flow. therefore, the majority of msmes are struggling, and they need a favorable financial plan for them to be sustainable. islamic finance can be used to provide much-needed funding during the recovery process. there is a huge demand for islamic financing products, especially among msmes. for investors in shariah-compliant services, it is more beneficial to seek islamic finance over the conventional funding provided by other financial service providers. the role played by msmes in society can be enhanced through financial support from organizations that provide investment funding. to eradicate poverty and achieve sdgs, developed and developing nations must work with msmes. favorable investment terms must be supported by economic and technological solutions. the experience and confidence in islamic finance will play a crucial role in helping msmes reach their full potential and overcome the repercussion of the pandemic. the rise of innovative technology, such as islamic fintech, provides an equal ground for islamic finance to compete and thrive better. our study had some limitations. firstly, limited access to information since the topic is an emerging issue. second, carrying out this research with much larger data on countries using islamic finance to support msmes would provide the researcher with sufficient data and insights needed to draw more robust conclusions. in the future, looking at information regarding the percentage of smes compared to large companies in countries where islamic finance is most developed would lead to a more in-depth analysis. references [1] a abou-gabal, nirvana, a. i. khwaja, and b. klinger. "islamic finance and entrepreneurship: challenges and opportunities ahead." entrepreneurial finance lab research initiative (eflri) islamic finance whitepaper (2011). [2] mahaini, n. "islamic microfinance: unlocking new potential to fight rural poverty." italy: international fund for agricultural development (2012). [3] rabbani, mustafa raza, et al. "exploring the role of islamic fintech in combating the aftershocks of covid-19: the pen social innovation of the islamic financial system." journal of open innovation: technology, market, and complexity 7.2 (2021): 1-19. [4] hanini, mohammad w., ismail s. iriqat, and ibtisam h. bawab. "evaluating the role of islamic banks in financing micro, small, and medium enterprises (msmes) in palestine." indian journal of economics and business 20.3 (2021). [5] bedjo santoso*. the role of micro, small, and medium european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6585published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 22/02/2022 accepted for publication: 23/12/2022 published: 29/12/2022 37 enterprises toward sustainable development goals through islamic financial institutions. advances in social science, education and humanities research, volume 409 2nd social and humaniora research symposium (sores 2019) [6] rabbani, m. r., bashar a., abdullah, y., khan, s. and ali, m. a. (2020). embracing of fintech in islamic finance in the post covid-19 era. accepted for ieee conference. (ieee explore). dasa’20. [7] haider, m., khan, s., rabbani, m. r. and thallasinos, y.e. (2020), “an artificial intelligence and nlp based islamic fintech model combining zakat and qardh-alhasan for countering the adverse impact of covid 19 on smes and individuals,” international journal of economics and business administration, 8(2), 348-361 [8] smolo, e., & mirakhor, a. (2010), “the global financial crisis and its implications for the islamic financial industry,” international journal of islamic and middle eastern finance and management. [9] bny. “2019 annual report.” 2019 bny mellon annual report | bny mellon, https://www.bnymellon.com/us/en/investorrelations/annual-report-2019.html. [10] raza rabbani, m., bashar, a., & khan, s. (2021). agility and fintech is the future of islamic finance: a study from islamic banks in bahrain. available at ssrn 3783171. [11] bank, world. “as islamic finance continues upsurge, new tool helps harness it for developing-country infrastructure.” world bank blogs, https://blogs.worldbank.org/ppps/islamic-financecontinues-upsurge-new-tool-helps-harness-it-developingcountry-infrastructure [12] imf islamic finance: opportunities, challenges, and policy options.2015 [13] islamic finance for smes hussein elasrag [13] international trade centre (itc), 2015) [14] international trade centre (itc), 2015; united states international trade commission (usitc), 2014) [15] santoso, ivan rahmad. "the role of islamic financial institutions in supporting economic growth in the digital era: case study in indonesia." prosiding 10.4441 (2020). [16] comcec sbb. https://www.sbb.gov.tr/wpcontent/uploads/2018/11/comcec_trade_outlook_201 3.pdf. [17] shafi, mohsin, junrong liu, and wenju ren. "impact of covid-19 pandemic on micro, small, and medium-sized enterprises operating in pakistan." research in globalization 2 (2020) : 100018. [18] thaker, m. a. b. m. t., h. b. m. t. thaker, a. b. a. pitchay, md f. b. amin, and a. b. khaliq. 2020. leveraging islamic banking and finance for small business: exploring the conceptual and practical dimensions. adbi working paper 1156. tokyo: asian development bank institute. available : https://www.adb.org/publications/leveraging-islamicbanking-financesmall-business [19] nafis alam. islamic finance: an opportunity for sme financing.ifac.2015 [20] raza rabbani, mustafa, abu bashar, and shahnawaz khan. "agility and fintech is the future of islamic finance: a study from islamic banks in bahrain." available at ssrn 3783171 (2021). [21] shaima hasan. islamic finance projected to shrug off pandemics, war and global economic woes. https://www.refinitiv.com/perspectives/market. insights/islamic-finance-projected-to-shrug-offpandemics-war-and-global-economicwoes/#:~:text=islamic%20finance%20has%20proved%2 0resilient,of%208%20percent%20until%202025. [22] haron, razali, and khairunisah ibrahim. "islamic financing in mitigating access to financing problems of smes in malaysia: a survey analysis." intellectual discourse 24 (2016). [23] hassan, m. kabir, mustafa raza rabbani, and mahmood asad mohd ali. "challenges for the islamic finance and banking in post covid era and the role of fintech." journal of economic cooperation & development 41.3 (2020): 93-116. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7162 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 44 implications for islamic finance development in finland: how do finnish muslims perceive riba and islamic banking? sanaa kadi1* 1* researcher, faculty of law, university of helsinki, sanaa.kadi@helsinki.fi, yliopistonkatu 3, helsinki, p.o. box 4, fi-00014 helsingin yliopisto, finland https://orcid.org/0000-0001-9002-8629 received: 29/11/2022 accepted for publication: 13/04/2023 published: 21/04/2023 abstract islamic banking and finance (ibf) has gained significant attention in recent years, including in finland where a growing muslim community has created a demand for islamic financial products. this research aims to explore the perceptions of muslims in finland towards riba and ibf and the implications for the development of ibf in finland. the study employs survey research utilizing a questionnaire for a sample of muslims living in finland about the reasons for not taking usurious loans and their reluctance to pay interest, which affects significantly the muslim community and leads to their financial exclusion, such as preventing them from owning a dwelling in finland or investing their money in projects that follow their belief. the results were exclusive and reflect the reality experienced by the muslim minority in finland. the findings reveal that while muslims in finland are generally aware of the concept of riba and the importance of avoiding interest-based transactions, there is a lack of understanding of the broader principles of ibf. in addition to the interesting results observed, the non-existence of islamic banking institutions in finland makes this research unique because it highlights the challenges facing the development of ibf in finland, including the lack of awareness and education about ibf, the lack of access to islamic financial products, and regulatory and legal barriers. the study concludes that there is a need for increased awareness and education about islamic finance in finland, as well as greater efforts to promote the development of a regulatory framework that is favorable to the growth of ibf, this study provides valuable insights into the perceptions of muslims in finland towards riba and ibf and the implications for the development of ibf in finland. keywords: interest; riba; islamic banks; islamic finance in finland; housing and muslims in finland; financial inclusion european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7162 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 45 1. introduction islamic banking and finance have gained increasing attention globally (biancone et al., 2020) as an alternative financial system based on sharia principles(davis, 2018; nazim ali, 2010) that prohibit riba and encourage risk sharing. finland as a nordic country with a growing muslim minority population has also shown interest in ibf. however, little is known about the perceptions of muslims of finland towards riba and ibf in finland. previous studies have explored the perceptions of muslims towards riba and ibf in other countries such as the united kingdom (bälz, 2007), malaysia, (chen, welsh, & cheong, 2022; ghaffour, 2017; ibrahim et al., 2019; loke ke wei & mohd thas thaker, 2017; mohamad, mohamad, & hashim, 2018; yahaya et al., 2016), and other islamic (khavarinezhad, biancone, & jafari-sadeghi, 2021) and arab countries (ben mimoun, 2019; cortina, ismail, & schmukler, 2018; itani, sidani, & baalbaki, 2011; nor, 2012; ray, 1995; shome, jabeen, & rajaguru, 2018; topal, 2019). some of these studies have also found that muslims generally prefer islamic banking over conventional banking due to their religious beliefs, although they also face challenges in accessing islamic financial products and services. finland has high-quality living standards and an industrialized economy. unlike the other nordic states, immigration in finland started to increase only in the 1990s and increased more in the 2000s (kauppinen & vilkama, 2016). in addition, muslim immigrants moved continuously to europe in the last decade (zucchelli, 2022). this makes the muslim community in finland grow considerably. however, the integration of immigrants into the new hosting state includes a lengthy process. immigrants need in the beginning support from the social service authorities, in the case of finland, immigrants get different benefits including housing facilities(kela, n.d.). although reasons for moving to another country are different, immigrants search for stable economic security. purchasing a home is a factor of success in the host country, and finland does not restrict homeownership rights; nevertheless, earlier studies have shown that there was a huge gap in homeownership between native citizens and immigrants (kauppinen & vilkama, 2016). moreover, owning a dwelling in finland requires generally taking a mortgage from the bank, also, the practice of charging interest on a loan is considered too usual that it is reputed to be determined by market forces and not to have any moral or ethical measurement (mews & abraham, 2007). interest in conventional finance is a common feature, it refers to the amount of money that a lender charges a borrower for the use of borrowed money (hasan, 2021) or assets, usually expressed as a percentage of the principal amount borrowed and is typically calculated on an annual basis, it is used as a way of compensating lenders for the risk, they take in lending money and as an incentive for individuals and businesses to save and invest their money. alternatively, the islamic financial industry is increasing continuously in different geographical areas (alharbi, 2015; kamdzhalov, 2022; maulidizen, 2018b; varga & bánkuti, 2021). however, western countries including finland are still taking measured steps toward the islamic financial sector(antoniazzi, 2022), western businesses risk missing occasions to figure out novel and pioneering financial services and products (bollani & chmet, 2020) in a relatively new market(huet & cherqaoui, 2015; maulidizen, 2019). the first islamic banks established in europe were in luxembourg in 1978(alharbi, 2015), however, the united kingdom has the most developed islamic financial sector in europe(di mauro et al., 2013) with six islamic banks providing various products in different areas of the financial sector(jirvaj, 2022), especially with the growth of sukuk(masood & bellalah, 2013) market in 2017(siddiqui & rizvi, 2022). the islamic bank of britain was in 2004 the first fully shariacompliant bank in europe(bälz, 2007). until now, no islamic banks have been established in finland although the muslim community is growing significantly. islamic banks are financial institutions that operate according to the principles of islamic law (sharia)(salman, 2021). the fundamental principle of islamic banking is that it prohibits the payment or receipt of interest considered usury (riba), as it is considered exploitative and unfair. riba is an arabic term that refers to any unjust increase in the value of a transaction involving an exchange of two different items of the same kind. riba in ibf specifically refers to the charging or paying of interest on a loan. this paper aims to examine the financial activities of the muslim community. we also investigate whether the absence of the islamic financial system has an impact on the economic well-being of the muslim community in finland, as well as on the national economy. despite the increasing interest in islamic banking and finance in finland, there is a lack of research on the perceptions of muslims in finland towards riba and ibf. this study aims to fill this gap by investigating how finnish muslims perceive riba and ibf and what implications this may have for the development of ibf in finland. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7162 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 46 in this paper, we will discuss whether the analysis of the religious background of the muslim community and the financial policy of the finnish state makes it possible to identify the elements of national policy that have a special significance for the economic outcomes of muslim citizens living in finland. the study proposes the following hypotheses; firstly, muslims in finland are more likely to prefer ibf over conventional banking and finance due to their religious beliefs and values. secondly, muslims in finland face challenges in accessing islamic financial products and services, which may hinder the growth of islamic finance in finland. the expected results of this study are twofold. first, the study aims to identify the perceptions of the muslim minority in finland towards riba and ibf. this will provide insight into the potential demand for ibf products in finland. second, the study aims to identify the potential for the growth of islamic finance in finland. by identifying the challenges and opportunities for the growth of ibf in finland, this study can guide policymakers and financial institutions on developing and promoting ibf products in finland. 2. literature review 2.1 towards a growing muslim community in finland according to statistics, the official population of finland was 5,548,241 at the end of 2021. in 2021, the population grew by 14,448 persons, with a population growth of 0.3 %(official statistics finland, 2022). also, the number of native speakers of finnish, swedish, or sami decreased by 10,747 persons, while the number of foreign-language speakers grew by 25,195 persons, which is the most in at least 40 years. the number of people with foreign origin was second highest after åland, in greater helsinki, where the share of the population was 15.7 percent (official statistics finland, 2022); according to brekke (2020), the estimated muslim population in 2020 was 80 000(brekke & larsen, 2020), while other statistics report in 2016 that 2,7 % of the finnish population was muslim, which is about 148 500 persons(hackett et al., 2017). furthermore, one-half of all people with foreign backgrounds lived in greater helsinki. examined by municipality, the share of people with foreign backgrounds among mainland finland municipalities was highest in vantaa, 23.4 percent, and espoo 20.1 percent (official statistics finland, 2022). also, the concentration of the muslim community in greater helsinki is significantly high. however, in a study comparing homeownership in three nordic capitals: stockholm, copenhagen, and helsinki; helsinki was the capital with the lowest homeownership among immigrants as the mainstream immigrants live in social housing (kauppinen, andersen, & hedman, 2016). on the other hand, öblom and antfolk 2017 stated in their study that individuals with arabic-sound names have difficulties accessing the rental housing market and that this influences their well-being on different scales (öblom & antfolk, 2017). also, kauppinen, andersen, and hedman (2016) emphasized that immigrants living in public rentals in helsinki are not willing to enter homeownership compared to other nordic capitals even if their income increases over time.(kauppinen, andersen & hedman, 2016) the expensive prices of dwellings in the nordic capitals oblige buyers to take out credits to become homeowners(skovgaard et al., 2015). kauppinen and vilkama (2016) stated in their study that ethnic discrimination is one of the important reasons that may influence immigrants’ homeownership in finland even if the question of whether the opportunity to get a credit loan is directly related to ethnic discrimination is not identified (kauppinen & vilkama, 2016). the researchers concluded that the ethnic minorities from sub-sahara and north africa have fewer opportunities than other minority groups. additionally, the researchers suggested that the other reason for not becoming homeowners might be non-compliance with the available loans with their religious background (kauppinen & vilkama, 2016). mensah and williams noticed the same findings in a similar study in canada, where the interviewed muslims evoked their religious background as a reason for avoiding taking interest-based mortgages (mensah & williams, 2014). skovgaard, holmqvist, dhalmann, and søholt have also explained in their study how the interviewees from the somali community considered the firm prohibition of paying interest when taking a mortgage for homeownership as one of the reasons not to purchase a dwelling in helsinki, because paying interest is not complying with their faith (skovgaard et al., 2015). in a similar research conducted in norway, the findings were that the interviewees who were muslim women had to consider the issue of riba (interest) related to a mortgage as a prerequisite to enter homeownership due to the unaffordable prices of dwellings(skovgaard et al., 2015). in another recent research conducted in norway among european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7162 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 47 muslim women, the findings were that the religious norms namely the prohibition of riba constitute a major factor influencing their entrance to homeownership (borchgrevink & birkvad, 2021). even muslims who think that taking a mortgage and paying interest can be considered as an exception, if housing stability is vital for them, and when there are no other alternatives available, they can be socially stigmatized by the community as interest -considered a form of ribais prohibited in the quran (skovgaard et al., 2015). 2.2 usury vs. interest usury is a notion more frequently linked with financial ethics constructed on religions whether christianity, judaism, or islam, than with the secular sector of modern finance (mews & abraham, 2007). usury was prohibited in all monotheist religions; in judaism, clear texts forbid the practice of usury when lending money (ahmad, 1981; calder, 2016; maulidizen, 2018a). and even if many religions have banned usury, only islam gives treatment to weaken the causes leading to this “evil” institution; none is willing to pay interest on borrowed money. interest payment is the only alternative or solution to get a loan when the loan is desperately needed and there is no other option (buyukcelebi, 2005). also, islamic law distinguishes between trade and usury. therefore, it makes a comprehensible and explicit difference between business earnings and interest on moneylending: “they have said that trade is just like unlawful interest. god has made trade lawful and has forbidden usury (riba)” (quran 2:275). (buyukcelebi, 2005) another reason for the ban on usury is the unilateral risk to the borrower who is paying interest to the lender (the richer), the lender in this position is taking no risk and making a profit from the weaker party. this is illustrated in the example of gambling and lotteries, where a borrower expresses a huge temptation to make an effortless and fast profit. still, the situation might not be as favorable as expected for the borrower to pay back the agreed amount of interest to the lender who has taken no risk at all (buyukcelebi, 2005; calder, 2016). however, the concept of usury is not a recurrent topic of debate in modern financial ethics; the term suggests an unclear idea of charging excessive interest that is rationally hard to explain and is also hard to protect by law. accordingly, it is hard to found what creates excessive interest especially if nowadays the principle of charging interest on a loan is considered as commonly acceptable and ethically correct (mews & abraham, 2007). after completing a literature review that touched on the topic previously, we concluded that the topic has yet to be studied accurately in finland. while previous literature has provided some evidence of the obstacles hindering entry into homeownership for immigrant minorities. researchers have clarified that for the muslim community, one of the reasons for not taking a mortgage was to avoid payment of interest due to religious proscriptions and that muslim minorities did not have other alternatives, such as taking interest-free loans. however, there is a gap in earlier literature about whether the religious background of the muslim community is the primary consideration of muslims regarding homeownership. in other words, what are the possible reasons that may influence the entry of the muslim community into homeownership? and what are the options offered for finnish muslim citizens to fulfill their homeownership rights? although there has been a growing interest in ibf in finland, there remains a gap in research on the perceptions of muslims in finland towards riba and ibf. this study aims to bridge this gap by exploring the perceptions of muslims living in finland towards riba and ibf and examining the potential implications for the development of ibf in finland. moreover, we are especially interested in this study by the muslim community living in finland and the financing possibilities they have as a minority group. we are interested in the question of whether they have equal rights with other citizens to enter homeownership in finland. also, the purpose of this research is to understand how muslims living in finland view the traditional banking system as they are living in a country where the muslim community is considered a minority, regardless of whether they were born in finland, or came from another country. this study is important because there is a lack of scientific research in this field in finland (ali & alquradaghi, 2019), it differs from earlier studies in many aspects, first, it analyses the finnish regulation concerning islamic finance alternatives for minority groups living in finland and wishing to have financial products that are compliant with their beliefs. second, it analyzes the possible alternatives that may create new opportunities for the finnish financial sector in the future. we try as well to distinguish the legal reasons that may hinder the establishment of islamic finance in finland. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7162 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 48 3. methodology this study aims to explore the perceptions of muslims in finland on riba and ibf. to achieve this goal, a survey-type methodology is used, which involves using a structured questionnaire to collect data from a representative sample of the population (mentz, 2012). the survey will be conducted to collect quantitative data on the perceptions of the muslim community in finland towards riba and ibf. utilizing a questionnaire, data collection, analysis, and discussion of research results is intended to provide a more complex understanding of the research question (kadi, 2022). the methods aim is to bring together information about the financial practices of muslim residents in finland and to understand the religious standards and their impact on their financial behavior. scientific methodologies are important because they support researchers in producing objective and valid laws based on objective and demonstrable facts. the population of interest in this study is the muslim community in finland. the sample will be selected using a random sampling technique to ensure that the sample is representative of the population. we will try to ensure that the sample size is large enough to detect significant differences in perceptions of ibf. primary data will be collected using a structured questionnaire developed based on a thorough review of the literature on ibf and previous studies on muslim perceptions of finance. secondary data will be collected from academic journals, government reports, and other relevant sources to provide background information. the data collection process will involve processing a self-administered questionnaire to the selected sample of participants. the questionnaire will be designed to collect data on the following variables: demographic characteristics, knowledge of ibf, attitudes towards forms of living, and perceptions of riba and ibf. the questionnaire will be written in finnish and english, and participants can also write in arabic to ensure that all participants can understand and respond to the questions. this study adheres to ethical considerations; participants will be informed about the purpose of the study, the voluntary nature of their participation, and the confidentiality of their responses. a survey was completed in october 2022, where 80 respondents participated and answered questions. the questions of the survey were selected according to the research question. we analyze and discuss the data collected in the discussion part, as it is essential to conduct legal research to derive new laws from the religious texts on usury through methodological, epistemological, and logical transformations and get a formal theory about everyday economic activities such as property, ownership, trade, moneylending, and contracts. (calder, 2016) it is, for instance, important to understand why usury is considered immoral and whether it limits the economic welfare of people. after analyzing the research question, a questionnaire was designed and sent to different islamic organizations and associations; it was also advertised and explained on different social media platforms, the survey took place in finland from 131st october 2022, and 80 respondents participated in the survey. the questionnaire was designed for the muslim community. however, few answers from non-muslims were received as well. 3.1 survey the survey was composed of three parts; the first part was about the respondent’s background such as gender, age, nationality, and education, the second part was about the respondents’ forms of living and their financial activities, and the third part was about the respondents’ religious background and what they think about usury or riba. 3.2 methods we proceeded with advertising the questionnaire by explaining the aim and importance of the survey; we asked people to answer and forward the link to their friends and relatives as this method, called snowball sampling, is effective in getting a maximum of specific respondents in a quick time. to understand the background of the participants in the survey, the respondents answered different questions where different options were proposed. two open questions were included to allow the respondents to express their thoughts. the answers were gathered anonymously, and no personal or sensitive questions were addressed to avoid any kind of misinterpretation. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7162 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 49 3.3 the conduct of the survey the questions were written in both english and finnish. there were in total 80 respondents. 41 men and 38 women and one respondent did not want to answer this question “fig. 1”. the age of the respondents was between 18 and more than 67 years. the higher group of respondents was aged between 36-45 years with 38 respondents “fig. 2”. figure 1. gender division of the respondents. source: (authors’ elaboration). figure 2. age division of the respondents. source: (authors’ elaboration). european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7162 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 50 3.4 some remarks 3.4.1 origin of the respondents: the highest number of respondents originated from iraq with 23 respondents followed by respondents from north africa with 18 respondents. this is probably because those two groups are active groups living in a community. the third group was the native finnish respondents with 13 participants followed by participants from the middle east with 11 participants. (table 1.) origins no native finnish 13 russian republics 1 middle-east 11 iraq 23 syria 8 somalia 7 turkey 1 north africa 18 sub-sahara 0 afghanistan 1 east-asia 0 caucasus 0 central africa 0 other country or area 3 table 1. the origin of the respondents (the total is more than 80 because some of the respondents have more than one nationality) source: (authors’ elaboration) 3.4.2 double or multiple nationalities: when counting the total of the respondents, there were more than 80 which can be explained that some of the respondents can have two or more nationalities at the same time. 3.4.3 non-muslim respondents: since the survey was designated specifically for muslims, the questions were designed on that basis as well. however, we received few answers from non-muslim respondents as well. in general, results are going to focus on the muslims’ perceptions, nevertheless, we will mention some of the interesting findings that we observed about the non-muslim participants as “exceptions” that may lead to further research in the future by using comparative research methods between muslims and nonmuslims. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7162 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 51 4. results we have noticed that the respondents were divided almost equally in gender, “fig. 1” which can be interpreted that the question of riba is an important issue for both genders. figure 3. 70% of the respondents are finnish citizens. source: (authors’ elaboration). figure 4. duration of living in finland: more than 90% have lived for at least 5 years in finland. source: (authors’ elaboration). 4.1 prohibition of riba this study aims to address the topic of interest on loans. the issue of usury -ribain islamic banking and finance is one of the most critical issues; it means an excess compensation or surplus value without due consideration. trying to define due consideration from the theological point of view is an issue that is in conflict of interest with financial and banking institutions. surplus value and speculation were major reasons for the 2008 global monetary crisis. of course, it is not in the interest of banks to prohibit interest, as interest is one of the ways of profit-making. even if more ethical banks are nowadays involved in promoting sustainability and protecting the environment. for the question: have you heard about riba? 74 out of 80 of our respondents have confirmed that they heard about riba, only 5 respondents did not know the term and one respondent was unsure about it. also, 93% of the respondents who are born muslim have heard about riba. this indicates that riba is a familiar concept for muslims and a well-recognized part of their belief. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7162 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 52 4.1.1 the reasons not to own a dwelling in finland the reasons not to own a dwelling in finland: 33 of the respondents directly link the reason not to own a dwelling in finland to the prohibition of interest by islam, they believe that they should not take usury loans and prefer to live in a rental house rather than apply for a loan to buy a dwelling. however, also the high price of houses in finland constitutes a challenge to own a house, thus 35 of the respondents answered that houses are too expensive “fig. 6” however, on the question we asked about whether you have considered buying a home in finland, 48 out of 80 answered yes, 3 answered that they had thought about this several times and 9 had considered sometimes. 19 respondents out of 80 answered that they did not think about buying a house in finland. “fig. 5” this indicates that although the respondents refrain from buying a dwelling in finland, a large percentage of them have already thought about buying a dwelling. this indicates as well that the high prices of dwellings in finland would oblige them to apply for a mortgage which is not in compliance with sharia. figure 5. 75% of the respondents have considered owning a dwelling in finland. source: (authors’ elaboration). figure 6. reasons not to own a dwelling in finland. source: (authors’ elaboration). 4.1.2 purchase loans 60 out of 80 of the respondents have answered that they have not taken loans before to buy equipment or cars while only 20 participants answered yes to that question; 19 respondents have paid interest on these loans. this interestingly shows that only 20% of the respondents have taken purchase loans while 80 % are still reluctant to pay interest on loans even for other purposes than buying a dwelling. one of the respondents explained: european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7162 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 53 “…i haven’t taken any loans because it is forbidden in islam…i wish if there were loans without interests…” anonymous 5 “…i'm not used to taking loans because life is good for me if i can buy i do it, otherwise i won't have to... but i buy phones from the communication companies because they do not impose interest…” anonymous 10 “…the finnish system is good, i don't miss the cause muslim and christian you are advocating, no religion is confused with business activities…” anonymous 6 there were some exceptions in the views of the respondents, while many respondents consider that economic activities are an important part of the belief and should be following the teachings of the religion, we can notice exceptions, for example, that religion and business activities should not be mixed. 4.1.3 other remarks an interesting answer from a jewish respondent was that paying interest is not a problem, but receiving interest would constitute an issue: “…i found having a loan is very easy if you have a job, and it helps really to establish lives in foreign lands. for us jews and for most of my muslim friends, paying interest on a loan isn’t a big deal, and the problem lies if you are the person receiving the interest. i hope i could be of some help…” anonymous 12 this is interesting to note in this research, as the quantitative results show as well that none of the respondents received interest from banks but 25% of the respondents have paid interest before. 4.2 social justice all religions in the world offer guidance on how one should deal with money ethically and responsibly. thus, both judaism and christianity considered interest on loans as an immoral practice and forbidden in the first place(ahmad, 1981; calder, 2016). islam condemns excessive wealth accumulation(rusnanda & fathoni, 2022). besides, the objectives of islamic law (maqasidal-sharia) provide a deep understanding of how to promote social well-being by establishing fairness(brescia et al., 2021) and reject injustice and lessening poverty(kamdzhalov, 2022; papa & rossi, 2022). there is evidence that the islamic financial model inspired by the maqasid-al-sharia is ethical and in compliance with green and sustainable finance(kamdzhalov, 2022; lanzara, 2021). thus, the islamic banking and finance sector is getting attention globally(meskovic, kozarevic, & avdukic, 2021) because of its “strong connection with the public and social sector”(biancone et al., 2022). on the other hand. muslims in finland face different challenges, among them, the absence of interest-free loans(otterbeck, tuula sakaranaho, & hajjar, 2008), in other words, muslims in finland do not have other options to get a loan but to pay interest. this makes them unable to economically progress, even if they have better living standards. at the same time, muslims who have savings will not invest these savings in banks because they do not want to receive interest from their deposits. 4.3 financial exclusion of muslims in finland 4.3.1 the option of living in rental houses as “fig. 7” shows the forms of living for the muslim community in finland, living in a rental house is the easiest option to stay compliant with the teachings of islamic law, even when the person earns a good income, which can constitute a financial exclusion for muslims as they will never improve their standard of living. “…not having islamic banking options puts muslims in finland in a very difficult position as practicing muslims are forced to live in rental properties their entire life. that can feel frustrating as rents are very high and there is no way to get that european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7162 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 54 money back, for your children to benefit from in the future. among middle-class muslims there is often this idea that you can make an exception to the rule (riba is haram) when buying a primary accommodation where you live in. many of my practicing friends have used conventional banking to buy a house because of this fatwa. we live in a global world that works on interest, so it makes one wonder if this is what was intended with the prohibition of interest. also, i have seen many in my social circle struggle with finding information on the topic in english. this is also frustrating because there doesn't seem to be a trusted authority to give fatwas for muslims in the west...” anonymous 5 figure 7. forms of living for muslims in finland. source: (authors’ elaboration). 4.3.2 the option of referring to fatwas anonymous 5 has referred to the need for a fatwa for muslims living in western countries about this issue, yet most scholars agree on the fact that paying interest is forbidden because interest is considered riba(siddiqi, 2004). moreover, the survey confirmed that most muslims associate interest with riba, only 8 respondents out of 80 think that interest is allowed and is not considered riba if there are no other options left. what was even more interesting in the survey is that none of the respondents answered that interest is allowed and is not considered riba. “…riba is forbidden by law... the definition of usury is what is added to the loan with the condition to be of the same kind... for example, if you borrow 100€, you return it 101€, and the difference is 1€, it is considered usury, which is forbidden by islamic law... in many buying and selling transactions, when one of us goes to an office to buy a car or a house, the owner receives the price from the bank, gives the bank the money, and the bank gets back the money if of the same kind... if the debt is delayed, the bank increases the money, and this is called the nasi-a usury ... the commodity becomes its guarantee with the bank... the issue is thorny, and we don't want to prolong it...” anonymous 9 5. discussion 5.1 the principle of profit and loss sharing the principle of profit and loss sharing points toward a real concern of the islamic bank as a creditor for the lucrativeness of the project (iqbal & mirakhor, 2011; varga & bánkuti, 2021). the conventional bank is concerned as well with the success and the lucrativeness of the financed investment, obviously because it must ensure that the installments are regularly paid according to the pre-agreed schedule if the condition of loan and interest payment is respected, the profits of the conventional bank will not be affected directly in the case of the low profitability of the creditor (iqbal & mirakhor, 2011). however, islamic finance has a different way to do finance (calder, 2016), the islamic bank must pay attention to and emphasize the lucrativeness of the project because the latter is directly associated with its profitability. for an entrepreneur, the relation between the payment of the credits to the creditor and the lucrativeness of the project is significant(iqbal & mirakhor, 2011; varga & bánkuti, 2021). european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7162 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 55 moreover, in profit-sharing agreements, risk management is taken into consideration as the payment is balanced according to the economic situation of the entrepreneur (iqbal & mirakhor, 2011). for example, if we have a system based on interest when a conventional bank accords a loan to an entrepreneur, the payments are mandatory without seeing whether the real project is making benefice or not; the bank may end the lending if it notices that the entrepreneur has payment troubles, in other terms “debt-servicing difficulties” (iqbal & mirakhor, 2011). however, if the debtor is making delays in only some payments for a period, due to a temporary economic recession, the bank might still consider it as a risk of a regime change, which may lead to an unexpected end of the contract by the bank, which is seen as an overact of the bank (iqbal & mirakhor, 2011). but, in a situation of an islamic model, the bank would react differently to this momentary change because they follow continuously their client´s project, to evaluate their part of the profits, which is a great benefit for instance, the reimbursement to the bank is linked with the continuity of the project (iqbal & mirakhor, 2011). however, many argued that islamic banking failed in different aspects because of internal and external reasons such as the fact that islamic banks operate in a capitalist global world, or the dominance of using murabaha financing instruments (cebeci, 2012; maulidizen, 2018c). 5.2 the islamic microfinancing the option of microfinancing is a simple and easy way to implement in an islamic financial framework, firstly because it offers persons modest funding opportunities (katterbauer & moschetta, 2022), and secondly, because it can constitute a good alternative for muslims when no interests are imposed. in finland, some fintech financial services offer different solutions of online factoring on some consumer goods with no interest if the term of repaying the loan is short. also, some respondents referred to the solutions they get from telecommunication companies that sell equipment with 0% interest. also, there is the possibility of microfinance loans with collateral. however, all these options constitute a small area of financing and do not solve the muslim community's problem when they want to invest in long-term projects such as owning a dwelling or creating a business activity. it would be interesting to see social enterprises and social cooperatives in finland taking the example of the different instruments already existing in islamic finance; this would support the social development goals and would have a positive impact not only for the muslim community but for all citizens living in finland(daniel & jonathan, 2020). this would also promote development goals (maulidizen & nida, 2019) and social welfare in finland. 5.3 the economic rights of people if we want to talk about the economic rights of people, such as the right to an adequate standard of living, the right to housing, or the right to have health care and work, we need to know what rights are.(rancière, 2004) we need to examine rights from a standpoint that claims that people do not suffer injustice. islam undoubtedly specifies that efforts made to render integration possible cannot prosper if justice and fairness are missing(chapra, 2001). as the study shows, 70 % of the respondents are finnish citizens “fig. 3”, yet 69 respondents out of 80 still live in rental houses, even though, 75% of the respondents have considered owning a dwelling in finland “fig. 5”. moreover, more than 90% of the respondents have lived in finland for at least 5 years “fig. 4”, the answers of the respondents to the open questions in the results section of the study highlight the interest they are showing in having an ibf alternative in finland. 5.4 the role of islamic finance in the achievement of the 2030’ sustainability goals the ethical principles of islamic finance are globally recognized. (prandi & colecchia, 2021) the debate on utilizing islamic finance’s principles to reach the goals of sustainable development is an undeniable fact(antoniazzi, 2022), usury ban principle was debated for a long time and it is inadequate to claim that some religious convictions proscribe usury merely for the reason that their religious manuscripts condemn it. (calder, 2016) therefore, there is a strong connection between ibf principles and the sustainability goals of the 2030’ agenda, (brescia et al., 2021) firstly because ibf can promote financial inclusion and improve access to finance for the muslim community, and secondly, because muslims who are not willing to engage in business investments in the conventional system can have another alternative to invest their money, which can influence positively the finnish national economy as well. 5.5 the need for a further survey to reveal new results as revealed in the results, muslims in finland are reluctant to pay interest on loans, this confirms previous research results conducted by skovaard, holmqvist, dhalmann, and søholt when they studied the cultural background of somalis in the nordic european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7162 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 56 capitals’ housing markets(skovgaard et al., 2015). while previous studies showed that one of the reasons for muslims not taking loans is the islamic prohibition of usury(mensah & williams, 2014; skovgaard et al., 2015), our study shows that the major reasons for muslims in finland are both, the high prices of dwellings and the prohibition of riba (fig.6), yet 80% of the respondents were reluctant to take any kind of loans because of the interest imposed. we can take the example of other eu states that have implemented islamic finance. the british experience however remains the most interesting to when studying and discussing the legal aspects of islamic finance in other european countries. furthermore, as the literature on islamic banking in finland is very limited, there is a need to conduct further research on interest-free loans with the muslim community in finland on a larger level. for example, we are interested in whether the muslim community in finland is interested in using islamic financial products if they were accessible, and whether they will become customers of islamic financial institutions if they are established in finland. 5.6 the difficulties in establishing islamic banks in finland the fact that muslims in finland are interested in using islamic financial products suggests potential demand for ibf in the country. however, our study also highlights the regulatory challenges that currently hinder the development of ibf in finland. it is a challenging mission to establish islamic banks in finland. first, it demands lots of effort from the legal standpoint, the islamic banking and finance sector need to follow the eu banking regulation and finnish regulation. secondly, it is required to have special regulations to permit the functioning of both conventional banks and islamic banks. moreover, new technologies such as blockchain and ai are highly influencing how financial and business activities are developing globally (calandra et al., 2022; zulfikri et al., 2022). in that sense, the ibf sector faces the challenge of competition with conventional banks, thus the main challenge for islamic finance is to afford competitive, varied, and pioneering financial products and services compared to conventional banking products, yet in compliance with islamic law.(nidyanti & siswantoro, 2022) finally, the establishment of islamic finance in finland faces the challenge of the difference in governance between the conventional and islamic systems (mabrouk, farah, & consultant -proximab group, 2021). islamic banks and financial institutions are ruled by islamic law (sharia-compliant) and must have a sharia supervisory board ssb which is one of the most important bodies of the islamic financial sector; furthermore, payment of interest and speculation are both forbidden and financial instruments must rely on a profit and loss sharing basis (pls) (mollah & zaman, 2015). also, islamic banks do not have enough methods to manage their liquidity risks compared to conventional banks((mabrouk, farah, & consultant -proximab group, 2021). finally, the need for scholars and qualified employees in the islamic financial sector in finland could constitute a challenge as they need special training to work in this sector. despite the obstacles, the study reveals a substantial potential demand for ibf in finland. if a more favorable regulatory environment is established, ibf could have a greater impact on promoting financial inclusion and fulfilling the requirements of muslims living in finland who prefer financial products that comply with islamic principles. further research is required to gain a better understanding of the expectations and preferences of finnish muslims concerning ibf and to assess the potential influence of ibf on financial inclusion and the economic development of finland. a thorough evaluation of the local environment is imperative to effectively carry out islamic financing transactions. this encompasses the state regulatory framework, tax laws, and obligatory consumer protection rules. adherence to mandatory jurisdictional regulations is essential in any islamic transaction. since different authorities have varying requirements, it is impossible to transfer a transactional form from one place to another without significant modifications and adjustments. in addition, paying attention to local peculiarities is also crucial, particularly regarding sharia issues. an islamic retail product must be customized to meet the specific needs of a particular muslim community and must be based on local sharia scholarship. while sharia is a universal ideal, it is subject to diverse local interpretations that must be considered when creating a shariacompliant retail product. consequently, developing islamic retail products necessitates a dual acculturation process, which involves adapting to mandatory state law requirements and the target muslim communities. this process requires flexibility from both regulators and islamic scholars (bälz, 2007). therefore, successful islamic financing requires analysis of the local environment, compliance with regulations, and product tailoring to meet specific muslim community needs, which demands flexibility from regulators and islamic scholars. 6. conclusion in conclusion, our study sheds light on the perceptions of muslims living in finland towards riba and ibf. our findings confirm that muslims in finland are reluctant to take interest-based loans and are interested in using islamic financial products. however, despite the potential demand for ibf in finland, there are still regulatory challenges that hinder the development of ibf. policymakers and financial institutions need to address these challenges and provide a supportive regulatory framework european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7162 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 57 to facilitate the growth of ibf in finland. we present in this paper a new study-driven approach to the perceptions of the muslim community in finland about riba. we investigated whether the absence of the islamic financial system has an impact on the economic well-being of the muslim community in finland, as well as on the national economy. our findings confirm that the absence of an islamic financial system in finland has an impact on muslims’ financial inclusion. muslims are not willing to take loans because most of them consider that paying interest is a form of riba. moreover, muslims are not willing to engage in business investments in the conventional system which can influence the national economy as well. we have examined the religious background of the muslim community and the financial policy of the finnish state and identified the elements of national policy that have special significance for the economic outcomes of muslim citizens living in finland. we concluded that practicing muslims tend to opt for avoiding conventional banking and financial activities because the element of riba is present in these financial products, which makes them financially excluded. this is illustrated in the example that despite a good income, devoted muslims continue to live in rental houses. this makes them not capable of economically progressing, even if they have better living standards as housing in finland is expensive. at the same time, muslims who have savings will not invest these savings in banks because they do not want to receive interest from their deposits. the results from the conducted survey and the statements collected from the respondents characterize a significant phase toward initiating a real debate about the future of islamic financing possibilities in finland. the results confirm previous research results concluding that the muslim community in nordic countries in general and in finland in particular face difficulties in entering homeownership because they have no adequate financing possibilities that are following their belief, because most of the respondents think that paying interest on loans is considered as riba. many arguments are raised in this study, first, that riba or usury is considered as unfair and immoral and therefore interest-free loans are a moral claim in all religions, second, this study raises the issue of the rights of finnish muslim citizens living permanently in finland, as they form a legal community and have individual rights and individual legal persons, therefore they should be the bearers of economic rights as well(habermas, 1995). third, we debated in this paper the challenges that constitute a hinder in front of the establishment of islamic finance in finland even if there is a will from the muslim community. among these challenges are the differences between the regulations in islamic banking and conventional banking, and the differences between the institutional bodies of both islamic banks and conventional banks, and that despite the strong connection between islamic finance principles and the sustainability goals of the 2030’ agenda, establishing islamic banks in finland would necessitate a huge effort from different institutions and especially in the field of legal research. with a more favorable regulatory environment, ibf can play a greater role in promoting financial inclusion and meeting the needs of muslims in finland who are seeking financial products that align with their religious beliefs. the findings of this study can help increase awareness among finnish muslims about the availability of islamic financial products and services that meet their religious beliefs. it can also encourage financial institutions to consider the needs of muslim customers and develop new products that align with islamic principles. in addition to that, policymakers can use these results to develop a more supportive regulatory framework for ibf in finland, which can promote financial inclusion and improve access to finance for the muslim community. like any research, this study also has some limitations that need to be considered when interpreting the results, one of the main limitations of this study is the sample size, which consisted of relatively small number of participants. this could limit the generalizability of the findings to the larger muslim population in finland. therefore, additional research is required to achieve more conclusive and accurate outcomes. another limitation is the use of a self-administered questionnaire as the primary data collection method, which may have resulted in some participants providing incomplete or inaccurate responses. additionally, the study focused only on the perceptions of muslims of finland towards riba and ibf and did not examine the perceptions of non-muslims or other minority groups in finland. finally, the study was conducted at a single point in time. despite these limitations, the study provides valuable insights into the perceptions of muslims towards riba and ibf and highlights the potential demand for islamic financial products in finland. acknowledgements i would like to express my sincere appreciation to all the participants who generously shared their time and insights for this study. without their valuable contributions, this research would not have been possible. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7162 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 58 references ahmad, s. m. 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(2022). trust enhancement in zakat institutions using blockchain technology: a qualitative approach. european journal of islamic finance, 9(1), 31–36. https://doi.org/10.13135/24212172/6312 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6800 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/05/2022 accepted for publication: 05/12/2022 published: 29/12/2022 1 a maqasid-ul-shari’ah analysis of the permissible futures trading in islamic financial markets ataollah rahmani1, alija avdukic1 1 al-maktoum college of higher education, 124 blackness road, dundee, uk. contact author: a.rahmani@almcollege.ac.uk contact author: a.avdukic@almcollege.ac.uk abstract despite the widespread use of futures contracts as a risk mitigation instrument in the current financial markets, islamic economies commonly feel uncomfortable with it for fear of its potential clash with the islamic law of contracts. this research aims to justify only the futures trading that contributes to reducing investors’ financial risks. this paper argues that a risk-hedging futures contract can islamically be justified if shari’ah rules are construed in the light of its broader purpose, what is known as maqasid-ul-shari’a. a qualitative research methodology with a deductive interpretive approach is used in this study to analytically explore the role of maqasid-ul-shari’a in authorising permissible futures trading. the relevant data is collected from primary sources (quran and sunnah) and secondary sources (islamic jurisprudence, textbooks, journal articles and review papers). by deploying the theory of maqasidul-shari’a, the prevalent islamic jurisprudential approach is constructively reinterpreted to formulate general principles and guidelines under which futures trading can comfortably be approved. the study's overall findings suggest that on several counts of necessities, risk-hedging futures help muslims preserve both the individual and the public wealth, safeguard the human self, honour and religion, facilitate their transactions and prevent future business conflicts. the maqasid-ul-shariah analysis of futures trading adds to the permissibility view that risk hedging futures trading should be recognised and declared as permissible not simply because they do not conflict with any prohibition or benefit the individual parties involved but also because they serve the broader interests of the public (al-masalih-al-aammah). this study is the first to analytically discuss the permissibility of futures trading under a combined reinterpreted guideline of islamic jurisprudence and maqasid-ul-shariah. keywords risk mitigation; islamic financial markets; islamic contracts; maqasid-ul-shari’a i. introduction exchange-traded futures transaction has long been used as a risk mitigation instrument in the commodity and financial markets [1]-[2]. an exchange-traded futures transaction often involves a binding contract to deliver, or take delivery of, a given quantity of a commodity, or a financial instrument, at a future date, at an agreed price, or a future price to be decided later. such a transaction reduces uncertainty about future assets and costs, facilitating efficient investment planning. businesses, producers, and general investors use futures to plan future investments in production and trading [3]. in return for a small fee, they can fix the price of assets well ahead of the actual bargain to avoid unexpected and unwanted price changes and production costs. also, they do not have to worry about the quality and quantity of future assets, as futures are standardised, covering only homogenous assets. they save costs and appreciate more comfort in trading futures than bargaining over the actual spot assets, which may require physical exchange and storage for vast quantities of various assets [4]. additionally, they trade futures as standardised contracts in organised futures markets with improved fair pricing, increased liquidity, and reduced transaction costs [4]. islamic and western economies have recognised the need for future trading [5]-[6]. as a derivative, a futures contract correlates to the main future contract and derives its value from its underlying asset [7]. investors would routinely use futures to circumvent commercial uncertainty. for investors, futures are attractive, particularly for their capability to reconcile the two seemingly contrary goals, i.e., securing high returns and mitigating investment risks in future contracts. they do not require buying and selling the actual commodity. instead, they can reserve buying or selling the item at a considerably lower cost. using futures, they can further allocate their investment risks more efficiently and reduce the information asymmetry [8]-[9]-[10]. yet, across muslim economies, the islamic finance industry commonly feels uncomfortable using futures contracts for fear of its potential clash with the islamic law of contracts [11]. many islamic jurists and scholars have opined that islamic law does not approve of the contract of futures as is conventional in western economies. they commonly believe that exchange-traded futures are excessively uncertain and sometimes bear interest, both of which are forbidden under the shari’ah law. the former violates the islamic prohibition against contractual gharar and maysir, and the latter infringes the no riba principle [12]-[13]-[14]. despite the absence of any direct prohibition in islamic resources against a futures contract, they declare it impermissible by way of ijtihad [15]-[16] european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6800 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/05/2022 accepted for publication: 05/12/2022 published: 29/12/2022 2 [17]. the practice of modern futures trading at regulated exchange markets did not exist at the time of the introduction of islam. it only evolved as late as the 19th century when the first organised futures market was developed in the united states. the new practice did not expressly match islamic law. hence, islamic jurists had to exert ijtihad to check and verify the permissibility of the practice under islamic law. they routinely made ijtihad by qiyas [18] to compare an exchange-traded futures transaction and a bay’a (sale) contract. they concluded that a futures transaction is impermissible because it falls short of the freedom from gharar requirement for a permissible bay’a. many contemporary islamic law academics and jurists attempted to engineer some form of islamised equivalent using the islamic contracts of bay’a-ul-salam and bay’aul-istisna. the former concerns a future sale where the price for an asset is paid upfront at the time of the agreement, but the commodity is to be delivered at a future time [2]-[13]-[19]-[20]-[21]. the latter is also a future sale whereby a party undertakes to manufacture, build or construct often fixed assets, with an obligation from the manufacturer or producer to deliver them to the customer upon completion [22]-[23]-[24]. these are shari’ahapproved contracts despite being future contracts. although they involve the exchange of future promises, bay’a-ul-istisna and bay’a-ul-salam are treated as exceptions to the standard rules of the shari’ah, which forbid future agreements [23]-[24]. their permissibility relies on the justifications of public need and necessity. yet, these islamised futures fail the primary purpose of the futures, i.e., the hedging financing and investment from transactional risks. they are not collateral but are concluded as the central contracts and involve actual sales, not promises to future sales that do not shift the risks between the parties, as existing in conventional futures. hence, the current approach of islamic finance concerning futures transactions is theoretically and practically problematic. in theory, it relies on an improper analogy between futures trading and bay’a, which forms the foundation for disallowing risk-hedging futures transactions in islamic finance discourse. further, it falls inconsistent with general maqasid-ul-shari’ah principles, such as the facilitation of commerce and the observation of ‘al-masalih-al-mursalah’. the islamised futures are incapable of achieving the future’s purpose too. in practice, the absence of future transactions contributes to chaotic financial markets in islamic economies. potential investors will have to make investment decisions in an uncertain environment. any such decision could be affected by any future change in the market conditions, which will, in turn, increase the risk of counterparty default and future disputes/conflicts. however, an islamic futures contract can serve the purpose of hedging if shari’ah rules are adapted in the light of the broader objective of shari’ah, what is known as maqasidul-shari’a. the term ‘maqasid-ul-shari’ah’ refers to the purpose and objective of islamic law, i.e., the underlying purpose of the explicit rulings of islam. however, the islamic finance industry has been taking a minimalist approach, i.e., one that would not go beyond the explicit rulings of fiqh-ul-shari’ah. it is dominated by practitioners who are often educated in western economies and willing to mimic such economies' practices, most notably in profitmaximisation while ensuring islamic compliance with the minimum rulings of fiqh-ul-shari’ah. this practice ignores the true objectives of shari’ah that are implicit in the shari’ah explicit rules. this paper suggests that the reduction of transactional risks is consistent with the objectives of shari’ah, even if that might call for the use of future contracts that are routinely prohibited under the rules of shari’ah. seen from the angle of maqasid-ulshari’ah, therefore, islamic futures can be reconceptualised and transformed into financial instruments that can truly serve the purpose, i.e., hedging financial risks. by applying the theory of maqasid-ulshari’ah, this paper seeks to justify the use of futures in the islamic finance industry. the article does not intend to manoeuvre around shari’ah laws, instead aims to explain the use of futures as a risk management tool under the guidance of maqasid-ul-shari’ah, hence, to contribute to the developing islamic finance field. towards this end, the rest of the paper divides into three sections. first, it is necessary to understand the nature of futures, their mechanism and function. what are futures, how do they work, and what purpose do they serve are essential questions to raise here. these are important as they provide the reader with background information and a better understanding of the primary purpose of futures, which is to manage investment risks like other derivative instruments. businesses routinely face different investment risks in their day-to-day running, and they use futures to mitigate such risks. today, risk mitigation instruments play a vital role in the development and growth of businesses and the financial sector in western economies. this is, however, absent in the islamic finance industry (section ii). second, islamic finance practice has taken a prohibiting approach to islamic law that ceases recognition of conventional futures for religious impermissibility and engineered islamised futures allegedly to stop any nonislamic practice across islamic economies. the islamic finance discourse, however, has developed beyond the incumbent prohibiting approach and embraced a minorityenabling view of the islamic law that holds for the permissibility of the risk hedging futures transactions and that accords to the general permissibility principle of the law of muamalat. a careful review of the primary sources of islamic law and the existing literature can help understand the foundational justifications from both approaches, either against or for future transactions. it enables one to assess their credibility better. how and why conventional futures contracts are treated as impermissible in islamic law and how and why the islamised futures fail european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6800 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/05/2022 accepted for publication: 05/12/2022 published: 29/12/2022 3 to function as derivative, and how this failure can be rectified through a reconsidered islamic approach that relies on maqasid-ul-shari’ah are therefore relevant questions that are to be asked and addressed next (section iii). third, the theory of maqasid-ul-shari’ah suggests that in circumstances where there is an apparent inconsistency between the implicit intent and the explicit rulings of islam over a particular matter, the former should be given priority. there are, however, interesting questions to raise and answer. what is meant by maqasid-ul-shari’ah, how does it differentiate from shari’ah law, under what circumstances it may override shariah's explicit rulings, and whether such supremacy of maqasid-ul-shari’ah can extend to and authorise futures trading, despite the conventionally perceived prohibition under the islamic law (section iv). finally, the paper will conclude in section v. this paper takes a qualitative legal research (doctrinal) methodology in conformity with its agenda, which is to reconsider the islamic ruling on the impermissibility of future trading and to recommend a reformed interpretation of the applicable law of islam in respect of such trading. many scholars have used this methodology in scientific research to determine the problem of the study, its dimensions, aspects, and causes [25]. a qualitative method enables the researcher to locate, analyze, and evaluate relevant regulations and laws relating to futures transactions in islamic derivative markets. it was selected for this study because it allows the researcher to investigate and understand how different laws and regulations can be interpreted and how these constructions can impact our understanding and practice within the real world [26]. a qualitative method also allows the generation of comprehensive insights into shari’ah scholars’ perceptions and experiences on future transactions. in doing so, a deductive interpretive approach is used in this study to analytically explore the role of maqasid-ul-shari’a in authorising permissible futures trading. the relevant data is collected from primary sources (quran and sunnah) and secondary sources (islamic jurisprudence, textbooks, journal articles and review papers). by deploying the theory of maqasid-ulshari’a, the prevalent islamic jurisprudential approach is constructively reinterpreted to formulate general principles and guidelines under which futures trading can comfortably be approved. the focus will be on the discovery and the prioritised application of the true objectives and the rationale of the rules of shari’ah. most resources re-examined in this research are either primary sources of islam written in the quran and narrated via sunnah or secondary sources found in islamic figh. as well as these, the paper will further make use of other literature on islamic finance to present a reconsidered and innovative interpretation of the applicable law of islam on futures trading. ii. futures futures is a tripartite agreement between a buyer, a seller and a commodity exchange clearing house where the parties agree to deliver or accept delivery of a specified amount of a particular commodity during an agreed period. it involves an obligation to fulfil future commitments to buy or sell. an exchange-traded futures contract is a legally binding commitment to deliver or take delivery of a given quantity of a commodity, or a financial instrument, at a future date and an agreed price [27]-[28]-[29]. by entering a futures contract, the buyer and the seller may agree to a price today for some asset to be delivered. it can be defined as an initial arrangement whereby parties promise to carry out a future transaction at a price determined at the time of the meeting. unlike options, futures carry an obligation to exercise the contract, i.e., pay the predetermined price or deliver the commodity [30]. the uk corporation tax act 2009 section 581 defines futures as a contract for the sale of property under which delivery is to be made at a future date and at a price so agreed, even if it is left to be determined by reference to the price at which a contract is to be entered into on a market or exchange or could be entered into at a time and place specified in the contract. the agreement is standardised in all respects, except for price and terms of delivery which are settled on the exchange floor on the delivery date and based on the settlement price for that date. standardisation of contracts allows interchangeability with all other warranties of the same delivery period [31]. the contract is registered with the clearing house, which guarantees contractual payment and delivery to every seller and buyer and which eliminates risk over contract performance [27]-[32]-[33]-[34]. it is conventionally referred to as a derivative because it earns its value from an underlying asset covenanted to become the subject of the main future contract [30]. the underlying asset could be either finance or commodity, such as agricultural commodities, metals, energy, currencies, and stock indexes. at maturity, financial futures are cleared through monetary settlement, whereas commodity futures are settled physically. in practice, all settlements take monetary form, meaning that, at maturity, buyers receive a monetary equivalent of the asset rather than an actual delivery of the asset [7]-[35]. historically, exchange-traded futures evolved from the practice of forward contracts that were common in ancient asia's early commodity markets [4]. reports suggest that forward rice transactions were an established commodity trading practice among the chinese rice producers and merchants of 2000 bc [5]. the hammurabi code, one of the oldest deciphered writings in the world dating back to 1750, found in the ancient mesopotamia area, has an apparent reference to forward contracts that allowed goods to be delivered on an agreed-upon price at a date in the future. the first regulated futures exchange is reported to be the dojima rice market that formed in osaka, japan, in 1650 and had some, but not all, of the features of modern futures. for instance, it included standards of a four-month contract term, four grades of rice only, no physical delivery and clearance through an established clearing house but imposed no european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6800 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/05/2022 accepted for publication: 05/12/2022 published: 29/12/2022 4 margining requirement on parties to the transaction [36]. in the western world, the elementary forms of futures trading were developed as late as the sixteenth-century era when cotton traders in liverpool and tea traders in london were using forward contracts. still, england's first chartered commodity trading exchange, the london metals and market exchange, was not established until 1877. however, the first organised futures market was developed in the united states, where the chicago board of trade (cbot) of the chicago mercantile exchange was created in 1848. this market's central traded futures contracts were three essential agricultural commodities of corn, wheat, and soybeans, which still account for the bulk of trading business conducted at the cbot today. the futures market has proliferated worldwide, covering many other products, including cotton, cocoa, orange juice, sugar, cattle, pork, foreign currencies, treasury bonds, stocks, gold, silver, copper, platinum, and palladium. according to the futures industry association statistics, the number of futures traded on exchanges worldwide in 2021 marked the fourth consecutive year of record-setting trading activity. the total volume of futures trading reached 29.28 billion contracts which accounted for a rise of 14.6% compared to the previous year, 2020. futures exchanges in the asia-pacific region had the most significant increase in trading in 2021. total volume in that region reached 30.55 billion contracts, up 10.40 billion or 51.6% from the previous year. north america, the second largest province in terms of trading volume, had 15.38 billion contracts traded in 2021, up 2.53 billion or 19.7% from the previous year. latin america continued its rapid growth with a total trading volume of 8.89 billion contracts, displaying a 37.5% rise. europe ranks fourth in terms of trading volume, with 5.45 billion contracts traded in 2021. although a futures contract is forward, it is more efficient than the latter [7]. futures contracts are standardised and associated with fewer uncertainties in terms of contract size, maturity, product quality, place of delivery, price, etc. they are also traded in regulated capital markets. a regulated market for futures makes it easy for investors to find a fair and safe deal [7]. the exchange clearing house guarantees payment on futures, so the counterparty risk is eliminated. on the other hand, forwards are unstandardised and transacted over the counters [27]. as the market is not regulated, potential investors routinely have trouble finding a fair and safe deal [37]. futures are generally recognised as a risk management financial instrument that offers a considerate solution to the risk/return dilemma. businesses and investors often use futures to hedge their investments against risks. every financial investment can attract risks and returns that are positively linked, meaning higher returns are generally associated with more significant risks. investors seeking higher returns must make a risk-return trade-off where expected returns are maintained while risks are reduced. often, they do so through futures as a risk management instrument. futures routinely protect an investment from market risks, i.e., any future fluctuations in the price of a given asset. while a financial investment may often be exposed to several types of financial risks [38]-[39], futures work to hedge the investment against the market risks only. this refers to the fluctuations in the price of assets due to changes in market conditions. price movements due to inflationary situations, variations of interest and/or currency exchange rates, demand/supply adjustments and/or renewed customer sentiments are the most common triggers of market risks. this risk is systematic and a result of the economy's exposure to the uncertainty affecting all market participants. while unavoidable, investors may manage the risk by contractually shifting it [7]. futures are traded among three categories of investors: i) hedgers, ii) arbitrageurs, and iii) speculators. hedgers are usually farmers and manufacturers who use futures contracts to manage the risk of price change and offset their business exposures. locking in the futures price would mean that the hedger would eliminate the risk of price volatility either positively or negatively, i.e., enjoying a fixed price when the price moves unfavourably but missing out when the price moves favourably. arbitrageurs seek to profit from discrepancies in the prices of identical or related futures instruments across different markets. these discrepancies occur when an asset is priced differently by multiple financial institutions. the arbitrageurs would buy an asset at one price from the first financial institution and then almost instantly sell it to a different institution to profit from the difference in quotes. speculators take on risk, especially anticipating future price movements, hoping to make significant gains to offset the risk. they are not interested in taking profit from the sale, saving the trouble and costs for the possession or delivery of the underlying assets. they trade futures to quickly gain from speculation about a favourable future price movement [40]. in other words, they are traders in its strict sense, i.e., making a profit out of the buying and selling of derivatives. they are the prominent players in the futures market [38]-[39]. some commentators even viewed them as the true initiators for developing the secondary market for futures [5]-[41]. investors from the other two categories are also likely to convert gradually into speculative traders as they see higher returns in speculative transactions. chance points to the formers who started as hedgers but developed later into speculators [42]. other investors may become speculators due to the bandwagon effect [38]. a common feature for all three categories of investors is the zero-sum game that underlies future trading [43]-[44]. this is where one party gains from the other party’s loss and vice versa [37]. iii. islamic law whether or not islamic law permits the use of futures has been controversial in islamic finance discourse and practice. islamic jurists and academics have grouped into two main camps. the prohibitionists believed that futures trading violates fundamental prohibitions of islamic law. the liberalists counterargue that futures transaction is a modern european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6800 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/05/2022 accepted for publication: 05/12/2022 published: 29/12/2022 5 innovation that islamic law has not addressed, so it should be regarded as permissible if there is no express prohibition or violation. while both groups agree that purely speculative futures trading is impermissible, they disagree on allowing futures trading that is meant for risk hedging. the former forbids it no matter speculative or risk hedging for gharar. the latter allows the risk hedging of future transactions, which contain only commercial uncertainty rather than gharar. a. prohibitionist view classical jurists and academics took the view that futures trading is impermissible [23]-[45]-[46]. they refer to a fundamental principle of the islamic law of contracts and contend that business and financial transactions must not involve gharar nor maysir, but futures transactions contain both [47]. futures transactions contain selling assets that either do not exist or are not owned by the seller at the time of contracting [48]. likewise, gharar exists where sellers do not own the underlying asset in future transactions [49]. futures transactions are impermissible because of their association with high risk resulting from the sale of non-owned or nonpossessed assets and gambling [50]-[51]. gharar originates from the arabic verb “gharra”, which means al-khida and translates as ‘to deceive or to be deceived’ [52]. in islamic law, it refers to any transactional risk, uncertainty and hazard incurred by one because of their lack of knowledge of material information concerning a particular business or financial transaction [53]-[54]. quran has not referred to gharar expressly but condemned it indirectly in verses regarding gambling [55]-[56]-[57]. quran aside, the sunnah of the prophet prohibits gharar in contracts [56]. in a well-known hadith, prophet stated: “do not sell what is not with you” (la tabi ma laysa indika). futures trading is thought to contain gharar, especially in respect of the future's underlying asset, which might not yet exist or be owned by the seller at the time of contracting, which further affects the certainty of the pricing [58]-[59][60]. gharar exists in a sale where one or both parties take excessive risks (mukhatarah) [61]. the transaction becomes void because of the prohibited gharar, and the goods exchanged under such void transaction become unlawful, making the parties liable for return/refund [62]-[63]-[64]-[65]. according to ibn tamiyyah, parties who hold on to such unlawful transactions are, then, deemed to have been devouring the property of others [66]. too, futures trading is claimed to be poisoned with maysir (qimar), which is thought to be the worst form of speculation commonly known as pure gharar [2]-[47]-[49]-[50]-[53]-[67][68]. the arabic word ‘maysir’ derives from yassira (to ease), and yassara (to succeed) means wining something too quickly or getting a profit without making an effort to earn it. islamic jurisprudence defines it as ‘taking a risk in the hope of gaining an advantage or a benefit whose materialisation is fully or substantially reliant on a game of chance’ [12]-[19]-[68]-[69]. al-misri describes it as a combative game played by two contracting parties, each of whom undertakes the risk of loss and the loss of one means the gain for the other’ [52]. quran condemns maysir in several verses, which describe it as ‘immoral gambling that sows the seed of enmity and hatred among humans. futures transactions involve maysir because they materialise zero-sum games in which gains are matched with corresponding losses [38]. apart from non-exchange contracts, islamic law allows only business contracts that can offer mutual gain while containing the possibility of risk. futures allow no room for mutual benefits. as de lorenzo [70] claims, ‘futures amount to bets on the direction the market is moving in’. it is, however, worth noting that nonexchange contracts such as gift (hiba), endowment (waqf), and unilateral promise (wa’ad) do not follow the rules of islamic law on exchange (business) contracts. they follow different rules of non-commutative contracts that allow the donor / the promissor to transfer ownership of an asset to a counterparty without consideration. non-commutative contracts are charity transactions, offering gain only to one party while capable of containing more significant uncertainty. as the name suggests, an exchange-traded futures transaction is a business contract of exchange, not a charity transaction. gharar also forms the primary rationale for the impermissibility of bay’a-ul-kali-bi-al-kali, which is further extended by analogy to exchange-traded futures transactions [56]-[69]-[72]-[73]-[74]. the bay’a-ul-kali-bi-al-kali concerns a sale whose countervalues are purely an exchange of promises. like a bay’a-ul-kali-bi-al-kali, futures trading contains a promise-based future exchange comprising mutual deferment of both counter-values. a commitment by the seller to sell and deliver a specified asset in return for a corresponding promise by the purchaser to purchase and pay for the same, both at a specified date in the future. the promisors in such a transaction then become the debtor and the creditor simultaneously in respect of the same transaction. as such, the transaction becomes a sale of one debt for another’, which is claimed to be prohibited under the islamic law of contracts. a sale can be valid in islamic law if either the price or the delivery is postponed, but not both [24]-[75][76]. in futures sales, both counter-values are non-existent at the time of the contract [24], so they are purely exchanges of promises. it is claimed that the prohibition of such sale under islamic law is mandated by a unanimous agreement of islamic jurists [66]-[77]-[78]-[79]-[80], also referred to as ijma which is a secondary source of islamic law [81]. the organisation of the islamic cooperation (oic) and the international islamic fiqh academy have also rejected the validity of any futures sale where the delivery of the merchandise is agreed to take place in the future (as a pending obligation) with the price to be paid on delivery. it is thought that such a contract is not permissible because of the deferment of both exchange elements. still, it may be amended to meet the conditions of a permissible salam (advance payment) contract. the european council for fatwa and research also confirmed this position. as futures trading verges on gharar, it is claimed that it violates the validity requirements of a permissible sale under islamic law. any contract of sale under islamic rule must take the form and satisfy the validity requirements of a bay’a european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6800 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/05/2022 accepted for publication: 05/12/2022 published: 29/12/2022 6 contract which is a nominated contract and permissible under the figh-ul-muamilat in islamic law. bay’a is one of the proprietary contracts (uqud al tamlik), and a valid bay’a involves transfer of title to the asset from the seller to the purchaser. this is also referred to as bay’a-ul-tamlik, which requires the countervalues to exist and be owned by the seller at the time of contracting to avoid gharar. islamic jurists have defined a sale as “tamlik-ul-eain be-al-thaman-il-ma’aloom”, meaning the transfer of title on a specific asset for a known price. this is also referred to as bay’a-ul-a’ayan, where the subject matter of the sale is a particular asset in rem rather than a generic obligation (kulli) [27]. if the seller does not own the specific goods before the sale, they cannot transfer ownership. similarly, parties cannot agree on the ownership of the goods to be shared at a future time. any form of postponing the transfer of ownership of the goods specified in the contract to a future time would transform the contract into maysir, which is prohibited [24]. in addition to these, where the goods are moveable, it is further suggested that the seller must already have the goods before resale [82]-[83]-[84], whereas in future, parties do not even intend delivery or possession [85] as transactions often complete by simply settling the differences in prices [86]. such transactions are seen as superficial and simply on paper rather than genuine transactions [1]-[27]). they are therefore classed as short-selling, which ceases to serve any proper economic function [6]-[87]-[88]. finally, it is worth noting that some modern scholars in this camp allow the use of islamised futures, i.e. futures transactions that are put in a sharia’h compliant format using substitute islamic contracts other than the standard bay’a. these include bay’a-ul-muajjal, bay’a-ul-salam, bay’a-ulistisna, bay’a-ul-sifah (sale of description), sulh (compromising settlement), muawadah (exchange) and jualah (reward) [4]-[5]-[73]-[74]-[89]-[90]-[91]-[92]. nonetheless, as it is explained next, such islamised futures fail to secure the main purpose of the futures derivative, namely risk hedging, to a great extent. b. permissibility view many contemporary jurists and academics have taken a liberal view that hedger-hedger futures trading would satisfy the permissibility requirement of the shari’ah law of contracts if the domain of the islamic prohibitions do not unnecessarily exceed their intended framework. islamic teachings suggest a careful distinction between two categories of intertwined relationships. one concerns faith (‘aqīdah), worship (ibadat) and ethics (akhlaq), whereas the other relates to socioeconomic conduct (muʿamalat). the first involves a human relationship with god whilst the second concerns the human relationship inter se. with regards to the former, believers do not have much freedom to define the terms of the relationship. there is, however, reasonable space for development and innovation in respect of the latter. for instance, muslims are required to do daily prayer exactly as prescribed, but they are free to choose to engage in business on their own terms. islam respects business contracts and recognises that such contracts are prima facie the creation of the evolving business practice. many business contracts existed even before the introduction of islam and were subsequently approved by it. islam, however, intervened in limited circumstances to secure compliance of business practice with certain islamic prohibitions as demonstrated in the fiqh al-muʿamalat. an example is the well-known distinction in islamic law between the practices of bay’a and riba. both existed before islam, but islam approved only the former and disapproved the latter. islam, therefore, endorses a general principle of permissibility (aṣalatul ibaḥah) and an adapted contractual freedom through which a newly evolved commercial contract should be assumed permissible by default unless it violates the prohibitions of islamic law. as the limitations are few and against the general permissibility principle, they will have to be applied exactly to their intended cases, rather than being applied overly and based on a generous construction. futures contracts and trading did not exist at the time of the introduction of islam, so the primary resources of shari’ah have not prohibited them. nonetheless, the prohibitionists made the prohibition of futures trading through an unreasonably generous interpretation of resources by way of ijtihad. to put it specifically, they have been routinely making an unjustified analogy (qias) between a permissible bay’a contract and a futures transaction and prohibiting the latter accordingly. the contemporary prohibitionists, on the other hand, appreciate that the analogy between bay’a and futures is an unjustified one, yet they make the analogy between futures transactions and classical contracts other than bay’a. according to this view, futures transactions whose underlying contract takes the form of either sulh, juallah, istisna or salam could better fit with the nature of futures transactions while adhering to islamic prohibitions [4]-[5]-[89]-[93]. such future transactions can be permissible under those frameworks, but not bay’a. such adapted forms of futures transactions surely ensure compliance with islamic prohibitions; yet again, they simply miss the purpose of risk hedging, which is to enable the parties to change their mind at the expense of a small cost when future events unfold unfavourably. the ijtihad by qias approach is failing. a futures transaction is a new mode of trading that undoubtedly does not fit with the rules of the classical contracts and, as many scholars indicated, calls for a fresh response tailored considering the operative procedures of future markets [94]-[95]-[96]. ijtihad by aṣalatul ibaḥah approach should replace the ijtihad by qias approach in the context of futures transactions. the proponent of permissibility further counterargue that a hedger-to-hedger exchange traded futures transaction not only does not associate with the forbidden transactional uncertainty (gharar) but rather such transaction reduces gharar to the minimum for three reasons [3]. first, the standardisation of contemporary futures trading requires the commodity traded to adhere to the set quality and quantity standards. futures contracts detail the quantity of the underlying asset and are standardized to facilitate trading on a futures exchange. they guarantee a level of quality regardless of where the asset is from. for example, crude oil futures ensure that regardless of european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6800 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/05/2022 accepted for publication: 05/12/2022 published: 29/12/2022 7 the refinery, a buyer can be sure they will be getting the same oil standard. likewise, one crude oil futures contract is normally tied with a specific quantity, so for example, on the chicago mercantile exchange, each contract covers 1,000 barrels of oil. therefore, if someone wanted to lock in a price on 10,000 barrels of oil, they would need to buy/sell 10 contracts. the futures markets are regulated by the regulatory bodies to ensure the integrity of futures market pricing, the absence of abusive trading practices or fraud, and the operation of reliable brokerage firms engaged in futures trading [27]-[32]-[33]-[34]. second, every regulated futures market is assisted by a designated clearing house tasked with validating and finalising the futures transaction, ensuring that both the buyer and the seller honour their contractual obligations. the key role of the clearing house is to accomplish the steps necessary to validate and finalize a futures transaction. acting as a middleman, it provides the security and efficiency that is integral to the certainty and stability of an exchange-traded futures market. the clearance procedures of the clearing house coupled with a twofold guarantee given to both the buyer and the seller in respect of the delivery of the asset and the payment of the price, virtually eliminate gharar and maysir. third, although risk-hedging futures transactions carry the potential for loss or gain, they generally serve both parties by eliminating uncertainty regarding the intended future exchange of goods/services and price. the potential for loss or gain also remains as an incidental commercial risk which is an inevitable part of engaging in business in general and is supported by the hadith that links returns to risk in commerce. commercial risks are either systematic and arise out of the exposure of the economy to uncertainty (e.g., a sharp change in market prices, supply of goods or government policies affecting business) or personal and resulting from individual preferences (e.g., risk of bankruptcy due to choosing to undertake business) [89]. a provision to this is the case of a speculative futures transaction. parties to a speculative futures transaction are not normally hedging any risk but are speculators for financial gain. the uncertainty associated with such futures transaction goes well beyond simple business uncertainty and constitutes enough gharar to essentially amount to maysir (gambling) which is certainly forbidden by islamic law. it is also counter argued by the liberalists [2] that the ban on unowned or unpossessed selling which is central to the prohibitionist approach is only relevant where the mabi’a (the subject matter of sale) is a specified object (a’yan) and not a generic fungible (kulli) asset that can be ascertained, replaced, or substituted in the future [97]-[98]-[99]. qur’an has not prohibited future transactions but rather validated such transactions. possession (qabd) prior to sale is generally thought not to be an essential requirement of a valid sale under the islamic law except only in relation to certain transactions. for example, possession (qabd) prior to sale and hand in hand delivery at the time of sale is a validity requirement in a currency sale (bay’a-ul-sarf) to avoid riba [3]-[27]-[100]. also, where the transaction involves selling foodstuff, the subject matter's prior possession is considered essential to avoid gharar [79]. even then, the foodstuff is construed to simply mean perishable food rather than the food that are traded preserved in tins or are bought and sold in standardized quantities and packages that are weighted, measured, sealed and labelled [3]-[27]-[101]-[102]. similarly, a sell of nonexistent and a sell of non-owned would not render the contract void. the former, selling non-existent goods whose existence is certain in the future, is permissible [103]-[104]. the latter, where the seller does not own the subject matter prior to sell, is considered by many islamic jurists only non-binding (muamelat-ul-fedhouliah) that could be corrected by subsequent ratification of the innocent party [105]. therefore, where the seller can ensure transfer of title and delivery, lack of ownership or possession of the subject matter at the time of contracting are no longer an issue [3]-[27]. in addition to these, the claim of ijma and hadith on the prohibition of bay’a-ul-kali-bi-al-kali, seem to be unsupported [3]. there are reported controversy among different schools of thought on the definition, types and scope of bay’a-ul-kali-bial-kali which conflict with the ijma claim. while hanbalies insist on ijma, many hanafi and maliki jurists and ibn taymiyah view dayn as a permissible asset just like a tangible good capable of being bought and sold [106]. the invoked hadith in sunnah appears to be weak and unreliable in terms authenticity and meaning [66]-[78]. many contemporary islamic finance specialists have taken the view that deferring in both countervalues of a sale transaction can be justified on several counts including hajah (needs) and dharurah (necessity) [107] maslaha (public interest) [2] and ibaha (permissibility) [7]-[35]-[53]-[64]-[108]-[109]-[110]-[111]. in the absence of a qur’anic prohibition on futures sales, the clear qur’anic respect for sales in general, the authorisation of deferred transactions in the islamic law of muamilat and the absence of gharar and riba, futures trading may simply fall back to the general principle of permissibility (ibahah) [3][35]-[112]. if such transaction is economically rational and actually reduces the risk for both hedging parties, then surely a more relaxed interpretation of islamic law based on maqasidul-shari’a, social welfare and public need could be justified [2]-[113]-[114]-[115]. iv. the theory of maqasid-ul-shari’ah the theory of maqasid-ul-shari’ah has great potential to resolve the ongoing controversy among sharia’h scholars over permissibility of risk hedging transactions in islamic finance discourse. the gist of the theory is to construe divine laws of islam prima facie according to their intended purpose rather than literal meaning. on several counts, it authorises risk hedging transactions despite their apparent clash with literal rulings of sharia’h. the theory is not, however, a straightforward one. often, the intended purpose which underpins the theory is implicit and hard to discover. the circumstances under which the theory may authorise futures trading thereby overriding the explicit rulings of shari’ah are not clear too. this section concerns the theory of maqasid-ul european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6800 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/05/2022 accepted for publication: 05/12/2022 published: 29/12/2022 8 shari’ah and its relevance in justifying permissibility of riskhedging transactions. islam claims to have constructed a new multi-faceted order with guidelines to safeguard humans’ prosperity in this world and thereafter [116]-[117]-[118]. unlike atheism [119]-[120][121]-[122], it does not regard nature as a purposeless evolution but rather a system with an assigned purpose created by the creator. everything, including economic activities, transactions, operations, and systems, should function in the same order [123]. the gist of the new order manifests in its maqasid al-shari’ah discourse [124]-[125]. maqasid-ulshari’ah seeks to demonstrate the purpose and objective of islamic law, i.e., the underlying purpose of the explicit rulings of islam [118]. maqasid-ul-shari’ah can be vague without proper interpretation, as islamic theorists have not agreed on how to materialise this underlying purpose. for many classical islamic legal theorists, it is the other word for public interests. a purpose is valid as long as it preserves the interests of the public or leads to the avoidance of some mischief (mafsadah) [126]-[127]-[128]-[129]-[130]-[131]). to identify a valid purpose, they would normally classify maqasid-ul-shari’ah into three levels of necessity: necessities (daruraat), needs (haajiyaat), and luxuries (tahsiniyaat). these levels are set hierarchal relative to the level of their importance to humans’ life, starting from the necessities as the highly essential at the bottom, the needs as the less essential in the middle and the luxuries as unessential on the top. the last two are respectively less essential and unessential for human life. for example, marriage, trade, and means of transportation are less essential as one’s lack of any of these would not pose a threat to their life. likewise, luxuries things such as using perfume, stylish clothing, and beautiful homes carry the lowest priority in one’s life. the first, on the other hand, is viewed as the wholesome essentials of humans’ life which is divided it into a further six categories of preservation of one’s religion (din), preservation of human self (nafs), preservation of intellect (‘aql), preservation of posterity (nasl), preservation of wealth (mal) and preservation of honour (erd). these necessities constitute the objective behind any revealed law, not just the islamic law. accordingly, an action taken in light of these necessities serves to the public interest and is therefore considered desirable’ [132]. this minimalist approach: fully mirrors fiqh-ul-shari’ah; fails to make a justified distinction between different rulings; cannot go beyond the explicit rulings of fiqh-ul-shari’ah; and is unable to scientifically identify and accommodate the implicit objectives of shari’ah from the original primary sources [124]. it simply echoes the traditional individualistic take on shari’ah and would not embrace universal values, such as justice, freedom and equality in appropriate cases. contemporary scholarship, on the other hand, have tried to remedy these shortcomings by articulating further classifications of the concept of maqasid. to begin with, a distinction has been made between generic objectives (one-fits all) in rulings of shariah (general maqaid) and objectives of the rulings that are group, situation, or case specific (specific or partial maqasid). while the former applies to the entire body of islamic law [118]-[133]-[134]-[135]-[136], the latter has a much smaller scope of application targeting a specific section of rulings [137]. a further distinction has also been made between the two principal limbs of shariah, i.e., ‘act of worship’ (ibadat) and ‘worldly transactions’ (muamalat) [138]. literal compliance is the default methodology for ibadat, thus no need for a deduced reasoning neither to any investigation or discovery of a specific objective, as they often go beyond human reason. the latter, on the other hand, needs the consideration of purposes as it concerns the worldly business dealings and seeks to benefit the ummah [124]. the maqasid-ul-shari’ah discourse has been helpful in the identification of valid objectives of shariah rulings, especially concerning worldly transactions within which futures trading falls. first, any proposed ban on futures trading must be justified, just like any other shariah rulings regarding worldly transactions. unlike an act of worship, futures trading requires no literal compliance. as explained earlier, the cardinal foundation of the prohibitionist approach in putting a firm ban on futures trading is gharar. futures trading is thought to contain gharar, especially in respect of the underlying asset, which might not yet exist or be owned by the seller at the time of contracting which further affects the certainty of the pricing [139]. the prohibition's higher objective is to avoid future conflicts between contract parties. this is the maqasid that is specific to the law of muamalat (business). gharar makes the entire contract uncertain, facilitates future disputes between the contract parties and creates an environment of chaos. a contract of gharar causes unnecessary transaction costs, wastes public resources and imposes upon one party unjust loss, hence, it is inefficient and unjust. the absence of a more desirable alternative, a general legal ban on such a contract would save all the concerned parties. but a futures contract is the alternative which would reduce or eliminate chaotic environment, thereby maintaining social morals. by entering into a futures contract, parties create a mutual environment of certainty in respect of their future exchange of assets and price [52]. whatever happens to the market, the two futures contract parties have a pre-planned arrangement which will remain stable within a set period and would not be affected by any future change in the market conditions. one and the foremost factor contributing to the evolution of futures trading out of the traditional forward trading practice has been to save parties from future disputes/conflicts. the standardization of the assets and payments in terms of maturity, quantity and quality in futures trading has reduced or eliminated uncertainty, thereby saving parties from unnecessary future disputes or conflicts. it saves the parties from multiple coincidence of wants and needs, provides for a fair price to be available from the market thereby assisting the parties to avoid unfair pricing [7] and eliminates the risk of counter party default. from a micro-perspective, futures market not only helps one party in finding the other party with opposite wants, but it also brings in confidence that the contract would be fulfilled, thus, productivity in commodities are not dampened by the risk of default of the counterparty. it also helps traders to a better wealth planning, provide liquidity strategies, and reduce european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6800 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/05/2022 accepted for publication: 05/12/2022 published: 29/12/2022 9 associated risks. from the macro-perspective, futures trading is much more cost-efficient than the spot trading and can lead to increased productivity of the businesses and to the growth of the economy. secondly, a cardinal objective and a general maqasid-ulshari’ah is ‘facilitation’; i.e., to make things easy for the people and to remove unnecessary hardships. it is generally the claim of islam that it is a religion that alleviates suffering of the ummah (the people), so shari’ah law consists of rules that are easy to follow and concessionary in most areas [52]. this general maqasid applies to both the ibadat and the muamalat sections of shari’ah equally. quran has referred to the alleviation of hardship in muslims’ socio-economic life in several verses: “allah has imposed no hardship (haraj) in religion”, “hardship attracts alleviation” and “necessity makes the unlawful lawful”. in the law of muamalat, this is particularly manifested through the ibaha (permissibility) principle which is facilitative to private transactions. the default position of shari’ah law in muamalat has been to ratify without intervention the current and evolving business customs and practices as long as those practices and customs produce better than harm to the society (koehler [140]). where, harm outweighs the good, a practice is declared void, so for instance, the contracts of gharar, riba, and maysir have been explicitly prohibited in the texts of the primary sources [141]. most islamic scholars would agree that facilitation has been the main objective of shari’ah in its recognition of bay’aul-salam despite being a deferred sale. although a sale of nonexistent is principally prohibited due to gharar, bay’a-ul-salam fulfils the higher purpose of removal of hardship and bringing ease to the people, hence it is prioritised over the primary rulings of shari’ah. the absence of the recognition of bay’aul-salam would have caused the small-scale farmers to face hardships. they produced agriculture commodities which were often seasonal, and a requirement of spot sale would have leaded to the clear risk of over-supply of such commodities at the relevant season in the market therefore facilitating a sharp depreciation of the market price of such commodities which would in turn have generated disastrous consequences for such farmers. as kamali [52] rightly observed ‘futures market facilitates regular permanent, and centralised trading of commodities by bringing ease to the process of buying and selling for both parties. with the market being regulated, the guaranteed function of the clearing house, futures markets can further control any sharp price movements of the commodities as traders are often averse to engage in behaviours that involve price speculation or unreasonable risktaking [142]. traders can limit the exposure of the price volatility in the commodities and take a hedging position to offset any loss/gain from the spot market [143]. third, maqasid-ul-shari’ah relies on the touchstone of almasalih-al-mursalah (the public interests). a contractual arrangement would satisfy the criteria if it were to enhance the interests of the public or to the avoidance of some mischief. as ibn taymiyyah stated “god most high never prohibited a contract which generates benefit to the muslims, and which does not cause any harm to them” [52]. that is also one of the main maqasids behind the rulings of shari’ah for the validation of both the bay’a-ul-salam and the bay’a-ul-istisna which seeks to recognise and respond to the legitimate needs of the public or parts of the public even though such may call for a compromise on the wholesale application of the gharar prohibition in respect of a sale of non-existent goods [144]. despite involving gharar, such sales have been approved, because they do not lead to conflicts between the contract parties, instead they secure the mutual benefits of the parties under the contract. fourth, risk-hedging futures trading meets the necessity element of maqasid-ul-shari’ah on several counts. to begin with, it helps preservation of wealth of the muslims. by using such futures, contract parties control future risks and mitigate uncertainty by fixing future assets and prices. such futures trading enables the parties to plan an arrangement for uncertain future so that uncertainty and future surprises and disputes are reduced. the preservation of wealth would further lead to the economic growth of muslim communities. furthermore, it would help preservation of muslims’ honour, as contract parties minimise potential future commercial failure (insolvency / bankruptcy). they maintain and deliver their business undertakings and promises on an ongoing basis which will in turn facilitate establishment of stronger business and financial network. also, the preservation of wealth may further lead to the preservation of human self, as parties have resources to maintain human dignity. additionally, the healthier the business, the stronger the dedication and serving of that business to the religion and the religious purposes, as parties have resources to undertake religious duties and to develop into a better human and to contribute to their muslim communities. finally, ijtihad which is unanimously considered as the most important tool for the development of shari’ah law and responsible for responding to the pressing needs of muslims in this ever-changing world is linked with maqasid-ul-shari’ah. the focus of ijtihad to date has been on finding a full match between a proposed product and the classical figh-ul-shari’ah with islamic jurist mimicking one another. many islamic jurists may regard any innovation that has no roots in the traditional practice of the muslim community as a form of bidʿah in islam which is prohibited. however, ijtihad will not function properly, if the jurists keep mimicking the past, stick firm to the explicit rules of the classical figh-ul-shari’ah and ignore the implicit rationale behind it [145]. most of the modern islamic jurists make a considered distinction between permissible and impermissible bidʿah. an innovation that concerns the worldly affairs is permissible whereas an innovation in matters of religion is impermissible and a great sin. as many contemporary scholars have suggested, a new form of ijtihad should be practiced; one that can evolve with the new developments and can ensure that its application mirrors the present time [52]-[145]-[146]. jurists must be prepared to go behind the explicit rulings of shari’ah to discover the true rationale of such rulings and to develop into competent shari’ah law interpreters who may then rightly engage in a re-examination of modern transactions in the light european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6800 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 26/05/2022 accepted for publication: 05/12/2022 published: 29/12/2022 10 of their true nature, function and purpose within the contemporary complex economic landscape [52]-[124]-[146][147]. this also explains why ibn qayyim warns of the danger of an undesirable tendency among present jurists to conform to the views of the earlier jurists: “shari’ah is based on wisdom and achieving people’s welfare in this life and the afterlife. shari’ah is all about justice, mercy, and good. thus, any ruling that replaces justice with injustice, mercy with its opposite, common good with mischief, or wisdom with nonsense, is a ruling that does not belong to the shari’ah, even if it is claimed to be so according to some interpretation” [124]. v. conclusion this paper deployed the maqasid-ul-shari’ah theory to establish a strong case for permissibility of the controversial futures transactions in islamic finance discourse and islamic financial markets. futures have been widely used by investors, businesses, and traders in the contemporary financial markets for either investment risk mitigation or speculative investment. islamic financial markets, however, have been reluctant to allow the use of futures trading, no matter risk hedging or speculative, for its perceived inconsistencies with shari’ah law. futures trading is thought to involve speculation and exchange of future promises both of which are prohibited in shari’ah for gharar. yet, the matter is unsettled in the islamic finance discourse. islamic jurists and academics have grouped into two main camps: prohibition and permissibility. the former which is the predominant approach took the view that futures trading violates fundamental prohibitions of islamic law; and the latter, whilst agreeing to the contention that purely speculative futures trading should be impermissible, disagree with the prohibitionists in that futures trading that is meant for risk hedging should also be disallowed. they counterargue that risk hedging futures transactions do not contain gharar for lack of speculation. futures transaction is a modern innovation with no comparative within the islamic law of business. since it is an innovative contemporary practice, an analogy cannot be drawn between futures and a contract of sale (bay’a) under islamic business law, which does not allow exchange of future promises. instead, islamic law should evolve through ijtihad to recognise the new arrangement under the operative procedures of futures market. futures trading should therefore fall within the ambit of the principle of permissibility (ibaha) and be declared permissible if there is no express prohibition. while the existing controversy in islamic finance discourse centers around conformity with the explicit rules of sharia’h, both views ignore the maqasid-ul-shari’ah take on the matter. this paper took a maqasid-ul-shari’ah approach in respect of futures transactions instead. it is the first contribution to fill the stated gap in current literature on islamic finance. it adds on to the permissibility view that risk hedging futures trading should be recognised and declared as permissible not simply because they do not conflict with any prohibition, or benefit the individual parties involved but also, they serve for the wider interests of the public (al-masalih-al-aammah). the findings of this research suggested that the current practice of islamic financial markets that mirrors the prohibitionist view displays a great deal of inconsistencies with general maqasidul-shari’ah principles. a blind ban on futures transactions ignores necessities of maqasid-ul-shari’ah and contributes to chaotic financial markets and increased future disputes/conflicts. on several counts of necessities, riskhedging futures help muslims to preserve both the individual and the public wealth, honour, human self, and religion. parties will have resources and credibility and will enjoy reasonable business certainty to maintain and develop wealth, undertake religious duties and develop into a better human and contribute their muslim communities and their economic growth. the maqasid-ul-shariah analysis which regards futures trading as an element of necessity aiming at securing the interests of the public is further compounded by the two higher objectives of shari’ah, i.e., facilitation of commerce and prevention of future conflicts in business practice. it is clear from primary resources of islam that facilitation of business has been the higher objective and default position of sharia’h law. where, the good outweighs the harm, a practice can be declared permissible despite it being associated with excessive uncertainty, so for instance bay’a-ul-salam contracts are generally permissible. in the case of a hedger-hedger futures trading, uncertainty is reduced to a minimum. the standardised format of contracts, the regulated market where the actual trading takes place and the clearing house’s guarantee function not only reduces chaotic environment and strengthens social morals but also provides a suitable alternative to an unwanted gharar prohibition which simply voids private contracting of futures. despite the strong link between sharia’h and maqasid-ulsharia’h, ijtihad has been reluctant to use the norms of the latter to make more sense of the former. many islamic jurists may take a too cautious position and regard any innovation that has no roots in the traditional practice of the muslim community as a form of the prohibited bidʿah. however, innovation in matters of the worldly affairs 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(2003). the principles of islamic jurisprudence. cambridge: the islamic texts society. paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 financial stability of islamic banks: a review of the literature 1 oaksprings educational services, nigeria, ak.odeduntan@oakspring.com.ng 2 international islamic university malaysia, abidewale@iium.edu.my abstract— the recent global financial crisis that began in the us and spread sporadically to other parts of the world has been a sort of awakening that financial stability of financial institutions should be on check from time to time. this scenario has called for a concerted effort that may possibly be geared towards introducing a framework or policy that tends to promote and sustain economic growth and stability. the present paper therefore reviews financial stability of banks by surveying the extant literature on the subject. it employs library method to gather information and further analyze it by way of comparative, inductive and deductive methods. the paper establishes that while some islamic banks are relatively stable in terms of their financial activities, some banks are not. keywords-component; global financial meltdown; islamic finance; financial stability i. introduction islamic finance industry has shown a tremendous growth in the last three decades. its cross-border activities have also maintained a steady growth. the events of the recent global financial crisis that reached its apex in 2008 will still be fresh in our memories. it is interesting to note that despite the long lasting impacts of the crises on many conventional banks across the globe, islamic banks were largely found to be insulated from it. this feat is connected with the fact that islamic finance operates in an environment that is highly regulated under the principles of shariah which prohibit investments in any type of instruments except those ones that are found to be compliant with the islamic principles of transaction. consequently, this impressive growth rate of islamic finance and its stability during financial crisis and beyond have continued to attract the attention of many policy makers and financial experts worldwide. while applauding the success and growth of islamic finance, researches have shown that participating banks (like islamic banks) were either not or less affected by the global financial crisis than their conventional peers. the reason for this the study claimed is attributable to its nature which emphasizes participating banking wherein all financial transactions are trade-based and asset-linked. meanwhile, financial stability remains an essential tool for economic growth because most transactions in the real economy are made through the financial system. realizing the role of the banking sector (as a main financial service sector) in the overall economic development, the stability and growth of any economy depend to a large extent on the stability of its banking sector. it among others serves as an intermediary that links surplus and deficit units and facilitates funds for productive purposes. this explains why the term ‗financial stability‘ has continually drawn attention in both academic and professional realms since we all have got to draw lessons from the global financial meltdown. reviewing the extant literatures on the financial stability of islamic banks, we found that only few researches have been carried out and their findings are accessible for all inquisitive minds. in the literature as well, some writers and authors such as cihak and hessel (2008) have tried to examine the financial stability of islamic banks within a large geographical territories; others have tried to contrast financial stability of islamic banks with their conventional counterparts. studies by umar islam muhammad and kozokov shakhboz (2009) as well as sitti rohaya mat rahim, norsilawati mohd hassan and roza hazli zakaria (2012) belong to this category. nevertheless, some other researchers like said ali (2012) have concentrated their studies on the risk management and performance or efficiency of islamic banks. meanwhile, overviews of most of these previous studies were actually concentrated on comparison between islamic and conventional banks. hence, only little attention or effort has been paid or dissipated as the case may be to examining financial stability of islamic banks as a whole or as an entity. this is the gap this paper therefore attempts to bridge. ii. islamic banking system in a periodical publication of the institute of islamic banking and insurance (iibi) based in london in 2013 titled ―discover new perspective‖, islamic banking is defined as: akeem kolawole odeduntan 1 and abideen adeyemi adewale 2 mailto:ak.odeduntan@oakspring.com.ng mailto:abidewale@iium.edu.my ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ‗a system of banking or a banking activity that is consistent with the principles of the shari'ah (islamic rulings) and its practical application through the development of islamic economics’ ismail (2010: 3) in one of his academic treatise defined islamic finance as: ‗islamic financial institutions that collect and invest money in a way that is in harmony with the rulings of islamic shari`ah; where money is exposed to profit and loss. they depend on their transactions in the islamic finance system which meets all the needs of economic sectors in return for a fixed share of unknown profit rate, thereby making them free of the prohibited usury’. meanwhile, monzer kahf (2007) gave the guiding precepts of islamic financing which according to him is basically very simple. islamic finance as practised could be said to rely on a combination of three principles comprising sharing, leasing and sale; as a result funds are channeled to entrepreneurs through sale, sharing and lease contracts. kahf maintained that this process of islamic finance is in line with growth and development of any economy that indulges in it. first of all, islamic finance is directly linked to real economy through the profit participation, the sale and purchase of commodities together with the acquisition and leasing of assets. besides, ethical and moral values are so much integrated with the financing to such an extent that gambling and other illicit activities which are often as a result of self aggrandizement and greed do not get funded, while devoting resources to charity and welfare needs. last but not least is the fact that in islamic finance participatory financing has substituted lending; this therefore facilitates a kind of relationship that is rooted on profit-generating activities between the financier and entrepreneur. iii. definitions of financial stability it is important to note that there is no broadly acceptable definition of financial stability. different authors and writers perceive it from different angles; this is connected with their divergent backgrounds and orientations. however, a basic reason for this divergence of opinion, according to schinasi (2004) is that the term ‗financial stability analysis‘ is still relatively new in terms of development and practice unlike monetary and macroeconomic stability analysis that have fully been developed. against the backdrop, alawode and al sadek (2008) identified two schools of thought in the literature with respect to the definition of financial stability. there is a school of writers that prefers to define financial instability while there is another school that attempts to define financial stability. a few of these definitions from different perspectives and schools that are considered for the purpose of this paper are briefly described as follows: citing the european central bank‘s publication entitled ‗financial stability review‘ (2012), financial stability was described as: ―a circumstance where the financial system (i.e. financial intermediaries, markets and market infrastructures) is able to withstand shocks, thereby reducing the possibility of disruptions in the financial intermediation process which are severe enough to significantly impair the allocation of savings to profitable investment opportunities‖ further, the bank negara malaysia (central bank of malaysia) defines financial stability as: ―the condition where the financial intermediation process function smoothly and there is confidence in the operation of key financial institutions and markets within the economy‖ in the same vein, the financial stability report (2008) of the central bank of bahrain defines financial stability as ―a situation where the financial system can function prudently, efficiently and uninterrupted, even in the face of shocks‖ foot (2003) opined that certain factors exist that contribute to enhance finance stability. these factors according to him must take place before financial stability can be ensured. they are: monetary stability; employment levels being close to the economy‘s natural rate; confidence in the operation of the generality of key financial institutions and markets in the economy; and the price movement being relatively real or financial assets within the economy that undermines monetary stability and the level between employment and economy‘s natural rate. a review of the foregoing definitions actually portrays financial stability as a broad concept that comprises different aspects of a financial system in terms of infrastructure, institutions and markets. these definitions on a general note reveal that the ability of a financial system to survive any economic pressure or stress is termed financial stability. however, in the study of davis (2001) systemic risk and financial instability is defined as ―a heightened risk of a financial crisis‖. equally, the author described a financial crisis as: ―a major collapse of the financial system, entailing inability to provide payments ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 services or to allocate credit to productive investment opportunities‖. ferguson (2003) in his study described financial instability as: ―a situation characterized by three basic criteria. these are: the seemingly sharp divergence of some important set of financial asset prices from fundamentals; significant distortion of market functioning and credit availability, domestically and perhaps internationally; and finally, the significant deviation of aggregate spending either above or below, from the economy’s ability to produce‖ chant (2003) defined financial instability as: …conditions in financial markets that harm or threaten to harm an economy‘s performance through their impact on the working of the financial system allen and wood (2006) referred to financial instability as: episodes in which a large number of parties, whether they are households, companies or (individual) governments, experience financial crises which are not warranted by their previous behavior and where these crises collectively have seriously adverse macro-economic effects all the above definitions of financial instability paint a picture of a financial system in all its ramifications that fails or is incapable of withstanding any given economic shock or impending economic crisis. from the above definitions, it may be deduced that the divergence of opinions of the scholars are primarily in terminologies. the use of terms by different schools of thought was basically to express their minds in the best possible form. this is because both schools acknowledge the importance of a financial system and its effectiveness or otherwise. an effective financial system ensures financial stability of an economy while an ineffective one contributes in no small means to the economy‘s financial stress and meltdown. iv. maintaining financial stability khwan and muljawan (2008) argued that financial stability depends on several factors. some of them according to the authors are the extent to which the owned funds are put in place by the owners of financial institutions, the level of transparency and disclosures, effectiveness of banking supervision and presence of efficient financial infrastructures as well as legal frameworks. in the view of chapra (2008) who posited that one of the measures of enhancing financial stability is to strengthen market discipline. this, he believed, could be achieved through promoting risk sharing by greater reliance on equity. another means of achieving market discipline according to the author is to tie the availability of credit to the real economy. moreover, chapra (2008) held that financial stability can be enhanced by curbing speculation as well as establishing the required support institution for the industry. the need to ensure financial stability in islamic banks has propelled the world bank and international monetary fund (imf) quoted by cihak and hesse (2008) to propose some basic observations that must be taken into cognizance when assessing stability in a given financial system particularly in the context of islamic banking. these observations are as follows: 1. the profit and loss sharing financing exposes islamic banks to risks that ordinarily should be borne by equity investors rather than holders of debt; 2. profit and loss sharing should not be made dependent on collateral or guarantees to reduce credit risk; 3. profit and loss sharing modes expose islamic banks to more operational risk; 4. product standardization becomes more difficult as a result of the multiplicity of potential financing methods, increasing operational risk and legal uncertainty in interpreting contracts; 5. islamic banks should use fewer risk-hedging instruments and techniques than conventional banks; 6. nonprofit and loss sharing modes of financing are less risky and more closely resemble conventional financing facilities, but are also associated with risks (such as elevated operational risk in some cases) that need to be recognized; 7. a specific risk inherent in islamic banks stems from the special nature of investment deposits, whose capital value and rate of return are not guaranteed. v. financial stability of islamic banks in reviewing financial stability of islamic banks, the study of mat rahim, mohd hassan and zakaria (2012) is one of the few in the line of the subject of this paper. mat rahim, mohd hassan and zakaria (2012) employed z-score model to find out whether islamic banks were less or more stable than conventional banks. the study collected data from 17 islamic banks and 21 conventional banks from their annual reports (consolidated and unconsolidated) in malaysia. the timeframe covered in this study was 2002-2010. the result of the ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 z-score model specification and npl analyses indicated that there was significant difference between islamic banks and conventional. nonetheless, the difference found was that islamic banks had significant result towards risk with respect to cost-income ratios, herfindahl index, gdp and of course inflation. in other words, the findings revealed that islamic banks were more stable than their conventional counterparts. said (2012) in his study measured efficiency in islamic banking during the global financial meltdown. owing to the fact that islamic bank promotes equity based model adopted the data envelopment analysis (dea) model. his data were collected from the financial statement of 47 islamic banks having critically analysed the end of the year balance sheet and income statement. for efficient analysis, the author classified islamic banks covered in the study based on size and region; thus, giving mention of small and large sized banks on one hand and middle-eastern and non-middle eastern banks on the other hand. the study concluded that large islamic banks had a boost in efficiency during 2006 to 2008 crises but declined in 2009. in contrast, however, small to medium banks witnessed lower level of efficiency at least at the initial stage. more so, said (2012) concluded that the efficiency of islamic banks improved appreciably during the economic crises at both regions: middle-eastern and non-middle eastern countries. furthermore, cihak and hesse (2008) studied the financial stability of islamic and conventional banks. all relevant were collected data from bank-scope database; due to availability to information, the data collected was on unconsolidated bank statement. anyway, the study encompassed 77 islamic banks and 397 conventional banks over a period of 1993 to 2004. the study which adopted z-score model to analyze its data found that islamic banks were more likely to be sound and stable than conventional banks. the result of the analyses also showed that large islamic banks were less stable than both small islamic banks and large conventional banks; while small islamic banks were quite as stable as small conventional banks. in other words, the findings of the study revealed that small islamic banks have a propensity to be financially stronger than conventional banks; when large conventional banks are possibly stronger than large islamic banks. the study of cihak and hesse (2008) also found that small islamic banks were financially stronger than large islamic banks. thus, the research concluded that islamic banks could be said to be more stable when on a small scale but were less stable when operating on a large scale. the reason advanced for the less stability of large scale islamic banks is that they find it more complex to regulate their credit risk monitoring system as they expand. in the same vein, cihak and hesse (2008) asserted that the consequential effect of inappropriate credit risk management is that various profit and loss arrangements will become very much more complicated as the banking operation experiences growth; thereby resulting in the prevalent of adverse selection and moral hazard. however, the findings showed that small banks do not share this with big ones. small banks are more stable as they concentrate on lowrisk investment and fee income while large banks do more of profit and loss business. albeit, transactions in islamic banks (and other related financial institutions) are totally free from interest, movements in the interest rate have significant effects on the performance of islamic banks. this was the outcome of a study conducted by zairy and salina (2012) that centered around a review of the literature on the rate of return and risk in islamic banks. the authors maintained that development of islamic banking alongside with the conventional banking system poses several problems while the persistent reliance on conventional market interest rate as benchmark due to absence of an islamic index rate of return at the moment increases the sensitivity of islamic banks to the changes in the interest rate. this, ultimately, contributes to the stability or otherwise of the islamic financial system. as a way out of this impediment, islamic banks should therefore create their own instrument that can be adopted in setting their rate of return. wahida and robin (2010) in their study compared efficiency of islamic banks and conventional banks in turkey, germany and united kingdom. the study which covered the period from 2005 to 2008 adopted a non-parametric method as a measure of efficiency. the authors found that islamic banks were more efficient than conventional. this meant that there was lower cost efficiency for islamic banks as against their conventional counterparts in europe. according to the authors, even though, the values of asset of islamic banks were not as much as that of the conventional banks, islamic banks were still efficient especially in terms of cost. the implication of this is that based on the outcome of the study islamic banks have cost control mechanism as compared to conventional banks. it is therefore proven empirically that islamic banks were more efficient in the three european countries than conventional banks. the problem facing islamic banks according to the study is the choice of input price mix. this is because the sources of inefficiency do not arise from managerial issues. meanwhile the reason for efficiency of islamic banks as noted above is that they seized the opportunity of the existing competitive atmosphere in the european integrated banking market. they also exploited favorable economic environment and banking innovations in 2007. this, thus, supports the hypothesis of market power and efficiency, the quiet life hypothesis in which more integrated market islamic banks improve management effort to maximize operating efficiency. so, the more the competition in the european market, the higher the pressures of cost control in islamic banks. furthermore, beck, demirgul-kunt and meriouche (2010) in their paper titled islamic vs. conventional banking found that islamic banks are more cost-effective in a large samples of ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 countries. however, in countries where both islamic and conventional banks exist side by side, conventional banks are proven to be more cost-effective than islamic banks. the study observed some variation of efficiency and stability of conventional banks across countries with different market shares of islamic banks. this suggests that in countries where the market share of islamic banks is higher, conventional banks tend to be more cost-effective but less stable. beck, demirgul-kunt and meriouche (2010) also found that during the recent global financial meltdown, little differences existed between the performance of islamic and conventional banks. the only differences lie in the fact that islamic banks were able to increase their liquidity holding and capitalization in the run-up and even during the crisis. this scenario gives a picture of why the stocks of islamic banks perform better during the meltdown than their conventional counterparts. the authors revealed that even though islamic banks are significantly more profitable and better capitalized than conventional banks, their returns tend to be much more volatile. in other words, they are closer to insolvency than conventional banks. besides, the study found that larger banks whether islamic or conventional were more efficient due to scale economies. this may make them engage in fee-based business and have easier access to wholesale market. the authors concluded that islamic banks are more efficient than conventional banks and have higher capitalization ratio. however, they are constraint in the sense that they are not stable as compared to the conventional system. in comparing the efficiency of islamic and conventional banks, hussein (2004) collected his data from bahrain banks and had his samples varied across banks. also, he selected eight islamic banks consisting one commercial and seven investment banks as well as eight conventional banks comprising five commercial and three investment banks. the study revealed that in general sense the performance of commercial banks is more stable than investment banks. the reason for this according to the author is as a result of the fact that investment banks are more vulnerable to external shocks. also, he argued that the difference between profit efficiency in islamic and conventional banks is not unconnected with the performance of commercial rather than investment banks. based on the outcome of his findings hussein (2004) concluded that generally speaking islamic banks performed better than their conventional counterparts. the author further argued that the difference between profit efficiency in islamic and conventional banks is not unconnected with the performance of commercial rather than investment banks. similarly, farook, hassan and qinch (2012) assessed the overall differences in the financial stability of islamic banks in comparison with conventional banks. the data collected comprised 50 islamic banks and 150 conventional banks covering the period 1991 to 2005. all necessary data were sourced from bank-scope‘s database. z-score was utilized as a measure of financial stability and the outcome of their findings showed that islamic banks are not as stable financially as their conventional peers. the study specifically purported that while small islamic banks are more financially stable than conventional banks, large islamic banks were found to be less stable. in the same token, shahid and abbas (2012) in their work adopted z-score and econometric model to study the financial stability of islamic banking in pakistan. the authors used the annual financial data for 2006 to 2009 covering all the 6 islamic banks that are operational in pakistan and top 10 conventional banks (i.e. based on the ranking of credit rating agency). their outcomes showed that small islamic banks seem to be stronger than small conventional banks as well as large islamic banks. large islamic banks on the other hand were found to be stronger than large conventional banks. however, conventional banks proved to be more efficient than other banks. similarly, rajhi (2012) considers the channels through which the global financial meltdown would affect islamic banks. the author empirically assessed the relative financial strength of islamic and conventional banks based on evidence covering individual banks in 16 banking systems. using z-score and a robust quantile estimation model, the study explored causes of insolvency risk in the middle east and north africa (mena) and southeast asian countries, by controlling for various factors, bank-by-bank data, macroeconomic and other systemwide indicators. the sample covers 467 conventional banks and 90 islamic banks for the period 2000-2008. the main research result shows that different methods have confirmed the risk of insolvency in mena and southeast asian countries. this, according to the author, is in contrast to the findings of several authors who did not detect a risk of insolvency in these countries. in a study by hussein (2010), financial stability in the banking sector was measured using three indicators which includes roav, tobin q and bank liquidity. the data was obtained from bank-scope and the sample drawn cut across six countries for the period from 2000 to 2007. the countries in their study are bahrain, kuwait, qatar, saudi arabia, oman and united arab emirate (uae). the sample comprised 194 banks out of which 50 are islamic banks and i44 are conventional banks. their findings with particular interest on liquidity showed that even though islamic banks are more capitalised than their conventional counterparts, liquidity in the banks within the gulf coperation council (gcc) countries are not determined by bank-specific factors. rather, external factors to the banks such as macro economic and market behaviour do have a significant relationship with liquidity of banks. ali (2012) examined the impact of the islamic banks market structure on the overall bank risk using z-index. the research ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 adopted bank-level data from 39 full-fledged islamic banks in 17 selected countries. the outcome of the reserach revealed high overall islamic bank stability. the result of the z-index showed that islamic banks enjoyed higher franchise value and greater stability. the author, however, concluded that the zindex result suggested that the investigated islamic banks might have used their market power to increase their financing rates which led to inrease in the credit risk. this, however, protects their charter value in the form of risk sharing rule and high capitalisation level. hence, the researcher concluded based on the outcome of his study that islamic banks are financially stable. the result of their concentration structure coupled with in-built prudential regulations from shariah butressed this fact. little wonder islamic banks are more conservative inlending and selecting their investment portfolio. mat rahim and zakaria (2013) examined relative stability between islam and conventional banks in malaysia. the relevant data was sourced from the banks‗ annual reports as well as consolidated and unconsolidated bank statement for various financial institutions in malaysia. this was gathered online and also from published copies. the time-frame for analysis is from 2005-2010, a total of six years. data was collected from all the existing islamic banks and conventional banks in malaysia. the result of the finding shows that islamic banks are relatively more stable than conventional banks even though factors affecting the duo‘s stability are similar, except for the degree of diversification in income. najjar (2013) utilized secondary data sources which represent annual report of commercial banks in bahrain for the period of 2005 to 2009 to analyze the financial performance of major banks in bahrain. the population included all the 109 banks in bahrain which comprised 82 conventional banks (retail and wholesale) and 27 islamic banks. the study used a set of ratios including credit risk ratio. with particular concern on the loan to deposit ratio, the finding revealed virtually all the banks in the study showed a decline trend. the reason for this was said to be the impact of financial crisis that had depressed the market making those banks to adjust their lending policies. onakoya and onakoya (2013) investigated the performance efficiency of conventional banks and islamic banks in the united kingdom from 2007 to 2011. four top islamic banks and five conventional banks were involved and compared on given financial ratios as performance indicators. the data were collected from the financial statements of these banks. this was further transformed into percentages and ratios for easy comparison. the findings showed that islamic banks are less exposed to liquidity risk and seem to be more cost-effective. tabash and dhankar (2014) supported the standpoint that islamic finance remains a stable and safe way of financing. the authors attempted in their study to examine the impact of global financial crisis on the key performance ratios of all fullfledged-islamic banks in the kingdom of saudi arabia (ksa). time series data from 2005 to 2010 were employed to document the relationship between the performance of islamic banks and financial stability for all fledged-islamic banks within the nooks and crannies of the ksa. the study adopted the trend analysis method to compute via microsoft excel the yearly financial ratios of islamic banking sector. this helped to determine liquidity ratios and capital adequacy ratios for the analysis. equally, one way analysis of variance (anova) was used to test hypotheses using spss. the outcome of the empirical results showed that islamic banking sector was more stable sector in terms of, capital adequacy and liquidity at least in the period under study. umar islam and kozokov (2009) conducted a study on financial stability of banks. the authors specifically compared financial stability of islamic banks and conventional banks; the study which adopted z-score model found that the difference is insignificant. we may attribute the little or no difference to the fact that islamic banks at least as practised in malaysia are basically debt based which principally deviate from the original principles of profit and loss sharing on which islamic finance is built. this makes them not too different from conventional banks. also, the study revealed that conventional banks demonstrated high variability and volatility as weighed against islamic banks. the reason is simply because islamic banks are based on basic islamic banking philosophy that actually prohibits them from investing in highly speculative or leveraged businesses or transactions. umar islam and kosokov (2009) further compared islamic and conventional banks using npl/asset ratio and the results indicated that islamic banks were stronger than their conventional counterparts in terms of operation. the study also unfolded that islamic banks had better liquidity situation than conventional. meanwhile, this result is however contradictory to the findings of cihak and hesse (2008) who posited that the loan/asset ratio of islamic and conventional banks were somewhat similar. however, the findings of abdi (2011) do not support the argument that islamic banks are more stable than conventional ones. abdi (2011) examines whether there is an empirical evidence to substantiate the assertion that islamic banks are more stable than conventional banks in general and more specifically during the global financial crisis. using regression and descriptive statistical tools to analyze his data, the outcome of the study showed that islamic banking is less stable than conventional banking in countries where both types are systematically important for the banking system such as the middle east and south east asia. the author, however, concluded that there are signs that point to the fact that islamic banking is improving its performance in this regard. ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 vi. summary invariably, the paper avails us the opportunity of appreciating islamic finance especially in this contemporary age. principally, islamic banking and finance is an industry that follows the dictates of the divine guidance. although it is a nascent industry in relation to conventional method, it has the potentials of not only bringing banking to the door steps of the individuals irrespective of their religious indoctrination but also making financial instability a thing of the past. therefore, a holistic analysis of the extant literatures reviewed in this paper reveals that islamic banks on a general term are financially stable either during or after the global financial crisis and are able to withstand any financial shocks. vii. conclusion this paper attempts to provide a comprehensive review of the financial stability of islamic banks particularly during and after the recent global financial crisis which still has a severe loss on the world economy. in a nutshell, many authors have continued to prove either through empirical studies or theoretical analysis that islamic banks are financially stable even during the unprecedented financial crisis that rocked the entire world. it must however be emphasized based on the outcome of our study that the excessive dominance of debt financing model that is prevalent in most of these islamic financial institutions can hamper the development that trail islamic finance in this contemporary age. furthermore, having understood the fact that the success of this nascent industry lies on innovation and designing products that meet the needs of the customers; the attitude of some practitioners who are fond of introducing policies and products that are dressed up conventional practices and loan structure in islamic finance need to be wary of the consequences of their action. rather, the basic objective of islamic finance should be the driving force. this paper therefore concluded that even though islamic banks are found to be financially stable, except in few instances; caution must be exercised by all stakeholders who are driven only by profit or dividends while underplaying the very essence of islamic finance, the maqasid shariah (the goal of shariah). in other words, the stakeholders should appreciate the overall goal of islamic finance in their conducts so that all and sundry will benefit from the opportunities islamic finance offers. 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[28] tabash mosab i. and dhankar raj s. ―the impact of global financial crisis on the stability of islamic banks: an empirical evidence‖ journal of islamic banking and finance. vol. 2, no. 1, 2014, pp. 367-388 [29] the financial stability and payment system report (2011) of the bank negara malaysia (central bank of malaysia), kuala lumpur [30] umar islam muhammad and kozokov shakhboz (2009) ―stability of islamic and conventional banks, an empirical comparative analysis‖ unplished. [31] wahida ahmed and robin h. luo ―comparison of banking efficiency in europe: islamic versus conventional banks‖ in international banking in the new era: post-crises challenges and opportunities, suk-joong kim and micheal d. mckenzie, eds. international finance review, vol. 11, emerald group publishing limited, 2010, pp. 361-389 [32] zairy zainol and salina hj kassim ―a critical review of the literature on the rate of return risk in islamic banks‖ journal of islamic accounting and business research. vol.2, no.2, 2012. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 which is more important in terms of profitability of islamic banks: bank specific factors or macroeconomic factors? an empirical study on malaysian islamic banks * department of business administration, shahjajalal university of science & technology, sylhet, bangladesh abstract—studies of islamic banks’ profitability are an important tool towards improving performance, evaluating bank operations and determining management plan to help in increasing the chance for the banks to survive in competitive markets. the present study seeks to fill a demanding gap in the literature by providing new empirical evidence on the factors that influence the profitability of the islamic banking sector in malaysia. the research thus conducts a comparative analysis of the determinants of the profitability of islamic banks operating in malaysia. the pooled ordinary least square method is employed using annual data from the period 2007 to 2013 on 11 islamic banks in malaysia. in order to evaluate the financial performance of these islamic banksthe profitability are measured using the return on assets (roa) indicator. the empirical findings of study reveals that bank-specific factors such as the efficiency ratios (overhead costs) is negatively and statistically significant to the profitability of the islamic bank’s performance, while equity financing is positive and statistically significant to the profitability of islamic banks. the credit risks and liquidity risks factors are insignificant on the performance of the islamic banks. on the other hand, macroeconomic factors such as inflation have a positive and statistically significant impact on the return on assets whereas savings on gross national income has a statistically significant and negative impact on the performance of islamic banks. keywords-bank-specific, macroeconomic, determinants, islamic banks, roa, efficiency ratios, equity finance, credit risk, liquidity risk, inflation, gross savings on national income. i. introduction islamic finance is getting widespread acceptance all over the world and is nowadays regarded as a serious competitor to “conventional finance”. during the last three decades, islamic banking matured into a viable alternative model of financial intermediation and gained credibility as witnessed by the establishment of a large number of islamic financial institutions all over the world. (karimet.al., 2010). in service providing economies, the banks play very key role as a financial intermediaries and also considered very important for economic developments. over the last twenty years, market conditions in banking have undergone extensive changes on both demand and supply sides (sufian&habibullah, 2009). on the demand side, customers have become more sophisticated, value-oriented and price sensitive. on the supply side, the globalization of financial markets has been accompanied by government deregulations, financial innovation and automation. these two factors have resulted in an increase in the number of competitors, followed by cost reductions and profit declines. it is reasonable to assume that these forces have posted great challenges to the islamic banks as the environment in which they are operating has been changing rapidly. this could reasonably be expected to have an impact on the determinants of their performance. despite considerable development in the islamic banking sector, empirical work on islamic banks performance is still its infancy. to date, empirical studies on the performance of the banking sector in the both developed and developing countries focused on the conventional interest based banking system, while there has been almost no conclusive research done on the performance of the islamic banking sector. mohammad ashrafulferdouschowdhury* ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 ii. objectives of the study 1. main objective: the main objective of the proposed study is to identify main determinants and discrepancies of the islamic banks performance in malaysia and to find out to what extent these discrepancies in the banks‟ profitability are due to variations in endogenous factors under the control of the bank management and to what extent of external factors. 2. specific objectives: 1. to analyze and compare the financial performance of all islamic banks in malaysia from 2007 to 2013. 2. to investigate and identify the differences in the determinants of bank‟s profitability in malaysia. iii. literature review existing literature groups the determinants (factors) of banks financial performance into two types (haron, 2004): the first is the macroeconomic determinants are those factors that are considered to be away from the control of bankadministration such as gross domestic product, conventional banks interest rates, competition, regulation,concentration, market share, ownership and inflation.in the literature, empirical studies on profitability of islamic banks have paidattention on specific and some concentrated on the panel of countries. the studies usedin the literature aimed at explaining the profitability of islamic banks includesmalaysia (asma et al., 2011; ahmad and ahmad, 2004), indonesia (izhar and asutay,2007), bahrain, egypt, sudan, and saudi arabia (al-jarrah and molyneux, 2003).these studies inspect theprofitability determinants of islamic banks. the second type of the determinants is the bank-specific factors, where the size of banks, capital adequacy, liquidity, and credit risk and expenses management effect were examined. the researchers found that only the variable size of banks statistically affects the profitability of islamic banks in the malaysia (asma et al., 2011). an indonesian study conducted by izhar and asutay (2007) with aimed to determine islamic banks profitability determinants. the results of the study conclude that service activities have no effect on profitability of indonesia islamic banks and were statistically insignificant. the study results has support the positive relationship and statistically significant between inflation and islamic banks profitability. a study conducted by ahmad and ahmad (2004) that affect malaysian islamic banks credit risk. the study concludes that assets size, risky assets ratio and islamic banks management efficiency effect found statistically significant on islamic banks credit risk. in the middle east, a study conducted by bashir (2003) examined the internal variables and economic environment impact on the performance of islamic banks. the statistically significant and positive relationship founds between capital adequacy and profitability of islamic banks. the researcher also concluded from the study, foreigners owned islamic banks have ability to attain higher profit ratio then the banks locally owned. the positive impact and statistically significant relationship of inflation founds on the profitability of middle east islamic banks. a study conducted by al-jarrah and molyneux (2003) on the banks and banks sample are taken from bahrain, egypt, sudan, and saudi arabia. the researchers found that in their selected sample islamic banks are most efficient. they also concluded that islamic banks funds cost is lower comparatively to other financial institutions cost. a study by hassan and bashir (2003) examine the impact of factors on profitability of islamic banks. hassan and bashir found the statistically significant and positive effect for the loans activities ratio and capital adequacy on the islamic banks profitability. the few internal and external determinants of profitability of islamic banks wereexamined by haron (1996). the researcher concluded from his study that deposits like(current, savings, and investment) alongside capital adequacy, total expensesand liquidity shows statically significant effect on the profitability of islamicbanks, and his study conducted in 2004, haron examined the islamic banks internalvariables and conclude that variables are statistically significant effect on theprofitability of islamic banks, and also concluded that the management of islamicbanks is more efficient in the competitive environment in comparison with itscompetitors. the result differ significantly in different studies due to the variation in the data and environment used in the analysis. even though there are numerous factors affect the profitability which acknowledged by the researchers. previous studies remain in focus for the continuation of this study but differ from many aspects. the study differs because of time of the study and the used variables in the model of study and the study population. so as far as the study concern, this is the first study in its kind in the selected countries and region. iv. islamic banking industry in malaysia: in malaysia, the first islamic bank, bank islam malaysia berhad (bimb), operated as the only islamic bank for 10 years since july 1983 before the government allowed other conventional banks to offer islamic banking services using their existing infrastructure and branches in 1993 [bank negara malaysia (bnm), 1994 and 1999]. the history of islamic banking in malaysia can be traced back to 1963 when tabunghaji (the pilgrims management and fund board) was ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 established by the government. it is a specialized financial institution that provides a systematic mobilization of funds from muslims to assist them perform pilgrimage in makkah as well as encourages them to participate in table1: status of islamic banks in malaysia (source: bank scope database) investmentopportunities and economic activities. in fact, due to its uniqueness, tabunghaji is considered to be the first of its kind in the world (mohammed seidu, 2002). based on the experience of tabunghaji, the government of malaysia then introduced a well-coordinated and systematic process of implementing the islamic financial system. the process can be divided into three phases. the first phase is considered as the period of familiarization (1983-1992) when bimb was established and the islamic banking operations were initiated in accordance with shariah principles, and is also the period when islamic banking act (iba) was officially enacted. the second phase, from 1993 to 2003, was aimed at creating a more conducive environment for competition among the banks. the third phase that commenced from 2004 was the period of further financial liberalization (bnm, 2004). during that period, the central bank paved the way for new foreign islamic banks to operate in malaysia by issuing licenses. the brief status of all islamic banks is given below: v. methodlogy a. data collection: to conduct this research work, we collect the bank specific variables of 11 islamic banks operating in malaysia for year 2007-2013 from bankscope database of bureau van dijk company by using random sampling method. meanwhile, the industry and macroeconomic variables data of corresponding countries have been collected from world bank and imf financial statistics (ifs) database. the following equations are used for the purpose of the study and estimated based on „pooled ordinary least square method. no. name year of establishment 1 affin islamic bank berhad 2006 2 al rajhi banking & investment corporation (malaysia) berhad 2006 3 bank islam malaysia berhad 1983 4 bank muamalat malaysia berhad 1999 5 cimb islamic bank berhad 2005 6 hong leong islamic bank berhad 2005 7 kuwait finance house (malaysia) berhad 2005 8 maybank islamic berhad 2007 9 ocbc al-amin bank berhad 2008 10 rhb islamic bank berhad 2005 11 standard chartered saadiq berhad 2008 table 2: list of the malaysian islamic banks included in the data sample bank name country rank by assets world rank by assets, total assets mil usd 2013 total assets mil usd 2012 total assets mil usd 2011 1. maybank islamic berhad 6 539 38,110 29,896 23,769 2. cimb islamic bank berhad 16 1065 15,061 16,750 13,567 3. bank islam malaysia berhad 18 1178 13,046 12,237 10,138 4. amislamic bank berhad 20 1329 10,773 10,525 8,321 5. public islamic bank berhad 22 1351 10,505 9,582 9,268 6. rhb islamic bank berhad 23 1474 8,877 8,374 7,129 7. hong leong islamic bank berhad 24 1721 6,836 6,858 n.a. 8. bank muamalat malaysia berhad 25 1831 6,138 6,823 6,683 9. hsbc amanah malaysia berhad 26 2185 4,438 3,972 3,287 10. affin islamic bank berhad 31 2387 3,758 3,834 3,315 11. ocbc al-amin bank berhad 32 2652 3,086 2,276 1,801 12. kuwait finance house (malaysia) berhad 33 2752 2,880 2,885 3,186 13. standard chartered saadiqberhad 36 3003 2,499 2,397 1,873 14. alliance islamic bank berhad 38 3180 2,261 2,210 2,134 15. al rajhi banking & investment corporation (malaysia) berhad 39 3329 2,058 2,245 1,930 16. asian finance bank berhad 56 5177 885 919 769 17. alkhair international islamic bank berhad 62 11549 132 187 189 http://www.bnm.gov.my/index.php?ch=li_islamic&pg=li_banking_affinislamic&ac=80&cat=islamic&type=ib&lang=en http://www.bnm.gov.my/index.php?ch=li_islamic&pg=li_banking_rajhi&ac=82&cat=islamic&type=ib&lang=en http://www.bnm.gov.my/index.php?ch=li_islamic&pg=li_banking_rajhi&ac=82&cat=islamic&type=ib&lang=en http://www.bnm.gov.my/index.php?ch=li_islamic&pg=li_banking_islam&ac=26&cat=islamic&type=ib&lang=en http://www.bnm.gov.my/index.php?ch=li_islamic&pg=li_banking_muamalat&ac=27&cat=islamic&type=ib&lang=en http://www.bnm.gov.my/index.php?ch=li_islamic&pg=li_banking_cimbislamic&ac=76&cat=islamic&type=ib&lang=en http://www.bnm.gov.my/index.php?ch=li_islamic&pg=li_banking_hl&ac=77&cat=islamic&type=ib&lang=en http://www.bnm.gov.my/index.php?ch=li_islamic&pg=li_banking_kfh&ac=78&cat=islamic&type=ib&lang=en http://www.bnm.gov.my/index.php?ch=li_islamic&pg=li_banking_kfh&ac=78&cat=islamic&type=ib&lang=en http://www.bnm.gov.my/index.php?ch=li_islamic&pg=li_banking_maybankislamic&ac=88&cat=islamic&type=ib&lang=en http://www.bnm.gov.my/index.php?ch=li_islamic&pg=li_banking_ocbcalamin&ac=95&cat=islamic&type=ib&lang=en http://www.bnm.gov.my/index.php?ch=li_islamic&pg=li_banking_rhbislamic&ac=75&cat=islamic&type=ib&lang=en http://www.bnm.gov.my/index.php?ch=li_islamic&pg=li_banking_stanchartsaadiq&ac=93&cat=islamic&type=ib&lang=en ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 b. model specifications: the panel data is used in analyzing the bank‟s portability determinants. in the panel data, the used model consists n cross-sectional units, denoted n=1, ...,n, observed at each of t time periods, t=1, ...,t. in data set, the total observation is n × t. the basic framework for the panel data is defined as per the following regression model : ynt= α+βxnt+ nt here, the functional form of profitability= f (bank specific variables, macro-economic variables) econometric specifications: return on asset (roa) = α+β1 llp/tl +β2eqass+β3nie/ta +β4loans/ta+ β5lngdpgr+β6 infli+β7 m2 +β8savings to gni+ where y represents the dependent variable (return on assets (roa), independent variables: llp/tl = loan loss provisions / total assets, eqass = equity/total assets, nie/ta = noninterest expenses/total assets reflects the operation function loan/ta= total loan/total asset gdpgr = annual gdp growth rate infli = inflation rate m2 = money supply savings to gni = savings to gross national income = error term c. dependent variable: 1. return on asset (roa): following among others, ben naceur and goaied (2008), kosmidou(2008), the dependent variable used in this study is roa which shows the profit earned per dollar of assets and most importantly and reflects management ability to utilize the banks financial and real investment resources to generate profits(hasan and bashir, 2003). for any bank , roa depends on the banks policy decisions as well as uncontrollable factors relating to the economy and government regulations. rivard and thomas (1997) suggest that bank profitability is measured by roa, as roa is not distorted by high equity multiplier and represents a better measure of the ability of the firm to generate returns on its profitability of assets. d. independent variables: 1. bank-specific determinants: i) asset quality ratio (loans loss provisions divided by the total loans): the ratio of loan loss provisions to total loans (llp/tl) is incorporated as an independent variable in the regression analysis as a proxy for credit risk. the coefficient of llp/tl is expected to be negative because bad loans are expected to reduce profitability. miller and noulas (1997) suggest that the greater the exposure of the banks to high risk loans, the higher the accumulation of unpaid loans would be and lower profitability would be. ii) capital adequacy ratio-total equity by total assets ratio: the eqass variable is included in the regression to examine the relationship between profitability and bank capitalization, strong capital structure is essential for banks in developing economics, since it provides additional strength to withstand the financial crises and increased safety for depositors during unstable macroeconomic conditions. furthermore, lower capital ratio in banking implies higher leverage and risk therefore greater borrowing cost. thus, the profitability level should be higher for better capitalized bank. iii) nie/ta(total overhead expenses divided by total assets): the ratio of overhead expenses to total assets, nie/ta, is used to provide information on the variations in bank operating costs. the variable represents the total amount of wages and salaries as well as the cost of running branch office facilitates. the relationship between the nie/ta variable and profitability level is expected to be negative, because banks that are more productive and efficient should keep their operating cost low. iv) loans/ta (total loans divided by total assets): the ratio of the total loans to total assets (loans/ta) is used as a measure of liquidity risk. it is the risk of not having cash or borrowing capacity to cover deposit withdrawals or new loan applications, which forces banks to borrow emergency funds at excessive cost. thus, when the proportion of funds invested in cash or equivalent cash increases, liquidity of bank of the bank decreases. so, a negative relationship between liquidity risk and profitability is expected. in banking literature, kyriakikosmidou, saleishtanna and pasioras (2005) found a positive relationship between the liquidity risk and profitability whereas hassan and bashir (2003) ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 founds negative association between the liquidity risk and the profitability. 2. macro-economic factors: i) gross domestic product (gdp) growth rate: a gross domestic product (gdp) is the amount that most commonly used macroeconomic indicators to measure economic activity within an economy. the gdp is expected to influence numerous factors related to the supply and demand for loans and deposits. empirical results show that gdp has a positive and significant effect on the performance of islamic banks (bashir, 2003; wasiuzzaman&tarmizi, 2010), because favorable macroeconomic conditions within the country create a good environment for the banking sector. ii) inflation-infli: another important macroeconomic condition which may affect both the costs and revenues of banks is the inflation (infl). staikouras and wood (2003) point out that inflation may have direct effects ( i,e increase in the price of labor) and indirect effects (i,e increase in asset prices) on the profitability of banks. iii) money supply-m2: money supplyrepresents the amount of money in the country, and how it affects the performance of islamic banks. it could be used as a proxy for macroeconomic conditions in the malaysian economy (kok et al., 2012). kok et al. (2012) and srairi (2009)found a positive and statistically significant effect of this variable on the performance of islamic banks. the same positive effect of the money supply is expected here, and will therefore be included in this study as an external variable because money supply reflects the macroeconomic conditions within a country, which influences the performance of islamic banks by affecting the financial situation of customers. iv) savings on gni: adjusted net saving (ans) as a percentage of gross national income (gni) is derived from the standard national accounting measure of gross saving by making four adjustments: (i) consumption of fixed capital is deducted to obtain net national saving; (ii) current public expenditure on education is added to account for investment in human capital; (iii) estimates of the depletion of a variety of natural resources are deducted to reflect the decline in asset values associated with extraction and depletion; (iv) deductions are made for damages from carbon dioxide and particulate emissions. the indicator is then computed by dividing ans by gni. adjusted net saving measure the change in value of a specified set of assets, excluding capital gains. if a country‟s net saving is positive and the accounting variables positive significant negative significant insignificant hypothesized relationship bank-specific determinants capital adequacy ratio kyriakikosmidou, saleishtanna and pasioras (2005); goddard, molyneux and wilson (2004) hassan and bashir (2003) short (1979) chirawa (2003) positive/ negative liquidity ratio kyriakikosmidou, saleishtanna and pasioras (2005); maghyereh and shammout (2004) bashir (2000); hassan and bashir (2003) negative overhead expenses ratio ben naucer and goaied (2001); hasasn and bashir (2003) kyriakikosmidou, saleishtanna and pasioras (2005); guru er al. (2005) negative asset quality ratio miller and noulas (1997) negative macroeconomic determinants gdp growth rate sauders et al., (1990); baerger et al., (1995) positive/ negative inflation staikouras and wood (2003) positive money supply (m2) kok et al (2012); srairi (2009) positive/ negative ans by gni bernheim and shoven (1991) positive/ negative table 3: sketch of literature review includes a sufficiently broad range of assets, economic theory suggests that the present value of social welfare is increasing. conversely, persistently negative adjusted net saving indicates that an economy is on an unsustainable path. bernheim and shoven (1991) have found there is a positive relationship between adjusted net saving (ans) as a percentage of gross national income (gni). ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 vi. results & analysis: the study tries to find the impact of internal factors and external factors of the performance of return on assets (roaa) in the following manner: a. descriptive analysis: to analyze the result of the study, first it is useful to comment on some preliminary features of our data. table 4 shows descriptive statistics for the profitability (roaa) and the bank-specific, industry-specific and macroeconomic variables used in our model. in average, the return on average asset of 10 islamic bank used in this study are 0.48 however, the mean of all other independent variables are positive. table 4: descriptive statistics notes: the dependent variable is roa is calculated as net profit divided by total assets. llp/tl is a measure of credit risk calculated as the ratio of total loan loss provisions by total assets. eqass is a measure of capitalization, calculated as book value of shareholders equity as a fraction of total assets. cir is proxy measure for the operating efficiency of management quality, calculated as personnel expenses divided by total assets; loans/ta is used as a proxy measure for credit risk, calculated as total loans divided by total assets. gdpgr is the gdp growth rate. infli is the inflation rate. here all the variables are in ratio form except the gdpgr and inflation rate where these two are in percentage form. the mean of liquidity ratio is the largest (51.81) and varies greatly across banks (max = 77.74 and min = 6.33). in average total equity over total assets is 7.7 and standard deviation is 3.72. as of credit ratio, and operation efficiency shows a mean of 3.46 and 1.69 respectively. over the period the average gross domestic product growth rate of malaysia is 3.70%, while inflation is 2.80%. from the macroeconomic perspective, the average of gdp growth rate , inflation, money supply and savings on the gross national income are 3.7%, 2.8%, 122.03% and 36.54% respectively. in terms of standard deviation,liquidity risk is the highest from bank-specific factors and money supply is the highest from the macroeconomic factors. b. regression results: this section shows the regression analysis of islamic bank‟s profitability and its internal variables and external variables. using fixed effect model, the regression are run using e-views 8. return on average assets are regressed with 8 independent variables taken from the period of 2007-2013. the table below shows the result: variables coefficient standard error p-value bank specific variable: asset quality(loan loss provision/gross loan) 0.048689 0.064734 0.4636 capital (operational risk) 0.120792** 0.053717 0.0400 liquidity (capital adequacy) 0.006702 0.013801 0.6343 operation(cir) -0.9261*** 0.122912 0.0000 macroeconomic variable: gdp growth rate (liquidity risk) 0.009044 0.057956 0.8781 inflation rate 0.183693** 0.191948 0.0537 money supply (m2) -0.000667 0.012986 0.9597 savings on gni -0.195026** 0.079424 0.0268 constant 6.798651 2.51496 no. of observations 79 f-test 11.75 (p=0.000) r-square 0.86 adjusted r-square 0.78 table 5: regression model notes: the dependent variable is roa is calculated as net profit divided by total assets. llp/tl is a measure of credit risk calculated as the ratio of total loan loss provisions by total assets. eqass is a measure of capitalization,calculated as book value of shareholders equity as a fraction of total assets. cir is proxy measure for the operating efficiency of management quality, calculated as personnel expenses divided by total assets; loans/ta is used as a proxy measure for credit risk, calculated as total loans divided by total assets. lnta is a proxy measure of size, calculated as a natural logarithm of total bank assets. gdpgr is the gdp growth rate. infli is the inflation rate. roa cir loans/ ta capital llp/tl gdp gr. infl m2 savings on gni mean 0.47 1.69 51.81 7.70 3.46 3.70 2.79 122.0 36.54 median 0.62 1.52 54.97 6.96 2.43 4.13 2.70 125.3 36.64 max. 2.00 9.24 77.74 19.65 18.80 7.23 5.44 144.1 42.12 min. -6.84 -0.41 6.33 1.000 0.65 -9.63 0.58 64.37 30.82 std. dev. 1.19 1.53 13.81 3.72 3.01 3.799 1.32 20.2 3.081 skew. -4.59 2.33 -0.511 1.392 2.87 -2.13 0.36 -1.81 -0.0928 kurto. 26.71 11.85 3.24 4.80 12.70 7.72 2.30 5.85 2.1081 ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 notes 2: values in parenthesis are t statistics, (***), (**),(*) indicates significance at 1, 5, and 10% level respectively. the results in table 5 relate to regressing roa on both the set of bank-specific variables and macroeconomic variables. from the table, r-squared is 0.86, which shows that about 86% ofindependent variables explain the dependent variable roaa. the adequacy of a model as predicting isvalidated by the f-test. as indicated in table 6, the value of f-stats is statistically significant which hasconfirmed that the models applied are useful for measuring the relationship between roaa and independentvariables. since the data has been normality distributed and there is no multicollinearity, it can be be said that the hypothesis testing based this model are correct. as it is mentioned early 4 bank-specific variables are used in this study. however, the result shows that capital adequacy ratio i,e equity to total asset ratio and operational efficiency ratio (i,e non interest expense/total assets) have a significant impact on the profitability of islamic banks in malaysia. the other two variables such as liquidity and asset quality have no statistically significant relationship with dependent variable roa at 5% and 10% significant level. referring to the impact of overhead costs on islamic bank profitability, nie/ta exhibit negative and significant impact on the profitability of islamic banks even at 1 % significant level. this result implies that increase (decrease) in these expenses reduces (increases) the profits of islamic banks operating in the malaysian banking sector. pasiouras and kosmidou( 2007) and kosmidou(2008) among others have also found poor expenses management to be among the main contributors to poor profitability. clearly, efficient cost management is prerequisite for improved profitability of the islamic banks. the level of capitalization (eqass) is positively related to islamic bank‟s profitability. it indicates if there is 1% increases in the level of capitalization, the level of roa will be increased by 0.12%. this empirical finding is consistent with berger(1995), goddard et al. (2004) and supports the argument that well-capitalized banks face lower cost of going bankrupt and thereby reduce their cost of funding. strong capital structure is essential for banks in developing economies, since it provides additional strength to withstand financial crisis and increased safety for depositors during unstable macroeconomic conditions. furthermore, lower capital ratios in banking imply higher leverage and risk, and therefore greater borrowing cost. thus it is reasonable to expect that the profitability level should be higher for better capitalized islamic banks. in addition, based on the two macroeconomic variables used in this study gdp growth rate and inflation, only inflation has a significantrelationship with profitability. here, inflation is positively related to islamic banks profitability, implying that during the period under study the levels of inflation were anticipated by the islamic banks. perry (1992) suggests that the effect of inflation levels on banking performance is positive if the rate of inflation is anticipated. anticipating inflation levels gave the banks the opportunity to adjust the profit rates accordingly and consequently to earn higher profits. the results about gdp growth rate and islamic banks profit ability are consistent with the results of hasan and bashir(2003)supports the arguments for a positive association between growth and banking sector performance . however, this study shows a positive but insignificant relationship. vii. concluding remarks & future implications: the islamic banking sectors in malaysia have undergone noteworthy reforms. despite considerable development in the islamic banking sector, empirical work on islamic bank‟s performance is still in fancy. the empirical findings of this study suggest that bank specific characteristics , in particular capital adequacy i,e equity financing has a positive and significant impact on the banks performance, while operational efficiency such as overhead expenses are negatively related to islamic bank‟s profitability. in this case the islamic banks should increase the portfolio of equity financing rather than the debt financing. it means islamic banks should increase the partnership contract like mudaraba, musharaka contract where risk sharing principle can be established. islamic banks in malaysia are ought to reinforce their equity in order to decrease the likelihood of bankruptcy and increase their size to benefit from the economies of scale. moreover, banks should improve the management of their loans with respect to total assets via better screening and monitoring of credits. islamic banks should manage their costs efficiently with respect to income to get the best return on asset. as we have found that the macroeconomic factors such as inflation and savings to gni plays an important role in the profitability of islamic banks. this is why; islamic banks should also concentrate on the exogenous factors so that they can earn more profits. finally, future research could include more variables such as taxation and regulation indicators, exchange rates as well as indicators of quality of the offered services. another possible extension could be the examination of differences in the determinants of profitability between small and large or high and low profitability banks. viii. references [1]ahmad, n. h. and s. n. ahmad (2004). 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(2012). the determinants of islamic banks profitability in malaysia, universiti tunku abdul rahman. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 37 islamic banks and the european banking union: an overview of critical issues and perspectives 1 university of rome 2 “tor vergata” (italy) contact the author: sandra.antoniazzi@uniroma2.it abstract— the aim of this paper is to provide a general, but indepth overview of aspects of incompatibility and actual interest profiles of islamic finance in relation to the legal system of the european banking union, identifying some prospects for positive future developments. it examines the relevant islamic principles for banking and the differences from conventional european banks for regulation and supervision, a number of experiences and possible relationships. the modern communication between the islamic banking scheme and the european (and international) one is certainly allowed by the activity of the ifsb regulator, especially as regards the adaptation to the basel committee standards and the related capital requirements, transparency criteria and common references, considering the global application to operate in the international markets. the examination of the relationship with the european banking union allows the identification of future profiles for debate and research in economics law, considering the suitability for regulatory adjustments and the interaction between eu and national law and the interesting ethical aims of the socially responsible islamic finance. keywords: islamic finance, islamic banking, european banking union, regulation, supervision, transparency, certainty of rules, comparison, perspectives i. introduction in europe, for several years now, there has been a significant growth of interest in islamic finance and banking for investment companies, islamic bond products and other credit collection instruments. very significant was the position of the financial service authority which, in 2004, issued an authorisation to operate to the islamic bank of britain [1] and to the first european islamic investment bank. other european countries have experimented with islamic financial products, albeit in a limited way [2]. in this context, it is interesting to look further at the possible relations between the conventional bank model that operates in the eu market and the islamic bank that follows criteria, including ethicalreligious ones (e.g., the prohibitions of riba and gharar), but with issue regarding risk control and data transparency, regulation and prudential supervision [3], especially in relation to the current european system, capital requirements and the basel iii agreement. the age-old question of the prohibition of interest is also known in conventional banking, in the sense of considering the difficulties of the weak contractor for elementary forms of lending; moreover, the reference to the prohibition of usury and to the forms of protection provided by the national systems that extend to the various forms of traditional operations is inevitable, while for the issue of supervision and risks, the evolution has been very different until the appearance of european banking supervision. from the islamic perspective, instead, the mechanism of pecuniary interests has been replaced by the “sharing” of the creditor in the profits and risks of the banking activity. in essence, the result of profit can be achieved through sophisticated legal constructions (shareholdings, investment funds, linked contracts) also to encourage credit, given that banks use credit in commercial operations, or with the affirmation of ethical justifying principles linked to necessity or the common good. in addition, the prohibition of gain (gharar), based on uncertainty for reasons inherent in the value of the asset for speculative purposes or when the asset is not determined for the contracting parties and, therefore, the contract is qualified aleatory, involves an element of risk and uncertainty that is, instead, central to contracts in european (and international) financial markets [4]. a derivative financial product is, of course, an instrument that “derives” its value (price) from that of an underlying financial asset. derivatives are intended to sandra antoniazzi1 https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 38 hedge business risks (e.g., foreign exchange options to hedge foreign exchange transactions between importers and exporters), but are currently mainly used for speculation on future price movements, as the value of derivative contracts consists of multiples of the actual economic transaction. these financial instruments certainly do not meet the requirements of linkage to an asset and the character of “non-speculation”; conservative shariah scholars argue that the prohibition of gharar eliminates speculation on interest, options and some conventional insurance contracts because they conflict with the prohibition of uncertainty and wagering (maysir), even if there is a hedging of an underlying economic transaction [5]. the main ways of collecting credit consist of current accounts for the management of payments, for which interest payable and receivable are foreseen and repayment is only guaranteed, and in savings deposits for which there is no form of guarantee regarding the return or the repayment of capital, but a share of profit paid periodically [6]; the other collection instruments, traceable to forms of co-participation or partnership mudàraba and mushàraka [7], muràbaha [8] are clearly different from bank deposits. for the well-known principle of the prohibition of interest, there are further particular rules in the islamic banking model [9]; it is based on precepts of the shariah: the prohibition of investing in activities forbidden by koranic law and in speculative activities, the sacredness of the contract and the obligation to pay the zakat, which is a religious tax; moreover, these principles also apply in the securities market [10]. therefore, the model of the islamic bank, precisely because of its necessary conformity to ethical-religious values, is conditioned in several respects: in investments, the bank must ascertain the credibility of the projects, the entrepreneurial skills of the client and the ethical character of the financed operation with regard to the aims; thus the collection of savings must be ethically consistent and the objective is obviously to attract the interest of savers, even if no interest is paid, through investment funds with participation in the profits according to pre-established conditions. as we known, the islamic banking has adopted the basel iii standards, a solution that revealed a significant regulatory challenge, given that the agreement does not consider the specificities of islamic banks and islamic products present various profiles of incompatibility with the european (and international) markets [11]. the context is complex and islamic banks are required to be adequately capitalised to inspire trust and maintain sufficient liquidity under basel iii, like european banks, in order to protect depositors and avoid expensive governments “bail-outs” in the case of defaults. besides an increasing number of islamic funds screen equity investments to ensure they are permitted and there are even indices tracking shariah compliant stock, most notably the s&p dow jones islamic indices. this framework suggests a reflection on the sector in relation to the european banking union, in order to identify conflicting legal profiles, and to highlight the need for specific european and national rules and compatibility aspects especially considering sustainable finance. the aim of the research is to outline legal considerations regarding the prospects for the establishment of islamic banks and the use of financial products; the results that emerge may provide a reference for future research. ii. literature review the article adopts an interdisciplinary analysis between law and economics, in the sense that the legal reflection cannot disregard decisive economics studies. the literature cited in the “references” section shows jurists have not confirmed a particular interest, beyond the episodic in the context of conferences, especially in the italian legal system or the initiatives of financial institutions (ecb, bank of italy). the results of economic studies make it possible to acquire an adequate awareness of the affirmation of islamic finance in the international markets and of the reasons for its necessary consideration in relation to the european legal systems. it should also be pointed out that the role of lawyers depends on the existence and interpretation of disciplines or at least the adoption of bills; as is well known, there are not european rules for islamic banking, but individual experiences of some european countries. from the bibliographical references emerge a clear minority of law studies and an extensive panorama of in-depth studies by italian and foreign economists who analyse the relevant presence in international market of islamic finance from several points of view. predieri was the first italian jurist to deal with islamic banks in essays in 1996 and 2006 with the broader aim of fostering knowledge of islamic law and contributing to cultural enrichment; piccinelli also follows this line, focusing on legal instruments. since 2006, some authors (donato, donini, freni, gimigliano, miraglia, piccinelli, porzio, rotondo, russo, santoro, scolart, casoria) have explored the topic from an interdisciplinary perspective, above all, in several collective volumes, often containing conference proceedings that highlight the intention to solicit further studies. however, the debate has not had much follow-up among italian jurists, while there has been more interest in other legal systems. there are also some contributions from foreign lawyers (aldohni, al-rimawi, ariff, arnaud, decock, engels, farook, housby, lewis, sagaert, wilson, knan, et al.) dealing with the differences between conventional and islamic banking systems, also with reference to the european union and the experience of the united kingdom. undoubtedly, the most numerous and specific studies consist of economics studies by many foreign (abbas, abiad, ahmed, aracil, ariff, asad, ashraf, asutay, chazi, ginena, gintzburger, hassan, khallaf, khavarinezhad, jafari-sadeghi, khan, zamir et al.) and italian authors (biancone, calandra, colecchia, floreani, miglietta, paltrinieri, prandi, lanzara et al.) who addressed various aspects of islamic finance: the response to the crisis, capital requirements and the application of basel iii, risk exposure of gcc banks and activities in the european context as well as sustainable finance profiles. https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 39 in this survey, the law and economics studies, reports and publications of the islamic financial services board (ifsb) [12] represent crucial references for an overall knowledge of the sector and regulation aimed not only at shariah compliance, but also at aligning islamic banks with international standards acquired by the european banking union and the single supervisory mechanism. this article could help fill a gap in law studies on possible relationships between the european system and islamic banking industry. iii. methodology the method of investigation adopted consists in comparing the typical legal principles and the economic aspects of islamic finance and the european banking union and national law, in order to verify whether the establishment of islamic banks and investment companies is conceivable or whether, for reasons of structural incompatibility, the current european regulations and organisation can only admit the offer of islamic finance products by conventional european banks. more precisely, the method of comparative law [13] allows a comparison of the relevant aspects of the two sectors of banking activity that belong to different law systems, examining the european discipline and the principles of islamic finance in order to identify possible areas of “coexistence” in the same system. the survey draws on the contribution of the extensive economics literature cited in the “references” section which has supported the study of legal profiles, in the light of the modern interdisciplinary research that is indispensable in such complex areas. in fact, for the field of islamic finance, economic studies are prevalent compared to the limited interest of european jurists. the difficulty of finding legal scholarship conditions the debate, which focuses mainly on the economic consequences and less on the construction of legal instruments for operational adaptation in the european banking system. in fact, lawyers tend to examine disciplines that already exist in the system of reference, the possible changes or bills; in this case there are no specific rules of european law, but there are general principles and individual experiences of some european countries that have allowed the use, within certain limits, of islamic financial products. economic studies, on the other hand, can evolve by examining global economic phenomena using case study criteria and empirical analysis of the activities of operators according to international standards. the approach is more open, and the object of the research concerns the economic consequences of existing legal schemes, which can provide an interesting basis for legal reflection, especially when a sector, such as islamic finance, is so widespread that it cannot be ignored by european legal systems. iv. findings and discussion a. the comparison with the european conventional banking system and differences relations with conventional banks are difficult because of the characteristics of islamic finance and banking activities exercised in the eu context according to different rules for the financial intermediary, above all, considering the management of the risk, to the rules of vigilance and to the regulation of competition. for the intermediary from the islamic discipline, the implementation of transparency depends essentially on the respect of conduct provided by the supervisory authorities and by the shariah guarantee committee for an ethical control, while the informative obligations depend on the discretion of the bank with inevitable problems of transparency and certainty of the rules. however, the ifsb has contributed significantly to improving relations with the conventional banking system. a central aspect that must be examined is the compatibility of the islamic banking activity with the european supervision discipline, on the requirements of liquidity of the capital and on the financial system in order to envisage a framework of admissible relations. in general, as we have seen, the principle of participation which is linked to the sharing of the risk characterises islamic banking activity and because of its structure it is not linked to an obligation of guarantee for the capital deposited and funds reimbursement, a substantial aspect which is not compatible with european banking discipline and the requirements of capital liquidity, especially after the innovations of the banking union. however, it is necessary to distinguish between the regime of free and participating deposits and, in fact, only the latter can be affected by losses, if the bank is not able to meet them with its capital reserves. moreover, it is necessary to point out that the location of the bank, be it islamic or conventional, conditions the applicable discipline in the relative order; the purposes of the bank deposit are different: in the islamic system, the capitalsation of savings and the guarantee of preservation, while in conventional banks the deposit has represented, at least until the financial crisis and the drastic reduction of interest rates, also a solution of investment and short-term savings [14]. an immediate comparison [15] between the two systems shows the different nature of the discipline: since for conventional banks the functions and operating procedures are provided for by european and national laws and standard rules, while for islamic banks the reference is the shariah to which the production of profits must conform, an objective common to the conventional bank, while the main function is different, which in the first case consists in participation in partnership activities and in the second in the intermediation of funds. the relationship with clients is a three-way one, i.e., between investors, partners and intermediaries, which is different from the “traditional” one based on the creditor/debtor dynamic; as for interest, this is not applicable as it is contrary to the rule of risk sharing between depositors and custodians of funds, unlike our system which provides for active and passive interest rates as a return and costs to be https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 40 incurred for the deposit. the approach is also different for the phase of verification of admission to projects financing, since the islamic bank gives importance to the feasibility, while the conventional one gives priority to the reliability of the applicants and financing based on the provision of guarantees. in the event of defaults or delays, the islamic bank cannot set interest or other charges, a rule that is, instead, general in the conventional scheme, and neither would there be an obligation to fully guarantee deposits, an issue that has been the focus of attention in the eu and in the choices of the ecb until the introduction of a single mechanism for the resolution of banking crises (reg. (ue) 15 july 2014, n. 806; directive (ue) 15 may 2014, n. 59). in any case, the obstacle of the prohibition of interest has prevented easy access to the interbank market and investment in “conventional” securities precisely because of their intrinsic nature of referring to interest-based return mechanisms. however, specific forms of investment and credit collection have been developed for issuance, consisting of transactions, especially in mutual funds, in participatory corporate contracts and in the issuance of bonds and sukuk, which are bonds deriving from the securitisation of portfolios of contracts, and in participatory current accounts. islamic bonds are issued by the state or other public entities according to the scheme of securitisation of public assets through sale and lease ijarah. in the mutual fund, the holders of the shares entrust the management of a capital to a specialised operator who is entitled to a fixed amount of the profits deriving from the management and the investor is entitled to a share in profits and losses proportional to the amount conferred, based on the trust agreement between bank and depositor. the management of the fund can also take place through a company, which is responsible for the correct administration of the investments in compliance with the islamic discipline and the directives of the body (committee or council) in charge of monitoring compliance with the ethical rules and for any financial losses from which an obligation of compensation generally derives [16]. b. islamic banking and european banking union the islamic bond market has gained significant consideration even among conventional investors as well in the last decade precisely because these instruments are linked to material assets and, therefore, with a high degree of security [17]. not only muslim investors are involved, as they formally conform to islamic principles, but also european ones, given the financial crisis caused mainly by the circulation of instruments that have unsafe mechanisms, based as they are on interest and debt. indeed, these securities are currently traded in the largest secondary markets mainly because of their security qualities. the growth of islamic banking can certainly be traced back to the spread of investment funds and islamic bonds; the establishment of the islamic bank of britain [18], which is an expression of this evolution also by means of innovative management methods in order to acquire credibility in the markets, notwithstanding its very particular and distinct framework compared to conventional banks. regarding taxes, the legislation in the uk facilitated the practical implementation of traditional models of acquisition avoiding interest, which are compatible with islamic law. new rules have been implemented to levy the stamp duty only once in cases of islamic mortgages and at first hsbc amanah first offered such islamic mortgages, with other banks following suit. however, it is necessary to highlight the problematic issues of compatibility with the conventional market, regulation in the classical sense and the necessary transparency of requirements, when islamic banks operate in european countries. it is necessary to consider the supervision exercised by the ecb and national central banks, according to the approach of european banking supervision (reg. (ue) 15 october 2013, n. 1024 and reg. (ue) 16 april 2014, n. 468 and related disciplines) and many rules (basel iii, eba) that impose obligations of capital requirements and procedures of necessary transparency (e.g., the “stress test” for banks) about aspects of accounting and internal decisions that can only be based on the adoption of technological innovations for communications between the operators involved. islamic finance schemes present interesting aspects from the perspective of a sustainable and socially oriented finance, but the critical issue is the certainty of the rules and their effective knowability through widely available technological tools. it is, therefore, necessary to have a high level of transparency in internal controls by the council of shariah, which plays a role analogous to the ethics committees, but according to islamic ethical-legal rules from which derives a certain unpredictability in the application of rules of conduct by way of interpretation. moreover, a certain uniformity of rules would be necessary, given the obvious differentiation according to the countries of origin, an objective in theory constantly affirmed by the gcc, but difficult to implement even for the discipline of competition [19]. the islamic bank is, however, for certain activities, certainly comparable to a conventional credit institution, but for further services of a financial nature, problems of vigilance arise and for the collection of credit “at risk”, there is a need for greater transparency also for the savers, especially for european investors. from the mudàraba and mushàraka schemes derives a significant involvement in the business risk of the bank and, therefore, adequate supervisory measures are necessary. in the case of mushàraka, the partnership contract between bank and client foresees that the capital in goods or liquidity derives from both and allows the control to actively participate in the project [20]. moreover, the need for an organisational separation of the activities of the bank is also envisaged for the islamic bank, in order to avoid possible conflicts of interest between the parties involved in the business, like the universal bank scheme [21]. c. tasks of islamic financial and banking authorities the islamic financial activity has, therefore, objectives of an economic nature (preservation of the capital, profits, https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 41 equilibrium between liquidity and profitability) and ethicalreligious rules (respect for the precepts and standards of behaviour of the koran and of the shariah, considering the legitimate goods halal and excluding the forbidden haram activities). moreover, the concept of cooperation replaces the traditional concept of competition in the market mechanism, which is instead central in the eu. the difficulty of “translating” ethical-religious or, at least, moral principles into rules of prudential supervision, which in the international market must be compatible with the requirements of basel iii, is evident, in addition to the uniform european framework for member states. furthermore, there is the necessary availability of information that can be acquired by financial intermediaries and investors, a condition favoured by technological innovation and tools in the most advanced countries along with the establishment of competent authorities. the schemes of islamic finance present characteristics that seem, in effect, to favour economic and social sustainability; however, the risk of unpredictable interpretations adopted by the shariah supervisory committees is still an element of significant perplexity, especially if we consider the essentiality of legal certainty and reliability of the financial products, after various crises for different reasons. the current solution represents a delicate compromise between the acceptance of international standards and the objective of shariahcompliance activities. the national islamic banking supervisory authorities must guarantee the stability of the financial system according to two objectives: the control of capital requirements with international indications and the modalities of activity that must be shariah-compliant. this stability depends on ensuring that islamic banks have systems in place to control requirements and internal shariah governance policies and processes to identify, monitor and control or mitigate shariah risk as a result of interpretations that may be inconsistent. as regards the relationship between liquidity and credit risk, some studies have compared islamic banks and conventional ones and revealed that the former are better than the latter in managing risks [22]. in addition, a further objective of financial regulation is the protection of consumer rights that may be affected by the proposed instruments, and it is essential that islamic banks ensure fairness and diligence in their operations and compliance with shariah precepts, as depositors are attracted to these institutions primarily for their ethical and religious principles. thus, the ifsb advises supervisors to provide banks with a framework of uniform internal rules to enable shariah compliance, although supervisors will inevitably have differing views on shariah governance given the different legal systems in which the banks operate. in addition, the ifsb ascertains the different needs of individual banks, which vary depending on different factors such as size and capital requirements; regulators should ascertain whether banks have control systems in place to ensure shariah compliance. to this end, the ifsb has developed some guiding principles on requirements for the distribution of islamic products in the capital market, for sukuk and collective investment schemes. the focus issue is the implementation of good practice in financial reporting and the establishment of an independent auditing systems and the task for any supervisory body can be made more manageable by learning from the experience of others and by applying available standards and guidelines. in this sense, the basel iii rules have contributed significantly. at the same time, it is possible to say that islamic finance schemes may contribute generally to spreading an economic approach of solidarity. d. the relationship of the gcc countries with the ecb and some limited experiences of islamic finance in eu member states from 2005 onwards, it is possible to identify frequent contacts between the eu and the gcc, managed by the general secretariat [23], and requests for specific advice to the ecb on the single currency project, which was planned for 2010, highlighting the european experience as a model to be followed for the establishment of a centralised banking entity, price stability, and fiscal and monetary convergence parameters [24]. however, links and political relations between the gcc and the eu date back to 1988 and a cooperation agreement, which provided for advice, mutual dispatch of delegations and annual meetings of ministers in sectors such as energy, transport, research and innovation, and the eu-gcc clean energy network and the eu-gcc trade and business cooperation facility. at present, the objective of the single currency is postponed or at least suspended, given that there are no recent definitive decisions in this direction, to which have to be added the problems of agreement between the various countries, especially for the international policy guidelines that have created diplomatic difficulties. decisive decisions are still being awaited on monetary union, while for the financial markets the european discipline has already influenced regulation well beyond its natural boundaries of application due to the need for necessary harmonisation in order to encourage investment, despite the critical aspects. in fact, in the adopting standards, the ifsb, which includes gcc banks, has inevitably further rooted the european schemes as an experience of best practice in conventional markets, initially considering the directive 2003/71/ec (on trading in financial instruments), the transparency of issuers’ information directive (2004/109/ec), the ucits directive 2009/65/ec (regulation of undertakings for collective investment in transferable securities) and, subsequently, the most recent regulations in force, as well as the criteria adopted by the basel committee for european and international standards. the cooperation of the ecb with non-eu countries has therefore also involved gcc countries, as it has strengthened relations with the general secretariat, central banks and monetary bodies of the member states since 2005, particularly with a view to introducing a single currency. instruments have also been developed to enhance cooperation with the major https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 42 central banks of many non-european states, including those of the gcc and their monetary authorities, through specific seminars [25], technical assistance and guidance, including through the contribution of expertise in the conduct of monetary policy, payment systems and banking supervision, as a “source of inspiration” for various systems. this advisory activity is part of the institutional tasks as provided for by article 5 of the statute of the escb-ecb (protocol no. 4); for the collection of statistical information, the ecb “shall cooperate with the institutions, bodies, offices or agencies of the union and with the competent authorities of the member states or third countries and with international organisations” (article 5.1.) while article 6 refers to international cooperation and participation in international monetary institutions. the ecb cultivates international relations [26] for cooperation with countries outside the eu; in particular, the article 8 of reg. (eu), 15 october 2013, no. 1024, on banking supervision, provides for the possibility for the ecb “to establish contacts and enter into administrative arrangements with supervisory authorities, international organisations and administrations of third countries, subject to appropriate coordination with the eba. these agreements do not create legal obligations for the union and the member states”. this provision, which also allows for forms of cooperation in prudential supervision, may help to expand relations with other systems, especially in the exchange of information and the adaptation to common international standards. in addition, a regulatory convergence between the eu, the gcc and other islamic countries is necessary for the establishment of islamic banks in europe regarding the prerequisites for banking authorisation (articles 4.1 (a) and 14, reg. (ue), no. 1024/2013), capital requirements, safety nets, independence and powers of supervisors. in fact, eu law and national legislation provide for rules on administrative and decision-making bodies in a way that is far removed from the presence of the shariah board. islamic financial instruments have been offered on the market for some time; in 2004, in the united kingdom the islamic bank of england obtained its authorisation, in 2006 sukuk was listed on the stock exchange and in 2014 saw the widespread issuance of islamic bonds with a specific discipline, as in luxembourg; while in 2004, germany, the land of saxony-anhalt decided on the issuance of sukuk as in france [27]. in europe, the financial sector considers the needs of muslims with some solutions, apart from the older case of the united kingdom, now no longer part of the european legal framework, due to the significant presence of a very traditionally oriented muslim population. in germany, there is a significant experience: the kuveyt türk beteiligungsbank (frankfurt) which obtained a licence as a deposit and investment bank in 2015 after an experience that began in 2004 [28], through a german bank that allowed the knowledge of islamic finance, along with some national regulatory innovations. other jurisdictions have introduced a special tax regime for islamic investors for specific products. stock exchange values are currently listed in the dow jones islamic market and ftse global islamic indexes. european banks already distribute shares in islamic equity funds for financial investments that exclude companies involved in gambling, alcohol, tobacco or interest-bearing loans. the development of islamic finance has depended on its significant reliability and resistance to financial crises (2007/2008 financial crisis period) due to its low indebtedness and use of operational instruments that are based on real assets. certainly, financial products are more expensive as sharing entails control costs, problems of information asymmetry and property management. for an effective contribution to sustainable finance, a common regulatory and supervisory system is needed to ensure transparency and certainty, as well as contracts with clear content, especially considering the link between law and moral principles in order to limit legal risk as much as possible. however, there are critical views regarding the tendency of islamic financial institutions to offer products and services that are in essence similar those offered by conventional institutions and to try to come up with new ideas to remain competitive as a viable alternative to conventional finance; at the same time islamic financial experts must ensure their islamic character [29]. financial transactions are guaranteed by assets and risksharing and transactions have real purposes (concrete and productive activities, real estate), limiting financial speculation; moreover, some recent reports [30] on islamic finance reveal prospects for growth, despite the difficulties caused by the pandemic [31]. these aspects are of considerable interest to european legal systems as an opportunity and alternative source of financing. in europe, there is a significant presence of “islamic counters” that have opened in conventional banks for depositors wishing to implement religious principles, but regulatory innovations must be introduced for supervision and regulation, in the sense that the eu member states where these banks are located should adopt their legislation considering all the potential risks in relation to this new financial activity. these perspectives also appeal to the italian system, on the assumption of appropriate regulatory changes necessary to overcome tax issues and incompatibilities with internal rules, in order to encourage the establishment of islamic banks, especially in the form of investment banks, while european advisory companies are already widespread. in 2010, a seminar, organised at the bank of italy, brought together gcc central banks and monetary authorities to examine financial and economic developments in these countries and in the euro area and the consequences of the global financial crisis for stability and monetary policy. a relatively favourable economic experience emerged, especially in comparison with advanced economies and emerging markets. the gcc region was seen as a major player in international financial markets, engaged in the efforts of the international community to reform the global framework for financial stability and banking supervision [32]. https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 43 later, in 2013 at the ifsb forum in rome at the bank of italy, the governor ignazio visco focused attention on the interest for islamic finance and the opportunity to attract foreign capital to underpin economic progress and the intensity of the commercial and financial links with the southern shores of the mediterranean and make it increasingly important for italy and its financial system to be equipped with the knowledge and the operational instruments needed to interact with financial systems complying with shariah principles: the principle that profits should be generated from fully sharing in the business risk of an investment, the socalled “profit and loss sharing principle”. the asset-banking requirement complements these prescriptions, providing for the link between each financial transaction and an identifiable underlying asset, but it has to be clearly ethical and certainly transparent. the offer of islamic financial products is characterised by high growth rates and the most relevant component is banking, but in non-islamic systems an adaptation of traditional and fiscal schemes is required. the italian legal system shows a limited and slow interest in these alternative financial instruments, compared to other european countries. bill no. 4453 of 2 may 2017, presents provisions concerning the fiscal treatment of the operations of islamic finance, given that a decisive obstacle to the expansion of islamic finance in italy consists in the “duplication” of taxation because of the complex structure of the operations to ensure compliance with the shariah, with an aggravation of fiscal costs in comparison with the instruments of conventional finance [33]. the objective is to “assure a taxation equal to that of the conventional financial operations” (article 1), in order to attract foreign investments and depositors from the muslim community in italy who already hold a high amount of savings. the “constant monitoring” will certainly have to be extended and supplemented by specific rules of regulation and supervision to be included in the current system. at present, the project is still assigned to the vi finance commission, but there have been no further developments. the slowness of the italian legislator has led some banking operators to consider the possibility of offering shariahcompliant products through “islamic windows”, i.e., special branches created in conventional banks. regulation appears to be a very important issue, in order not to exclude from access to credit a sector of the population corresponding to at least one million residents, both for social reasons and for evaluations of credit support and incentives for investment funds. e. the role of the ifsb the context of reform of the international rules and global difficulties have undoubtedly aggravated the relevant complexity of the multiple tasks carried out by the ifsb as regulator and supervisor of the islamic banks in the system of natural belonging and as an authority that adopts the choices of necessary alignment to the conventional system for obvious interests in international markets. this organisation promotes and enhances the soundness and stability of the islamic financial services industry by issuing global prudential standards and guiding principles, broadly defined to include banking, capital markets and insurance sectors. the respect of punctual constraints of capital is a further controversial aspect, given that for the islamic banks the prevailing limits consist in ethical rules of the shariah, in addition to the evaluations of control of merit which depend on the interpretation of the shariah, exercised by a council (or committee) of the shariah, and limits for the liabilities in the balance sheet. however, in addition to these forms of ethicalreligious control, there is also the regulation of islamic banks for the aspects that are linked to risk and capital requirements. in this context, the ifsb has taken on a decisive role, established in 2002 and operational since 2003, precisely because of the particularity of the requirements of financial institutions, which involves several banks in the arab countries of the gcc and which provides international standards and obligations comparable to those provided by basel iii and the discipline on banking supervision. indeed, the ifsb has published standards, guiding principles and technical notes covering various regulatory aspects for islamic banking markets, insurance markets and financial markets. the ifsb is an international organisation aimed at introducing standards, promoting and enhancing the soundness and stability of the islamic financial services industry by issuing prudential rules and guiding principles for the financial services industry (banking, capital markets and insurance sectors). the standards developed derive from a complex process specified in guidelines and standard-setting procedures, which are characterised by the issuance of exposure drafts, the conduct of workshops and public hearings. in addition, the ifsb prepares very concise annual reports, conducts research and coordinates initiatives, roundtables, seminars and conferences for regulators and industry participants and for these purposes it cooperates with international, regional and national organisations, research institutes and market participants, as a “dialogue” entity with the conventional banking system. the ifsb standards follow a comprehensive due process as outlined in its guidelines and procedures for the preparation of standards/guidelines; it involves the issuance of exposure drafts and carries out workshops and public hearings, research, conferences for regulators and stakeholders [34]. these activities are carried out in cooperation with relevant international and national organisations, research entities and market players. the islamic financial services industry stability report 2021 [35] offers a selection of results from the ifsb international research and surveys to achieve a broader and common understanding of critical issues in islamic finance. in line with governments and regulators in other countries engaged in economic recovery and the adoption of fiscal and monetary measures, the ifsb has been engaged in analysing the most effective interventions to support the banking sector and sustained its growth momentum in 2020 recording a growth rate of 10.7% year-on-year based on significant https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 44 improvement, especially in the islamic banking and capital markets segments. the financial stability indicators remained satisfactory, especially when compared with previous years’ performance, conventional peers, and assessment criteria used by international standard-setting bodies. the ifsb closely monitors developments in the global financial system generally and specifically in the jurisdictions of its members; it has published a compendium of policy responses and a paper on the impact of the pandemic on the islamic financial services industry (ifsi) and several standards, guides and technical notes to complement the work of other international standards but also to cater for the specific tasks of the ifsb. the analysis conducted on the islamic banking segment is based on the prudential and structural islamic financial indicators (psifi) database of the ifsb, which has extended coverage of the database to both the islamic capital market and takaful segments from 2020 onwards. the report examines the implications for the soundness and resilience of the global ifsi and recent economic developments and changes in the global financial system, with a particular focus on the pandemic. the 2021 report presents an overview of the vulnerability aspects and the outlook of the global islamic financial services industries and ifsb members regarding the three key sectors: islamic banking, the islamic capital market and islamic insurance that are objects of an in-depth analysis based on data from the prudential and structural islamic financial indicators database of the ifsb. this document provides an indicative outlook for the ifsi, which makes it a prime reference for information on the stability of islamic finance globally and across national systems. the developments and significant economic impacts depend on the widespread public health measures for the global pandemic, an external shock that did not affect the banking sector. however, the economic and social impacts have affected the stability of financial systems. the islamic social finance sector can promote stability by diversifying the financial system and indirectly by financial and social inclusion through providing inclusive financial services for poorer people. this financial sector could complement the commercial financial sector through the zakah and waqf that can provide stable funds to tackle the adverse impact of negative shocks such as the pandemic. the zakah is a percentage of wealth a waqf represents in social capital that is relatively stable during negative shocks, and they provide support to people in need [36]. covid-19 has impeded the achievement of many goals, but it has also highlighted the need to make significant changes. according to the report, in this regard, islamic social finance needs to transform to become more effective and resilient in order to help promote the development of sustainable and stable economic, social, environmental and financial systems. as in the european system, economic support measures and macroprudential policy measures [37] helped to improve financial conditions and to mitigate any potential financial stability risks that remained relatively resilient with significant differences in several countries. reading the report reveals the islamic banking and islamic capital markets sectors contributed to the increase in total worth of the global ifsi, while takaful sector experienced a slight contraction; otherwise, the ifsi demonstrated overall growth in 2020 despite many systems experiencing economic recessions as a result of lockdowns and heightened uncertainty due to the pandemic [38]. for example, the gcc countries maintained their position as the most important market for islamic finance activities in 2020 and the middle east and south asia region is the second largest share remaining consistent with the previous year. the data emerging from the report do not seem negative, if compared to the european experience and if we consider the level of transparency adequate; however, adjustments are also needed to participate in the european market. the countries examined, although they share an islamic approach to the economy, also have very different situations in the financial sectors, due in part to differences in internal regulations, profitability levels and the market for available energy resources, as the report clearly shows. for a useful comparison of compatibility with the european system, it is therefore necessary to examine the commitment to the basel iii standards. the report considers the basel committee programme and strategic priorities for 2021-2022 that focused on implementation and evaluation; it will complete existing work on the prudential treatment of cryptocurrency exposures about which a consultation document was published in june 2021 and on disclosure requirements related to market risk and sovereign exposures. in particular, the report specifies that disclosure requirements may have some impact on future ifsb standards, confirming the direct influence on islamic banking system. in 2020-2021, international entities in the banking, securities and insurance sectors issued several documents (reports, consultations, standards, survey reports) that are relevant to the tasks of the ifsb, and show global developments and the impacts of new choices also as a result of the pandemic. the ifsb, “being the complementary global standard setter” for the islamic banking, capital markets and takaful sectors, monitors standards and guidelines of these global authorities (basel committee on banking supervision, international organisation of securities commissions, financial stability board, international association of insurance supervisors). their activities and standards have been seriously affected by the pandemic; in fact, some entities have done significant short-term work in response to it, for example, by providing members with access to information on measures taken in other jurisdictions. some postponements of the implementation dates were decided for agreed reforms in order to allow institutions to focus more fully on their responses to the pandemic crisis, for example, the consultation on new principles for operational resilience and revised principles for the sound management of operational risk of the bcbs. the ifsb also adopted a consultation on effective practices for cyber incident response and recovery, and iosco consulted on revisions to its principles for outsourcing with operational resilience as a https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 45 driver of several changes. in these documents, there are no references to the specifically islamic financial and banking regulations, but their influence on the work of the isfb will emerge in future standards on broader aspects such as risk management or the supervisory review process. other topics for specific definitive standards relate to the impact of financial technologies, particularly crypto-assets and “stable coins”, but also include the use of artificial intelligence and machine learning by asset managers and other capital markets intermediaries and the use of big data analytics in insurance [39]. the islamic financial system has shown resilience, and unprecedented interventions by governments and regulators have allowed markets to continue in their tasks [40]. the ifsb has identified a programme focusing particularly on fund liquidity and non-bank financial institutions based on analytical study and a number of changes in standards. in fact, islamic capital markets have some very positive profiles such as the very limited use of derivatives and the adoption of social projects of financing, while in the sukuk market a shortage of liquidity has become apparent. f. the regulatory criteria, standards and supervision of islamic banks: the needs for transparency and knowability through technological innovation the implementation of ifsb standards represents a challenge in some jurisdictions that have a limited experience, because they should have adequate infrastructure to support islamic finance and a skilled policy team. the guidelines represent an opportunity to improve implementation rates by leveraging on the experience of other members and sharing the basic steps of regulatory and supervisory authorities that have successfully implemented ifsb standards [41]. most of the regulatory and operational aspects of islamic banking depend on the respective central banks which develop the legislative framework for competition within the islamic financial sector; the legislations also contain provisions on governance and provide for shariah compliance committees or boards for financial institutions, present e.g., in all gcc countries [42]. the main role of the shariah supervisory boards is to ensure that the instruments offered by financial institutions are coherent with the fiqh (jurisprudence) on ethical-religious rules as a form of supervision and governance with additional tasks, e.g., advising the board of directors, providing guidance to islamic financial institutions on the limits of activity, without executive functions that fall exclusively to the management of the bank or a strategic role for the board of directors. the shariah board has no competence regarding the management of the risks, apart from those deriving from its own decisions or from the fatwa [43] which is a legal opinion on any shariah question, according to a predetermined methodology. in fact, the board establishes rules and principles relative to shariah, ensures that the policies and procedures of the islamic financial institutions are compliant and can take decisions to create certainty of compliance. together with the board of directors and other operational committees, the shariah committee can prevent aggressive lending and higher-risk activities, counter unethical practices, and ensure compliance and principles for social justice purposes, although there may be changes of direction in decisions [44]. in this context, shariah-compliant financing is a contributing factor to the efficiency of the gcc national banks and the functioning of the overall financial sector. while several banking laws regarding islamic finance require banks to have a shariah board in-house, most regulators are reluctant to engage in shariah matters and this trend is controversial. malaysia’s regulation [45] is an exception, as the central bank has its own shariah board, whose fatwa may be of a higher level than the shariah boards of individual islamic banks for internal control [46]. this ensures consistency and probably a reduction in risk, but it could potentially limit debate in the future by centralising the decision on compliance. within the corporate governance system, therefore, adequacy to shariah is essential, not least to help mitigate the effects of potential risks through due diligence respecting the ethical underpinnings of islamic economics. however, from recent empirical evidence it emerges that the best practices of shariah governance have not achieved the efficiency envisaged by the banks, which pursue objectives of governance of the activities according to the ethical islamic economy [47] and the prevention of financial crises. compliant financing has demonstrated positive effects, but improving the quality of institutions, the rule of law, and the effectiveness of government action have emerged as equally important aspects as part of strengthening lending by banks in gcc countries. the main policy implication is that governments and policymakers will have to adapt legislation more vigorously and adopt reforms of laws and regulations governing the banking and financial sector and a more open economy. gcc countries have, in fact, long been in the process of continuously reforming their business sectors to make them more competitive internationally, but attention to strengthening the institutional framework in which finance operates is essential [48]. however, the issue of securities regulation cannot be addressed independently of an examination of the legal context, especially since there are no abstract schemes developed in advanced regulatory regimes that can be adequately introduced into systems with different assumptions and ethical-religious limitations that are a source of legal risks inherent in the application of shariah and constitutive effects for commercial legislation, such as the prohibitions of riba and gharar that limit the modus operandi of stock markets and the choice of securities [49]. the shariah produces legal and economic risks that are not quantifiable a priori and that can directly influence modern arab commercial legislation and, in the worst-case scenario, could render the new discipline inapplicable, given the exercise of supervision according to ethical-religious criteria. in essence, the influence of shariah cannot be fully foreseen in the examination of commercial legislation, as assessments are based on criteria that are subject to interpretation that is often https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 46 not unambiguous and not even accessible through instruments of certain knowability. the need for transparency is particularly evident in order to reduce risks as they can be known and foreseen in advance [50]. g. the rules on capital requirements the ifsb institutional website has been enriched with content, and transparency has undoubtedly increased in recent years; however, the difficulty of framing ethical-religious principles in uniformly applicable rules and standards of banking regulation is evident. the objectives of the guidelines are very similar to those pursued by the eba and esma and, therefore, to the indication of technical standards as a basis for national regulatory and supervisory authorities to define, in turn, specific rules and guidelines on adequacy requirements for the marketing of financial products and investment funds [51], the dissemination of information in the sector and, in particular, greater harmonisation of regulation and practices, in order to encourage investments from third countries. in addition, they include the competence to prepare stress tests [52], similar to the eba. among the guiding principles in the offer of sukuk securities and investment funds, inspired by good practices in conventional and islamic markets, are the rules of clear, accurate and not misleading information to investors as well as timely disclosure for a reasonable investment decision; in particular, for sukuk securities, the structure and related contracts must be described with sufficient clarity to allow the investor to understand and assess any risks attached to it [53] and there are similar rules for investment funds adopted by national regulators [54]. the regulatory standards and guidelines for islamic banks can be divided into two basic categories: the first set of standards relate to islamic counterparties and consist of guidelines and conventional international standards that include the prudential standards necessary to ensure a stable financial system; in this development the ifsb uses existing international standards issued by relevant bodies, such as the basel committee, as the basis for its own standards with adaptations to suit islamic banking practices. for example, the capital adequacy standard for institutions (other than insurance institutions) offering only islamic financial services (2005) is based primarily on the principles of pillar 1 of the basel ii standards. in particular, the ifsb amended and adapted two basel committee documents to develop appropriate capital requirements for islamic banking practices. following the financial crisis, ifsb considered the new guidance of basel iii by adopting revised capital adequacy standard for institutions offering islamic financial services (ifsb-15) incorporating the changes in capital adequacy requirements of the new international standards [55]. thus, the basel committee rules are acquired indirectly through the intervention of the ifsb which adapts them to the reality of islamic banking. the second type of ifsb standard rules is unique to islamic financial activity and consists of guidelines for an adequate supervisory framework in the application of shariah for islamic financial institutions also through digital solutions [56]. the ifsb, in its publication guiding principles of risk management for institutions (other than insurance institutions), has defined the various categories of risk (e.g., credit, investment, market, liquidity and operational risk) and clarified that islamic financial institutions should be characterised by a comprehensive risk management process and transparency and reporting requirements. the process should consider adequate measures to comply with the rules and principles of the shariah and ensure adequate risk reporting to the supervisory authority; among the forms of risk, credit risk: the islamic financial institutions (ifis) should have a specific strategy of financing and the instruments used must be in conformity with the shariah, which recognises the potential credit exposures that can arise in different phases of the various financing agreements [57]. as regards investment risk, ifis should have appropriate risk management strategies and reporting processes in place in relation to risk characteristics for equity investments, including mudarabah and musharaka investments. with respect to market risk, for all assets, ifis should have a system of appropriate technology tools with respect to risk management and reporting, to be considered separately, including for those that are not intended immediately for the market and/or exposed to high volatility pricing. in terms of liquidity risk, ifis should have a liquidity management framework (including reports) in place, considering separately and in total liquidity exposures related to each category of current accounts, and restricted and unrestricted investment accounts. finally, for operational risk, ifis should have adequate systems and controls in place, including oversight to ensure compliance with ethical and religious norms and principles, including the risk of non-compliance with shariah [58]. thus, islamic banks face the same risks (dependent on insolvency, commodity price fluctuations, liquidity management, regulatory and market risks) as conventional institutions, but the typical risk is that of not properly fulfilling the principle of risk sharing in financial transactions or religious precepts related to economic activities. the principles prepared by the ifsb also concern the transparency and necessary detailed information on the financial instruments and the investment funds for conformity to the shariah, in order to allow informed decisions according to ethical-juridical rules; furthermore, specific regulations are provided for the composition of the board, their roles and responsibilities, the circumstances in which the noncompliance can occur and the procedures to detect and control the risks, the processes of internal and external audit as well as the possible pecuniary sanctions as a measure of “purification” for the non-compliant incomes. there are requirements for transparency and constant updating of data by appropriate electronic reporting systems. the shariah-compliant contracts used by islamic banks modify the risk-return characteristics of the products and have relevant regulatory implications [59]. however, despite the https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 47 particularities, some regulatory standards of the basel committee can be applied to islamic banks, while the specific characteristics in relation to ethical rules are certainly not considered by international regulatory standards. for example, the use of profit-sharing investment accounts (psia) raises several issues, e.g., whether to consider them as deposits or treat them as capital, as there is a risk-sharing element to the assets. moreover, since the returns of psias are based on the principle of profit-loss ratio, the rights of investor-depositors need to be protected and the fiduciary nature of the contract also requires greater transparency in the related banking operations [60]. this is a concrete problem common to other international bodies adopting rules with standard provisions and, in fact, even the ifsb does not have “enforcement powers” [61] to ensure the effective application of its prudential standards in the various countries involved, and it is inevitable that enforcement depends on national regulators; in essence, few supervisors have incorporated these standards into national regulation and it is possible to state that the regulatory regimes of islamic banks can be traced to three solutions: the first concerns a few countries (e.g., bahrain, oman [62]) that have adopted specific regulatory guidelines; the second solution concerns countries that require banks to follow the regulations foreseen for conventional banks, even if adaptations are necessary to respect the shariah. the third solution adopted by countries such as saudi arabia and the united kingdom [63] is to subject islamic banks to the same regulation as conventional counterparties and islamic banks adjust their operations to the existing regulation. while in the jurisdictions where there is no regulation of islamic finance, the banks, also islamic, adapt to the national regulatory provisions based on the standards of the basel committee and in these countries the islamic banks must use products and instruments that conform to these rules and to the ethical-legal rules of the shariah even if a frequent contrast emerges between products that conform both to those standards and to the ethical rules. thus, e.g., under the basel iii rules on capital requirements, islamic banks should ascertain acceptable capitalisation (tier-1 and tier-2) and the value of risk-weighted assets in their portfolios with the new risk benchmarks. since psia cannot be accepted as capital under the strict basel iii definitions, one solution may be to issue long-term equity-based sukuk that meet the definition of capital under the new regulatory requirements. in addition, as basel iii pays more attention to market and other special risks, the risk references for partnership contracts such as mudarabah and musharaka and sales-based instruments such as salaam and istisna’a (a medium-term funding technique) are likely to increase. the basel committee had already published guidelines in relation to liquidity for risk management prior to the crisis (basel ii), but with the crisis, the central role of capital further emerged, and this led to the definition of specific requirements with basel iii. the aim of introducing the appropriate capital liquidity requirements is to promote a more flexible banking sector, improving its ability to withstand shocks from different sources. basel iii introduced the liquidity coverage ratio (lcr) to meet short-term liquidity needs and risks and the net stable funding ratio (nsfr) to ensure adequate medium and long-term liquid funds. in particular, saudi arabia has implemented the requirements set out in basel iii, through the saudi arabian monetary authority, which has undertaken a number of initiatives to strengthen the prudential framework for bank capital and issued the basel iii risk-based capital framework in december 2012 to implement the first phase, which came into force in january 2013. a number of new rules and policies were also introduced in october and december 2012, in particular on capital requirements for bank exposure to central counterparties, the 3 pillar and the liquidity coverage ratio. the united arab emirates also recently adopted the capital requirements of basel iii through its own regulations [64]. the risk of liquidity arises when banks face problems in acquiring sums of cash at reasonable cost from loans or from the sale of assets. in conventional banks, the needs of financial liquidity can be satisfied by private sources, by other financial institutions and by inter-bank money markets. the islamic banks, instead, must consider the constraints of the shariah in accessing liquidity from these sources. since interest-bearing loans are prohibited, under shariah it is not possible to borrow funds to meet liquidity requirements in case of need and, therefore, there are limits to borrowing; moreover, debt sales are prohibited by islamic law in most cases and banks could not sell their debt-based assets to ensure market liquidity. in this context, the identification of quantitative limits to borrowing is a central issue, as banks cannot receive large sums as interest payments and loans must not consist of more assets than the assets held, and loans involving large debts cannot be used to ensure liquidity; over the years, the general rules have been expressed more clearly as a certain reference for the banks and, in particular, the shariah-compliant financial parameters [65] of the dow jones islamic market indexes [66] are relevant as criteria of reference for the shariah boards of the financial institutions [67]. for example, it is prohibited to hold shares in corporations which are in debt to the amount of more 33% of their own capital resources, which draw more than 5% of their profits from non-operating interest revenue or whose receivables amount to more than 45% of their own capital resources. besides, there were several attempts to establish generally binding standards in order to guarantee sufficient legal security such as the shariah standard of the accounting organisation for islamic financial institutions (aaoifi) based in bahrain [68]. without an adequate supply of shariah-compliant liquidity instruments and active markets in which to trade, it will be difficult for islamic banks to meet the requirements of basel iii, since they would have to shorten the maturity of their assets and increase the duration of their liabilities and capital, in order to meet the liquidity requirements. this may put islamic banks at a disadvantage compared to their conventional counterparts and create obstacles to long-term growth; therefore, additional measures and initiatives with innovative interpretations for shariah compliance need to be https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 48 introduced to address liquidity requirements. in many contexts, there are no inter-islamic banks or organised money markets with reference funds in the event of a crisis. furthermore, due to the lack of liquidity for sukuk instruments and active sukuk markets, the islamic banks present significant risks of liquidity, given that these certificates represent a positive alternative to the traditional bonds (the issuer must return to the buyer the initial countervalue and the agreed rate of interest), but are structured in such a way that the profits are linked to a concrete asset or to an underlying property with a relative right of ownership. while central banks in some countries play an important role in providing tradable instruments to meet short-term liquidity needs, liquidity quotas are still a major problem, forcing many banks to raise more funds. the prohibition of the interest rate entails difficulties in the management of the liquidity in the absence of a shariah-compliant inter-banking market and because of the impossibility of investing in government securities at short expiry and at low risk; a solution is represented by the issuance of sukuk to be understood as share certificates of islamic investment, even if related, by affinity, to bonds. therefore, liquidity management is one of the most challenging and relevant objectives, but with a particular difficulty if liquidity instruments and infrastructure do not evolve. a robust liquidity framework for the islamic financial sector will be needed, not only to meet liquidity requirements under basel iii, but also for the development of private sources of liquidity and public support services. v. conclusions a. prospects for islamic finance in the eu and future economics law research in the european system of conventional banks, the need to adapt to the requirements of the basel standards, transparency rules and digital transformation and innovation, raise issues that may inhibit the development of islamic finance. in fact, the euro-system provides for interest-based instruments, and, for prudential regulation and supervision, all european banks are required to adhere to deposit insurance and financial services clearing systems, especially after the banking union. in contrast, islamic jurisprudence, which has long prevailed in several islamic countries, has held that the investment deposits of islamic banks, which follow the “profit and loss sharing principle”, cannot be covered by deposit guarantee schemes. however, recently, this aspect has evolved due to the significant role played by the ifsb. moreover, there is a significant further obstacle to the creation of islamic banks, as the corporate governance and management board of european banks, which take full responsibility for management decisions based on eu and national laws, can certainly not be shared with the shariah board [69]. in general, therefore, there are several legal difficulties and complex profiles for the spread of islamic banks in europe, precisely because of the prevailing legal schemes. the establishment of banks would require a specific legal rule, not so much because of the european regulation that, in any case, is in line with the well-known international standards, but because of the issue of banking authorisation which still involves the supranational and national regulatory level and above all because of the internal national rules that need to be integrated. in fact, article 14.1, reg. (eu) n. 1024/2013 provides that any application for an authorisation to take up the business of a credit institution to be established in a participating member state shall be submitted to the national competent authorities of this legal system in accordance with the requirements set out in relevant national law. thus, for example, in the case of an islamic credit institution to be established in italy, the related application must be consistent with the objective requirements determined by article 14 of the italian banking law (testo unico bancario), in line with the approach introduced by directive 1977/780/eu now merged into directive 2013/36/eu [70]. the authorisation is an administrative measure, which is issued when the conditions laid down in article 14.1 are met. it is issued by the ecb, on the proposal of the bank of italy, and is denied by the ecb or the bank of italy, when the verification of the conditions, provided for in paragraph 1, does not guarantee sound and prudent management. for the establishment of non-conventional banks, it would be necessary to introduce specific rules on the admissibility of issuing authorisation with additional conditions for carrying out the activity, given the profound differences, just as specific rules are needed for the offering of islamic financial products by domestic banks. the study of the german experience could be a useful investigation for new rules and future economic law research, in order to identify a solution compatible with italian (or other european) banking laws and tax disciplines, on the assumption of a clear desire on the part of the legislator, obviously fallowing a political decision. on the other hand, it would be easier to foresee european banks offering islamic financial products or branches, although the problem of taxation or other legal compatibility questions would arise. this solution should be encouraged and studied, in view of the tangible advantages associated with it and for the presence of islamic savers and investors, but with adequate controls on the purpose of the investments. however, eu and national legislation need a solution for reasons of legal certainty. apart from these central aspects, it is necessary to consider the process of profound change, already underway and accelerated by external events, affecting the activities of banks, the acceleration to new technologies and the related and new risks associated with them, issues that require rapid innovations in terms of the tasks of regulators and legal disciplines. from the european perspective, the pandemic has confirmed the importance of a solid system of rules capable of directing banks towards virtuous and prudent behaviour and strengthening the ability of the system to cope with the crisis. reforms and the establishment of the european single https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 49 supervisory mechanism go back some ten years to address the financial crisis, but the framework made it possible to respond to the problems of the health crisis with more adequate capital strength and liquidity. banks during the most acute phase of the pandemic supported the economy and regulators and supervisors strengthened the resilience of the financial system. currently, the basel committee intends to improve prudential rules based on studies to verify their actual adequacy and effectiveness; the implementation of the “final basel iii” standards has been postponed to january 2023 due to the pandemic and to increase banking capacity to face the new challenges. these considerations can only be extended to islamic banks: their challenge will be the “final basel iii” implementation for their attractiveness in the international markets, and future success will depend on the imminent further adjustment in the direction of homogeneous standards. certainly, this evolution will be examined by future legal and economics research. thus, several regulatory measures were adopted at international and eu level, allowing banks to absorb losses and lend during a very challenging period. the choices of postponing the implementation of the recommendations to 2023 and not adopting any further reforms (the so-called “basel hard stop”), in order to ensure the medium-term stability of the prudential regulatory framework, are consistent and appropriate, while not undermining the commitment of banks to transpose the new rules. the european commission has formulated a proposal for a legislative act from which a wide-ranging debate has ensued to ensure the competitiveness of european banks, compliance with the basel recommendations and the application of the proportionality of the rules, without any substantial weaknesses [71]. this context undoubtedly has international consequences and can only affect islamic banks and their relations with eu banks. for future research it will be interesting to examine how the forms of risks (credit, market and operational) are dealt with in the european banking union, according to the basel indications, and how the same risks are assessed by the ifsb which, moreover, has adopted the same rules, precisely in order to cultivate profitable relations with conventional banks. the reform of the basel iii rules has pursued three objectives to improve credibility, simplicity and comparability and has affected all risks of the so-called first pillar (credit, operational, market). in the case of market risk, it has not been easy to reconcile credibility, which is linked to the ability of quantitative measures to correctly reflect risks, with that of simplicity, which entails the rapid and immediate application and interpretation of calculation methods. consequently, the search for a compromise has prevailed. the previous reform of the basel standards took place more than a decade ago, in connection with the 2007/2008 crisis, involving a comprehensive review of prudential standards and confirming the appropriateness of risk-sensitive rules. indeed, from the outset, the basel ii rules had significant limitations and an inadequate incentive scheme, and so needed to be corrected. the new formulation has improved the credibility of risk measures, including through the reporting system, and has limited non-responsible behaviour in risk management. the pandemic has certainly confirmed the desirability of ensuring the existence of adequate capital for banks that can help to cope with external difficulties as financial support for companies and other private clients. regarding credit risk, as the eba pointed out in the “call for advice” of the european commission, numerous revisions to be considered as widespread practices in the eu. other revisions allow the european legislator discretionary choices that may contribute to the adoption of a discipline adapted to the specific aspects of the european systems. for operational risk, final basel iii significantly amends the current framework by providing a single standardised approach for calculating the capital charge that replaces the previous approaches, of which three were standardised and one was based on internal models, which showed complexity, inadequacy in identifying the risk profiles of the banks, and significant problems of comparability across banks and systems. regarding market risks, the path has been very complex. the new standards, which were approved in an initial version in 2016 and in 2019, change the treatment of risks according to a more appropriate approach to identify all the risks related to the trading activities of banks. the increased focus on risk has resulted from the increased complexity of the rules, as the new standard has been defined based on the operations of major international banks. the transposition of the rules in europe entails the application of the principle of regulatory proportionality, adequately balancing the simplicity and specificity of the measures, the provision of strict conditions for the use of internal models, but which must not constitute regulatory barriers accessible only to the major international banking groups, and simplified solutions for those banks that carry out insignificant trading activities, even though less sensitive to risk. this complex evolution inevitably affects the adaptation of islamic banking and financial products for access to the european market. there are several practical implications that cannot be solved by interpretation, but require a specific european legal framework on which to base national implementing rules, a model that is already applied to conventional banks for harmonisation requirements. therefore, a special regulation is needed for the coexistence in the banking union of european banks and islamic banks and financial products, at least to obtain banking authorisation for legal certainty and uniformity of solutions. in addition, national supervisors could assess the admissibility of shariahcompliant banking contracts offered by conventional banks through the combination of several schemes that allow for effects that comply with domestic banking laws. the adoption of legal rules will, of course, depend on political choices, both at supranational and internal level. economic studies examine the relevance of islamic banking activities also for some interesting sustainability aspects and this is a concrete basis for legal considerations to request regulatory interventions at european and national level. https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 50 adaptation, not immediate and simple, to international standards cannot be considered the only solution because of the implications, also theoretical, of the relationship between two sectors that are based on some very different principles. finally, we must mention the various similarities between the principles of islamic finance (e.g., in the case of sukuk) and the principles of public-private partnership for infrastructures [72], regarding risk sharing, the lender as partner, the exclusion of speculative intentions and certainty in the definition of contractual performance. the comparison could be the topic for interesting studies in the future. moreover, the united nations published a study in 2016 highlighting the possible contribution of islamic finance to promoting the sustainable development goals of the 2030 agenda to finance infrastructure. however, sustainable finance requires rules and techniques to manage risk and technology to enable knowledge of standards and accounting rules for the maximum transparency in transactions, and control of compliance with islamic law as well as compatibility with the conventional system: objectives that are very complex to achieve [73]. references [1] r. wilson, “islamic banking in the united kingdom”, m. f. khan and m. porzio (eds.), islamic banking and finance in the european union: a challenge, cheltenham: e. elgar, 2010, 212 ff. [2] v. j. sadeghi and p. p. biancone, “shariah compliant international entrepreneurship: a study of islamic finance in europe”, european journal of islamic finance, 2017, 8, 4 ff.; p. p. biancone and m. radwan, “european companies: evaluation for sharia compliance “opportunities and challenges”, european journal of islamic finance, 2017, 5, 1 ff. [3] m. f. khan, “islamic banking in europe: the regulatory challenge”, m. f. khan and m. porzio (eds.), islamic banking and finance in the european union, cit., 61 ff; c. porzio, “islamic banking versus conventional banking”, ivi, 91 ff.; l. donato and m. a. freni, “islamic banking and prudential supervision in italy”, ivi, 189 ff.; v. santoro, “the riba prohibition and payment institutions”, ivi, 222 ff.; r. wilson, “the interface between islamic and conventional banking”, m. iqbal and d. t. llewellyn (eds.), islamic banking and finance, cheltenham: e. elgar, 2002, 198 ff.; y. abdul-rahman, the art of rf (ribafree), islamic banking and finance: tools and techniques for community-based banking, hoboken: wiley, 2014. [4] see the koran (sura ii, 29). for islamic law and economy principles, see a. predieri, “il diritto apicale metastatale. analogie fra diritto comunitario e diritto islamico”, diritto dell’unione europea, 1996, 677 ff.; h. askari and r. taghavi, “i fondamenti di principio di un’economia islamica”, moneta e credito, 2005, lviii, n. 232, 175-178; a. predieri, shari’a e costituzione, roma: laterza, 2006; a. habib “product development in islamic banks”, edinburgh: edinburgh university press, 2011; l. m. al-rimawi, raising capital on arab equity markets, legal and juridical aspects of arab securities regulation, croydon: kluwer law international, 2012, 102 ff.; i. zamir and m. abbas (eds.), economic development and islamic finance, washington: the world bank, 2013; e. francesca, economia, religione e morale nell’islam, roma: carocci, 2013; m. donini and d. scolart, la sharì’a e il mondo contemporaneo, roma: carocci, 2016; p. p. biancone, la banca islamica, torino: giappichelli, 2017; f. miglietta and p. p. rampino, gli strumenti di finanza islamica a sostegno del sistema italia, milano: pearson italia, 2017, 7 ff.; s. i. u. d. asad, “islamic finance: concepts, transactions, developments, and critique”, w. decock and v. sagaert (eds.), islamic finance, between religious norms and legal practice, cambridge: intersentia, 2019, 39 ff. [5] k khan, “how ‘islamic’ is islamic banking?”, journal of economic behavior & organization, 2010, 816-817; j. d. fry and j. m. taylor, “foreign direct investment in arab countries: a guide to better understanding islamic financial doctrine”, the international bureau of the permanent court of arbitration (ed.), strengthening relations with arab and islamic countries through international law, croydon: kluwer law international, 2002, 302-304; t. v. russo, i contratti shari’a compliant, valori religiosi e meritevolezza degli interessi. contributo allo studio, napoli: esi, 2014, 43 ff. [6] g. m. piccinelli, banche islamiche in contesto non islamico, materiali e strumenti giuridici, roma: istituto per l’oriente, 1996, 22-23; g. m. piccinelli, “operazioni islamiche di provvista e di gestione del risparmio: il modello del cliente-socio”, g. gimigliano and g. rotondo (a cura di), la banca islamica e la disciplina bancaria europea, milano: giuffrè, 2006, 17 ff. [7] porzio c., “intervento”, gimigliano g. and rotondo g. (a cura di), la banca islamica e la disciplina bancaria europea, cit., 84-85; s. i. u. d. asad, “islamic finance: concepts, transactions, developments, and critique”, w. decock and v. sagaert (eds.), islamic finance, cit., 49-50; a. gatto, “principi e tecniche di finanza islamica”, economia, impresa e mercati finanziari, 2008, 31 ss.; c. porzio (a cura di), banca e finanza islamica, roma: bancaria editore, 2009, 28-29; f. miglietta and m. g. starita, “una tassonomia dei contratti”, ivi, 31 ff.; m. k. lewis, “adapting understanding of riba to islamic banking: some developments”, m. ariff m. and m. iqbal (eds.), the foundations of islamic banking, cheltenham: e. elgar, 2011, 54 ff.; m. k. lewis, “a theoretical perspective on islamic banking and financial intermediation”, m. k. lewis, m. ariff, s. mohamad (eds.), risk and regulation of islamic banking, cheltenham: e. elgar, 2014, 35-37; f. khan, “how “islamic” is islamic banking?”, cit., 808-810; h. ahmed, “basel iii liquidity requirement ratios and https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 51 islamic banking”, journal of banking regulation, 2015, 253-254. [8] s. i. u. d. asad, “islamic finance: concepts, transactions, developments, and critique”, w. decock and v. sagaert (eds.), islamic finance, cit., 52-53. [9] m. ariff and m. k. lewis, “similarities and differences in islamic and conventional banking”, m. k. lewis, m. ariff, s. mohamad (eds.), risk and regulation of islamic banking, cit., 56 ff. [10] r. wilson, “christian and islamic perspectives on contemporary finance”, w. decock and v. sagaert (eds.), islamic finance, cit., 14 ff. [11] new rules were approved in december 2017 that should have come into force in 2022 with more stringent requisites of capital and new patrimonial indexes of the banking assets to face the market risks. the entry into force, initially provided for the 1st of january 2019, was postponed to the 1st of january 2022, to allow the adjustments in a longer time with a transitional regime until the 1st of january 2027, date of full application. see “basel iii: finalising post-crisis reforms. december 2017” with further official documents at www.bis.org. for the covid pandemic, the entry into force of the “final basel iii” standards has been postponed until 1st of january 2023. see a. pilati, banca d’italia, “final basel iii e oltre: inquadramento evolutivo, prime analisi d’impatto, prossimi passi”, 22 giugno 2021; a. louhichi et al., “the regulationrisk taking nexus under competitive pressure: what about the islamic banking system?”, research in international business and finance, 2020, vol. 51, january. about measures of banking supervision to address the consequences of the pandemic, see k. lackhoff (ed.), banking supervision and covid-19, a handbook, münchen: verlag c.h.beck, 2021. [12] according to ifsb stability report 2021. [13] g. samuel, “comparative law and its methodology”, d. watkins and m. burton (eds.), research methods in law, second edition, london: routledge, 2017, 122-145; l. j. moran, “researching the visual culture of law and legal institutions: some reflections on methodology”, journal of law and society, 2021, 48, 44-58. [14] a. f. aysan, m. disli, m. duygun, h. ozturk, “religiosity versus rationality: depositor behavior in islamic and conventional banks”, journal of comparative economics, 2018, 1 ff.; s. g. prandi and d. colecchia, “pricing of islamic banking and conventional banking: an empirical study”, european journal of islamic finance, 2021, 18, 1 ff. [15] r. sbia, h. hamdi, b. k. onur tas, s. al rousan, “gulf cooperation council stocks and the effect of domestic monetary policy shocks”, international journal of economics and financial issues, 2016, 6(2), 629 ff. [16] m. ariff and m. k. lewis, “similarities and differences in islamic and conventional banking”, cit., 62 ff.; m. k. lewis, “ethical principles in islamic business and banking transactions”, m. ariff and m. iqbal (eds.), the foundations of islamic banking, cit., 60 ff.; a. m. el tiby, islamic banking, new york: wiley, 2011, 73 ff.; h. ahmed, “basel iii liquidity requirements ratios and islamic banking”, cit., 254-255. [17] g. m. piccinelli, banche islamiche in contesto non islamico, cit., 31-32; khan f., “how ‘islamic’ is islamic banking?”, cit., 815-816; t. v. russo, i contratti shari’a compliant, cit., 143 ff. [18] wilson r., “islamic banking in the united kingdom”, g. gimigliano and g. rotondo (a cura di), la banca islamica e la disciplina bancaria europea, cit., 215 ff.; m. abu-alkheil and h. – p. burghof, w. a. khan, islamic commercial banking in europe: a cross-country and inter-bank analysis of efficiency performance, international business & economics research journal, 2012, n. 6, 647 ff. in 2004 the financial service authority issued the banking authorisation and in december 2014, the name “islamic bank of britain” was changed to “al rayan bank”, see www.alrayanbank.co.uk. [19] r. wilson, “competition in islamic banking”, r. wilson (ed.), islamic financial markets, london: routledge, 1990, 19 ff.; a. khan, m. k. hassan, a. paltrinieri, s. bahoo, “trade, financial openness and dual banking economies: evidence from gcc region”, journal of multinational final management, 2021, 62, 1-16. [20] h. ahmed, product development in islamic banks, edinburgh: edinburgh university press, 2011, 202 ff; h. ahmed, m. asutay, r. wilson, “reflecting on islamic banking and financial crisis: risks, reputation and stability”, h. ahmed, m. asutay, r. wilson (eds.), islamic banking and financial crisis: reputation, stability and risks, edinburgh: edinburgh university press, 2014, 5 ff. [21] r. costi, “conclusioni”, gimigliano g., rotondo g. (a cura di), la banca islamica e la disciplina bancaria europea, cit., 240 ff.; ariff m., lewis m. k., “similarities and differences in islamic and conventional banking”, cit., 57 ff. [22] k. ginena, “sharì’ah risk and corporate governance of islamic banks”, corporate governance, 2014, vol. 14, 1, 98 ff. about banking supervision and ethical-religious criteria, see n. trad, a. m. trabelsi, j. f. goux, “risk and profitability of islamic banks: a religious deception or an alternative solution?”, european research on management and business economics, 2017, 40 ff.; c. w.h. cheong, “risk, resilience, and shariah-compliance”, research in international business and finance, 2021, 55, 1 ff.; m. k hassan, a. khan, a. paltrinieri, “liquidity risk, credit risk and stability in islamic and conventional banks”, research in international business and finance, 2019, 48, 17 ff. see ifsb-19, guiding principles on disclosures requirements for islamic capital market products (sukuk and islamic collective investment schemes), april 2017, at www.ifsb.org. https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 52 [23] the general secretariat, based in riyadh, prepares reports, studies and accounts for the gcc; it also drafts rules and regulations and is responsible for assisting member states in implementing decisions taken by the supreme and ministerial councils, at www.gcc-sg.org; m. sturm and n. siegfried, “regional monetary integration in the member states of the gulf cooperation council”, ecb occasional paper series, n. 31, june 2005, 25 ff., at www.ecb.europa.eu. [24] m. sturm and n. siegfried, “regional monetary integration in the member states of the gulf cooperation council”, cit., 32 ff; a. alkholifey and a. alreshan, “gcc monetary union”, at www.bis.org. see gulf cooperation council (gcc) and the eu, external action, at www.europa.eu; ecb, “economic integration in selected regions outside the european union”, monthly bulletin, october 2004, 67 ff.; habib m. m. and stra’sky’ j., “oil exporters in search of an external anchor”, ecb occasional paper series, n. 958, november 2008, 7 ff., at www.ecb.europa.eu. [25] m. miraglia, “islamic banks: criticality of the system and profiles of regulation, perspectives of harmonization”, rivista trimestrale di diritto dell’economia, 2011, 338 ff. see ecb, annual report 2005,152-153; ecb, monthly bulletin, 2008, 14 at www.ecb.europa.eu. for example, ecb seminar, 19th january 2012, with gcc states central banks and monetary agencies, organised by the ecb and the central bank of united arab emirates (ecb, report 2012, 154). see ecb, report 2013, 169; report 2014, 106; report 2015, 101 and report 2016, 104, at www.ecb.europa.eu. [26] s. antoniazzi, la banca centrale europea tra politica monetaria e vigilanza bancaria, torino: giappichelli, 2013; id., “l’unione bancaria europea: i nuovi compiti della bce di vigilanza prudenziale degli enti creditizi e il meccanismo unico di risoluzione delle crisi bancarie”, i-ii, rivista italiana di diritto pubblico comunitario, 2014, n. 2 and n. 3-4, 359 ff. and 717 ff.; id., “the ecb’s banking supervision and european administrative integration: organisation, procedures and legal acts”, italian journal of public law, 2015, 318 ff.; r. ayadi and w. p. de groen, “banking and insurance in the gcc countries: is there regulatory convergence with the eu?”, ces research papers, n. 4, 2013, 101, at www.cesp.eu. [27] in united kingdom, the al rayan bank, the european islamic investment bank, the bank of london & the middle east, securities house, the european finance house were established and in france, e.g., the national bank of kuwait, tejerat bank, qatar national bank; while in germany: the irani bank sepah, kuveyt turk. in addition, some conventional banks also offer islamic financial products, e.g., commerzbank, deutsche bank, dresdner bank (germany), crédit agricole (france), hsbc group, usb group, barclays, lloyds (uk). see w. mansour, m. b. abdelhamid, o. masood, g. s. k. niazi, “islamic banking and customers’ preferences: the case of the uk”, qualitative research in financial markets, 2010, n. 3, 185 ff.; d. ecke, islamic banking: grundlagen und potenzial in deutschland, hamburg: diplomica verlag gmbh, 2012; grewal k., “islamic finance in the global financial system”, f. di mauro et al., islamic finance in europe, ecb occasional paper n. 146, june 2013, 25 ff., at www.ecb.europa.eu; m. ashfaq, islamic banking and finance in europe: the case of germany and united kingdom, a theoretical and an empirical analysis, frankfurt: pl academic research, 2017. [28] see www.kt-bank.de. the kt bank ag is the first bank in germany and the eurozone that has introduced comprehensive financial products and services according to the “ethical, sustainable and transparent islamic banking principles” for the muslim community and for all other customers interested. this bank is a wholly owned subsidiary of the turkish kuveyt türk participation bank established in istanbul. kuveyt türk has been laying groundwork in germany since 2004 by means a german branch that explained the islamic model. in 2010, kt bank ag entered the market and was granted, by the federal financial supervisory authority (bafin), the authorisation for non-eea deposit broking. then in march 2015, the bafin granted a full banking license under german law for the provision of deposit and credit business in germany. kt bank is also a member of the “entschädigungseinrichtung deutscher banken gmbh” (edb), to secure clients’ deposits up to € 100,000. on july 1st, 2015, it started business branches in berlin, frankfurt, mannheim, cologne and munich, planning to offer islamic products in other eu countries. the kt bank ag is a subsidiary of the kuveyt türk participation bank a.ş, established in 1989 in istanbul, and is leading the islamic banking market in turkey for more than thirty years. kuveyt türk’s shareholders include the kuwait finance house, the most important finance house in the gcc region (62%) and the turkish general directorate of foundations (18%). [29] g. gomel (coord.), islamic finance and conventional financial systems. tendencies of the market, profiles of supervision and implications for the activities of the central bank, bank of italy, issues of economy and finance (occasional papers), n. 73, october 2010, at www.bancaditalia.it; n. schoon, modern islamic banking: products, processes in practice, chinchester: wiley, 2016, 158 ff. [30] “dubai islamic economy development centre report” 2020/21 (sgie), at www.iedcdubai.ae; s&p global report “islamic finance 2021-2022: toward sustainable growth”, at www.spglobal.com. [31] ifsb regulatory and supervisory measures to mitigate the impact of covid-19: recommendations relating to the takāful/retāful industry, 6 august 2021; a. a. adewale, “assessing the stability of the islamic https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 53 banking industry amid the covid-19 pandemic”, ifsb working paper, wp-18/12/2020. for economic studies see m. m. hamed, “the role of islamic social finance in mitigating humanitarian crises”, european journal of islamic finance, 2020, n. 16, 1 ff.; md. tanvir alam, “role of islamic finance during covid-19: a study on practical implication of zakat as short-term emergency support system”, european journal of islamic finance, 2020, n. 16, 1 ff. [32] “eurosystem and gcc central banks and monetary agencies hold second high-level seminar”, rome, 29-30 june 2010; eurosystem and gcc central banks and monetary agencies hold second high-level seminar, mainz, 14 march 2008, at www.ecb.europa.eu. see g. gomel (coord.), finanza islamica e sistemi finanziari convenzionali. tendenze di mercato, profili di supervisione e implicazioni per le attività di banca centrale, banca d’italia, questioni di economia e finanza (occasional papers), n. 73, ottobre 2010, at www.bancaditalia.it. [33] see the draft law at www.camera.it; a. franco and c. sallustio, “the taxation of sukuk in the italian context: is italy’s tax system ready for islamic financial instruments?”, european journal of islamic finance, 2017, n. 7, 1-6; f. miglietta and p. p. rampino, gli strumenti di finanza islamica a sostegno del sistema italia, cit., 67 ff. [34] ifsb forum on covid-19 and its implications on institutions offering islamic financial services, 26 august 2020; the ifsb’s 2nd innovation forum discussing “digital transformation of islamic finance and other innovative solutions for post-covid 19 recovery”. for new rules and standards see “exposure draft, core principles for islamic finance regulation [financial market infrastructures]”, 10 september 2021; core principles for islamic finance regulation (financial market infrastructures), 26 december 2021; for further documents and draft rules see www.ifsb.org. [35] the isfb was established in malaysia with the support of the international monetary fund on the 3rd of november 2002 (operative from the 10 march 2003), including banks of many countries (united arab emirates, bahrain, saudi arabia, oman, qatar and kuwait, malaysia, etc.); see www.ifsb.org. [36] islamic financial services industry stability report 2021, 101 ff.; see reports 2015/2020. [37] d. a. asafa et al., “effectiveness of macroprudential tools for islamic banking”, ifsb working paper series, wp-27/08/2021, 23 ff. [38] a. a. adeyinka, “regulatory and supervisory issues in takaful windows”, ifsb working paper series, wp16/12/2020; report 2021, 6. [39] report 2021, 7-10; 40 ff.; 121; 118 ff. [40] about the assessment of the soundness and resilience of the islamic financial system and analytical data, see report 2021, 39 ff. [41] report 2021, 128 ff. 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[46] z. shafii and s. salleh, “enhancing governance, accountability and transparency in islamic financial institutions: an examination into shari’a internal control audit”, h. ahmed, m. asutay, r. wilson (eds.), islamic banking and financial crisis, reputation, stability and risks, cit., 149 ff. [47] h. ahmed, m. asutay, r. wilson, “reflecting on islamic banking and financial crisis: risks, reputation and stability”, cit., 13. 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[49] a. s. gintzburger, “an analysis of global trends and regional pockets in the application of islamic financial contracts in malaysia and in the gulf cooperation council”, m. k. hassan and m. mahlknecht (eds.), islamic capital markets, chippenham: wiley, 2011, 316 ff. https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 54 [50] t. azrak et al., “does information disclosure reduce stock price volatility? a comparison of islamic and conventional banks in gulf countries”, international journal of emerging markets, 2021, 16 (8), 1769-1792. [51] ifsb, islamic financial services industry, stability report 2017, 43 ff.; strategic performance plan 2016-2018; ifsb-19 guiding principles on disclosure requirements for islamic capital market products, 2-4. [52] see ifsb, tn-2, technical note on stress testing for institutions offering islamic financial services (iifs), december 2016; ifsb, exposure draft technical note on stress testing for institutions offering islamic financial services (iifs) [tn-2]. [53] see ifsb-19 guiding principles on disclosure requirements for islamic capital market products, 6 ff. and 14 ff. [54] for example, the dubai financial services authority, an independent regulator within the dubai international financial center, adopted in 2007 a hedge fund code of practice as a general regulation of hedge funds. [55] ifsb, islamic financial services industry, stability report 2017, cit., 35 ff.; a. msatfa, “basel iii in the islamic finance industry”, journal of investing, 2012, 165 ss.; o. m. al-hares, n. m. abughazaleh, a. m. el-galfy, “financial performance and compliance with basel iii capital standards: conventional vs. islamic banks”, the journal of applied business research, 2013, 4, 1031 ss.; h. visser, “islamic finance in non-muslim-majority jurisdictions: regulatory issues”, islamic finance, 2019, 83 ff. [56] guiding principles on shari’ah governance systems for institutions offering islamic financial services (ifsb10); ifsb has organised its online executive program, “managing digital transformation risks for islamic financial institutions (ifis), 30 september 2021; a. a. adewale and r. ismal, “digital transformation in islamic banking”, ifsb working paper series, wp-19/12/2020. [57] a. boumediene, “is credit risk really higher in islamic banks?”, the journal of credit risk, 7 (3), 2011, 97 ff.; t. chamberlain, s. hidayat, a. khokhar, “credit risk in islamic and conventional banking”, international advances in economic research, 2018, 24 (1), 99 ff. [58] z. shafii and s. salleh, “enhancing governance, accountability and transparency in islamic financial institutions: an examination into the audit of sharia’a internal control system”, malaysian accounting review, 2010, 9 (2), 23 ff.; s. z. farook and m. o. farroq, “incentive-based regulation for islamic banks”, journal of islamic accounting and business research, 2011, 2 (1), 8 ff.; e. oz, z. r. khokher, m. m. ali, r. rosman, “sharì’ah non-compliance risk in the banking sector: impact on capital adequacy framework of islamic banks”, ifsb working paper series, 5 march 2016, 1 ff. about risk regulation see n. alam, “impact of banking regulation on risk and efficiency in islamic banking”, journal of financial reporting and accounting, 2013, 1, 29 ff.; p. abedifar, p. molyneux, a. tarazi, “risk in islamic banking”, review of finance, 2013, 2035 ff.; a. i. maghyereh and b. awartani, “the effect of market structure, regulation, and risk on banks efficiency”, journal of economic studies, 2014, n. 3, 405 ss.; a. r. alotaibi and a. v. mishra, “global and regional volatility spillovers to gcc stock markets”, economic modelling, 2015, 45, 38 ff.; a. ali, “analysis of the determinants of capital adequacy ratio: the case of full-fledged islamic banks in the gulf cooperation council (gcc)”, european journal of islamic finance, 2019, 14, 1 ff.; a. a. adewale and others, “risk-based supervision in islamic banking”, ifsb working paper series, wp-15/12/2020. [59] ifsb-19 guiding principles on disclosure requirements for islamic capital market products, 13 ff. e 24 ff.; s. f. najeeb and m. m. mustafa, “strengthening the financial safety net: the role and mechanisms of sharì’ah-compliant deposit insurance schemes (scdis)”, ifsb working paper series, 6 march 2016, 1 ff.; ifsb, tn-3 technical note on financial inclusion and islamic finance, december 2019. [60] s. archer, r. a. a. karim, v. sundararajan, “supervisory, regulatory, and capital adequacy implications of profit-sharing investment accounts in islamic finance”, journal of islamic accounting and business research, 2010, n. 1, 10 ff. [61] m. casoria, “la regolamentazione concorrenziale nei paesi arabi del golfo. cronache di un enforcement abbozzato”, mercato, concorrenza, regole, 2018, 401 ff. [62] the central bank of bahrain adopted cbb rulebook, http://cbb.complinet.com/cbb/microsite/cbb_rulebook.htm, and the central bank of oman adopted the islamic banking regulatory framework in 2012, at http://www.cbooman.org/news/ibrf.pdf. [63] dubai financial services authority. about islamic banking in uk: a. k. aldohni, “soft law, self-regulation and cultural sensitivity: the case of regulating islamic banking in the uk”, journal of banking regulation, 2014, n. 2, 164 ff.; e. s. housby, islamic financial services in the united kingdom, edinburgh: edinburgh university press, 2011. [64] h. ahmed, “basel iii liquidity requirement ratios and islamic banking”, cit., 253 ff. [65] basel committee on banking supervision, assessment of basel iii risk-based capital regulations saudi arabia, september 2015; “regulatory consistency assessment program (rcap)”, assessment of basel iii liquidity coverage ratio regulations saudi arabia, september 2015, at www.bis.org. in may 2016, the capital market authority announced changes to incentivise further foreign investment (in gcc quarterly review, q2, 2016). since january 2017, listed companies are required to use the standards prepared by the international financial reporting https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6424 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 15/10/2021 accepted for publication: 30/03/2022 published: 18/04/2022 55 standards for the financial reporting framework (in gcc quarterly review, q4, 2016, at www.linklaters.com). [66] see dow jones islamic market indices methodology, december 2017, at https://us.spindices.com. in 1999, in bahrain, the dow jones islamic market indexes provided for the first shariah indices and offers a timely list of almost 70 shariah-compliant measures covering equities and fixed income securities around the world. see s&p dow jones islamic market world index, 31 august 2021; m. campra, s. pucci, v. brescia, “can the dow jones sustainable index be useful for evaluating dow jones islamic market companies? european journal of islamic finance, 2020, first special issue, 1 ff. the index measures the performance of stocks traded globally that pass rules-based screens for adherance to shari’ah investment guidelines. about “shariah risk” see h. visser, “islamic finance in non-muslim-majority jurisdictions: regulatory issues”, cit., 88 ff. about the role of the auditing organisation for islamic financial institution, see t. v. russo, “i contratti shari’a compliant, valori religiosi e meritevolezza degli interessi”, cit., 49 ff. [67] m. ashraf m. and a. lahsasna, “proposal for a new sharì ah risk rating approach for islamic banks”, international journal of islamic finance, 2017, 1, 87 ff.; a. musleh alsartawi, “performance of islamic banks: do the frequency of shari’ah supervisory board meetings and independence matter?”, isra international journal of islamic finance, 2019, vol. 11, no. 2, 303-321. [68] the central bank of bahrain has issued capital adequacy regulations (circular n. 52/2017, which came into force on 1° february 2017 and fully implemented in 2019) in line with basel iii, see gcc quarterly review, q1, 2017, at www.linklaters.com. about the role of central banks, see a. a. hossain, central banking and monetary policy in muslim-majority countries, cheltenham: e. elgar, 2015. [69] e. aracil, “corporate social responsibility of islamic and conventional banks: the influence of institutions in emerging countries”, international journal of emerging markets, 2019, 14 (4), 2019, 582-600; i. a. oladapo et al., “perception of stakeholders on governance dimensions of the islamic banking sector”, international journal of emerging markets, 2019, 14(4), 601-619; s. el-halaby et al., “the non-economic consequences of disclosure in islamic banks”, international journal of emerging markets, 2018, 13(6), 1948-1968. about jurisprudence see s. coopchik, “judicial decision-making in islamic banking and finance”, european journal of islamic finance, 2015, 2, 1 ff. [70] see the italian banking law “testo unico bancario (t.u.b.)”, especially artt. 10 et seq.; t. v. russo, i contratti shari’a compliant, cit., 140 ff. about collection of savings, the principle of the obligation to repay under art. 11 t.u.b. is contrary to the typically islamic current accounts which exclude it, but combinations of contracts would be possible, obviously according to mechanisms which would have to be accepted by the supervisory authorities, see f. miglietta and p. p. rampino, gli strumenti di finanza islamica a sostegno del sistema italia, cit., 69-71. on banking activities see g. gimigliano, “art. 10”, in s. bonfatti (a cura di), commentario al testo unico bancario, pisa: pacini, 2021, 41 ff., and banking authorisation see a. benocci, “art. 14”, ivi, 74 ff.; c. brescia morra, il diritto delle banche, le regole dell’attività, bologna: il mulino, 2020. [71] european commission, “banking package 2021: new eu rules to strengthen banks’ resilience and better prepare for the future”, 27 october 2021, for the implementation of basel iii (also known as basel iv) agreement that will involve the amendment of directive 2013/36/eu, reg. (eu) n. 575/2013 and separate proposals about the capital requirements regulation (crr) and capital requirements directive (crd iv), at ec.europa.eu. on amendments (commission delegated regulation (eu), 20 october 2021, n. 439/2022) to the crr see “european banking institute report on economic policy and financial regulation measures: international, eu and euro area levels”, 19 march 2022, at www.ebi-europa.eu. [72] u. f. moghul, a socially responsible islamic finance: character and the common good, london: palgrave macmillan, 2017; f. miglietta and p. p. rampino, gli strumenti di finanza islamica a sostegno del sistema italia, cit., 79 ff.; forum finanza sostenibile (2019), “l’unione europea e la finanza sostenibile, impatti e prospettive per il mercato italiano”, at www.finanzasostenbile.it. [73] s. khavarinezhad and p. p. biancone, “future trends and finance approaches in islamic banking”, european journal of islamic finance, 2019, 12, 1 ff.; s. khavarinezhad, p. p. biancone, v. jafari-sadeghi, “financing in the islamic system and sustainable economic development of selected islamic countries”, european journal of islamic finance, 2021, 19, 18-23; v. brescia, a. adam sa’ad, r. bt hassan, s. musa bin syed jaafar alhabshi, f. lanzalonga, “exploring sustainability from the islamic finance perspective”, european journal of islamic finance, 2021, 19, 45 ff.; f. lanzara, “islamic finance and sustainable development goals. a bibliometric analysis from 2000 to 2021”, european journal of islamic finance, 2021, 18, 1 ff. https://www.ojs.unito.it/index.php/ejif/index european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6714 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 25/04/2022 accepted for publication: 19/11/2022 published: 29/12/2022 38 islamic bank profitability: financing micro and small segment, promotion, financing quality, labor aspects (indonesia cases) lucky nugroho1, federica miglietta2, erik nugraha3, soeharjoto4 1 universitas mercu buana, jakarta, indonesia. correspondence author: lucky.nugroho@mercubuana.ac.id 2 università degli studi di bari aldo moro, italy 3 universitas sangga buana ypkp, bandung, indonesia 4 universitas trisakti, jakarta, indonesia abstract this study aims to analyze the effect of financing distribution (fdr), lending to micro and small business segments (msf), promotion cost ratio (pcr), loan quality (npf), and employee productivity ratio (lcr) on the profitability ratio of islamic banks (return on assets-roa). the method used in this study is a quantitative method using multiple regression models. the data used is secondary data from islamic banks published during the 2012-2018 period. furthermore, the number of samples from this study amounted to 42 samples of islamic commercial banks. the results of this study are that the distribution of financing (fdr) has a positive and significant effect on the performance of islamic banks (roa), and the distribution of financing to the micro and small business segment has a positive and significant effect on the performance of islamic banks (roa). in addition, promotional activities and employee productivity also have a positive and significant impact on the performance of islamic banks (roa). at the same time, the quality of financing has a negative and significant influence on the performance of islamic banks (roa). the research implications are to provide information related to islamic bank performance research regarding promotion effectiveness and employee productivity. keywords islamic bank, financing, micro and small financing segment, promotion, financing quality, productivity. jel classification: g02, g14, g21 i. introduction islamic banking services in indonesia have existed since 1992 when bank muamalat was the first indonesian islamic bank was established. therefore, islamic banks in indonesia have served the indonesian people for 29 years and should improve the indonesian people's welfare. this follows the objectives of islamic banks, namely, creating the social wellbeing of humanity [1], [2]. however, the current phenomenon is that the performance of islamic banks still has challenges, as indicated by the market share for 29 years that has not been able to reach 10%. figure 1. below is the achievement of islamic bank market shares in the last four years: figure 1. development of islamic bank market share for the 2017-2020 period source: [3] based on figure 1 above, the growth of the islamic banking market share is 6.34%. therefore, if islamic banks have existed for 29 years, the market share growth per year grows by 0.22%. this condition is contrary to the market potential of indonesia as the country with the most significant number of muslims in the world [4]. in addition, the government has a plan to make indonesia the center of the islamic economy and finance in the world. therefore, the government should have a program to increase the market share of islamic banks to increase the number of people using the products and services of islamic banks [5]. furthermore, compared to other countries, the performance of islamic banks in indonesia still needs to be improved. this phenomenon is shown in figure 2 below: european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6714 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 25/04/2022 accepted for publication: 19/11/2022 published: 29/12/2022 39 figure 2. return on assets (roa) of indonesian islamic banks and islamic banks in middle eastern countries source: [6] referring to figure 2 above, islamic banks in indonesia have the lowest return on assets (roa) level compared to 10 other countries in the middle east. thus, the performance and profitability of islamic banks in indonesia still need to be improved. based on the phenomenon of low roa in the indonesian islamic banking industry, islamic banks' contribution to improving people's welfare in indonesia is still not optimal [7]. furthermore, to improve the performance of islamic banks, it is necessary to optimize product sales from islamic banks. the main product of islamic banks that directly increases revenue is the distribution of financing. financing in islamic banks is the distribution of loans with shariah contracts consisting of buying and selling contracts (murabahah, istishna, salam) and cooperation contracts (mudharabah and musharakah), and rental contracts (ijarah) [8]. if the distribution of financing increases, it has the potential to increase income from islamic banks. the type of income from islamic bank financing depends on the financing contracts distributed by islamic banks. income from islamic banks can be margin, ujroh (fee), or profit-sharing ratio [9]. in addition to optimizing the distribution of financing to improve performance, islamic banks also need to improve performance by focusing on business segments, namely the distribution of financing to the micro and small business sectors. dusuki (2007) and arafah & nugroho (2016) [10], [11] state that islamic banks as banks that carry out their business activities based on sharia principles, must concern micro and small entrepreneurs. the majority of economic actors in indonesia are micro and small entrepreneurs. so, focusing on channeling financing to the micro and small business sectors will impact helping to increase their business sales turnover [12]. the increase in business turnover from micro and small business actors will have implications for increasing their welfare [13], [14]. in addition to the low market share of islamic banks, the islamic financial literacy of the indonesian people was also low in 2019. islamic financial literacy only reached 11.10%. furthermore, 11.10% islamic financial literacy achievement shows that in the indonesian population who understood islamic financial products in 2019, only 11.1% understood islamic financial products. meanwhile, the financial literacy of the indonesian people has reached 38%, so there is a significant gap between islamic financial literacy and financial literacy. therefore, the low islamic financial literacy has implications for the low number of people using financial products and services from islamic banks [15], [16]. therefore, to increase users of islamic financial products and services, promotions are needed in the form of socialization and other forms of dissemination to provide information and education to the public regarding the products and services of islamic banks [17]. islamic bank's business performance determines its sustainability. the better the islamic bank's business in distributing its funding with good qualities, the more the potential for the sustainability of the islamic bank [6], [18]. [18]–[20]. the sustainability of islamic banks is highly dependent on the trust of islamic bank stakeholders. the quality of the funding has to demonstrate the trust of stakeholders. if the distribution of islamic bank financing is of quality, then the risks faced by the islamic bank will be more measurable [21], [22]. conversely, suppose the quality of islamic bank financing distribution is low. in that case, the islamic bank will be exposed to enormous risks in the future, so there is the potential to cause losses for the islamic bank. on the other hand, employee productivity must be increased as well. the higher the productivity of the workers, the higher the income of the islamic bank. employee creativity and innovation in making products and services that suit the needs and desires of the community. thus, more and more people will use the products and services of islamic banks, which will have implications for the increase in income of these islamic banks [23]. thus, based on the phenomena mentioned above, the problem statements in this study include: § does the distribution of financing affect (financing to deposit ratio-fdr) the return on assets (roa)?; § does the portion of micro and small business sector financing (micro and small segment financing-msf) affect roa?; § does the promotion (promotion cost ratio-pcr) of islamic banks affect roa?; § does the quality of islamic bank financing (nonperforming financing-npf) affect roa?; § does the productivity of islamic bank employees (labor cost ratio-lcr) affect roa?. based on the problem statements, this study aims to analyze the factors that can affect the improvement of the performance of islamic banks. the urgency of this research is to help the government identify the factors that can improve the government's performance to make indonesia a center of world islamic finance and economy. in addition, islamic banks, as the locomotive of a country's economy, should have quality human resources. the productivity of human resources indicates this through innovation and creativity in developing products and services that are of interest to the public. furthermore, the novelty of this study is that the analysis of profitability in terms european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6714 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 25/04/2022 accepted for publication: 19/11/2022 published: 29/12/2022 40 of business, productivity, promotion, and financing quality aspects have not been carried out by previous researchers. therefore, the implications of this research will provide new information related to research topics in the field of performance of islamic banks and give insight to the government to improve the performance of islamic banks through the determinants factors included in this research. ii. literature review furthermore, the theoretical basis used in this study is the tawhid string relationship (tsr) which is a reference to the importance of performance for islamic banks based on the qur'an as a source of islamic law. the explanation of the qur'an related to the vital role of performance and profit is as follows: § performance is closely related to one's deeds as stated in the qur'an surah at tawbah verse 105: and say, "do [as you will], for allah will see your deeds, and [so will] his messenger and the believers. and you will be returned to the knower of the unseen and the witnessed, and he will inform you of what you used to do." § performance in the qur'an is also related to a person's good measure based on his deeds and deeds listed in the qur'an surah al-mulk verse 2: “[he] who created death and life to test you [as to] which of you is best in deed and he is the exalted in might, the forgiving.” § furthermore, performance in islam, as well as good practice, will have an impact on the safety of life in the world and as a provision for life in the hereafter, which is stated in the qur'an surah an-nahl verse 97: “whoever does righteousness, whether male or female, while he is a believer we will surely cause him to live a good life, and we will surely give them their reward [in the hereafter] according to the best of what they used to do.” in addition, the theory used in this study refers to agency theory, where agents will try to maintain the performance of the companies they manage so that they can survive in the company [24]. furthermore, in maintaining the company's performance, there are key financial performance indicators, one of which is roa [25]. roa is the result or profit from the company's business activities. therefore, the higher the roa, it can be reflected that the management in the company has adequate ability to manage the company. on the other hand, company profits come from the company's core business, [26]. therefore, the variable used in this study is the distribution of financing because it is related to the performance of islamic banks [27]. however, according to dusuki [28], micro and small segment financing in islamic banks must be the main concern and product. this is because islamic banks must have social values that aim to benefit the whole community, especially low-income people [11]. however, banks are also financial institutions that are very sensitive to public trust [29]. therefore, islamic banks must also be able to maintain the quality of the financing that has been distributed so that the public has confidence that the funds placed in the bank are safe [30]. the better the quality of the bank, the better the performance of the bank because it can mitigate risk optimally [31]. furthermore, apart from the core business, banks must also be able to achieve the targets set through optimal promotional activities so that public literacy of the products and services owned by the bank can increase so that they decide to use the bank's products and services [16], [32]. therefore, promotion costs are one of the variables used to determine the roa of islamic banks. furthermore, human resources have a significant role in driving bank business activities. the more prosperous the employees are, the greater the work ethic will be [33]. therefore, the higher the work ethic, the higher the innovation and creativity of the employee, which will increase the bank's productivity. thus, increasing productivity will have an impact on optimal performance of the institution [34]. therefore, discussions related to the productivity and profitability of islamic banks are crucial for further analysis based on several aspects such as financing, micro, and small segment, promotion cost, financing quality, and labor cost. iii. methodology the research method used is a quantitative method using multiple regression analysis with a data panel. the data used is secondary data from the annual reports and published (audited) financial reports. the number of islamic commercial banks used in this study from 2012 to 2018 was 12 banks. however, what can be used as samples are 6 islamic commercial banks that have complete data according to the needs of this study. the details of the mechanism and the criteria for taking the number of samples are shown in table 1 as follows: table 1 sample selection criteria no criteria amount 1 number of islamic commercial banks in indonesia operating during 2012 2018 13 2 islamic commercial banks that do not have the complete data needed for research during 2012 -2018 (6) the number of islamic commercial banks used as samples in the study 7 number of data samples observed 2012-2018 (7x6 years) 42 source: authors’ elaboration furthermore, the development of hypotheses and operational variables from this study are as follows: a. effect of fdr on roa the main business of islamic banks is to collect funds from the public and channel them back to the community in loans or financing. the distribution of financing to islamic banks must be based on the real sector and underlying assets to impact national economic growth. in addition, the internal european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6714 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 25/04/2022 accepted for publication: 19/11/2022 published: 29/12/2022 41 distribution of islamic bank financing will have implications for an increase in income so that the return on assets (roa) ratio of the islamic bank will also increase. the formula for fdr is as follows: b. effect of pcr on roa promotion is an effort to introduce products and services to the public to increase public information about the promoted products and services. increased information on products and information will motivate people to use or decide to buy these products [35]. thus, the more influential the promotion of the products and services of islamic banks will have implications for increasing the income of islamic banks so that the roa of islamic banks will also increase. the variables of the promotion cost ratio (pcr) in this study are as follows: c. effect of npf on roa the business activities of islamic banks must be handled responsibly or called al “ghorm bil ghurmy, al kharaj bid dhamany”, namely business activities will be risky, and these risks must be managed responsibly [36]. therefore, if financing distribution to islamic banks is good, the risk of losing islamic banks will be more predictable [37]. thus, if the risk of loss from islamic banks is low, the income received will also increase, so the roa of islamic banks will also be better. therefore, the financing quality formula (npf) is as follows: d. effect of lcr on roa employee productivity is measured by the results obtained compared to the costs incurred [38]. if the output produced is higher than the expenditure, the more productive the activity is [39]. human resources are vital capital for islamic banks to carry out the bank's business activities [40], [41]. therefore, islamic banks must focus on developing their human resource capabilities through training following the company's development needs and employee career development. furthermore, the productivity of islamic banks is determined by creativity and innovation in marketing and developing their goods and services to be accepted and used by the community. therefore, the formula for the labor cost ratio is as follows: e. roa as dependent variable the islamic bank's performance achievement is vital for investors and stakeholders to ensure sustainability in its business activities [42]. one of the vital indicators to measure performance is profitability, represented by one of the key financial indicators is return on assets (roa) [43]. moreover, the formula for roa is as follows: furthermore, based on the development of hypotheses and operational variables from this study, the equations of this research are as follows: (1) remarks: roa: return on assets; fdr: financing to deposit ratio; msf: micro and small financing ratio; pcr: promotion cost ratio; npf: non-performing financing; lcr: labor cost ratio. iv. results and discussion the test model was first tested for normality of the residuals using the jarque-bera (j-b) test. in this study, the level of significance used was α = 0.05. the basis for making decisions is to look at the probability numbers from the j-b statistics, with the following conditions: § if the probability value of p 0.05, then the assumption of normality is fulfilled; § if the probability < 0.05, then the normality assumption is not fulfilled. figure 3. jarque-bera normality test source: results of the eviews 9 software european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6714 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 25/04/2022 accepted for publication: 19/11/2022 published: 29/12/2022 42 based on figure 3 above, it is known that the probability value of the j-b statistic is 0.317. because the probability value of p, which is 0.853, is greater than the significance level, which is 0.05. this means that the assumption of normality is met. a. multicollinearity test in this study, the symptoms of multicollinearity can be seen from the vif value. [44] states that if the vif value is > 10, this indicates multicollinearity. the results of the multicollinearity test are presented in table 2 below: table 2. multicollinearity test source: results of the eviews 9 software based on table 2 above, the results of the multicollinearity test show there are no symptoms of multicollinearity between the independent variables. the vif value is not more than 10 [45]. b. autocorrelation test assumptions regarding the independence of the residuals (non-autocorrelation) can be tested using the durbin-watson test. the statistical value of the durbin-watson test ranged between 0 and 4. statistical values of the durbin-watson test that were smaller than 1 or greater than 3 indicated an autocorrelation. table 3. autocorrelation test with durbin-watson test log-likelihood -51.55356 hannan-quinn criter. 2.831635 durbin-watson stat 1.702421 source: results of the eviews 9 software based on table 3 above, the value of the durbin-watson statistic is 1.702 because the value of the durbin-watson statistic is between 1 and 3, i.e., 1 < 2.240788 < 3, then the non-autocorrelation assumption is met. in other words, there is no high autocorrelation symptom in the residuals. c. heteroscedasticity test furthermore, to test whether there is heteroscedasticity or not, the breusch-pagan test can be used. table 4 below presents the results of heteroscedasticity testing using the breusch-pagan test. table 4. heteroscedasticity test with breusch-pagan f-statistic 5.030133 prob. f (5,36) 0.3714 obs*r-squared 17.27419 prob. chi-square (5) 0.3540 source: results of the eviews 9 software based on the results of the breusch-pagan test in table 4 above, it is known that the prob. chi-square 0.3540 > 0.05, which means there is no heteroscedasticity. d. chow test the chow test is used to decide whether the model used is common effect or fixed effect, with the decision criterion that if the cross-section f prob score > 0.05, then the common effect model will be used. however, if the cross-section f prob score < 0.05, the fixed effect model will be used. table 5 below presents the results of the chow test as follows: table 5. chow test effects test statistic d.f. prob. cross-section f 0.830911 (6,30) 0.5555 cross-section chi-square 6.456886 6 0.3740 source: results of the eviews 9 software based on the results of the chow test in table 5 above, it is known that the cross-section f prob score of 0.5555 > 0.05, then the common effect model will be used. e. hypothesis model test moreover, to test the hypothesis of this study, a test was carried out, which included analysis of the coefficient of determination, simultaneous effect testing (f test), and partial effect testing (t-test). the results of the statistical values of the coefficient of determination, f test, and t-test are presented in table 6 below: coefficient uncentered centered variable variance vif vif c 0.699219 36.91701 na fdr 0.809947 1.661248 1.494840 msf 0.009531 17.63686 1.936858 pcr 0.000763 2.718408 1.129617 npf 2.77e-05 2.376449 1.128585 lcr 0.114247 9.392404 1.973143 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6714 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 25/04/2022 accepted for publication: 19/11/2022 published: 29/12/2022 43 table 6. hypothesis test variable coefficient std. error t-statistic prob. c 0.302120 0.836193 0.361304 0.7200 fdr 1.848839 0.899970 2.054333 0.0473 msf 0.411366 0.097626 4.213707 0.0002 pcr 0.076515 0.027620 2.770304 0.0088 npf -0.013210 0.005259 -2.511705 0.0166 lcr 0.687303 0.338005 2.033410 0.0494 r-squared 0.551783 mean dependent var 3.571905 adjusted r-squared 0.489530 s.d. dependent var 1.248340 s.e. of regression 0.891903 akaike info criterion 2.740646 sum squared resid 28.63770 schwarz criterion 2.988884 log-likelihood -51.55356 hannan-quinn criter. 2.831635 f-statistic 8.863635 durbin-watson stat 1.680047 prob(f-statistic) 0.000015 source: results of the eviews 9 software based on table 6 above, it is known the value of prob. (fstatistics), which is 0.000 < 0.05, it can be concluded that all independent variables, namely fdr, msf, pcr, npf, and lcr, simultaneously significantly affect the roa variable. therefore, all independent variables used to determine their effect on roa, including fdr, msf, ocr, npf, and lcr, can be used as determinants for practitioners in managing and improving the performance (roa) of islamic banks. nevertheless, based on table 6 above, the following multiple linear regression equation is obtained: (2) furthermore, according to equation 2 and table 6 then can be analyzed the factors that affect roa are as follows: § it is known that the regression coefficient value of fdr is 1.848 with a prob value of 0.047, which is < 0.05 significance level, then fdr has a positive and significant effect on roa; § it is known that the regression coefficient value of msf is 0.411 with a prob value of 0.000, which is < the significance level of 0.05, then msf has a positive and significant effect on roa; § it is known that the regression coefficient value of pcr is 0.076 with a prob value of 0.008, which is < 0.05 significance level, then pcr has a positive and significant effect on roa; § it is known that the regression coefficient value of the npf is -0.013 with the prob value of 0.016, which is < the significance level of 0.05, then the npf has a negative and significant effect on roa; § it is known that the regression coefficient value of lcr is 0.687 with a prob value of 0.049, which is < 0.05 significance level, then lcr has a positive and significant effect on roa. the distribution of financing in islamic banks has a crucial role in generating income. therefore, the results of this study state that fdr has a positive and significant effect on roa. moreover, islamic banks must compete with conventional banks in loan products so that people will be interested in using loan products from islamic banks [46]. furthermore, according to nugroho et al. (2020) [47], the community's considerations in using sharia products are based not only on obedience to the teachings of islam but also on their function, ease of access, and usefulness. during the industrial revolution 4.0, the vuca era (volatility, uncertainty, complexity, and ambiguity), and the current covid-19 pandemic, the banking industry, including the islamic banking industry, has digitalized products so that people can use banking services with limited mobility [48]. according to the results of this study, islamic banks that have an identity as pro-social banks should have a business focus on micro and small entrepreneurs because these segments contribute to increasing income from islamic banks. loans to the micro and small business segment (msf) have a positive and significant impact on roa, so the more loans disbursed to this segment, the greater the potential for profit for islamic banks. according to maad et al. (2014) [49], micro and small entrepreneurs have responsible behavior in paying loan installments. many micro and small entrepreneurs want to avoid borrowing from banks because they are afraid they will not pay the installments [50]. therefore, most micro and small entrepreneurs have good and responsible behavior in terms of character. if micro and small entrepreneurs do not pay their loan installments, this is caused by problems their business conditions face [51]. the islamic financial literacy of the indonesian people still needs to improve. therefore, islamic banks need to promote and disseminate islamic financial products and services to the public to increase information on the benefits, uses, and access to these products and services. this is evident from the results of this study, where the ratio of promotional costs (pcr) has a positive and significant effect on the performance of islamic banks (roa). furthermore, islamic banks must collaborate with all relevant stakeholders in carrying out promotions so that the information transfer process becomes more effective. collaboration between parties such as islamic banks, universities, government, and social institutions is vital. as a result, the socialization impact of islamic financial products and services becomes more effective and significant. the quality of financing for loans disbursed by islamic banks is crucial in achieving performance. it is known from the results of this study that the quality of financing (npf) has a negative effect on the performance of islamic banks (roa). the higher the npf, the potential to reduce the profit of islamic banks [19]. therefore, the distribution of islamic bank financing must apply the principles of three pillars which european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6714 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 25/04/2022 accepted for publication: 19/11/2022 published: 29/12/2022 44 include: (i) business aspects, (ii) risk aspects, and (iii) operational aspects. furthermore, the business aspect is that the financing distribution must follow the company's business focus and the portfolio guidelines owned by the islamic bank. the risk aspect is applying risk acceptance criteria following the segment of the business distribution so that the risk of bad debts can be mitigated. in addition, operational aspects also need to be implemented to maintain good corporate governance in the distribution of financing so that there is no abuse of financing approval authority in implementing the four eyes principles [52]. employee productivity as the principal capital of islamic banks to achieve the performance of islamic banks is a determining factor. it is known from this study that lcr has a positive and significant effect on roa. thus, islamic banks' employee productivity, which includes professionalism, innovation, and creativity, becomes essential to improve their performance [53], [54]. in addition, the higher the ability to innovate and be creative of islamic bank employees in making products and services that are to the needs and desires of the community, it will have an impact on increasing income from islamic banks because more people will use the products and services of the islamic bank. however, based on the phenomenon of the low market share of islamic banks and the results of this study, the input to the regulator is to help islamic banks carry out socialization and dissemination related to products from islamic banks to the public. in addition, the government also provides an option for state civil servants to receive their salaries using an islamic bank account. v. conclusion according to the results and discussion of the research, the conclusions of this study are as follows: § the ratio of financing distribution (fdr) has a positive and significant effect on the roa of islamic banks. therefore, islamic banks must be able to compete with conventional banks in making loan products that follow the needs and desires of the community; § the ratio of lending to the micro and small business (msf) segment has a positive and significant impact on the roa of islamic banks. thus, islamic banks should have a business focus on the micro and small business segment so that the performance and reputation of islamic banks that are pro-social towards improving welfare will increase in the community; § promotional activities (pcr) from islamic banks positively and significantly affect roa. based on this, islamic banks must actively promote and collaborate with all stakeholders, both educational institutions, regulators, and non-governmental organizations, to improve the islamic financial literacy of the community; § financing quality (npf) has a negative and significant effect on the roa of islamic banks. therefore, the management of islamic banks must focus on the quality of the loans disbursed. in addition, the application of the principle of prudence is vital in mitigating risks that will arise in the future; § employee productivity (lcr) has a positive and significant effect on the roa of islamic banks. thus, the management of islamic banks must be concerned about increasing the ability, innovation, and creativity of islamic bank employees to sell products and create products and services following public expectations. the implication of this research is to provide repertoire related to islamic bank performance research based on the point of view of the effectiveness of the promotion and the productivity of the employees of the islamic bank. in addition, this research also has implications for regulators and practitioners of islamic banks to improve islamic banks' performance. several factors need to be a concern, including the ability to channel financing (fdr), lending to the micro and small business segment (msf), increasing promotion (pcr), maintaining financing quality (npf), and also increasing employee productivity (lcr). nevertheless, the limitation of this study is that the use of factors that affect roa is limited to the variables fdr, msf, pcr, npf, and lcr. therefore, further research can add to the factors that affect roa. references [1] m. a. choudhury, m. s. hossain, e m. t. mohammad, «islamic finance instruments for promoting long-run investment in the light of the well-being criterion (maslaha)», j. islam. account. bus. res., vol. 10, fasc. 2, pp. 315–339, 2019, doi: 10.1108/jiabr-11-20160133. 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[54] m. f. dulaimi, m. p. nepal, e m. park, «a hierarchical structural model of assessing innovation and project performance», constr. manag. econ., vol. 23, fasc. 6, pp. 565–577, 2005, doi: 10.1080/01446190500126684. 01_hilmy_ejif european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7321 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 1 awareness of islamic financial institutions among non-muslims in the ampara district of sri lanka h.m.a. hilmy (1), s.a. sajith (2), m.a.f. ilma(3) 1 senior lecturer, department of islamic studies, faculty of islamic studies and arabic language, south eastern university of sri lanka ahmedhilmy@seu.ac.lk 2 department of islamic studies, faculty of islamic studies and arabic language, south eastern university of sri lanka sajithbinzain@gmail.com 3 department of islamic studies, faculty of islamic studies and arabic language, south eastern university of sri lanka ilmaanees97@gmail.com received: 26/01/2023 accepted for publication: 20/07/202023 published: 28/07/2023 abstract islamic financing refers to the financing activity that complies with islamic law and its practical application through the development of islamic economics. it is one of the fastest-growing sectors in the world. the activities of islamic financial institutions are found in all over the globe. in sri lanka, islamic banking was introduced by amana investment in 1997. started primarily to cater for the muslim community as a private operation, it had become to be one of the growing financial sectors in sri lanka. more than 19 financial institutions offer islamic finance services in sri lanka, including one fully-fledged islamic bank and seven islamic banking window operations. overall, the performance of islamic banking services has been identified by researchers as steady but slow compared to the growth of conventional finance. there is a huge potential for the islamic banking and finance industry to grow and reap its full potential with proper regulatory and institutional support. islamic finance had been used by muslims and non-muslim customers in the country irrespective of religious influence. there had been valid concerns over this burgeoning industry in sri lanka that need to analyze in detail. therefore, this research aims to determine the awareness level of non-muslims of ampara district in sri lanka about islamic financial institutions and identify whether they realize the existing difference between islamic financial institutions and conventional financial institutions in sri lanka. this study had been carried out using quantitative methods. for this study, primary data were collected through the questionnaire. questions were distributed to all the respondents through google forms, and data was obtained. among the selected sample size of 200 respondents, only 165 questionnaires were valid and used for the data analysis. the questionnaire consists of two parts: the first part requires the details of the respondents, and the second part deals with the awareness level regarding financial institutions. collected primary data was analyzed through microsoft excel and presented through the tables and figures. secondary sources were collected through academic journals, books, research articles, and thesis and website articles. according to the findings, even if non-muslims are as aware of islamic financial institutions as conventional financial institutions, their engagement level in islamic financial institutions is very low. keywords: awareness; islamic financial institutions; non-muslims; sri lanka; islamic finance; islamic law european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7321 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 2 1. introduction islamic finance is a term that reflects a financial business that is not contradictory to the principles of the shari’ah. islamic finance refers to how businesses and individuals raise capital through islamic shari’ah. islamic finance demands the avoidance of riba (usury) and gharar (ambiguity or deception) (ilma et al., 2022; ross, 2022; trokic, 2017; rahmani & avdukic, 2022). islamic finance or shari’ah compliant financing (scf) is one of the fastest growing segments of the global financial system, with an estimated compound annual growth rate of 17% since 2009. the islamic finance sector continues to grow, expanding to new jurisdictions and maintaining momentum in countries with a well-established presence (islamic finance, n.d.; omoruyi & osaigbovo, 2022). the activities of islamic financial institutions are found all over the globe. according to the sri lankan context, islamic banking was first introduced by amana investment in 1997. started primarily to cater for the muslim community as a private operation, it had become to be one of the growing financial sectors in sri lanka. currently, there are more than 19 islamic financial institutions that have been continuing their activities (fawzer, 2016; hilmy et al., 2021). in particular, islamic banks, islamic insurance companies, islamic leasing companies and many other institutions provide services (zaki & hussainey, 2015). islamic finance has emerged as an effective tool for financing development worldwide, including in non-muslim countries (kaadi, 2023; the world bank, 2015). in this regard, sri lanka is also a non-muslim country which provides islamic financing services. as this, 90.2% of the population is non-muslims as buddhist, hindus and christianity (u.s. department of state, 2021). furthermore, services of islamic banking and finance are not just for muslims but also for non-muslims (sajith et al., 2021). according to nairoos et al. (2019), most non-muslims are less aware of islamic financial concepts, products, services and features. this study was done in 2018 and 2019 based in sungawila, sri lanka. moreover, abdullah et al. (2012) indicate in their study that non-muslims are eager to learn about islamic finance. this study investigates the relationships and perceptions about the islamic banking and finance system among non-muslim undergraduates at the south eastern university of sri lanka. but our study has done in 2022 and 2023 based on the data collected from the non-muslims of ampara district, sri lanka. therefore, this study is conducted to identify the level of awareness of islamic financial institutions among the non-muslims in ampara district. ampara district consists majority of non-muslims. almost 60% of non-muslims live there. therefore, these non-muslims can be involved in the islamic banking and finance sector due to the awareness of islamic banking to the non-muslims who live with 40% muslims. 2. literature review many studies have been conducted on awareness of islamic financial institutions among non-muslims in the global level and local level. studies under-taken by several researchers to investigate the awareness level of non-muslims on islamic financial institutions locally and globally and their findings are being discussed below. the research entitled "perception of non-muslims customers towards islamic banks in malaysia" abdullah et al. (2012) is examine non-muslim customers’ perception of islamic banking products and services in malaysia. the result of this study showed that islamic banking services are making headway among non-muslims in kuala lumpur. another study entitled, "non-muslims’ perceptions toward islamic banking services" have been written by hidayat & al-bawardi (2012) in saudi arabia. for this study data have been gathered through selfadministered questionnaires from non-muslim expatriate bank customers in saudi arabia. results of the study indicate that all the respondents are aware of and have or had prior islamic banking exposures. furthermore, the findings indicate that majority of non-muslim customers in saudi arabia perceive current islamic banking services as diverse and suitable in satisfying their banking needs. research of sayilir & soud (2017) explains that there a significant difference between perceptions of muslims and non-muslims with respect to islamic banking in tanzania. furthermore, with respect to level of awareness of islamic banking the findings reveal that nearly two thirds of muslim respondents are aware of islamic banking whereas only one third of non-muslim citizens are aware of islamic banking. respondents claim that they learn about islamic banking products and services mostly through friends or islamic banks. moreover, muslim and non-muslim citizens tend to have different factors which may encourage or discourage them to use islamic banking. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7321 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 3 additionally, the research entitled "perceptions of islamic banking among muslim and non-muslim citizens in tanzania" done by soud & sayilir (2017) is examining the awareness regarding islamic banking products and services as well as the factors which influence citizens of tanzania in choosing islamic banking. snowball sampling technique and chi-square test have been used in this study. according to the findings, there is a significant difference between the perceptions of muslims and non-muslims concerning islamic banking in tanzania. furthermore, according to awareness of islamic banking, nearly two-thirds of muslim respondents are aware of islamic banking, and only one-third of non-muslim respondents are aware of islamic banking. pratiwi et al. (2019) studied "perception of non-muslim religious leaders to islamic financial institution". this study aims to determine the perception of religious leaders regarding the existence of islamic financial institutions. data for this study was obtained through interviews with religious leaders. the findings of this research showed that socialisation efforts regarding the existence of islamic financial institutions in the religious community were still needed so that the actualization of the concept of islam through inclusive financial institutions could be realized. sohail & ahmed (2021) studied "non-muslims attitude and perception towards islamic banking: a case of district peshawar". in this study, the factors that are being considered by the non-muslims are found in the available literature. and also, the relationship between the mentioned independent variables and the dependent variable, acceptance of islamic banking among non-muslims, is checked through the spss. based on the findings of this study, factors, cost/benefit analysis, the bank’s reputation, and advertising are valued the most by non-muslims in selecting an islamic bank. furthermore, findings suggest that non-muslims value the factors, religion, and social pressure the least in selecting an islamic bank. another study was conducted by nimsith et al. (2018) regarding awareness of islamic banking products and services among non-muslims in sri lanka. one of the main purposes of this study is to examine the level of awareness, understanding and perceptions of non-muslims in sri lanka of islamic banking products and services. and also, this study aims to identify if there is any demographic influence on the awareness, understanding and perceptions of islamic banking products and services among non-muslims in the ampara district. 200 respondents from different areas in the ampara district have been selected for this study. according to the study's finding, non-muslims’ understanding level towards islamic banking concepts is average, and their perceptions of non-muslims towards islamic banks vary among themselves. safrin & nairoos (2019) studied "attitudes of non-muslims on islamic financial institutions: a study based on sungawila area in sri lanka". the purpose of this research is to identify the attitudes of non-muslims toward islamic financial institutions. a representative sample of 150 respondents is surveyed with the help of a structured questionnaire developed for this purpose. it is possible to see through this study that the data were analyzed through spss. the finding of this study shows that the majority of non-muslims are not expected to view islamic financial institutions only for muslims' obligations on the other hand, they are less aware of islamic financial concepts, products, services, and features. and also, most of the non-muslims are expected to see should open more up branches and facilities of islamic financial institutions. sulaiha & mazahir (2018) conducted a study entitled "awareness of non-muslims about islamic financial institutions in colombo district". the primary objective of this study is to determine the awareness level of non-muslims in the colombo district about islamic financial institutions. the secondary objective is identifying whether they realize the differences between ifi and cfi. for this research, 200 questionnaires were distributed to non-muslims in the colombo district. the research findings show that non-muslims of the colombo district have a general awareness level of islamic financial institutions but require further knowledge to better understand the difference between islamic financial institutions and conventional financial institutions. according to the study "the perception about islamic banking and finance system among non-muslim undergraduates in south eastern university of sri lanka" non-muslim undergraduates have knowledge of islamic banking & finance. although many non-muslim undergraduates are aware of this, but they don't have much knowledge about it. this finding is based on data obtained from 50 respondents (ahamed et al., 2021). islamic financial institutions face many challenges. particularly, misconceptions about islamic financial institutions are prevalent in countries with large numbers of non-muslim citizens. non-muslim citizens may perceive islamic financial institutions negatively and think that islamic financial institutions are only for muslim citizens (soud & sayilir, 2017). according to the previous study, majority of the nonmuslims are not expected to view islamic financial institutions are only for muslims' obligations on other hand they are less european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7321 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 4 aware of islamic financial concepts, products, services and features (safrin & nairoos, 2019). furthermore, many non-muslims are aware of islamic financial institutions but need to learn more about them. they are eager to learn this. but they need to have an opportunity to learn about this (ahamed et al., 2021). finally, according to the 2012 census, the ampara district has a total population of 649,402. more than 60% of them, including buddhism, hinduism and christianity, are non-muslims (brinkhoff, 2021). thus, it is important to find out the views of non-muslims, who are the majority of the ampara district, regarding islamic financial institutions and create awareness among them about islamic financial institutions therefore, this study intends to examine the level of awareness and knowledge of non-muslims concerning islamic financial institutions in ampara district. 3. methodology this is quantitative research, using both primary and secondary sources of data. primary data was collected through the distribution of questionnaires. ampara district was selected as the research area, and questionnaires were distributed to all the respondents, and data was obtained. a sample size of 200 respondents was selected for this study. however, out of 200 distributed questionnaires among the respondents, only 165 were valid cases, finally selected for the data analysis. the questionnaire consists of two parts: the first part requires the respondents' demographic details, and the second part deals with the awareness level regarding islamic financial institutions. collected primary data was analysed through microsoft excel and presented through the tables and figures. secondary sources were collected through academic journals, books, research articles, and thesis and website articles. 4. results and discussions this study focuses the non-muslims in ampara district, sri lanka to investigate the awareness level of islamic financial institutions among non-muslims. the data obtained from 165 respondents have been analyzed and presented in this results and discussion section. table 1 describes the information related to demographic of the respondents such as gender, religion, age category and educational qualification. out of 165 respondents 58% were male and 42% were female. 5 categories of respondents such as buddhist, hindus, christianity, catholic, non-religious have responded for this study and most of them are hindus (47%). moreover, the majority of the respondents (51%) were in the age group of 20-30 years and less respondents belonged to the below 20 categories. according to the educational qualifications of the respondents, most of them are educated and 47% of them have completed bachelor’s degree. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7321 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 5 table 1: respondents’ demographic profile value frequency percentage gender male 95 58 % female 70 42 % religion buddhist 35 21 % hindus 78 47 % christianity 29 18 % catholic 16 10 % non-religious 07 04 % age category below 20 12 07% 20-30 84 51% 31-40 37 22% 41-50 19 12% above 50 13 08% educational qualification g.c.e. o-level 13 08% g.c.e. a-level 26 16% diploma 25 15% higher national diploma 15 09% bachelor’s degree 78 47% masters 08 05% source: survey results (2022) european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7321 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 6 figure 1: respondents' bank account details source: survey results (2022) when looking at the bank account details of the respondents, the data shows that 90% of them have a bank account, most of them opened an account before 2015, and 73% have an account with the intention of getting savings services. however, the data also shows that although most have saving accounts, respondents also avail of services such as current accounts, term deposits, and fixed deposits. figure 2: islamic financial institutions (ifis) which known to the respondents. source: survey results (2022) 148 17 60 32 45 11 148 31 5 20 0 20 40 60 80 100 120 140 160 y es n o b ef or e 2 01 5 20 15 20 17 20 17 20 20 a ft er 2 02 0 sa vi ng a cc ou nt c ur re nt a cc ou nt t er m d ep os it f ix ed d ep os it have a bank account? the year opened it respondents' bank account 150 (56%) 42 (16%) 5 (2%) 26 (10%) 12 (4%) 10 (4%) 8 (3%) 7 (2%) 8 (3%) 0 20 40 60 80 100 120 140 160 amana bank lolc al-falah lb as-salama amana takaful hnb takaful commercial adhala boc annoor people leasing as-safa hnb an-naja european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7321 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 7 figure 2 shows that 56% of the respondents are aware of amana bank, 16% are aware of lolc al-falah and 10% are aware of amana takaful. however, only a few respondents (5 persons 2%) know lb as-salama. according to this, it can be concluded that people are aware of amana bank through more advertisements and due to the lack of advertisements, less awareness of lb as-salama. as per the previous research, which has done base on the undergraduates of the south easter university of sri lanka, only 30% of respondents have known the amana bank, 20% of respondents have known the boc bank's an noor islamic unit, 10% of respondents have known the commercial bank's al adalah unit, 5% of respondents have known the hnb bank's al najah unit, 25% of respondents have known about the al falah unit, and 10% of respondents have known the people's bank's al safa unit (ahamed et al, 2021). so, the results of this research have confirmed that the amana bank has increased its awareness among the non-muslims more than the other islamic financial institutions in sri lanka but still has to do more to get a good positive reach. figure 3: financial institutions (fis) which respondents availed the services. source: survey results (2022) figure 3 shows the conventional and islamic financial institutions where respondents availed services. according to the above figure, most respondents avail the services from conventional financial institutions (cfis) than islamic financial institutions. figure 2 shows that 64% of respondents know amana bank and takaful, but only 3% avail services from these financial institutions. therefore, even though non-muslims are aware of islamic financial institutions, their consumption of them could be much higher. 50 55 72 13 9 10 12 5 8 5 2 0 10 20 30 40 50 60 70 80 c om m er ci al b an k p eo pl e' s b an k b o c b an k sa m pa th b an k h n b b an k l o l c l b f in an ce n sb b an k se yl an b an k a m an a b an k a m an a t ak af ul cfi ifi european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7321 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 8 figure 4: matters which consider by respondents as principles of ifis. source: survey results (2022) when asked to identify the key principles of islamic financial institutions, 38% of the respondents agreed that absence of interest is a principle which following by all islamic financial institutions. furthermore, among other principles, risk sharing was agreed by 27% of respondents, profit-loss sharing agreed by 16% of respondents, and absence of gambling agreed by 13% of respondents as principles. however, very few respondents (6%) agreed with the absence of uncertainty as a principle. the main reason for this may be the lack of awareness among the non-muslims about it. from the previous research which has done based the data collected from the non-muslims of colombo district, they have confirmed that in identifying the main principles of an islamic financial institution, around 90% of the respondents agreed that ‘absence of interest’ is a principle followed by any islamic financial institution. most of the respondents failed to realize that risk sharing, absence of gambling and uncertainty are also equally important principles as only about a quarter of the population identified it (sulaiha and mazahir, 2018). so, from the results of both studies we can come to the conclusion that the non-muslims of colombo have more awareness and knowledge about the principle of islamic financial institutions than the non-muslims of ampara district. 76 (38%) 53 (27%) 32 (16%) 12 (6%) 25 (13%) 0 10 20 30 40 50 60 70 80 absence of interest risk sharing profit loss sharing absence of uncertainty absence of gambling european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7321 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 9 figure 5: factors consider by respondents as appropriate for engaging in ifis. source: survey results (2022) when the respondents were asked about the appropriate factors for engaging in islamic financial institutions, they mentioned factors such as ifis offer more benefits than cfis, well-versed employees, property regulated, transparent and safety as shown in figure 5. among these factors, 44% respondents accepted that safety is the most appropriate to engage in ifis. furthermore, 21% chose transparent, 16% chose ifis offer more benefits than cfis, and 11% chose well-versed employees. however, only few respondents (8%) accepted property regulated as an appropriate factor to engage ifis. figure 6: reasons why respondents do not want to seek services from the ifis. source: survey results (2022) 84 (44%) 40 (21%) 15 (8%) 20 (11%) 31 (16%) 0 20 40 60 80 100 safety transparent property regulated well-versed employees islamic financial institutions offer more benefits than conventional financial institutions 78 (30%) 55 (21%) 10 (4%) 25 (9%) 6 (2%) 3 (1%) 12 (5%) 20 (8%) 51 (20%) 0 10 20 30 40 50 60 70 80 90 lack of popularity as it is a newly started company limited branches in limited places delays caused by procedural steps during service consumption i thought that islamic financial institutions offering their services only… islamic financial institutions are so far away islamic financial institutions receive more charges than conventional financial… many procedures/regulations need to be followed in islamic financial institutions products term and contracts are difficult to understand not interested european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7321 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 10 figure 6 illustrates why respondents want to avoid seeking services from the ifis. according to the above figure, 30% of the respondents want to refrain from engaging in ifis due to lack of popularity as it is a newly started company. furthermore, respondents mentioned that limited branches in places are also why people couldn't engage with the ifis. and some respondents opined that they do not seek services from ifis due to needing to be more interested. 9% of the respondents indicated that they did not engage with islamic financial institutions because they thought that islamic financial institutions offered services only to muslims. therefore, such reasons indicate insufficient knowledge and clarity about islamic financial institutions among nonmuslims. sulaiha and mazahir (2018) stated in their research, based on the data collected from the non-muslims of the colombo district, that only 8% of the respondents are not willing to deal with an islamic financial institution. their main reason is that they are unsure whether islamic financial institutions are true to their name by following the shari’ah principles or if it is just another form of deception. around 25% believe there is no difference between islamic and conventional financial institutions. the remaining 27% are not interested in dealing with an islamic financial institution. of the 25% of the respondents who are neither willing nor unwilling to deal with an islamic financial institution, 45% say that the products and services offered by these institutions could be clearer. another 30% say that the explanation provided by employees of these institutions about the products and services could be clearer. the rest cites that there needs to be updated information about the products and services offered by these institutions. so, from the results of both studies, it can be understandable that the thoughts and the mindset of the respondents from both areas are quite different in why they do not want to seek services from the ifis. 5. conclusion and recommendation according to the discussion, non-muslims are as aware of islamic financial institutions as conventional financial institutions. however, their engagement level in islamic financial institutions could be much higher. specifically, the analysis presents that the respondents only avail services from amana bank and amana takaful. furthermore, although the respondents accepted some of the key principles of islamic financial institutions, they also presented some reasons for their reluctance to engage with islamic financial institutions. therefore, even if non-muslims are aware of the difference between islamic financial institutions and conventional financial institutions, they should be given more awareness about islamic financial institutions and their concept. thus, to increase the awareness level of non-muslims, more advertisements should be given about islamic financial institutions, and awareness programs should be organised. however, they need more exposure to understand the difference between a conventional financial institution and an islamic financial institution. the following recommendations can be taken into consideration: • islamic financial institutions should take more initiatives to create awareness among the people as a whole, particularly the non-muslims. organizing more roadshows, promotions, workshops, handing out pamphlets at strategic areas are just some ways. • an islamic financial institution should highlight the roles and duties performed by each of its departments so that customers have properly information to act on. • information provided in the islamic financial institution website or in any pamphlets should be maintained and updated regularly. • ensure the front-line employees of any islamic financial institution are well versed in the islamic finance field and able to communicate effectively with the customers. • avoid the use of too many jargons when dealing with customers as this can cause difficulty for them. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7321 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 11 references abdullah, sidek, & adnan. 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(2022). a maqasid-ul-shari’ah analysis of the permissible futures trading in islamic financial markets. european journal of islamic finance, 9(3), https://doi.org/10.13135/2421-2172/6800, 1-13. ross, m. l. (2022, january 11). working with islamic finance. retrieved from investopedia: https://www.investopedia.com/articles/07/islamic_investing.asp safrin, s., & mohamed nairoos, m. (2019). attitudes of non-muslims on islamic financial institutions: a study based on sungawila area in sri lanka. international journal of research and innovation in social science, iii(xii). sajith, a., & fathima ilma, m. (2021). causes of inflation in sri lanka and the solutions proposed by islam. 10th south eastern university international arts research symposium -2021 on 3rd february 2022 (p. 3). oluvil: south eastern university of sri lanka, oluvil, sri lanka. sayilir, o., & soud, n. (2017). perceptions of islamic banking among muslim and non-muslim citizens in tanzania. international journal of islamic economics and finance studies , 3 (3) , 15-29 . doi: 10.25272/j.21498407.2017.3.3.02, 15-29. sohail, m., & ahmed, u. (2021). non-muslims attitude and perception towards islamic banking: a case of district peshawar. journal of managerial sciences, 15(4). soud, n. s., & sayilir, o. (2017). perceptions of islamic banking among muslim and non-muslim citizens in tanzania. international journal of islamic economics and finance studies, 3(3). doi:10.25272/j.2149-8407.2017.3.3.02 sulaiha, f. m., & mazahir, s. m. (2018). awareness of non-muslims about islamic financial institutions in colombo district. empowering national development through religious, languages, culture and society. oluvil: fia, seusl. the world bank. (2015, march 31). islamic finance. retrieved from https://www.worldbank.org/en/topic/financialsector/brief/islamic-finance trokic, a. (2017). an analysis of takaful: the potential and role in financial inclusion and challenges ahead. european journal of islamic finance, (7). https://doi.org/10.13135/2421-2172/2085. u.s. department of state. (2021, may 12). 2020 report on international religious freedom: sri lanka. retrieved from https://www.state.gov/reports/2020-report-on-international-religious-freedom/sri-lanka/ european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7321 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 12 zaki, f., & hussainey, k. (2015). conversions to islamic banks: jurisprudence; economic and aaoifi requirements. european journal of islamic finance, (3). https://doi.org/10.13135/2421-2172/1111. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7108 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 24 gmm dependency model for shariah and underlying indices of india during covid-19 period saif siddiqui 1, sumbul2 1associate professor, department of management studies, jamia millia islamia (central university), new delhi-110025, india 2 contact author research scholar, department of management studies, jamia millia islamia (central university), new delhi-110025, india khan7sumbul@gmail.com received: 11/05/2022 accepted for publication: 27/03/2023 published: 21/04/2023 abstract the national stock exchange of india (nse) has presented nifty 50 shariah and nifty 500 shariah indices to provide unconventional indices for sharia-compliant companies. these indices follow sharia laws and can be used in portfolios that are culturally dependable commodities for investors who do not wish to put their money into the undesired business. nse witnessed big movements in the indices during the covid-19 period. this study seeks to understand the association between nifty 500 sharia and nifty 50 sharia and their respective selected indexes, nifty 500 and nifty 50, during the covid-19 pandemic. the period from 27/01/2020 to 31/05/2022 has been taken for this study. the techniques applied, like correlation, co-integration, gmm, etc. based on the objectives of this paper. we conclude that the return of sharia indices is better compared to the other indices. also, stocks compliant with sharia indices are less risky and a better alternative for the portfolio during pandemic times. keywords: shariah indices; gmm; nse; modelling; covid-19 1. introduction a sharia index is referred to as an index of companies that needs to be compliant with the sharia law. it focuses on socially responsible investment products of companies and is used as a measurement tool for valuing a section of the stock market. shariah board understands the shariah principles and forms the foundation of shariah indices. the constituents of these indices are based on existing indexes screened by the shariah board. investors worldwide are attracted by these products guided by the sharia principle, because they ensure that the investors’ money is not used in stock options that are not aligned with islamic beliefs. being introduced in the mid-1970s, the islamic finance industry has grown with numerous achievements in a brief amount of time. the assets in islamic banking have shown an unexpected increase of 17.6% from 2009 to 2013 every year. not european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7108 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 25 only this, growing companies like ernst &young predicted an increase of 19.7% by 2018. the sector is further predicted to grow annually by a percentage of 15 to 20, making it one of the quickest-growing sectors in the financial industry. dow jones, ftse, s&p, and morgan stanley are some index providers that offer indices compliant with the sharia law to attract investments worldwide. in february 1999, dow jones became the first company to introduce the islamic index. bombay stock exchange (bse) and the national stock exchange of india (nse) are responsible for offering sharia-based indices in india. furthermore, the nifty 50 shariah and nifty 500 shariah were introduced by nse on february 2008 and december 29, 2006, as their base date. with these indices, investors have the option to engage their money in activities that are compliant with sharia law. in addition to nifty50 shariah and nifty500 shariah, nse calculates nifty shariah 25. the nifty 50 index is the parent index to nifty50 shariah index, without any fixed number of companies. moreover, the parent index, the nifty 50 index, constitutes sharia-compliant indices. this index is used for various applications, including portfolio benchmarking, index funds, etfs, and structured product launches. additionally, taurus, uti, kotak, reliance, bajaj allianz, hsbc, tatas, etc., are some financial institutions working towards introducing shariah products in the indian financial market. this research paper aims to analyze the selected sharia indices on different parameters for understanding the various investment options available under sharia law while referring to the indian financial market. the findings of this study will be helpful to fund/ portfolio managers in developing suitable portfolios. 2. literature review according to kumar (2022), the sharia indices are highly volatile due to being a recent phenomenon and studied only four macroeconomic variables. the author tried to study the relationship between macroeconomic variables and sharia stock indices. johansen's co-integration test shows cointegration between interest rate and money supply for only ftswind sharia indices. irfan et al. (2021) assessed the pandemic's influence on the islamic stock markets bse shariah (india) and jii (indonesia). indian stock market showed a downward slope, while the stock market in jakarta showed an upward slope after the declaration of the pandemic. this concludes that the efficient market hypothesis is true as the market reacts to information, and bad news has a clear effect. ahmad and ibrahim (2020) compared klse syariah index with the klse composite index performance. risk-adjusted returns were compared using the adjusted sharpe, treynor, and adjusted jensen alpha index. for both unadjusted and riskadjusted returns, the performance of these two indexes was similar. this indicates that one index is not superior to another. the author offers the possibility that market participants have not yet recognized the "value" of stocks certified by the syariah committee. according to jamaluddin (2013), the government of india is taking interest in the shariah finance business in the country and is showing growth. prof rajan’s report also contains a paragraph on islamic banking which the author has mentioned. based on these, the author concludes that india is one of the world's potential markets for islamic finance. as reported by arshad & rizvi (2013), compared to traditional indexes, the islamic index is subject to radical or short-term effects due to rapid changes in volatility. the author used a wavelet to analyses the selected indices by taking 15 years of data period. the study has a practical impact on the modern financial situation, where islamic financial assets show steady growth despite the financial crisis. ashraf & deo (2015) discovered the linearity of the indian sharia indexes, cnx nifty, cnx500, and s&p bse tasis 50, from january 1, 2008, to june 30, 2013. the authors attempted to test non-linear dependence through the bds test. the results implied that non-stationary and linear dependence don’t cause linearity; rather, non-linearity is caused by volatility. the authors state the need for policy regulations for the sharia market. al-khazali et al. (2014) studied the performance of nine dow jones islamic indexes with nine dow jones conventional indexes using stochastic modelling. the period taken is divided into three; from 1996 to 2000, 2001 to 2006 and 2007 to 2012. the period from 1996 to 2012 was also considered. syauqi beik (2011) analysed the performance of jii with other islamic and conventional stock indexes during the start of the catastrophe period. the data is from january 1, 2006, to december 31, 2008. in the long run, no cointegration and longterm relationship was found between the indonesian markets and malaysian markets and the usa however, in the short run, it significantly affects the jii. the author concludes that jii is the least volatile index of all the markets that should be used to attract more investment. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7108 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 26 as reported by charles et al. (2012), which studied the indices of global and local, islamic indices fluctuate more than conventional indices. daily data has been taken over 15 years from the dow jones islamic and conventional indexes. iccs (iterative, cumulative sum of the square) method has been used for analyzed data. the author concluded that variance had been affected in islamic and conventional indices. hassan et al. (2005) investigate the potential effects of islamic shariah screening on the performance of islamic investment portfolios compared to conventional portfolios. transaction expenses or management fees do not impact their findings because they only look at index funds. they use djim databases of 8 years and a range of techniques comparable to those utilized in the current investigation. they come to similar conclusions as we did about the fact that islamic funds sometimes outperform traditional index funds. hassan & girard (2010) reported in their research that conventional funds outperformed islamic ones in a bullish market, whereas conventional funds outperformed a bearish tone. in challenging economic times, including islamic mutual funds in a portfolio helps to reduce downside risk. islamic and conventional funds represent less than 50% of the market index represented by kuala lumpur's proxy for diversification. ahmad & ibrahim (2020) compared the three-year performance of the klsi and klci indexes. they looked at the performance as determined by the risk and return of both indices using a variety of approaches. the t-test for comparing means, the treynor index, the adjusted jensen alpha, and the adjusted sharpe ratio (sr) were some of the methods employed. the sample was divided into three parts: the full sample, the growth period during the first year of the 2000 fiscal year, and the decrease period during the two years that followed. the klsi had poor returns for both the overall and declining eras. however, it marginally outperformed the klci during the period of growth, according to a comparison of the raw returns and risks from 1999 to 2002. albaity & ahmad (2008) looked at how klsi and klci did in the short and long term. our research shows no statistically significant difference between islamic and traditional stock market indices regarding risk-adjusted returns over seven years. we also use the causality and johansen cointegration tests to analyse their shortand long-term links. the long-term equilibrium shows that both indices move together in addition to a considerable short-run presence of bidirectional causality. this implies that the direction of klsi's shortand long-term movement is well predicted by the movement of klci. therefore, making a prediction based on the other is helpful. al-khazali et al. (2014) investigated nine important dow jones indexes, including asia pacific, canadian, emerging markets, us dji, and others, to compare the performance of islamic stock indices and that of their conventional counterparts. the study used a stochastic dominance analysis technique with data from 1996 to 2012. the study shows that, except for the european market, conventional indexes statistically outpace islamic indices. however, globally, european and us islamic indices outperformed their traditional equivalents throughout the financial crisis of 2007–2012. according to the study, islamic indexes performed better than their traditional counterparts throughout the financial crisis. ,in their study abdullah et al. (2013) assessed the degree to which the asian stock market fluctuates in response to intraregional influences by analyzing the longand short-term interconnections between the international and asian emerging stock markets. it was determined that the united states controls other markets in both the shortand long-term on a global scale. moreover, the established oecd and the growing asian countries have significant long-term and short-term interactions. regionally, the data indicate that hong kong plays a significant role in southeast asia. they are compatible with the "contagion effect" theory, which states that asian markets are better described by their regional markets than by developed markets. over the course of four years, ul haq (2013) analyzed daily data from the sensex and the bse's shariah 50 indexes to make a comparison between traditional and shariah indices in the context of the indian stock market. this paper uses some statistical methods, including a granger causality test, a wavelet analysis, and cointegration. the findings indicate that there is long-term cointegration between the two indices, as well as a two-way flow of information. ,in their study biancone & radwan (2016), assess the compliance of european businesses to sharia law. the authors conclude that their findings have shown a good opportunity for businesses to move towards the principle of islamic finance. the authors also mention the qualitative and quantitative challenges towards this step, the qualitative being related to certifications and the quantitative being related to debt-structuring models. bollani & chmet (2020) have conducted a bibliometric analysis of the publications related to islamic finance. this study helps to determine the direction the research in islamic finance is moving. the authors see an increasing research interest in islamic finance. the literature mainly focuses on “banking, rates, comparisons with traditional banks and portfolios, analysis of governance and control structures”. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7108 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 27 according to siddiqui & rizvi (2022), copula's results suggest that sukuk have strong dependency whether shariah complaint indices have less dependency in the pre-crisis period. but mena sukuk and nifty shariah 50 showed an upsurge with a great margin during covid-19. it also shows that gcc sukuk and nifty shariah 50 are optimistically correlated in the context of their returns. garch results reveal the asymmetric co-movements for gains and losses. at last, the outcomes reveal higher and lower tail dependency among the sukuk and shariah markets. the results vary due to period variation of copulas, which shows dependence differentiation over time for all samples. siddiqui & sheikh (2016) examined the effort to comprehend better the investments to be made in shariah indices, an analysis of the selected shariah indices with the underlying indices on several factors has been done. they used the 3sls and gmm tools for analysing the data over the period of 8years. they used nse and nse shariah indices. as a result, there is no cointegration between the underlying and shariah indices. the market for financial assets based on shariah is expanding. this work represents a significant advancement in creating optimal portfolios that include assets from shariah indexes. in his study, abbes (2012) attempted to find out the relationship between the shariah and conventional indices based on risk and return. he used the egarch to find the effect of risk in indices. also, the capm and sharpe ratio was used to find the return and difference between the shariah and conventional indices. he took ten years of data to achieve the objectives of the study. the study concluded that there is no relationship between the conventional and shariah indices at risk, return, and performance-based; they are not affected by each other. the literature review provides different and contradictory results in connection with various indices of different countries. as a result, it is impossible to portray a consistent relationship between shariah and conventional indices. earlier studies used techniques, including var, capm, ordinary least square, impulse response, dcc-garch, granger causality, treynor ratio, jenson alpha, cointegration test, and others have been employed in earlier investigations. still, we found that they have not used gmm. adding the advanced model generalized method of moments is vital to the current study (gmm). additionally, simultaneous equations (se) are used, as the researcher did not use se and advanced modeling approaches in earlier studies on the shariah indices and nse. the present study is expected to answer the problem statement of what could be the change in dependency structure between shariah and underlying indices in a pandemic period like covid -19. therefore, it is necessary to use sophisticated models to investigate whether the shariah and underlying indices are related to the national stock exchange of india. 3. research methodology 3.1 data this study is empirical and causal in nature. it is based on secondary data sources. data has been taken from nse, india’s largest stock exchange. since nse has the highest turnover, it is justified to use it in the current study in the context of india. for the current study, the sharia indices include the nifty 500 shariah and nifty 50 shariah, while the nifty 500 and nifty 50 are underlying indices. the official website of nse has been used to collect the indices’ daily closing price data from 27/01/2020 to 31/05/2021. 3.2 empirical framework statistical techniques used in this research include an empirical framework for measuring co-movement. further, descriptive statistics have been used for analyzing the potential return and risk of the indices. secondary data analysis, including unit root test, cointegration test, gmm estimation, have also been employed for further analysis and hypothesis testing. the more standard methods like the unit root test and cointegration test, ols, when applied in the system equation environment. this is because it makes the use of an instrumental variable (iv) procedure for estimation in a consistent manner; the same is absent in ols. not only this but the standard errors are also reduced without requiring any known distribution of errors which is necessary while using ols. gnm also works efficiently because it ensures that the endogeneity problem does not occur. the european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7108 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 28 endogeneity bias occurs when an independent variable is found to be correlated with an error term of the regression model. ordinary least squares (ols) might involve biased regression coefficients. table 1. indices source: authors’ elaboration 3.3 objectives of the study the study aims to build efficient models for advising stakeholders and assessing the returns and volatility of nse sharia indices relative to their underlying indices. to achieve this broad purpose, the following specific study objectives are highlighted: 1. to compare the volatility of the nifty 50 and nifty 500. nifty50 shariah, nifty500 shariah. 2. to create a cointegrate model of the nifty 50 and nifty 500. nifty50 shariah, nifty500 shariah. 3. to understand the model between the effect of shariah and nifty 50, nifty 500. nifty50 shariah, nifty500 shariah over each other. 4. to model the returns of shariah and nifty 50, nifty 500. nifty50 shariah, nifty500 shariah. 3.4 hypotheses h01 = shariah has a lower standard deviation than the underlying indices. h02 = shariah, and the underlying indexes are not co-integrated over the long run. h03 = shariah indices and the conventional indices are not related in any way. h04 = nifty 500 does not significantly affect the return of nifty 500 shariah. h05 = the return of the nifty 500 is not significantly influenced by the nifty 500 shariah. 4. results 4.1 descriptive statistics descriptive statistics reflect the fundamental characteristics of a variable. table 2 shows that the nifty 500 index has a mean return of 0.079252, which is more profitable than other indices. here, we may observe an intriguing fact: compared to its underlying stock market index concerning the mean return, the nifty 500 shariah is a superior investment option. concerning risk, the nifty 500 shariah is also the slightest unpredictable stock market index. the 1.62% and the nifty 50 1.54% are considered the highest-volatility indexes. sn indices symbol log differenced 1 nifty50 n dn 2 nifty50 shariah ns dns 3 nifty 500 n5 dn5 4 nifty 500 shariah ns5 dns5 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7108 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 29 dn dn5 dns dns5 mean 0.054668 0.585943 0.079252 0.070640 s.d 1.541837 5.347535 1.302763 1.623542 skewness -1.086919 -2.527403 -1.481654 -0.408204 jarque-bera 3412.130 4583.059 5379.772 11183.31 probability 0.00000 0.00000 0.0000 0.0000 table 2. descriptive statistics source: authors’ elaboration it is seen in the descriptive statistic that the mean return is higher in the case of nifty 50 and nifty 50 shariah but contradictory results in the nifty 500 and nifty 500 shariah which is higher in the underlying index. this shows that with larger base shariah index may give a lower return. sharia indices have a lower level of volatility than their equivalent underlying indices. these returns have a lower standard deviation than those on the other investments. compared to the nifty 50 and nifty 50 shariah indices, the nifty 500 and nifty 500 shariah indices exhibited a larger chance of a significant return decline. additionally, the null hypothesis of normality is not confirmed by the jarque-bera test. 4.2 correlation there is a relationship between the returns on the nifty 50, the nifty 50 shariah, the nifty 500, and the nifty 500 shariah. correlation analysis is the quickest and most straightforward method for assessing an indicator's predictive power. all indices are significantly associated with one another, as evidenced by the correlation values ranging from 0.1096 to 1.000 (table 3). d_n d_n5 d_ns d_ns5 d_n 1.000 0.3583 0.3506 0.3099 d_ns 0.3506 0.1569 1.000 0.7916 d_n5 0.3583 1.000 0.1569 0.1096 d_ns5 0.3099 0.1096 0.7926 1.000 table 3. correlation analysis source: authors’ elaboration 4.3 unit root test since stationarity is required for modelling and non-stationarity is a need for co-integration, the stationarity of the variable is examined using the unit root test. we opted to use the augmented dickey fuller (adf) test to analyze the unit root in the data from the study. if there is a unit root in the nifty 50, nifty 50 shariah, nifty 500, and nifty 500 shariah indices, or if the data are not stationary, then the null hypothesis (ho) is confirmed to be correct. given that the probability values are more than 5% for all variables, the null hypothesis is accepted at level. in the case of the nifty 50, the nifty 500, and the nifty 500 shariah, each variable either possesses unit roots or is non-stationary at the level of the index. after accounting for the initial discrepancy, the variables have become more stable. 4.4 johansen co-integration test: the johansen co-integration test is utilized so that the long-term co-movement of the indices that are being looked at can be measured. in this test, there are two statistics trace and maximum eigen value to identify the number of equations that demonstrate the existence or non-existence of co-integration. the hypothesis is accepted and that there is no cointegrated equation. this is in accordance with the null hypothesis that there is no equation (r=0), indicating that there is no cointegration among the variables. the outcome of this investigation also european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7108 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 30 demonstrates that the trace statistics (25.02992) are below the critical value (24.27596) and that the probability is 0.0401, which is over the significance level of 5%. hypothesized trace 0.05 no. of ce(s) eigenvalue statistic critical value prob** none 0.045484 51.93622 40.17493 0.0022 at most 1 0.031281 25.02992 24.27596 0.0401 at most 2 0.011222 6.660781 12.32090 0.3602 at most 3 0.000238 0.137844 4.129906 0.7593 table 4. unrestricted cointegration rank test (trace), johansen co-integration test, series: n ns n5 ns5 source: authors’ elaboration trace test indicates 2 cointegrating eqn(s) at the 0.05 level *denotes rejection of the hypothesis at the 0.05 level **mackinnon-haug-michelis (1999) p-values hypothesized maxeigen 0.05 no. of ce(s) eigenvalue statistic critical value prob.** none 0.045484 26.90630 24.15921 0.0207 at most 1 0.031281 18.36914 17.79730 0.0410 at most 2 0.011222 6.522937 11.22480 0.2940 at most 3 0.000238 0.137844 4.129906 0.7593 table 5. unrestricted cointegration rank test (maximum eigenvalue) source: authors’ elaboration max-eigenvalue test indicates 2 cointegrating eqn(s) at the 0.05 level. * denotes rejection of the hypothesis at the 0.05 level **mackinnon-haug-michelis (1999) p-values when we tested the hypothesis for r=2, r=3, and other numbers of equations. this was the same conclusion that we came to when we tested the hypothesis for other numbers of equations. the conclusion that the indices are not co-integrated is reached because of this, which leads to the acceptance of the null hypothesis. the findings of the second statistic, a test known as the max eigen value test, are consistent with the conclusion that r = 0 is true. as a result of the fact that the critical value, 24.15921, is lower than the maximum statistical value, 26.90630, and the probability, 0.0207, is lower than 5 percent, it can be concluded that the null hypothesis is correct. according to the similar results that we obtained, which support the null hypothesis, the max eigen values are less than the critical values. this indicates that the null hypothesis is correct. as a result, the test reveals that there is no co-integration or long-term link between the indices, which translates to the conclusion that they do not ultimately move in tandem with one another. 4.5 granger causality test since there is no causation between the series, the null hypothesis (h0) is chosen to examine granger causality. the results of below table show that there is no correlation between the returns of the nifty 50, nifty 50 shariah, nifty 500, and nifty 500 shariah. this is because each series has a granger causal probability value greater than 5%. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7108 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 31 null hypothesis: obs f-statistic prob. d_n5 does not granger cause d_n 581 0.96011 0.3835 d_n does not granger cause d_n5 581 2.21204 0.1104 d_ns does not granger cause d_n 581 56.3929 4e-23 d_n does not granger cause d_ns 581 1.05639 0.3484 d_ns5 does not granger cause d_n 581 133.530 2.e-48 d_n does not granger cause d_ns 581 2.37319 0.0941 d_ns does not granger cause d_n5 581 54.3795 2.e-22 d_n5 does not granger cause d_ns 581 0.91786 0.4000 d_ns5 does not granger cause d_n5 581 166.641 8.e-58 d_n5 does not granger cause d_ns5 581 4.03665 0.0182 d_ns5 does not granger cause d_ns 581 18.9745 1.e-08 d_ns does not granger cause d_ns5 581 1.78675 0.1684 table 6. granger causality test source: authors’ elaboration 4.6 gmm estimation: we apply the generalized method of moments (gmm) estimation to this model. we offer estimations based on methods to confirm the reliability of our findings. equations used are as under: dns = α1 + β1 * dn + β2 * dn5 + β3 * dns5 dns5 = ω1 + β4 * dn + β5 * dns + β6 * dn5 dn = ϑ1 + β7 * dns + β8 * dn5 + β9 * dns5 dn5 = ρ1 + β10 * dn + β11 * dns + β12 * dns when it comes to choosing the nifty 50, the gmm model suggests that none of the three independent indices—the nifty 50 shariah, the nifty 500 shariah, and the nifty 500 shariah—are significant. it is not possible to use the terms nifty 50, nifty 500, or nifty 500 shariah to refer to the same thing as nifty 50 shariah. when systems equations are used to estimate the returns of nifty 500 shariah as well as to calculate nifty 500, the nifty 500 shariah index is simply a relevant index that may be used. dependent endogenous coefficient std. error t-statistic prob. α1 dn c 208.2922 47.28753 4.404803 0.000 β1 dn5 1.439370 0.018205 79.06637 0.000 β2 dns 2.632514 0.073837 35.65328 0.000 β3 dns5 -2.885665 0.069294 -41.64378 0.000 ω1 dn5 c -130.0703 34.85340 3.731925 0.002 β4 dn 0.687071 0.009240 74.35628 0.000 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7108 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 32 β5 dns -1.796664 0.060997 -29.45489 0.000 β6 dns5 2.004195 0.039838 50.30854 0.000 ϑ1 dns c -30.07721 24.33754 -1.235836 0.2170 β7 dn 0.363476 0.010465 34.73143 0.000 β8 dn5 -0.520310 0.018152 -28.66398 0.000 β9 dns5 1.075798 0.023147 46.47776 0.000 ρ1 dns5 c 30.05649 21.27050 1.413060 0.1582 β10 dn -0.334977 0.008347 40.13316 0.000 β11 dn5 0.487673 0.009794 49.79307 0.000 β12 dns 0.903603 0.020811 43.41874 0.000 table 7. estimation method: generalised methods of moments source: authors’ elaboration 5. conclusion and implication the study focused on developing an efficient model which could forecast the returns of shariah indices with its selected indices. during covid-19, shariah indexes show lesser volatility as compared to the underlying indices, which means they are a better investment as compared to conventional indices. although the nifty 500 is the most profitable index, the nifty 500 shariah is the better investment option as it offers the least risk among the underlying indices as offer the least volatility. the high positive correlation value shows the interdependence of all the selected indices. however, there is no cointegration and causal relationship between the underlying indices, as shown by various tests conducted on the data. indices based on shariah are gaining popularity all over the world due to less risk and less volatility as compared to conventional indices. . cause-and-effect analysis of the indices did not show any significant relationships among the returns of indices. it is also crucial to note that gmm model revealed that only two variables, nifty 500 shariah and nifty 500, were found to be significantly impacting one another as system equations. hypothesis accepted/rejected on the basis of results h01 accepted lower standard deviation in shariah h02 rejected no cointegration h03 accepted no cointegration h04 rejected nifty500 shariah is significantly influence while nifty500 h05 rejected nifty500 is significantly influence while nifty500 shariah table 8. hypothesis summary source: authors’ elaboration sharia-based financial assets are gaining exceptional growth in the financial market. the study adds value to such market investments guiding optimal portfolio management consisting of sharia indices products. results of the study are a guide to fund managers for strategically diversifying their portfolios while being compliant with the sharia law. since the study the goal of diversification is also achieved because there is no shortor long-term causation. furthermore, sharia indices can serve the purpose of offering optimum portfolio since they are relatively lesser risky. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7108 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 33 references abbes, m. b. 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(2013). co-integration and causality in different time scales between sensex and shariah : 50 indices in indian stock markets. journal of islamic economics banking and finance, 9(4), 164–174. https://doi.org/10.12816/0031382 1 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6199 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejifcontent is licensed under a creative commons attribution 4.0 international license received: 11/05/2021 accepted for publication: 16/11/2021 published: 30/12/2021 social performance of islamic banks ˗ theoretical and practical insights admir meskovic1, emira kozarevic2, alija avdukic3 1 university of sarajevo, school of economics and business, trg alija izetbegovic 1, sarajevo 71000, bosnia and herzegovina 2 university of tuzla, faculty of economics, urfeta vejzagića 8, tuzla 75000, bosnia and herzegovina 3 university of dundee, al-maktoum college, , 124 blackness rd, dundee dd1 5pe, united kingdom contact author: admir_meskovic@live.com abstract — this study analyzes the social performance of 40 islamic banks from 13 countries over the period 2012-2018, aiming to investigate to what extent islamic banks around the world meet the social goals of the islamic moral economy. as key financial institutions that operate within the framework of the islamic moral economy, islamic banks are expected to play and emphasize their socio-economic role in society by improving their economic, social, ethical, and environmental performance. therefore, social performance in this paper was measured via a comprehensive evaluation framework using a maqasid index based on disclosure analysis. the main findings suggested that islamic banks achieved 35% of the maximum index value, which indicated a room for improving their social performance. there was an encouraging fact that social performance over the observed period grew on a yearly basis. the average growth rate of social performance per year was 3.58%, which did not guarantee significant changes in a short time, but it was evident that banks made some progress in this regard over the observed period. moreover, the highest score of islamic banks' social performance was recorded in the category i3 (“self”) of the social performance index, which was based on the level of investment in the real sector, particularly small and mediumsized enterprises (smes). on the contrary, the lowest rating was registered in the category i5 (“posterity”). an alarming fact was that islamic banks demonstrated deficient environmental awareness and achieved low performance in this index component. further, banks from indonesia achieved the highest social performance. also, to provide an easier understanding of the social performance of islamic banks compared to the expectations of the islamic moral economy, banks were categorized into specific categories according to a rating system similar to the camels approach in conventional banking, but based on the islamic moral economy social performance framework. keywords: islamic moral economy, islamic banks, social performance, maqasid i. introduction the concept of incorporating social responsibility into business and finance has attracted considerable attention in the last couple of decades. notably, the global financial crisis 2007-2009 relaunched the debate on ethics in finance and banking and also spurred additional interest in research in islamic banking, as noted by nuhanovic & kozarevic [1]. socially responsible financial institutions have developed in the west to build a fairer and more sustainable society. at the same time, islamic banking has developed to provide the islamic world with acceptable ways of financing the development needs of society. however, chapra [2] notes that islamic banking “is not only interest-free but is oriented towards achieving social welfare”. theorists of the islamic moral economy have been advocating this position practically since the development of the modern islamic moral economy, banking, and finance. they point out that the islamic prefix dictates ethical behaviour and commitment to social goals. according to authors such as maali, casson & napier [3] and kamla, gallhofer & haslam [4], the goal of the islamic moral economy is in itself to promote human well-being, while islamic banking is an operational form of the islamic moral economy. this approach to banking carries an ethical identity because of its religious roots, as haniffa & hudaib [5] claimed. islamic banking is dominated by the idea that islamic banks are financial institutions oriented towards the promotion of social welfare. therefore, islamic banks are expected to be more socially responsible than conventional banks as noted in haniffa & hudaib [5]; dusuki [6]; warde [7]; farook, hassan & lanis [8]; aribi & arun [9]. some critics, however, argue that islamic banks strive for profit as actively as conventional ones and are profit-oriented, while ethical and social goals have very little influence on the behaviour of these banks and their business practices pollard & samers [10]; warde [7]; belal, abdelslam & nizamee [11]. authors in this field point out the fear that the debtoriented culture of conventional banks inspires the strategic vision of islamic banks. el-gamal [12] and khan [13] go so far as to suspect that these institutions exploit muslim believers by selling them products that are formally in line with the principles of the islamic moral economy but not in line with its spirit and intentions, and the question of the social impact of islamic banks arises. 2 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6199 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejifcontent is licensed under a creative commons attribution 4.0 international license received: 11/05/2021 accepted for publication: 16/11/2021 published: 30/12/2021 the results of previous research works examining the social performance of islamic banks argue that the social, ethical, and environmental performance of these banks is “unimpressive” and show a “lack of social responsibility” as concluded by asutay & harningtyas [14]. also, studies in this area such as rusydiana & firmansyah [15]; antonio, sanrego & taufiq [16]; mergaliyev, asutay, avdukic & karhbahi [17] indicate the frequent absence of the expected positive effects of these financial intermediaries on society, but also note that in these social performances, there are significant differences between the analyzed islamic banks analyzing the business practices and social performance of islamic banks some authors mentioned that possible reasons for this situation are the “conventional regulatory environment and rules” according to which islamic banks operate, as noted by mohammed & taib [18]), “an early stage of development in which islamic banking finds itself” as concluded by warde [7], as well as many other challenges these banks face in reality, especially in terms of legal and regulatory framework, political and economic climate, including lack of human capital as noted by hasan [19]. however, most authors who analyzed this issue concluded the obviousness of islamic banks' poor social performance but providing no empirical evidence. in the next chapter we will present the theory of islamic moral economy and concept of maqasid. after this, we will elaborate literature on social performance of islamic banks. methodology will be presented in the fourth chapter, followed by results and discussion. ii. theorethical framework asutay [20] scrutinizes axioms and basic principles that define the framework for conducting economic activities based on qur'an and sunnah: • tawhid the belief that god is one, therefore the purpose of man is one; • adalah and ihsan justice and good deeds, which are expressed in human relations; • tazkiyah growth and development in harmony and self-purification which ultimately helps man to overcome his problems in terms of the existence of interests between the individual and society; • rububiyyah giving a chance to attain perfection; • fardh responsibility, obligatory actions and activities that are socially oriented; • amanahresponsibility for others; • hilafah human responsibility towards god; • ukhuwwa solidarity and unity for the purpose of achieving general well-being; • takaful cooperation and interdependence with each other; • maqasid legal and rational framework of islamic economic activities. kuran [21] notes that axioms and principles of islamic moral economy explicitly emphasize moral activities in private life but also those activities that cause harmful consequences such as throwing away waste, extravagance and immodesty in an effort to stimulate generosity, and similar harmful externalities. it follows that the maqasid offers a legal-rational framework within which all economic activities from the islamic aspect should be carried out. meeting the goals of sharia with the intention of achieving moral results implies a systematic and dynamic understanding, which implies broad but not limited measures to ensure well-being through the implementation of justice and equality, as noted by siddiqi [22]. in addition to islamic axioms, tripp [23] emphasizes that the fundamental principles of the prohibition of interest and the giving of zakat characterized through unity, consideration, and friendliness are the main instruments for achieving the goals of islamic moral economy. however, chapra [24] emphasizes that these principles, along with the rules of inheritance are not the only values that people need to consider in order to achieve individual good in this world but also in the future, but also the overall approach of islamic moral economy that makes interest-free economy, social justice , equal opportunities, private ownership, moral filters in resource use, self-interest motivation, wealth creation as well as collective endeavors in both competition and cooperation (asutay [25]; chapra [24]) to achieve maqasid. the objectives of the islamic moral economy rely on the objectives of sharia, as noted by asutay [25]. the goals of sharia are either stated directly in the qur'an and the sunnah or are derived by the consensus of scholars based on the qur'an and the sunnah. all of them deal with the reason for the existence of sharia itself, which is, as almost all jurists recognize, to serve the interests of all people (maslaha) and to remove damage or disorder. some lawyers consider that these are two aspects of the same goal, which is the common good. based on the existing literature that reflects different approaches to the goals of the islamic moral economy, mohammad and shahwan [26] divided the goals of the islamic moral economy into goals based on philosophy and operational goals. philosophically grounded goals are those goals that are related to the inner dimension of the islamic moral economy in general and lead to its infinite goals. adapting the goals of the islamic moral economy, the authors similarly divided the topics into four aspects: caliphate, tawhid, rububiyah, and tazkiyah. the caliphate is a state of responsibility and the role of man as his vicegerent, tawhid is the unity and sovereignty of allah, rububiyah refers to the human consciousness that allah is the provider and sustainer of creation, and tezkiyah refers to the purification of the human soul. all these four themes represent the horizontal and vertical relationship between man and allah, and man and other human beings. 3 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6199 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejifcontent is licensed under a creative commons attribution 4.0 international license received: 11/05/2021 accepted for publication: 16/11/2021 published: 30/12/2021 one of the most widely accepted classifications of maqasid is from al-ghazali, a prominent and highly esteemed reformer who lived in the fifth century ah, classified the maqasid (i.e., the goals of the islamic moral economy) into five main categories stating that the very purpose of sharia is to promote the welfare of the people, which consists in protecting their religion (dīn), their life (nafs), their intellect ('aql), their offspring (nasl), and their wealth (māl). anything that ensures the protection of these categories serves the public interest and is desirable, and anything that violates them is against the public interest and it is desirable to remove it. in his research works, the great islamic scholar abu ishaq al-shatibi confirmed al-ghazali's position on the five protected values, as noted by al-raisuni [27]. these, however, are not the only values or goals. there are other values that the qur'an and the sunnah point to. thus, while these five can be considered primary, other goals or values can be consequential or secondary. the realization of secondary goals is necessary because the primary goal cannot be achieved without realizing secondary goals. it is also important to point out that although “preservation” or “protection” is used, it does not mean preserving the status quo but rather developing these values. according to karcic [28], we can conclude that although most scholars generally accept these five values in the field of islamic jurisprudence (fiqh) and sharia science as universal, not all scholars have always adhered to the list of these five, and some have added additional ones (for example, honour). even al-shatibi did not always adhere to only the five categories mentioned, which means that even the listed universal values are “living matter”. therefore, it is necessary to strive for continuous enrichment of primary values and their consequences so that well-being is continuously improved following the changing needs of individuals and their society and humanity, thus enabling everyone to continue on the path to a better future. such enrichment may be challenging if we stick to the framework of only the needs discussed by the classical ulema. times have changed and needs have also changed. najjar [29] extended the maqasid based on four objectives and eight corollaries, as identified by bedoui and mansour [30], providing a framework for assessing the social performance of islamic banks. the framework was used by several studies such as asutay and harningtyas [14] and mergaliyev, asutay, avdukic & karbhari [17], who used that framework referring to it as “invigoration” rather than “safeguarding” as part of chapra's [31] redefinition of maqasid. through such a reinterpretation and extended maqasid as a dynamic construct beyond a safeguarding role, an embedded islamic moral economy frame is constituted for the islamic banks to operate within, as noted by asutay & yilmaz [32]. iii. literature review different authors used different methods and terminology when trying to evaluate some aspects of the operations of islamic banks, usually criticizing them for disbalance between islamic banking theory and practice. also, more studies are attempting to develop a maqasid measurement methodology and just a few of them measuring the islamic banks' social, ethical or environmental performance. aggarwal and yousef [33], hasan [34], and nagaoka [35] were among the first to note that islamic banks rarely provide long-term financing to start-ups that need capital. the first researchers who expressed the need to assess the performance of islamic financial institutions concerning their social goals were hasan [19] and tag el-din [36]. hasan [19] highlighted the essential criteria, methods, and procedures usually used to assess the performance of islamic banks, however mostly ignoring the primary purpose of these institutions and their accountability to society under the principles of the islamic moral economy. in a pioneering work, mohammed, dzuljastri & fauziah [37] used a new approach to measuring the performance of islamic banks based on the goals of the islamic moral economy and they were the first who used the term “maqasid index” as an indicator of such performance. the study went through three phases in the development of this index. the authors refered to the sekaran [38] method for operationalizing the theory, which resulted in performance measures. furthermore, they asked 16 experts to decide on the relative importance of the measures developed, which resulted in average weights for each measure. finally, they applied hwang and yoon's [39] method for simple weighting. this phase was conducted to quantify the ratios of sample performance and the weight assigned to targets and the developed variables. the study examined the social performance of six large islamic banks globally and ranked them according to the results. asutay [40] pointed out that the transformation of the original form of islamic banking into purely commercial islamic banking resulted in incredible financial success but to the detriment of the islamic moral economy's social and economic development aspirations. therefore, the mentioned article sought to investigate the social failure of islamic banks and other financial institutions and identify the main reasons for this failure. the critical analysis led to the realization that islamic financial institutions compromised islamic values and trends in “financialization” and financial engineering. based on the growing number of authors who confirmed the gap between the practice of islamic banks and the aspirations of the islamic economy, it could be determined that islamic banking failed to achieve the goals of the islamic economy. the author concluded that islamic banks did not significantly affect the development of the economy and that social impact was not among the objectives of these banks. asutay, therefore, proposed the establishment of particular institutions that would bear the burden of economic development and that would be resistant to the trend of “financialization” that gripped commercial islamic financial 4 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6199 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejifcontent is licensed under a creative commons attribution 4.0 international license received: 11/05/2021 accepted for publication: 16/11/2021 published: 30/12/2021 institutions. thus, the debate in recent years has been on “form versus essence” or sharia-compliant financing versus islamic-based finance, which calls into question the overall legitimacy of the current practice of islamic finance and banking. asutay and harningtyas [14] measured the social performance of islamic banks in the light of the goals of the islamic moral economy by najjar [29], with eight basic orientations and associated elements. the sample consisted of 13 islamic banks from six countries over the period 20082012. the results showed that the islamic banks in the sample mainly focused on people, religion and rights, and less on wealth as dimensions of the goals of the islamic moral economy. empirical evidence pointed to poor achievement of the social goals of the islamic banks. in their paper, ngalim and ismail [41] proposed indicators of development in achieving social well-being based on the goals of the islamic moral economy formulated by chapra [31]. the empirical analysis was based on annual reports of 20 islamic banks from malaysia, indonesia and the gulf cooperation council (gcc) countries, and showed that the best performance was achieved by the islamic banks from indonesia. as far as social performance is concerned, empirical results from these regions showed that most islamic banks still did not meet the goals of the islamic moral economy. alamer, salamon, qureshi & rasli [42] proposed the development of an index of socially responsible practices of islamic banks through a review of bank activities in two dimensions ˗ processes and outcomes, taking rationale for such a division from the islamic categorization of illegal acts. authors focused on a process-based approach, observing processes through following aspects: charity, environment, human resources, investment and risk sharing, research, and development. they further focused on investments and believed that the index that measured the socially responsible activities of islamic banks should focus on whether and to what extent islamic banks used musharaka and mudaraba in their activities. bedoui [43] developed a five-dimensional metric for measuring ethical performance based on the definition of sustainable development. these metrics were then generalized using the goals of the islamic moral economy previously explained in the model by bedoui [44] and bedoui and mansour [30]. authors claimed that such a system ensured that each firm or organization ethically promoted human well-being, prevented corruption, and improved social and economic stability rather than simply maximizing its performance in terms of financial returns. this measurement of ethical performance ensured that a firm or organization that aggressively forced financial results at the expense of ethical aspects of business was poorly evaluated. mergaliyev, asutay, avdukic & karbhari [17] used an enhanced approach to the theoretical framework of islamic moral economy goals in assessing islamic banks' ethical, social, environmental, and financial performance. a panel analysis using several key determinants, along with the political and socio-economic environment, ownership structures, and factors related to corporate and sharia governance, was used to identify the main determinants of the social performance of islamic banks. through a panel analysis, this paper revealed that the share of the muslim population, the duality of the ceo and sharia governance were variables that positively affected the social performance of islamic banks. however, the results indicated a negative impact of the country's gdp, financial and human development index, political and civil rights, institutional ownership, and a higher share of independent directors in general on the social performance of islamic banks. hudaefi and noordin [45] also pointed out that islamic and conventional banks could not be compared using conventional performance measures, and in their research, they developed a model for measuring the performance of islamic banks, taking into account a number of studies from this field. these included the islamicity disclosure index, idi, and the islamic quantitative index, iqi (hameed, wirman, alrazi, nazli & pramono [46], the ethical identity index, eii (haniffa & hudaib [5]), the maqasid al-shariʿah index, msi proposed by mohammed, dzuljastri & fauziah [37], adaptation of bedoui's [44] approach, social performance evaluation as proposed by sairally [47]; asutay & harningtyas [14], islamicity measurement measuring how islamic banks are truly islamic by ascarya & sukmana [48], as well as the shariʿah compliance rating proposed by ashraf & lahsasna [49]. alhammadi, alotaibi & hakam [50] investigated the success of islamic banking based on the higher ethical goals of the islamic moral economy. they firstly considered the importance of ethical and social dimensions for banks in general. the authors examined whether islamic banks achieved socio-economic justice and demonstrated best practices by ensuring social well-being. the authors also analyzed islamic banks' ethical and social performance based on an index that highlighted bank disclosures related to education, social justice, and wealth redistribution. empirical evidence suggested that conventional performance measurements no longer reflected the ethical goals of islamic banks and that they negatively affected the achievement of social well-being by these banks. the result revealed financial cost of achieving the goals of the islamic moral economy, as islamic banks that achieved high scores for the social performance index sacrificed financial performance. this supported the view that islamic banks prefered financial returns over their ethical and social impact. biancone, saiti, petricean & chmet [51] as well as bollani & chmet [52] recognize that ethicality of the finance and the banks is often placed in second place even in the case of academic research in the field of islamic banking. 5 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6199 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejifcontent is licensed under a creative commons attribution 4.0 international license received: 11/05/2021 accepted for publication: 16/11/2021 published: 30/12/2021 iv. methodology when it comes to the methodology of empirical part of this research, it was used a balanced panel of annual data for 40 banks from 13 countries, covering period from 2012 to 2018. the criteria for composing the sample was the availability of the data, and the pool of islamic banks that published annual reports with necessary data for the period given was almost exhausted. among the countries covered, there were two countries from europe (the united kingdom and bosnia and herzegovina), five countries from asia (pakistan, bangladesh, malaysia, indonesia, and sri lanka), and six countries from the middle east (jordan, kuwait, bahrain, the united arab emirates, the kingdom of saudi arabia, and qatar). an evident difference in islamic finance practice and ethical and social goals of the islamic moral economy was the motivation for the counducted research. therefore, the purpose of this paper is to investigate the social performance of islamic banks under the islamic moral economy's maqasid framework. social performance was measured via an index based on the theory of the islamic moral economy previously developed by asutay and harningtyas [14] and further enhanced by mergaliyev, asutay, avdukic & karbhari [17]. in constructing a framework for evaluating the social performance of islamic banks, najjar's model of islamic moral economy goals was implemented through four goals and eight areas, according to mohammed, dzuljastri & fauziah [37], which was further refined by bedoui & mansour [37], asutay & herningtyas [14], and mergaliyev, asutay, avdukic & karbhari [17]. dimensions, elements, and indicators were distributed to each relevant area according to a critical assessment of the above frameworks. figure 1. maqasid evaluation framework source: authors' research adapted from mergaliyev, asutay, avdukic & karbhari [17]; mohammed, dzuljastri & fauziah [37]; bedoui & mansour [30]; asutay and harningtyas [14] the concept of dimensions, elements, and indicators was adopted from mohammed, dzuljastri & fauziah [37] to measure general objectives by deriving them into some specific indicators. therefore, the framework for the general evaluation can be shown as done in figure 1. through content analysis, a social performance index was constructed and used to measure the social performance of islamic banks. a weighted approach was used during index calculation to avoid any possible bias in scoring, according to antonio, sanrego & taufiq [16], while researchers such as belal, abdelslam & nizamee [11] and haniffa & hudaib [5] applied an unweighted approach. in calculating the social performance index with all its sub-indices, according to haniffa & hudaib [5], the dichotomous approach was mainly used in the sense that the item received a rating of “1” if found in the annual report and “0” (zero) if it could not be found in the annual report. however, some sub-indices also considered quantitative data from the banks' financial statements, especially concerning categories i3, i5, and i7. indicators from categories i5 and i7 were scaled for the values to be in the range of 0 to 1. the linear scale transformation (lst) method was applied according to singh, murty, gupta & dikshit [53], who specifically addressed the methodologies for estimating sustainability indices consisting of their sub-indices. v. results the results of this study are consistent with the results of similar studies on smaller samples, confirming the mentioned gap between the islamic moral economy's expectations and islamic banks' practice. the overall social performance of the islamic banks for the period 2012-2018 averaged 0.3580, or 35.80%, compared to the expectations of the islamic moral economy. figure 2. islamic social performance indicator source: authors' research ,1124014 ,6818006 ,2707880 ,3324374 ,4509516 ,3580094 ,00000 ,100000 ,200000 ,300000 ,400000 ,500000 ,600000 ,700000 ,800000 6 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6199 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejifcontent is licensed under a creative commons attribution 4.0 international license received: 11/05/2021 accepted for publication: 16/11/2021 published: 30/12/2021 as shown in table 1, hong leong islamic bank bhd (malaysia) had the maximum value of social performance index in one year, i.e., 2018 (the value of social performance was 0.6818 or 68.18%), while the islamic bank of britain (today al rayan bank plc) achieved the minimum value of social performance index in the year 2012 (0.1224 or 11.24%). islamic bank of britain operated in a conventional environment with underdeveloped regulations, competing with large banking groups operating in the united kongdom for decades (or even hundreds of years). although this bank improved its score in the last two observed years, after it was acquired, it was one of the proofs that islamic banks did not have equal status in areas where the conventional financial system was highly developed and where they had to deal with large and well-established banks. on the other hand, hong leong islamic bank bhd is an example of results where the government of a country made significant effort to develop regulations and encourage the development of the islamic financial system, but also forcing the goals of the islamic moral economy, as hassan & nor [54] pointed out. the presented score is relatively low compared to theoretical expectations, but the results are consistent with other studies conducted on smaller samples. regarding the assessment of the actual social performance of islamic banks, many empirical studies have provided evidence that, although islamic banks achieve significant financial performance, they have poor performance in the ethical and social dimensions required by the islamic moral economy. asutay [40] concluded that, based on his empirical research, it could be argued that “social failure” of islamic banking exists due to their transition from the islamic moral economy goals based on risk-sharing to the neoclassical goal of financial performance as the primary goal of islamic banks. only four islamic banks, as can be seen from table 1, had an average social performance index in the period 2012-2018 higher than 0.5 (or 50%). however, the social performance index was growing year-on-year; more precisely, while in 2012 only two banks had the index greater than 0.5, in 2018 the number was seven banks. such a low social performance index supports the conclusions reached by asutay [40]. furthermore, from 2012 to 2018, 36 analyzed banks achieved a positive change in social performance, whilst four banks had a negative trend. the paradigm of the islamic moral economy provides guidelines for social responsibility of islamic economic entities towards society and expands them through expectations based on the goals of the islamic moral economy. however, according to several empirical studies to date, islamic banks have failed in their social responsibility practice. for example, sairally [47], haniffa & hudaib [5], platonova [55], belal, abdelslam & nizamee [11], as well as mergaliyev, asutay, avdukic & karbhari [17], found that most islamic banks carry out only some charitable activities without a systematic approach to social responsibility. thus, social performance is a weak area in the overall performance of islamic banks, indicating a discrepancy with the goals defined by the islamic moral economy. based on this empirical evidence, it can be concluded that islamic banks do not meet the expectations of the islamic moral economy but also muslims in general, which was previously also stated by el-gamal [12], who concluded that “islamic finance has often failed to serve the economic purpose for which certain premodern contract structures were codified in classical jurisprudence”. therefore, mergaliyev, asutay, avdukic & karbhari [17] pointed out that it is crucial to develop an empirical framework based on the goals of the islamic moral economy in order to test the observed shortcomings in the ethical and social performance of islamic banks in the context of those goals, even beyond the standard five. categorization of social performance in order to categorize the compliance of the operations of the islamic banks with the expectations of the islamic moral economy and to categorize these banks into specific categories, for this research, a rating system based on the camels rating system in banks was created, according to barr, killgo, siems, & zimmel [56] and hays, de lurgio & gilbert [57]. although authors in the field of islamic finance such as adib, nabiha & khalid [58] and hameed, wirman, alrazi, nazli & pramono [59] criticized the camels system because it emphasizes financial indicators, in our case we used only the categorization of the camels system on indicators based on the theory of islamic moral economy (see table 2). following this categorization and the results of the index of social performance of islamic banks, we can conclude that islamic banks in the observed period only partially met the expectations of the islamic moral economy, i.e., most of them were “marginally aligned” with the islamic moral economy principles. however, the trend is positive, and this score is moving towards “fair compliance”. table 2. the rating system of islamic banks in accordance with maqasid score compliance with maqasid 80-100% strong compliance 60-79% satisfactory compliance 40-59% fair compliance, with space for improvement of some categories 20-39% marginal compliance, with a certain risk of non-compliance 0-19% unsatisfactory, with a high risk of non-compliance source: authors' creation an encouraging fact was that most banks' social performance index in the observed period grew from year to year. the average growth rate of social performance index was 3.58%, which did not promise significant changes in a short time, but it was evident that banks progressed during the observed period. the lowest individual score of social performance that any of the banks had during the analyzed period was 0.1224 (islamic bank of britain in 2012), while the highest score of one bank was 0.6818 (hong leong 7 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6199 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejifcontent is licensed under a creative commons attribution 4.0 international license received: 11/05/2021 accepted for publication: 16/11/2021 published: 30/12/2021 islamic bank bhd in 2018). with its value-based intermediation approach, malaysia has made a significant breakthrough in the social performance of the islamic banks operating in this country. as figure 3 illustrates, the islamic banks were on average in the higher part of the “marginal compliance” category and, if this trend continues, in the coming years they could move to the “fair compliance” category, the medium category in the rating system of islamic banks explained in table 2. figure 3. social performance index of the islamic banks over the period 2012-2018 source: authors' research social performance by the objectives of islamic moral economy the highest score of the islamic banks' social performance was recorded in the category i3 (“self”), based on the level of investment in the real sector, smes in particular (figure 4). this fact is in line with mergaliyev, asutay, avdukic & karbhari [17]results, provided that the mentioned authors did not scale the value of components i5 (“posterity”) and i7 (“wealth”). figure 4. social performance by the objectives of islamic moral economy source: authors' research adapted from bedoui [44]; asutay & herningtyas [14] if we observe individual index components under the previously presented ranking system (table 3), we can conclude that only component i3 (“self”) had a satisfactory consistency. components i2 (“human rights”), i6 (“social entity”), and i1 (“faith”) had fair compliance. furtheermore, components i7 (“wealth”) and i4 (“intellect”) had marginal alignment, while i8 (“environment”) and i5 (“posterity”) had unsatisfactory alignment. table 3. assessment of the banks' compliance by index components objective score descriptive assessment i3: self 0.642608 satisfactory compliance i2: human rights 0.497198 fair compliance, with space for improvement i6: social entity 0.466108 fair compliance, with space for improvement i1: faith 0.431853 fair compliance, with space for improvement i7: wealth 0.278447 marginal compliance, with risks of non-compliance i4: intellect 0.268671 marginal compliance, with risks of non-compliance i8: environment 0.173857 unsatisfactory compliance i5: posterity 0.105333 unsatisfactory compliance source: authors' research as far as the component i3 (“self”) is concerned, it implies investments of islamic banks in the real sector, particularly smes. as the research results shown in table 3, as well as table 4, indicate on, it was the strongest in the social performance index and recorded an average score of 0.6426. most analyzed islamic banks in this area had a very high score because they had to finance halal projects exclusively with a specific fundamental basis behind them. generally speaking, an islamic bank cannot just borrow money like a conventional one, it either invests or trades, or rents, some tangible assets, so almost all islamic bank financing is appropriate for this index component. further, the component i2 (“human rights”) consists of the most significant number of indicators compared to other components, i.e., more than half of the total number of indicators (139). this component primarily deals with corporate governance. it can be concluded that corporate governance in most analyzed islamic banks was appropriate, with some potential for improvement. there is potential for improvement in evaluating the work of the bank's board, the relationship between the audit committee and the bank's management, the strategic role of the sharia committee and the audit committee, as well as equal opportunities policies for employees and potential employees (for example, employment policy in some gcc banks favours domestic candidates). moreover, the general situation with human rights, the share of women in committees and the like can be significantly improved in most analyzed islamic banks. like the component i2, the component i6 (“social entity”) was in the “fair compliance” segment. most banks in this segment achieved a good result in sponsoring community 0,4319 0,4972 0,6426 0,26870,1053 0,4661 0,2784 0,1739 i1: faith i2: human rights i3: self i4: intellect i5: posterity i6: social entity i7: wealth i8: environment 8 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6199 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejifcontent is licensed under a creative commons attribution 4.0 international license received: 11/05/2021 accepted for publication: 16/11/2021 published: 30/12/2021 activities, commitment to social role and economic development, and offered lists and reports on realized charitable activities. banks were generally not active in the art sponsorship segment, and many also did not offer qard hassan (i.e., loans with no cost and additional fees) or at least did not disclose this. banks may avoid talking publicly about qard hassan mechanism because, in that case, they may face an increased number of requests for such (unprofitable) products. most analyzed banks (67%) payed zakat and published the amount paid for zakat, while some banks handed these activities over to the owners. the component i1 (“faith”) was also in the “fair compliance” category with potential for improvement. the analyzed banks had a high score in committing to operate under sharia principles, operating exclusively within the permitted investments and financing models. approximately 45% of the islamic banks published how they treated illegal transactions, but only 27% published whether such transactions took place, while an even smaller percentage (20%) of those explained what the transactions were and the reasons for doing so. principally, the only correct way to treat non-compliant transactions is for the proceeds to go to a separate charity account/sub-account. when it comes to the component i7 (“wealth”), as well as the component i4 (“intellect”), it was “marginally compliant, with risks of non-compliance”. regarding i7, many banks did not have profit equalization reserves (per), probably because they did not even have real investment accounts based on mudaraba, since wakala was a “safer” choice and more similar to conventional deposits. as far as roa and roe are concerned, islamic banks traditionally do not have high values of such indicators. in this research, altman's z-score was an indicator that significantly influenced the increase in the total value of i7, which was the reason why i7 was one of the variables that had to be scaled to a value between 0 (zero) and 1 (originally, the minimum value of i7 before scaling was -11.0329, while the maximum value was 49.6030; mainly thanks to the z-score which had high values, e.g., 57.1609 in the case of jordan in 2018). regarding the component i4 (“intellect”), more than half of analyzed islamic banks provided specific scholarships for students, and they were also active at conferences in islamic economics and banking. however, only few of them published data on research and development costs, public relations costs, and employee training costs. they were also very rarely involved in art-related activities, which were the reasons for the relatively low score in this area. the analyzed islamic banks had “unsatisfactory compliance” in the field of i8 (“environment”) and i5 (“posterity”). it was evident that the islamic banks did not publish much environmental policy information or, more likely, did not have it. this discovery is in line with the results obtained by hassan & harahap [60], who emphasized that it was surprising how little attention islamic banks payed to the issue of the environment. unlike analyzed islamic banks, which mostly come from countries where these issues are not regulated, many banks in europe have high standards in environmental policy and are certainly ahead of the islamic banks. according to this research, component i5 (“posterity”) was the weakest in the social performance index and recorded an average score of 0.1053. in general, this component includes employee costs, taxes, dividends, depositors' deposits, zakat, waqf, and sadaqah/charity concerning net income. some of the analyzed banks did not pay dividends and an even smaller number of them payed zakat, while there were almost no bank that invested in an endowment. also, there were cases when banks made a negative profit (loss), and in these cases, the i5 component had a negative sign. however, it was scaled to the range from 0 (zero) to 1, achieving a meagre value (i.e., close to zero). table 4. descriptive statistics by index components i1 i2 i3 i4 i5 i6 i7 i8 mean 0.43 0.49 0.64 0.26 0.10 0.46 0.27 0.17 standard error 0.01 0.01 0.01 0.01 0.00 0.01 0.00 0.01 median 0.40 0.51 0.60 0.22 0.08 0.46 0.25 0.10 mode 0.40 0.48 1.00 0.22 0.08 0.46 0.25 0.00 standard deviation 0.20 0.16 0.25 0.20 0.08 0.21 0.12 0.24 sample variance 0.04 0.02 0.06 0.04 0.00 0.04 0.01 0.05 kurtosis 0.21 0.24 1.22 0.83 56.38 0.69 23.21 1.45 skewness 0.55 0.06 0.07 0.89 5.90 0.15 4.42 1.51 range 0.86 0.75 0.89 0.88 1.00 0.88 1.00 1.00 minimum 0.10 0.12 0.10 0.00 0.00 0.00 0.00 0.00 maximum 0.96 0.88 1.00 0.88 1.00 0.88 1.00 1.00 count 280 280 280 280 280 280 280 280 source: authors' research vi. discussion this research comes with a general conclusion that islamic banks in the sample achieve only 35% of the goals of the islamic moral economy, which corresponds to the results of ngalim & ismail [41] and asutay and harningtyas [14], who concluded on a smaller sample of 13 islamic banks that there are shortcomings in achieving their social goals. in principle, there is almost a consensus of researchers that islamic banks do not achieve the goals of the islamic moral economy, while this research considers the largest number of islamic banks and represents research at the global level. aggarwal & yousef [33], hasan [61], and nagaoka [35] previously noted that islamic banks rarely provide long-term financing to start-ups that need capital, and it is precisely the financing of start-ups and smes, which was one of the indicators in the methodology the authors used in this research. although most of the analyzed banks provided financing for start-ups, the share of such financing (by number and by amount) was negligible. according to abedifar, molyneux & tarazi [62], banks try to justify this 9 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6199 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejifcontent is licensed under a creative commons attribution 4.0 international license received: 11/05/2021 accepted for publication: 16/11/2021 published: 30/12/2021 shortcoming with the high level of moral hazard presented on the market, but islamic banks generally have less justification than conventional banks for this indicator because they should also have mechanisms for investing in venture capital. however, profit-sharing financing representation in the assets of islamic banks, according to the islamic financial services board [63], is around 5%. kozarevic, nuhanovic and nurikic [64] noted that islamic banks face particular types of risks that conventional banks do not have to take into account. therefore, the risk itself might be the reason for avoiding risk-sharing modes of financing in islamic banking practice. mohammed & shahwan [26] highlighted that risk and profitsharing are critical characteristics of islamic banks, which distance them from conventional financial institutions and bring about positive qualitative changes in the economic system. if the trend of preference of debt models and instruments by islamic banks continues, they will find themselves in a situation where the difference between islamic and conventional banks is negligible, as al-amine [65] already warned. the results of this research revealed that islamic banks mainly focus on “self”, “faith”, and “human rights” as dimensions of the goals of the islamic moral economy (or maqasid). these findings are consistent with asutay and harningtyas [14]. however, the findings are contrary to mergaliyev, asutay, avdukic & karbhari [17], who found that the most significant focus of islamic banks is on the preservation of assets, i.e., making a profit. moreover, alhammadi, alotaibi & hakam [50] found financial cost of achieving the goals of the islamic moral economy because islamic banks that achieved high scores for the social performance index sacrificed financial performance. therefore, there is trade-off between financial and social performance (although further research is needed), and islamic banks have not previously had social performance in their goals and have not paid enough attention to them. this needs to be changed in the future. the country whose islamic banks are most successful when it comes to social performance is indonesia, as antonio, sanrego & taufiq [16], and ngalim & ismail [41] found. the above mentioned trade off is not very straightforward, as customers often recognize social role of organizatons, as noted by biancone, secinaro, brescia & iannaci [66] noted that customers/clients often recognize social role of organizations, while iannaci and jonathan [67] concluded that this social role of islamic financial institutions can contribute to restarting the process of social innovation. vii. concluding remarks this research is motivated precisely by the suspicion of differences between the theory of the islamic moral economy and the practice of islamic banks, i.e., by the empirical confirmation of these differences and determining the determinants of these social performance, with a particular focus on external determinants. many researchers have previously criticized the practices of islamic banks without explicit empirical confirmation of these differences. also, most research has been done on a sample from one or several countries, and identifying determinants of social performance from the environment was not possible under these conditions. the level of social performance was measured by an index based on the theory of the islamic moral economy, the value of which is derived from the annual reports of islamic banks, based on qualitative and quantitative data. this index follows the goals of the islamic moral economy following the works of classical authors in islamic law, which contemporary authors took over in the field of islamic moral economy. it must be acknowledged that these universal values are also “living matter”, which can be adapted according to the circumstances. the methodology used in the research is the most detailed and demanding method applied so far to measure the social performance of islamic banks, with 139 individual indicators (qualitative and quantitative), which needed to be assessed based on the analysis of the content of annual reports. the backbone of the theoretical framework of the research is the theory of the islamic moral economy. this study, therefore, represents a coherent study in the field of the islamic moral economy on a global sample of islamic banks, according to suggestion by biancone & secinaro [68] who suggested that such phenomenon should be investigated at the global level. the services provided by islamic banks may look similar to those of conventional banks, but the models they use to mobilize and place funds are different. generally speaking, the purpose of islamic banks is to serve society and ensure fairness to all parties. however, if an islamic bank uses models of islamic banking without considering the maqasid, , it in principle has no particular impact on society (compared to conventional banks) and does not serve its purpose. the crux of the issue is that islamic banks have adopted mainly those models that are structurally similar to conventional financing models, while initially, islamic models, based on risk and profit-sharing, have been neglected. without intention to repeat the details that were elaborated earlier in the result and discussion sections concerning the results of other research, it is necessary to highlight that islamic banks, according to this research, achieve only 35% of the goals of the islamic moral economy. the specificity of this research on the social performance of islamic banks is that it was done on a larger sample and using a more robust methodology than others, while most other authors viewed the operations of banks from only one aspect (e.g., used financing models). moreover, the social performance analysis results suggest that islamic banks mainly focus on people, religion, and rights as dimensions of the goals of the islamic moral economy. such performance of islamic banks globally can be described as “marginally compliant” with the expectations of the islamic moral economy. 10 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6199 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejifcontent is licensed under a creative commons attribution 4.0 international license received: 11/05/2021 accepted for publication: 16/11/2021 published: 30/12/2021 viii. references 1. nuhanović, a. i kozarević, e. 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(2021). islamic finance and globalisation through halal tourism. quaderni di diritto e politica ecclesiastica, 131-142. appendix: list of indicators of maqasid performance of ibfis based on najjar's maqasid framework no key objectives consequ ences no dimension elements source: indicator/disclosure aspect a safeguarding the value of human life 1. faith 1 pls products functional distribution mohammed, dzuljastri & fauziah [37] mudharabah and musharakah modes/total investment modes 2 elimination of negative elements that breed injustices interest free product mohammed, dzuljastri & fauziah [37] interest free income/total revenue 3 1.underlying philosophy and values vision and mission haniffa & hudaib [5] i. commitments in operating within shari'ah principles/ideals 12 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6199 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejifcontent is licensed under a creative commons attribution 4.0 international license received: 11/05/2021 accepted for publication: 16/11/2021 published: 30/12/2021 statement disclosure haniffa & hudaib [5] ii. commitments in providing returns within shari'ah principles haniffa & hudaib [5] iii. focus on maximising stakeholders returns or values haniffa & hudaib [5] iv. directions in serving the needs of muslim community haniffa & hudaib [5] v. commitments to engage only in permissible investment activities haniffa & hudaib [5] vi. commitments to engage only in permissible financing activities haniffa & hudaib [5] vii. commitments to fulfil contracts via 'contract (uqud) statement' haniffa & hudaib [5] viii. appreciation to shareholders and customers 4 2 & 3. interest-free and islamically acceptable deals shari’ah section in ar shari’ah report on financial transactions haniffa & hudaib [5] disclosure of any unlawful transactions haniffa & hudaib [5] description of unlawful transactions haniffa & hudaib [5] disclosure of how gains from such activities have been handled belal et at. (2014) disclosure of reasons for undertaking unlawful transactions belal et at. (2014) opinion of ssb regarding necessity of undertaking unlawful transactions 2. rights & stakehol ding 5 2 & 3. interest-free and islamically acceptable deals product aspects employees haniffa & hudaib [5] i. employees appreciation haniffa & hudaib [5] ii. number of employees haniffa & hudaib [5] iii. equal opportunities policy haniffa & hudaib [5] iv. employees welfare haniffa & hudaib [5] vi. training: other haniffa & hudaib [5] vii. training: student/recruitment scheme haniffa & hudaib [5] ix. reward for employees 6 corporate governance indicator (fairness and transparency) general aspects 1 ifsb guiding principles for corporate governance belal, abdelslam & nizamee [11] strategic role and function of the board of directors belal, abdelslam & nizamee [11] strategic role and function of executive management belal, abdelslam & nizamee [11] strategic role and function of internal auditors belal, abdelslam & nizamee [11] strategic role and function of external auditors belal, abdelslam & nizamee [11] strategic role and function of ssb belal, abdelslam & nizamee [11] mechanisms for balancing the accountability of the above organs belal, abdelslam & nizamee [11] does the organisation comply with internationally recognised corporate governance standards belal, abdelslam & nizamee [11] has the board of directors (bod) set up a governance policy framework belal, abdelslam & nizamee [11] has the board of directors set up a governance committee belal, abdelslam & nizamee [11] does the governance committee include a member of the audit committee 13 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6199 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejifcontent is licensed under a creative commons attribution 4.0 international license received: 11/05/2021 accepted for publication: 16/11/2021 published: 30/12/2021 belal, abdelslam & nizamee [11] does the governance committee include a member of the ssb belal, abdelslam & nizamee [11] does the governance committee provide the bod with reports and recommendations based on findings belal, abdelslam & nizamee [11] does the role of the governance committee overlap with the role of the audit committee 7 corporate governance indicator (fairness and transparency) bod aspects bod (composition , appointment and reappointment, board meetings, and director's fees and remuneration) belal, abdelslam & nizamee [11], haniffa & hudaib [5] names of board members belal, abdelslam & nizamee [11], haniffa & hudaib [5] positions of board members belal, abdelslam & nizamee [11], haniffa & hudaib [5] pictures of board members belal, abdelslam & nizamee [11], haniffa & hudaib [5] profile of board members uk cgc (frc, 2014) does board composition is diverse? uk cgc (frc, 2014) number of meetings by bod (if more than 4=1, if no = 0) uk cgc (frc, 2014), principles for enhancing corporate governance (basel committee, 2010) does the board stated in the annual report how performance evaluation of the board, its committees and its individual directors has been conducted? oecd (2004) in case of capital structures and arrangements that enable certain shareholders to obtain a degree of control disproportionate to their equity ownership should be disclosed. corporate governance indicator (fairness and transparency) executive management aspects executive management belal, abdelslam & nizamee [11], haniffa & hudaib [5] names of management team belal, abdelslam & nizamee [11], haniffa & hudaib [5] positions of management team belal, abdelslam & nizamee [11], haniffa & hudaib [5] picture of management team belal, abdelslam & nizamee [11], haniffa & hudaib [5] profile of management team principles for enhancing corporate governance (basel committee, 2010) are key management decisionse made by more than one person (“four eyes principle”) is any management board? corporate governance indicator (fairness and transparency) committees aspects audit, remuneration and nomination committee oecd (2004), uk cgc (frc, 2014), fsf principles for sound compensation practices (fsf, 2009) is remuneration policy for members of the board and key executives disclosed? uk cgc (frc, 2014) is there a remuneration committee? 14 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6199 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejifcontent is licensed under a creative commons attribution 4.0 international license received: 11/05/2021 accepted for publication: 16/11/2021 published: 30/12/2021 uk cgc (frc, 2014) does a remuneration committee consist of at least 3 independent non-executive directors? uk cgc (frc, 2014) is the remuneration committee meeting at least 4 times per year? fsf principles for sound compensation practices (fsf, 2009) does the remuneration committee or bod periodically supervise and review compensation schemes in the firm? clarkson et al. (2006) are other types of remuneration of executives disclosed? oecd (2004) are selection and nomination processes disclosed? uk cgc (frc, 2014) is there a nomination committee? uk cgc (frc, 2014) is the majority of members of a nomination committee independent non-executives? hameed et al. (2004) f. there is an audit committee hameed et al. (2004) g. the audit committee consists of at least three nonexecutive directors, whom a majority are independent hameed et al. (2004) h. audit committee includes someone with expertise in accounting hameed et al. (2004) i. audit committee recommends the external auditor at the annual shareholder’s meeting hameed et al. (2004) j. at least, once a year the committee met with the external auditors without executive board members present, to review financial statements hameed et al. (2004) k. details of the activities of audit committees, the number of audit meetings held in a year and details of the attendance of each individual director in respect of meetings are disclosed hameed et al. (2004) l. audit committee members attend at least 75% of meetings on average 8 corporate governance indicator (fairness and transparency) – shari’ah governance shari’ah governance gsifi-1 (aaoifi, 2010) are the fatwas, and rulings of the shari’ah supervisory board binding on the islamic financial institution? gsifi-1 (aaoifi, 2010), ifsb-10 (ifsb, 2009) is shari’ah supervisory board appointed by the shareholders in their annual general meeting or by bod, but not by management? gsifi-1 (aaoifi, 2010) the shari’ah supervisory board should not include directors or significant shareholders of the islamic financial institution. 15 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6199 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejifcontent is licensed under a creative commons attribution 4.0 international license received: 11/05/2021 accepted for publication: 16/11/2021 published: 30/12/2021 gsifi-1 (aaoifi, 2010), haniffa & hudaib [5] does ifis publish the fatwas, rulings and guidelines issued by its ssb during the year (including newly issued, revised or amended decisions)? ifsb-10 (ifsb, 2009) are ssb members and iscu/isru staff providing training to other staff: management, back and frontoffice? ifsb-10 (ifsb, 2009) is there a process of assessment of effectiveness of ssb (collectively and individually per each member)? ifsb-10 (ifsb, 2009) is the assessment report on effectiveness of ssb provided to bod/agm for making decisions on ssb (resignation/nomination new members and etc.)? ifsb-10 (ifsb, 2009) in case of conflict between bod and ssb, is ssb provided with direct access to agm? ifsb-10 (ifsb, 2009) is there a mechanism for ensuring absence of conflict of interest for ssb members? (i.e. disclosure to other governance bodies)? ifsb-10 (ifsb, 2009) do ssb follow shari’ah pronouncements of national shari’ah bodies (if existed) or internationally recognised bodies? ifsb-10 (ifsb, 2009) in case of not following national/international shari’ah pronouncements in ssb's decision, are such decisions disclosed so that they can be openly assessed by the industry’s stakeholders (subject to confidentiality)? ifsb-10 (ifsb, 2009) do ssb periodically on systematic manners interact with bod? ifsb-10 (ifsb, 2009) does ssb oversee the computation and distribution of zakat to be distributed to charity? haniffa & hudaib [5] are names, positions and pictures of the ssb members provided? 9 corporate governance indicator (fairness and transparency) other aspects other hameed et al. (2004) c. there is a risk management committee hameed et al. (2004) f. the maintenance of an effective system of internal controls is disclosed belal, abdelslam & nizamee [11] does the bank have a formal disclosure policy that has been approved by bod? 10 ethical aspects ethical behaviour and consumers' rights belal, abdelslam & nizamee [11] does the organisation comply with an ethical code of conduct ? belal, abdelslam & nizamee [11] has this ethical code of conduct been described? belal, abdelslam & nizamee [11] is there an ethical committee? 16 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6199 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejifcontent is licensed under a creative commons attribution 4.0 international license received: 11/05/2021 accepted for publication: 16/11/2021 published: 30/12/2021 belal, abdelslam & nizamee [11] are employees trained in ethical policies? belal, abdelslam & nizamee [11] does the organisation comply with customer protection legislation? b safeguarding the human self 3. self 11 investment in vital real sector and sme investment ratios in vital real sector mohammed, dzuljastri & fauziah [37] investment in real economic sector/total financing financing microfinance ngalim and ismail (2014) investments to microfinance and sme 4. intellect 12 advancement of knowledge education grant and research mohammed, dzuljastri & fauziah [37] education grant or scholarship/total expenses mohammed, dzuljastri & fauziah [37] research expenses/total expenses belal, abdelslam & nizamee [11], haniffa & hudaib [5] does the company sponsor work experience programmes for students? belal, abdelslam & nizamee [11] has the organisation been involved in establishing educational institutions? belal, abdelslam & nizamee [11] is the organisation involved in any arts related activities? ngalim and ismail (2014) does ib provide educational financing? 13 installing new skills and improvement training mohammed, dzuljastri & fauziah [37] training expense/total expenses 14 creating awareness of islamic banking publicity / awareness on islamic banking mohammed, dzuljastri & fauziah [37] publicity expense/total expenses haniffa & hudaib [5] vi. conferences on islamic economics c safeguarding the society 5. posterity 15 redistribution of wealth wages (ro1) ngalim and ismail (2014) wages / net income tax (ro2) ngalim and ismail (2014) tax / net income shareholders (ro3) ngalim and ismail (2014) shareholders dividends / net income depositors (ro4) ngalim and ismail (2014) depositors returns / net income zakat (ro5) ngalim and ismail (2014), mohammed, dzuljastri & fauziah [37] zakat / net income waqf (rv1) ngalim and ismail (2014) waqf / net income sadaqah & infaq (rv2) ngalim and ismail (2014) sadaqah & infaq / net income 6. social entity 17 developmental and social goals zakah, charity and benevolent loans haniffa & hudaib [5] i. bank liable for zakah haniffa & hudaib [5] ii. amount paid for zakah haniffa & hudaib [5] iii. sources of zakah haniffa & hudaib [5] iv. use/beneficiaries of zakah haniffa & hudaib [5] v. balance of zakah not distributed-amount haniffa & hudaib [5] vi. reasons for balance of zakah haniffa & hudaib [5] ix. zakah to be paid by individuals-amount haniffa & hudaib [5] x. sources of charity (saddaqa) haniffa & hudaib [5] xi. uses of charity (saddaqa) haniffa & hudaib [5] xii. sources of qard al-hassan haniffa & hudaib [5] xiii. uses of qard al-hassan haniffa & hudaib [5] xiv. policy for providing qard al-hassan haniffa & hudaib [5] xv. policy on non-payment of qard al-hassan g. community haniffa & hudaib [5] i. creating job opportunities haniffa & hudaib [5] ii. support for org. that provide benefits to society 17 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6199 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejifcontent is licensed under a creative commons attribution 4.0 international license received: 11/05/2021 accepted for publication: 16/11/2021 published: 30/12/2021 haniffa & hudaib [5] iii. participation in govt. social activities haniffa & hudaib [5] iv. sponsor community activities haniffa & hudaib [5] v. commitment to social role belal, abdelslam & nizamee [11], oecd (2004) does the organisation work closely with the local community? belal, abdelslam & nizamee [11], oecd (2004) does the organisation develop and apply self-regulatory practices and management systems that foster a relationship of confidence and trust between enterprises and the community? belal, abdelslam & nizamee [11], haniffa & hudaib [5] is the organisation committed to supporting community organisations? belal, abdelslam & nizamee [11] any mention of commitment to local economic development made? belal, abdelslam & nizamee [11] is there a description of charitable activities achieved? belal, abdelslam & nizamee [11] does the bank support employee involvement in charities? belal, abdelslam & nizamee [11] does the organisation sponsor any community programmes? belal, abdelslam & nizamee [11] amount spent on school, art or sport sponsorship d safeguarding physical environment 7. wealth 18 fair returns fair returns mohammed, dzuljastri & fauziah [37] profit equalization reserves (per)/net income 19 earning ability return on asset jaffar and marnavi (2011) net income/total assets return on equity jaffar and marnavi (2011) net income/total equities 20 distress predictability altman's zscore for emerging markets othman and shahadan (2015) altman's z-score for emerging markets 8. ecology 21 environment indicators policy objectives and environmenta l issues gsifi-7 (aaoifi, 2010) mandatory policy screening investments on environmental impact gsifi-7 (aaoifi, 2010) recommended policy on reduction of adverse impact on environment gsifi-7 (aaoifi, 2010) investments and funds for contribution to environment improvements hameed et al. (2004) f. energy, paper or water savings gri (2013) is the environmental section of ar following gri or other best practices? european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7429 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 34 halal tourism: a web content analysis in italy cemil gunduz1*, davide calandra2, paolo biancone3 1 contact author tokat gaziosmanpasa university, tokat, taşlıçiftlik campus, 60250 tokat / turkey cemil.gunduz@gop.edu.tr 2 university of turin, department of management “valter cantino”, corso unione sovietica 218, bis – 10134 – turin (italy) davide.calandra@unito.it 3* university of turin, department of management “valter cantino”, corso unione sovietica 218, bis – 10134 – turin (italy) paolo.biancone@unito.it received: 18/12/2022 accepted for publication: 12/04/2023 published: 21/04/2023 abstract due to the increase in the muslim population and per capita income worldwide, halal tourism and islamic finance sectors have caught a rapid development trend in recent years. this study presents information about halal concept hotels in italy, a european country where halal tourism offer is an emerging sector. in this study, interview and web content analysis, which are qualitative research techniques, were used. the study's main purpose is to give preliminary information about the halal products and services offered in italy, one of the most preferred countries by muslim tourists, to reveal the current situation of halal concept hotels and the evaluations for the future of halal tourism in italy. according to the research results, over 800 hotels across italy have at least one halal product or service. although lazio is the region with the highest number of halal hotels, the most common halal hotel group is 4-star hotels. italy has 194 halal-concept pools and beach facilities for women and families. among the facilities halal-themed hotels offer tourists are prayer areas, halal food, alcohol-free rooms and family privacy. keywords: halal tourism; islamic tourism; italy; halal-concept hotels; muslim tourists 1. introduction in recent years, there has been a significant increase in halal and islamic products in the tourism and financial sectors due to the increase in the muslim population and per capita income worldwide (muheramtohadi & fataron, 2022). europe is one of the regions where the muslim population has increased the most. the increase in the muslim population in europe has important social, cultural, and economic consequences. halal food has increased demand for products and services, including travel and finance (gunduz, 2023). there are many comprehensive studies on muslim countries in halal tourism (el-gohary, 2016; gunduz & topaloglu, 2021; jaelani, 2017; sulong, abdullah, & chowdhury, 2022). however, studies on halal tourism in non-muslim countries are limited (aji, muslichah, & seftyono, 2021). in this study, it is aimed at answering the question of how halal tourism can develop in a european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7429 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 35 non-muslim country. in this context, preliminary information about halal products and services offered in halal concept hotels in italy, one of muslim tourists' most preferred destinations, will be presented. the study will use qualitative research techniques, including interviews and web content analysis, to answer the research question. thus, in-depth information will be obtained from a leading travel agency's sales and marketing department in online halal hotel reservations to collect data on halal food services, non-alcoholic areas, hotel ratings and types, geographical distribution and leisure activities for ladies and families. these obtained data will be categorized and interpreted in the findings section. finally, in the conclusion part, evaluations will be made on the future of halal tourism in italy. this study provides theoretical and practical information about the products and services offered by halal-themed hotels in italy. theoretically, the conformity of the products and services offered by such hotels with islamic laws and customs gives an idea about islamic law and traditions. in addition, considering that such hotels are not only for muslim customers but are also visited by people from other cultures, it draws attention to intercultural communication and harmony issues. in practice, determining the current situation of halal hotels and their services in italy will give an idea to investors who will enter this sector. the fact that such hotels provide services designed according to the needs of muslim tourists and comply with islamic rules can increase the number of tourists by making their holidays more enjoyable. in addition, emphasizing the importance of halal certification in the tourism sector can help create new job opportunities in this field. in this context, this study provides an important opportunity to raise awareness about halal tourism in italy and meet the needs of muslim tourists in the tourism sector. this study focuses on a literature review of the concept of halal tourism and the challenges of halal tourism in non-muslim countries. halal tourism can be defined as an understanding of travel per islamic traditions. this type of tourism includes travel destinations where halal food is offered, places of worship following islamic traditions are available, and islamic values are respected. halal tourism has become popular worldwide, especially in recent years, due to the increasing number of islamic tourists. however, halal tourism in non-muslim countries faces different challenges. these challenges include local service providers' need for knowledge and skills, inadequate local services, and the availability of suitable halal food. this study aims to raise awareness of halal tourism in non-muslim countries among researchers and tourism industry stakeholders in the field of halal tourism. the paper proceeds as follows. the next section provides a theoretical overview of halal tourism definitions and characteristics. additionally, challenges in non-muslims will be then defined. section 3 will define the methodological workflow followed by the research team. section 4 will provide the results of our study. finally, section 5 discusses and concludes the analysis. 2. literature review 2.1 background and definitions halal tourism refers to activities that supply muslim travellers' needs by providing services and facilities that comply with islamic law, such as halal food, prayer facilities, and accommodations (carboni & idrissi janati, 2016; secinaro & calandra, 2021). this type of tourism is becoming increasingly popular among muslim travellers who seek to balance their faith-based requirements with their desire to explore new destinations and cultures. according to the (mastercard-crescent rating, 2022) index, the muslim travel market is projected to reach 230 million travellers by 2026, with a total expenditure of usd 300 billion. this indicates a significant potential for growth in the halal tourism industry, estimated 10% of the global travel market. this will foster the contribution to developing the tourism industry in muslim-majority and non-muslim countries (mohsin, ramli, & alkhulayfi, 2016). the facility of halal tourism services provides muslim travellers' needs and promotes cultural exchange and understanding between different communities (carboni & idrissi janati, 2016). this is particularly relevant in the current global context, where there is a need for more inclusive and sustainable tourism practices (biancone, secinaro, brescia, & calandra, 2020; rosato, caputo, valente, & pizzi, 2021). halal tourism can also positively impact the economy by creating new job opportunities and supporting small and medium-sized enterprises (budiman, mustahal, & basit, 2022). one of the main features of halal tourism is the provision of halal food, which refers to food prepared by islamic dietary laws and certified alongside the supply chain (henderson, 2016a). it includes meat from animals slaughtered in a specific way and avoiding pork and alcohol. halal tourism also requires accommodation free from prohibited elements, such as alcohol, and provides prayer facilities for muslim travellers (othman, ahmad, & zailani, 2009; tan, ali, makhbul, & ismail, 2017). additionally, activities should be aligned with islamic principles and values. for instance, tourism activities and locations should avoid gambling and nightclubs (wardi, abror, & trinanda, 2018). instead, halal tourism activities focus on cultural and heritage experiences and religious tourism, such as visiting historical mosques, islamic centres, and other religious sites abroad (ekka, 2023). european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7429 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 36 2.2 halal tourism characteristics as mentioned, this is a dedicated tourism segment important for muslim travellers and the tourism industry. for travellers, halal tourism provides a way to travel while adhering to islamic principles and values. however, for the tourism industry, this means creating dedicated services for muslims. this can be particularly difficult in non-islamic countries where halal services are less widespread, and in some cases, there are also cultural constraints (wibawa, pranindyasari, bhawika, & mardhotillah, 2023). in general, halal tourists pay a lot of attention to food, which may or may not make them agree to leave for a new destination. for example, as indicated by (henderson, 2016b), halal certification is a strong element in the food supply when travelling abroad for muslims. therefore, the presence or absence of halal food (with certification) is an element that brings a strong competitive advantage to the destinations chosen at the departure stage. in addition, tourists at the booking stage might consider the services offered by accommodation facilities. these include elements such as the presence of the koran in the rooms, the absence of alcoholic beverages in the minibar, on-demand room systems not programmed to receive adult-only channels, the presence of cosmetics and toiletries without food or alcoholic substances or even the presence of prayer rugs and a compass indicating mecca in the rooms (biancone, secinaro, radwan, & kamal, 2019; muharam & asutay, 2019). in addition, according to (battour & ismail, 2016), the indoor or outdoor presence of prayer rooms may also be a feature muslim tourists seek. furthermore, according to (battour & ismail, 2016). the existence of pools, spas or beaches reserved and divided between men and women can be a decision driver for muslim tourists, especially those with high spending power. in recent years, scientific studies have also shown case studies of using technology to enable halal tourist enjoyment (battour & ismail, 2016). this is the case of the (royal thai embassy, 2015), which indicated how the tourism authority of thailand (tat) officially announced the launch of its first app designed specifically for muslim visitors to facilitate access to muslim products, services, and facilities throughout thailand. finally, airports and package tours are the last two strategic elements for attracting halal tourists. the case of airports (battour & ismail, 2016) show how a muslim-friendly airport is often considered a starting point to promote and market the destination as halal. this includes halal food inside the facility and dedicated prayer rooms. finally, tourist packages sold in halal countries and to non-halal destinations are potentially important for promoting an entire regional territory. table 1 below summarises the characteristics presented here. halal tourism characteristics references food (halal certification) (secinaro & calandra, 2021) accommodation (biancone et al., 2019; muharam & asutay, 2019) pool, spas and beaches (battour & ismail, 2016) applications for smartphones and tablet (battour & ismail, 2016; royal thai embassy, 2015) airports (battour & ismail, 2016) prayer rooms (mohsin et al., 2016) table 1. halal tourism characteristics source: authors’ elaboration 2.3 halal tourism challenges in non-muslims countries halal tourism faces several challenges, particularly for muslim travellers when travelling to non-muslim countries. these challenges, as previously mentioned, include finding halal food and prayer facilities, ensuring that accommodations and transportation are by islamic values, and navigating cultural and language barriers. these challenges can be daunting for muslim travellers, especially those unfamiliar with the local customs and traditions of the places they visit. this can lead to isolation and disconnection, making it difficult for them to enjoy their travel experience fully (rasul, 2019). despite these challenges, there are also opportunities for halal tourism to promote cultural exchange and understanding. by providing for the needs of muslim travellers, halal-friendly destinations and accommodations can create a welcoming and inclusive environment that promotes cross-cultural interactions (vargas-sánchez & moral-moral, 2019). this can help break down cultural barriers and stereotypes and foster a greater appreciation and understanding of different cultures and religions. halal tourism can also provide an opportunity for non-muslim travellers to learn more about islamic values and practices and to develop a greater respect for the beliefs and traditions of muslim communities. (sulong et al., 2022) furthermore, halal tourism has the potential to generate economic benefits for both the tourism industry and local communities (jia & chaozhi, 2019). by addressing the needs of muslim travellers, the tourism industry can tap into a growing and profitable market segment. in addition, halal tourism can promote economic development in local communities by creating european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7429 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 37 jobs and generating income for local businesses. this situation is described by (nurdiansyah, 2018) through a case study in thailand demonstrates how the tourism sector plays a strategic role in supporting the development of an economic sector by increasing foreign exchange and related incomes. 3. methodology in addressing our research aims and question, we use a qualitative approach. it typically involves collecting data through interviews, observation, and document analysis and analysing the data using content analysis and thematic analysis (bhattacharya, 2017). additionally, as suggested by (britten, 1995), a qualitative study is a powerful tool for exploring complex, nuanced phenomena that cannot be easily captured using quantitative methods alone. one of the key power elements of qualitative research is its ability to generate rich, detailed data that captures the experiences, perspectives, and meanings that participants attach to their social world (braun, clarke, boulton, davey, & mcevoy, 2020). these data can be gathered through various methods, including interviews, focus groups, observations, and document analysis (biancone, secinaro, marseglia, & calandra, 2021). furthermore, a qualitative study ensures flexibility and adaptability (dal mas et al., 2020). unlike quantitative research, which typically uses standardized measures and procedures, qualitative research allows for a more fluid and iterative approach. researchers can modify their research questions and methods in response to emerging themes and insights and use data to generate new hypotheses or explore unexpected findings. this allows for a more nuanced understanding of complex phenomena and can lead to new and innovative insights (secinaro, calandra, cappa, & bignamini, 2020). additionally, qualitative research is well-suited to interdisciplinary and collaborative approaches, as it can draw on a range of theoretical and methodological perspectives to address complex research questions. within the scope of the study, a leading travel agency in the field of online halal hotel reservations is discussed using the case study method. the data used in the study were obtained by using the interview technique with the sales and marketing department of the travel agency and obtaining the necessary permissions (gertsen & søderberg, 2011). interviews are a widely used data collection technique in qualitative research. this technique allows the researcher to gain in-depth information about his subject (allan & skinner, 2020). these are performed in an unexplored case study of halal tourism adoption in a nonmuslim country such as italy. in addressing our research aims, six questions were asked of the manager of the leading travel agency for 95 minutes of interview: 1. what hotels on your website offer halal food services? 2. how many of the hotels on your website have non-alcoholic areas? 3. how is the distribution of the hotels on your website according to the number of stars? 4. what is your website's distribution of accommodation businesses according to their types? 5. how is the distribution of the hotels on your website according to the geographical regions of italy? 6. what are the leisure activities for ladies and families at the hotels on your website? after the interview phase, the elements gathered are transcribed by a multidisciplinary team consisting of assistant professors and researchers with proven experience in qualitative research. finally, as indicated (silverman, 2020), the interview allowed viewing additional materials supporting the research protocol, such as paper and computer databases, historical performance reports and internal procedure documents. therefore, in addition to the interview, the research team was provided with a holistic information set based on the evidence collected and paper documents that were subsequently analysed, allowing for the integration of the concepts under analysis. among these, also (halalbooking, 2022) and (halal trip, 2023) as the two widely adopted platforms for booking halal tourism experiences worldwide. 4. results with the importance of halal tourism, the demand for halal-friendly accommodation options has also increased. with its diverse cultural heritage and picturesque natural beauties, italy has started meeting halal tourism's needs. responses from the tourism industry in italy to the growing demand for halal food services, non-alcoholic areas and halal-concept hotels are presented in this section. in addition, various aspects of halal tourism in italy are examined, including the different types and regional distributions of halal concept accommodation establishments and leisure activities for women and families. in this part of the study, some data from the online travel agency (halalbooking, 2022), which is discussed within the scope of the case study, are presented in tables and graphics. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7429 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 38 table 2 provides information about the halal food services of hotels displayed in the online travel agency. as can be seen, the number of hotels with halal food nearby is 729, and the number of hotels that can provide halal food upon request is 243. in addition, some foods offered by 50 hotels are considered halal. the number of hotels where all of their meals are halal is 15. in some hotels, halal food and halal food can be found in the food and beverage establishments in the vicinity. halal food number all halal food 15 some halal food 50 halal food on request 243 halal food nearby 729 table 2. halal food services for hotels source: authors’ elaboration hotels with non-alcoholic areas are shown in table 3. according to this, 728 hotels have non-alcoholic rooms. alcohol is not served in facilities other than 202 hotel categories (such as villas, pensions, and chalets). 16 hotels are completely alcoholfree. although some hotels do not serve alcohol, non-halal food such as pork may be available. alcohol-free areas number alcohol-free property 202 alcohol-free restaurant 16 alcohol-free room 728 table 3. alcohol-free areas source: authors’ elaboration table 4 shows the halal concept hotels in italy according to the number of stars. while determining these hotels, the hotels listed in the relevant online travel agency and offering one or more halal products or services to the tourists are included in this table. the group with the highest number of halal hotels consists of 359 hotels (44%) with 4-star hotels. 3-star hotels are in second place with 218 hotels (26%). in third place is non-star hotels with 134 (16%) establishments. these businesses are small-scale accommodation facilities such as hotels, motels, apartments, and hostels. five-star halal hotels rank fourth on the list. five-star hotels are followed by 1-star hotels (3%) with 23 hotels and 2-star hotels (2%) with 18 hotels. stars number ***** 76 **** 359 *** 218 ** 18 * 23 unrated 134 total 828 table 4. halal concept hotels in italy, according to the number of stars source: authors’ elaboration table 5 shows the distribution of halal concept accommodation businesses according to their types. accordingly, hotels with stars constitute the largest group with 670 (84%) facilities. in this group, there are halal concept hotels with at least 1 star and a maximum of 5 stars. in second place, there are 42 guesthouses. the ratio of guesthouses among total accommodation establishments is 5%. there are 25 apart-hotels (3%) in third place. ski hotels is the group with the lowest halal concept business. some of the ski hotels are only open during the winter season, which may have caused this number to be low. the european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7429 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 39 reason for the low rates of facilities other than hotels is thought to be the fact that many of these facilities are not registered online. property type number hotel 694 guest house 42 apart hotel 25 inn 21 villa 11 country house 11 honeymoon house 7 resort 6 apartment 4 townhouse 4 ski hotel 3 total 828 table 5. distribution of halal concept accommodation businesses according to their type source: authors’ elaboration italy has 20 administrative regions, five of which are constitutionally autonomous (eurostat, 1999). when the regional distribution of halal concept hotels in italy is examined, it is seen in table 6 that the region with the most halal hotels is lazio (338). it is thought that most halal hotels are concentrated in this region because it is in the "lazio" region of rome, the capital of italy. after lazio, most halal hotels are in tuscany (109). florence has the region's highest concentration of 4and 5-star halal hotels. the veneto (103) region, located in the geographical region of northeast italy, comes in 3rd place on the list. the capital city of this region is venice, whose population exceeds 4.9 million (european statistical office, 2019). veneto, respectively; lombardy (98), campania (59), sicily (35), apulia (22), liguria (19), sardinia (12) and piedmont (10) regions follow. there are 23 halal concept hotels in 10 regions other than these regions. locations number lazio 338 tuscany 109 veneto 103 lombardy 98 campania 59 sicily 35 apulia 22 liguria 19 sardinia 12 piedmont 10 other regions 23 total 828 table 6. regional distribution of halal concept hotels in italy source: authors’ elaboration the map in figure 1 below shows the regional distribution of halal hotels in italy. regions with a high concentration of halal hotels are shown in dark red, while regions with a sparse distribution are shown in light yellow. it is seen that the density of halal hotels is higher in the western regions of italy. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7429 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 40 figure 1. regional distribution map of halal hotels in italy source: authors’ elaboration figure 2 contains pieces of information about leisure activities for ladies and families in halal hotels. there are a total of 194 halal concept pool and beach facilities in italy for ladies and families. figure 2. leisure activities for ladies and families source: authors’ elaboration the number of secluded wellness or spa facilities is 79. the number of facilities with a mixed pool (hijab swimwear is allowed) is 73. the number of facilities with a secluded spa centre is 17. the number of hotels with a mixed beach (where hijab swimwear is allowed) is 14. the number of facilities with a sheltered outdoor pool in the villa/room is 6. the number of accommodation facilities with a secluded outdoor pool is 3. the number of accommodation facilities with a sheltered indoor pool is 2. as seen in graph 2, there is no hotel with a separate beach or pool exclusively for women or men. it is thought that this is due to the absence of a halal hotel certificate, which is common in the country. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7429 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 41 5. discussion and conclusion the study gives preliminary information about the halal hotel products and services offered in italy, one of the muslim tourists' most preferred countries. qualitative research techniques such as interviews and web content analysis were used to collect data on the products and services offered by halal hotels in italy. the data presented in the case study are related to halal tourism in italy and provide information on halal food services, non-alcoholic areas, halal concept hotels and their regional distribution in italy. the largest number of hotels (729) provide halal food nearby, followed by 243 that can provide halal food on demand. some food offered by 50 hotels is halal, and only 15 hotels offer all halal food. as it can be understood from here, muslim-friendly hotel services in italy are still in their infancy. in the study, data on non-alcoholic areas in hotels were also discussed. accordingly, 728 hotels have non-alcoholic rooms, and 202 do not serve alcohol in their facilities. the number of completely alcohol-free hotels is 16. this number is quite low compared to the tourism potential of italy. the study also examined the distribution of hotels providing halal service according to the number of stars. accordingly, most halal hotels (44%) consist of 4-star hotels, followed by 3-star hotels (26%) and non-star hotels (16%). five-star hotels have the lowest number of halal hotels (5%). five-star establishments have large and versatile restaurants, especially those that serve alcohol, which is why it takes more work to serve halal food. therefore, it is thought that 5-star hotels may be the least halal hotel category due to their facilities that are not suitable for providing halal food services. the distribution of halal concept accommodation businesses according to their types was also evaluated in this study. hotels constitute the largest group, 84% of halal concept accommodation establishments. although guesthouses, apart-hotels, inns, villas, country houses, honeymoon houses, holiday villages, apartments, townhouses, and ski hotels are other accommodation establishments with the halal concept, they are relatively few in number. according to the data on the regional distribution of halal concept hotels in italy, the highest number of halal hotels (338) are found in lazio, followed by tuscany (109) and veneto (103). there are halal concept hotels in lombardy, campania, sicily, apulia, liguria, sardinia, piedmont and ten other regions. however, it can be said that the most active region in halal tourism is italy's western coast. halal tourism is a tourism sector that provides services by the islamic faith and has gained importance in recent years due to the increase in the number of muslim tourists living in non-muslim countries (battour, hakimian, ismail, & boğan, 2018). this form of tourism meets the needs of tourists who believe in islam by ensuring they spend their holidays by their religion. in non-muslim countries, halal tourism contributes to the growth and development of the tourism sector (jia & chaozhi, 2019). tourists who believe in islam spend their holidays in countries with halal tourism services. therefore, they constitute an important market for the tourism sector. in addition, halal tourism services contribute to increasing employment in the tourism sector and developing local economies. one of the limitations of this research is that since the sample only covers halal hotels and services in italy, generalizations cannot be made about halal tourism sectors in other countries. in addition, other research limitations are that the data sources are limited to web content analysis and interviews, examining only hotels may reflect only some of the sector; and not examining the experiences and opinions of tourists. the results of this study show that the halal tourism sector in italy is developing rapidly, and halal-concept hotels are becoming widespread. future research provides opportunities for a deeper understanding of this industry. these include examining the products and services offered by other businesses (travel agencies, airline companies, etc.) in the halal tourism sector, analyzing the experiences and expectations of tourists about halal tourism services in more detail, and determining strategies for further development of the sector. in addition, monitoring trends and developments in the halal tourism sector will provide more up-to-date and detailed information about the sector's future. acknowledgements we would like to thank the management and staff of halalbooking.com & halaltrip.com for their valuable information. references aji, h. m., muslichah, 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(2023). discovering the importance of halal tourism for indonesian muslim travelers: perceptions and behaviors when traveling to a non-muslim destination. journal of islamic marketing, 14(1), 61–81. https://doi.org/10.1108/jima-07-2020-0210 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6816 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 08/06/2022 accepted for publication: 18/11/2022 published: 29/12/2022 14 a critical shariah and maqasid appraisal of islamic credit cards abdulazeem abozaid1, saqib hafiz khateeb 2 1,2 college of islamic studies, hamad bin khalifa university, doha, qatar contact author 1: abozaid.abdulazeem@gmail.com contact author 2: saqibhk1@gmail.com abstract islamic banks and financial institutions have recently started issuing islamic credit cards as substitutes for conventional credit cards after the shariah scholars, due to the riba involved, unanimously deemed the traditional credit cards unlawful. however, islamic credit cards have different structures; some have been structured based on eina or tawarruq sales even though these two types of deals were ruled unlawful by the fiqh academies. however, the most common structure of islamic credit cards is the ijarah model, where the card issuer is deemed a lessor of the services embedded in the credit card, apart from the provision of credit, against fixed periodical fees. although this structure seems acceptable from a shariah point of view and has been endorsed by the shariah boards of the issuing islamic banks, it involves some issues that must be carefully addressed. the paper elaborates on these critical issues and analyses the different contractual relationships involved in these cards to outline the prospectus of a genuine shariah-compliant credit card. keywords credit card, islamic credit card, islamic finance, islamic banking, islamic product development i. introduction islamic finance is a system that identifies and promotes economic and financial tools and products consistent with sharia's principles. although islamic financial institutions share similarities with conventional financial intermediaries as both are profit-maximising institutions and offer traditional banking services. still, they differ in some of the principles under which they operate. islamic principles require that earnings come from permissible means and be spent on good categories of expenditure allowed in sharia. generally, islam prohibits investing in businesses that are considered unethical or are contrary to the islamic ethical teachings and values, like dealing with riba (usury/interest), gharar (speculation/uncertainty), maysir (gambling), and investing in unpermitted activities and businesses in islam, like alcohol, tobacco, pork-related products, and pornography etc. [1]. moreover, its investments should be asset-backed or identified as an underlying tangible asset, and a proper application of the profit and loss-sharing concept should be maintained [2]. islamic economics mainly regards wealth as a means for achieving justice, equality, fairness, and economic equilibrium in society. islam does not discourage maximising wealth if it does not create a situation of social distortion or violate the norms of islamic justice. elbassiouny [3] summarises that islamic finance's comprehensive goal is avoiding harm to all humanity and promoting its properties. speaking of the objectives of islam, around which the general rules of islam are based, dusuki, and abdullah [4] refer that the key objectives include safeguarding the religion, the intellect, the human self, the progeny, and wealth. in islamic financial institutions, adherence to shariah principles is monitored by either an internal or external shariah supervisory board (ssb). this board is a panel of shariah scholars who assess the products and practices of the institution and conclude about the institution’s compliance with the shariah requirements [5]. islamic finance is the fastest-growing sector of finance in the world. although it started in muslim countries, it has also spread to non-muslim countries and serves muslims and non-muslims alike. muslims count for around 24% of the global population, and islam is the world’s secondlargest religion, with the fastest growth rate, according to a pew research center’s 2011 report [6]. these factors have also assisted in the remarkable growth of the industry worldwide. moreover, biancone and radwan’s [7] study points out that countries worldwide are looking to introduce islamic finance as an alternative financial system after the recent financial crisis. this is because, despite the latest financial crisis that caused difficulties for many conventional banks worldwide, yilmaz [8] claims that islamic banks were broadly safe from the situation, courtesy of their prudent financial behaviours. the islamic finance industry has experienced exponential growth in recent years, and the assets held under islamic finance management have already crossed reuters’ [9] expectation of $1 trillion. conventional financial institutions have extended their operations to provide islamic financial products catering to islamic investors. biancone and radwan [10] highlight that entrepreneurs financed by banks have been gradually increasing in most countries where islamic banks operate, for example, the united kingdom and switzerland, where there is a more excellent european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6816 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 08/06/2022 accepted for publication: 18/11/2022 published: 29/12/2022 15 supply of entrepreneurs who have started demanding islamic financial products. the paper is divided into seven sections. after the introduction and literature review, the article discusses the basis and features of credit cards, their advantages, and their disadvantages in section iii. the following section is the appraisal of islamic credit cards considering the objectives of sharia, which is the main subject of this research. it covers the basics of the legitimacy of different types of islamic credit cards and mentions the scholars’ stances therein. sections v and vi discuss two major concerns in using credit cards and their permissibility. the paper concludes by summarising the results and suggestions in section vii. ii. literature review despite the expansion and growth of islamic finance in the previous decades, its full potential has yet to be realised in various arenas. it must expand its services to innovative financial tools in tandem with islamic principles to realise its true potential. one such financial tool is the introduction of credit card products, like the already existing tool in conventional financial institutions. al-enazi [11] claims that islamic financial institutions have adopted credit card practices by altering specific components that contradict the shari’a requirements, for example, by eradicating the interestbased elements included within conventional credit cards. most of the literature on an islamic credit card is focused on its basis from islamic texts, and a few research, like choo et al. [12], study the consumer’s choice of credit cards and their acceptability. other studies, like johan & putit [13], relate to the issues of people’s knowledge and religiosity influencing their decisions on whether to opt for credit cards or abstain from them. on the other hand, mansor and azman [14] studied factors, like demographics, to observe whether they can be a good indicator for an islamic credit card. given the substantial increase in electronic payments, to the detriment of cash payments, islamic credit cards have already penetrated the banking sector and are abundantly found in the market. but there needs to be more research considering the connection between current islamic finance practices and their validity, given the complexities of modern-day financial developments. but to ensure that the islamic credit card and its services can help strengthen the competitive position of islamic banking vis-à-vis the conventional banking system, the banks must deepen their understanding regarding the legitimacy and basis of such a product, too averse any shariah risk emanating from such a product [15]. the motivation for this paper comes from the necessity to appraise the current practice of islamic credit cards from a maqasid perspective and to assess its legitimacy since its issuance and its underlying contracts while addressing the shari’a perspectives of credit card structures. this paper is exploratory and conceptual, providing insights for researchers, decision-makers, and practitioners on how islamic credit cards can prove better compliance with sharia. iii. credit cards, its advantages and disadvantages islamic banks are required to expand marketable products and services based on islamic instruction standards. one of these services, which is the focus of the study, is the islamic credit card. financial institutions, typically banks, provide a credit card that enables the cardholder to borrow funds as loans from that institution under the agreement to repay the loaned amount by the bill’s due date or incur an additional agreed amount. a credit card is a means of payment which involves buying first and paying later, as defined by yee, eam and sanusi (2007) [16]. it is based on the principle of a loan without interest (i.e., riba) if the loan is repaid on or before the specified date, i.e., the grace period, and with interest if repayment is delayed beyond that time. charging interest only in case of delay beyond the agreed repayment period is one variety of riba al-jahiliyya, which is impermissible. according to oic fiqh academy [17], resolution no. 108 (2/12), issuing and dealing with conventional credit cards is unlawful due to this reason. nevertheless, despite this shariah primary concern, credit cards generally have unique features and benefits for their holders and issuers. a credit card is one of the most convenient and secure payment tools accepted worldwide. it has replaced the need to carry cash, which is especially handy for international travellers where local currency is needed or where it is difficult to take large amounts of money in one or different currencies. the cardholders also benefit from increased purchasing power, in addition to being rewarded in the form of points, cash-back offers or gifts, prizes and discounts for using the credit cards. the user may qualify for additional credit facilities if he can build a good credit history. a credit card holder can shop through the internet, where no cash payment is accepted, allowing him more significant opportunities and possibly better prices, such as buying travel tickets, booking hotels, and participating in international auctions. cardholders use it for e-payments and electronic purchases to guarantee payment, which has sparked explosive sales growth for expenditures on transactions which require a system of insuring payment (fineberg) [18]. it can also be used to make automatic recurring payments from the card, such as phone, water and electricity bills. merchants also have a share of benefits from credit card systems like guaranteed payment, fraud protection, cash balance safety, and increased sales and revenue due to the boost in cardholders’ purchasing power. credit cards increase business activities and profits because it provides people access to finance. radishe [19] points out that this explains why businesses consent to waive a specific percentage of the value of their sale items (the interchange fee) for the benefit of the credit card issuer. to this effect, the card issuers may grant new cardholders’ attractive rebates to lure them into subscribing to the card, especially on their first purchases or for a limited time. since the credit risk of cardholders is shifted from the merchant to the card issuer, i.e., the bank, the merchants are guaranteed to receive the payments. it can also european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6816 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 08/06/2022 accepted for publication: 18/11/2022 published: 29/12/2022 16 help traders reduce the difficulty of handling cash in their businesses and the costs of transporting it to banks. similarly, the credit card issuers benefit from different types of penalties and fees like card issuing fees, annual card fees, card renewal fees, cash withdrawal fees, late payment penalties etc., in addition to the price they charge to the merchants for using the technological infrastructure that they use to accept payment through credit cards. it provides a profit for the issuers through a percentage on all purchases that are charged (the interchange fee) to the merchants accepting the card, in addition to the amount charged to the cardholder if he delays the credit payment beyond the grace period as well as the amount charged for using the card to withdraw cash. this interchange fee is permissible according to oic fiqh academy resolution no. 108 (2/12) and according to the shariah standard no. 2/5 issued by accounting and auditing organization for islamic financial institutions (aaoifi) [20]. issuers may also charge issuance or periodical fees to the cardholder regardless of whether the cardholder uses the card. oic fiqh academy’s resolution no. 108 (2/12) deems these permissible as they are against the embedded services in the card, apart from the credit involved. however, credit cards have drawbacks for cardholders, issuers and accepting parties. the conventional credit cardholder is supposed to pay the considerable compound interest (riba) if he does not repay the credit amount before the end of the grace period. the interest rate is estimated at around 2% per month. the grace period is cancelled if an unpaid amount remains from the last period. the interest calculation begins on the first day the monthly bill is issued. this could lead the cardholder to be gripped in the clutches of debt so that he may keep paying his debts for several years. the issuing parties justify the high interest by the high probability of default and failure to repay the debt. this means that some cardholders pay on behalf of others to render this business as profitable to the issuers. apart from this financial disadvantage, credit card encourages its holder to buy unnecessary things, encouraging thus extravagance and the purchase of luxuries, which contradicts moderate spending and good management of money. abozaid [21] highlights that it contradicts the shariah stand on debt, as shariah does not encourage incurring debts. however, it encourages providing good loans to those who are impecunious and in need. the concept of credit cards encourages consumerism and debt-taking, which leads to mounting indebtedness and financial instability in society. the traders also lose some profits from the credit card because the banks issuing the credit cards discount a certain amount (2.5% on average) from the value of the sale items through the card (the interchange fee). this could cause businesses to increase their prices to compensate for this deduction, and such an increase is ultimately borne by the buyers. thus, credit cards contain benefits and harms for their users, and it is left to the financial skills and knowledge of the user and the way he/she chooses to use it. however, they have become part of the demands of modern life. with an increase in internet usage and the trend of e-commerce, and other technological advancements, the credit card has become an indispensable tool for effecting payment. there is hardly a single person living in a country with a developed financial system who does not carry a credit card, especially in this digital era. according to the world payments report 2020 (capgemini) [22], global non-cash transactions surged nearly 14% from 2018-2019 to reach 708.5 billion transactions, the highest growth rate recorded in the past decade. the report predicts a compound annual growth rate (cagr) of 12% for global non-cash transactions for 2019-2023. does this pose a question: do these benefits justify using credit cards if the holder seeks to repay the loaned amount within the grace period? on the other hand, is the mere subscription to a credit card a problem from a shariah perspective due to the possibility of paying interest if there is an unplanned or unintentional delay, or due to the implicit agreement of paying riba in the case of delayed repayment? to answer these questions, the paper will present the supposed alternative to credit cards that islamic banks provide. if this alternative were sound from the shariah perspective, it would free us from the need to use conventional credit cards, and it would assist us in judging their use as impermissible. iv. credit cards issued by islamic banks since conventional credit cards are based on debt financing, and any increment to the debt violates islamic law, islamic banks started issuing credit cards as an alternative to conventional credit cards after the latter was ruled impermissible, given the riba involved. the relationship between the conventional credit card issuer and the cardholder is based on riba if there is a delay in repayment beyond the grace period. the oic fiqh academy, in its resolution no. 63 (1/7) defines the credit card as “a document given by its issuer to a mutual or a juridical person based on a contract between them enabling it to buy goods or services from a vendor who approves the document, without paying the price immediately as the document includes the issuer's commitment to pay.” financial institutions have devised different structures of credit cards, to correct the riba-based relationship between the issuer and the cardholder. among these structures, the paper will discuss the most popular ones; credit cards based on ‘īna or tawarruq, and service ijārah. a. firstly, credit cards based on bay al-‘īna or tawarruq tawarruq refers to buying a commodity from one party on credit and selling it to a different party for cash to obtain cash. ‘īna is a sale that is mostly resorted to to circumvent the prohibition of riba by selling a commodity to the person seeking financing at a deferred price then instantly buying it back at a lesser spot price. thus, tawarruq shares the same objective of bay al-‘īna as both are meant for extending cash money. however, tawarruq remains technically distinguished from bay al-‘īna as in the latter, the commodity is resold to its original seller, while in tawarruq it is sold to a third party. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6816 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 08/06/2022 accepted for publication: 18/11/2022 published: 29/12/2022 17 given that credit cards are used for financing the bank provides financing for the cardholders and gains its profits from that financing and given that riba is regarded impermissible, some islamic banks structure their cards in the following formulas as they do not regard practising tawarruq and bay al-‘īna as problematic. the islamic bank initiates a tawarruq or ‘īna sale with the customer. then it creates a special account, i.e., the customer's credit card account, and places the financing amount in it. the customer is then given a credit card with a credit limit equal to the amount of financing stored in that account. thus, the cardholder is using the card to pay from the money he got from the ‘īna or tawarruq procedure and has not borrowed anything from the card issuer, i.e., the bank. once the monthly bill is issued, the cardholder should top up that account, within a specified period (like the grace period in a conventional card), with the same amount spent on the bill, to renew the balance of his credit card. if the customer is late in repayments, the bank gains profit (not riba) from the difference between the prices in the preceding ‘īna or tawarruq sale. for example, if the bank sells a commodity based on ‘īna to a customer for 15000 on a deferred basis, and then buys it from him for 12000 on the spot, then the 12000 is set as the credit limit and is placed in the card’s account and not given to the client. if the customer delays topping up the account beyond the grace period, the bank charges the client for this delay with a set amount through the difference between the two prices, i.e., 3000. if the client frequently delays repayment until the amount charged to the customer has reached 3000, the bank requests him to sign another ‘īna or tawarruq contract. this means that the ‘īna or tawarruq contract does not come into effect if the client repays during the grace period or returns the card without falling behind on his repayments. in the latter case, the bank performs a clearing between the two prices in the īna or tawarruq; the price that it is due to the client (12000) and the price that is due to the bank (15000). the difference between them, i.e., the profit from ‘īna or tawarruq, due to the bank, is waived. in the previous example, the bank exonerates the customer of the difference of 3000. exoneration also occurs if the client’s delay does not reach 3000, as the bank exonerates him or her of the remaining amount. shariah appraisal of ‘īna/tawarruq-based credit cards both ‘īna and tawarruq contracts are meant to justify profiting from cash financing, and as such, they are impermissible. tawarruq was ruled unlawful by the oic fiqh academy resolution no. 19/5 since it involves a contrivance to riba. ‘īna is, moreover, impermissible according to all jurists, including shafi’is, who only validate its contract based on it being a contract that has fulfilled the contractual conditions of a sale contract. however, as noted by al-kasani [23], ibn qudamah [24] and al-dasuqi [25], the shafi’is regard it impermissible when it is intended to justify profiteering from a loan contract. hence, structuring credit cards based on them is impermissible. nevertheless, some irregular fatwas appeared recently to validate these two sales, designed to circumvent the riba prohibition and yield the same result as a conventional loan. some fiqh scholars, such as the shafi’is, rule ‘īna as a valid sale given its valid sale structure but ruling it as valid does not imply that it is permissible, since a valid contract is not necessarily permissible, as mentioned by abozaid [26]. b. secondly, credit cards based on service ijārah as mentioned earlier, credit card has several advantages for their holders, merchants, and issuers too. the issuers may charge issuance fees or periodical fees to the cardholder regardless of whether the cardholder is using the card. these charges are deemed permissible by oic fiqh academy resolution 108 (2/12) as they are against the embedded services in the card or some privileges that may come with it, such as club memberships, complimentary insurance, and discounts on some items, to name a few. in principle, placing fixed fees on credit cards for such services is a permitted condition for the permissibility of the services offered. this is because it is permissible in shariah to charge a fee for a lawful service, just like it is permissible to demand a price for selling a lawful commodity. ijārah is a sale of a usufruct or service, so it is a sale contract. the real usufructs that the card issuer provides to the cardholder justify for him to charge a fee, whether the fee is paid in one go, on a monthly or yearly basis, or a mix of them. further, different types of services justify varying fees. a privilege card (like platinum or gold) may be charged higher for its valued services. the cardholder pays a fixed fee to the issuer in return for services offered. this fee remains the same regardless of the usage of the card, as in the case of conventional credit cards. however, islamic banks that issue these cards waive the fee if the cardholder repays the full value during the grace period. otherwise, the bank obliges the cardholder to pay the full monthly fee, even if only a single penny is left to be repaid. islamic banks grant this waiver regardless of whether the cardholder uses the services included in the card because the banks want their cards to remain equally competitive in the market since conventional credit cards waive the additional amount if the cardholder repays the billed amount within the grace period. hence, one will find that islamic banks offer similar privileges to their customers as conventional banks. nevertheless, there is no shariah issue with this waiver, as it is given as a gift (hiba). c. sharia’h appraisal of ijārah-based credit cards as stated earlier, a credit card provides some services that may justifiably warrant a fee. according to oic fiqh academy resolution no. 108 (2/12), charging fees by the card issuer against the services embedded in the card, except for the credit, is permissible. however, according to oic fiqh academy resolution no. 139 (5/15), these cards must not include any prohibited service. credit cards contains a loan, in the form of the credit card limit that the issuing bank provides to the cardholder. this credit cannot be regarded except as a loan, and profiting from a loan is impermissible, as it is riba. hence, there are two components in a credit card: the services and the loan. a profit can be earned from the service, not the loan. combining a loan and any other contract like a sale or a lease european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6816 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 08/06/2022 accepted for publication: 18/11/2022 published: 29/12/2022 18 entails caution from a shariah perspective because the fee or the price might be increased in return for giving the loan, as in the hadīth that suggests that “combining salaf and sale is not permitted”. the hadith, as reported by abu dawud (hadith no. 3504); al-tirmithi (hadith no. 1234); al-nasai’ (hadith no. 4611), ahmad (hadith no. 6683), reads: “the messenger of allah, peace be upon him, said: “salaf with the sale is impermissible, or two conditions in a sale, or gaining from the sale of something without or before bearing its liability, or selling what you do not have”. al-nafrawi [27] acknowledge that although this hadīth refers to combining a sale with salaf, i.e., a loan, but like sale in this regard is any commutative contract, such as ijarah, as the jurists say. the reason for the prohibition is that the price of the sale item could increase or decrease to cater for the loan. for example, the lender may tell the borrower: i will lend you 200 dollars on the condition that you buy this (specified) item from me for 50 dollars, though its market value is less than 50 dollars; or on the condition that you sell me this (specified) item for 50 dollars, though its market price is higher than 50 dollars. nevertheless, the outward text of this prohibition means that all exchanges combined with a loan are prohibited, including ijarah, an exchange contract. the effective cause of the prohibition is clear, that is, using an exchange contract as a stratagem (tahayul) or a legal artifice to circumvent the sacred law, to enable profiting from a loan. accordingly, it could be acceptable to say that it is possible to excuse this combination [of sale and loan] if it is not used as a legal trick. however, two conditions must be met while applying this combination of sale and loan to the credit card’s structure, in addition to not using it as tahayul: (i) that the fee charged for credit card services should not be higher than the normal market fee (if it can be approximated) for these services, and (ii) the fee should not change if the credit limit changes. the fee may change if the credit card with a higher credit limit provides extra services of additional market value that make the difference in the fee compared to that of the lower credit card limit. thus, it is prohibited that cards differ in their fees due to a difference in their credit limit. however, if the cards with different credit limits come with different services, and the extra fee reflects the extra service's market value, then the fee difference can be justified. this implies that the cards that differ only in credit limit while their services are the same may not vary in fees. for example, if the gold-branded credit card has a monthly fee of 200 dirhams and its credit limit is 25,000 dirhams, while the platinum-branded credit card has a monthly fee of 400 dirhams with a credit limit of 50,000 dirhams, and there is no difference in the services offered by the two cards, then the difference of fee cannot be justified. or if there is a difference but limited to a restricted number of complimentary valet car parking per month, for example, and the monthly market total value of this service is only 50 dirhams, then this makes the remaining amount between the fees (150 dirhams) in return for the extra credit, i.e., the loan impermissible. v. earning from cash withdrawals it is impermissible for the credit card issuer to profit from cash withdrawals from atms using these cards. this is because the withdrawal amount is a loan, and profiteering from a loan is riba. however, it is permissible for the card issuer to cover its actual withdrawal costs, since the issuing bank incurs some costs for the withdrawal, especially when the withdrawal occurs in another country and with a different currency. on top of that, it is permissible for the card issuer to receive a fee for the withdrawal service, provided it is no more than the fee normally charged on debit cards. this is to ensure that the credit provided with the credit card remains free of charge. however, when a withdrawal with a credit card occurs in another country, it is permissible for the issuer to take a reasonable commission equal to the usual fee for exchanging and transferring money. this is because the bank issuing the card provides the service of both exchanging and transferring money in this case. in this regard, oic fiqh academy, in its resolution no. 108 (2/12) ruled that: “cash withdrawal by the cardholder is a loan from the issuer, and it raises no shariah objection if there is no ribawi increment. not included are flat fees in return for this service and not related to the amount of the loan or its period, but any increment above actual service is impermissible and is riba”. in this regard, it is worth noting that aaoifi shariah standard no. 2 (4/5) also allows the issuer to charge a flat fee against the service of cash withdrawal, but it does not restrict the permissibility of being against the actual service. vi. using a conventional credit card when no real islamic alternative is available the problem with conventional credit cards is that riba is conditioned and paid if the cardholder delays repayment. payment of riba is a grave issue that is only permitted in cases of dire necessity. however, if the cardholder takes necessary precautions to avoid payment of riba by keeping his expenditures within his budget and opting for automatic deductions of the credit used from his bank account, then the only matter that remains contested is his implicit agreement to payment of riba. the cardholder receives the card after undertaking to pay riba if he delays the repayment, and as such, he is entering into a fundamentally impermissible contract. however, the following considerations might help ease this particular concern: 1) there needs to be a genuinely legitimate islamic alternative that overcomes the riba problem in credit cards. 2) the undertaking to pay riba is an enforced condition (shart ith’āni) that cannot be changed or dropped by the subscriber, and it is of no consequence if the cardholder always pays during the grace period. 3) many people in our time need credit cards to buy goods and services that may not be possible through other means or for the same price. this is european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6816 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 08/06/2022 accepted for publication: 18/11/2022 published: 29/12/2022 19 in addition to the inconveniences associated with carrying cash especially given the risk involved, particularly for travellers. nevertheless, if a card that performs the roles of a credit card comes to exist, and it is free from the credit, i.e., a loan, it must be used instead. according to oic fiqh academy resolution no. 139 (5/15), using a (debit) card that does not involve credit is lawful even if issued by a conventional financial institution. to explain further, if a debit card performs the main functions of a credit card, it should be used instead, since there will be no justification then to use a credit card and bear the cautions that come with it. those cautions relate to the possibility of paying riba eventually and encouraging people to buy non-necessities using others’ money while incurring unnecessary debts. all these contradict the higher economic objectives of the islamic shariah and function against its principles in moderation in spending and debt incurring. vii. conclusion in conclusion, structuring a credit card that is compliant with islamic law and in a way that is profitable to the issuing party is possible in principle. the way is to charge a fee for the services associated with this card but considering that this fee must not be against the loan granted with the card. therefore, two conditions must apply: the fee should be equal to the market value of these services, and it should not increase with the credit limit of the card unless coupled with additional services whose market value equals this difference in the fee. islamic financial instruments require both strengthened accounting standards and more expertise and qualified people, and many efforts are needed to raise awareness of such instruments. the paper also records the following results: • credit cards issued based on ‘īna or tawarruq are invalid due to the invalidity of their underlying contracts. issuing a credit card based on service ijarah, however, is possible but with conditions. • islamic financial institutions issuing credit cards may charge a commission to the merchants accepting the card, as a percentage of the price of the goods and services. • it is permissible for the card issuer to receive a fee for the cash withdrawal service provided it is no more than the fee normally charged on withdrawals using debit cards. if, however, an additional service is provided, such as withdrawal from outside the country, then a higher fee is permissible provided that the profit for the additional service does not exceed the normal market remuneration for the money transfer service. • if a debit card performs the same roles of a credit card, then it should be used instead of the credit card, especially since the latter involves cautions that contradict the higher objectives of the islamic shariah and functions against its principle of moderation in spending and debt incurring. • on a final note, issuers of islamic credit cards should do all possible to block the card from being used to buy unlawful commodities or services. references [1] el-komi, m. and croson, r., “experiments in islamic microfinance”, journal of economic behavior & organization, vol. 95, pp. 252-269, 2012. 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[27] alnafrawi, al-fawakih al-dawani, beirut: dar al-fikr, 1994. paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif 1 sharia compliant “possibility for italian smes” 1 university of turin, italy, paolo.biancone@unito.it 2 university of turin, italy, maha.radwan@unito.it abstract— islamic finance have been a flourishing phenomenon recently with a very high growth rates and countries worldwide are exerting efforts to introduce it as an alternative financial system especially after proving its stability in the last financial crisis. introducing the islamic finance in italy would be very important step with high potential opportunities due to the creation of investment opportunities, increase of liquidity, accessing arab sovereign funds, and promoting integration policies for immigrants. understanding the current nature of the italian companies in particular the small and medium enterprises (smes) and by testing their eligibility of being sharia compliant in this paper; which is a fundamental step for exploring the feasibility of adapting them to the islamic financial system and therefore the possibility for financing them through islamic financial instruments; had proved its validity with an optimal results whether on the screening process or the performance and profitability measures. keywords; islamic finance, sharia compliant, smes, sharia indices, sharia compliant screening. i. research problem and objectives small and medium enterprises (smes) are the basic stones in most of the economies. they contribute heavily to the economic growth worldwide. most of the countries always try hardly to encourage development of smes as it contributes a lot not only to economic growth, capital accumulation but also through the employment opportunities that they create. this research aims to explore the feasibility of adapting italian smes to the islamic financial system and verify the possibility of financing them through islamic financial instruments which requires certain aspects to be fulfilled. applying this would require that the italian smes to be a sharia compliant. objectives of the research are: to test the italian smes for sharia compliant screening to determine the eligibility of italian smes to the islamic finance to evaluate the problematic criteria‟s that could prevent the smes from being eligible figuring out what are the suitable tools that islamic finance could offer to smes ii. introduction and literature review islamic finance is, indeed, a growing sector with its diversity in different segments in various parts of the world. although the islamic finance industry started to flourish recently, islamic theories of economics have existed for more than a millennium. however, only in the 20th century muslim scholars and academics seriously started to revisit these topics; and this had been the beginning for the modern islamic finance industry to emerge in the 1970s (iqbal & mirakhor 2011) [13]. islamic finance has not taken root solely in muslim countries but has also spread to non-muslim countries. it is not serving only religious muslims in muslim‟s societies and muslims in western countries but also it started really to flourish as an ethical non risky attractive financial instrument for nonmuslim population. islamic finance is a system for all financial transactions that are conducted according to sharia which is the legislative framework that regulates all aspects of lifxe for muslims; it governs all their public and private life. sharia is derived directly from four main sources: 1) the holy quran; which is the holy book that contains the words of allah “god”. 2) sunna; which refers to hadith “sayings”, actions, of prophet mohamad “messenger of allah”. 3) ijma; which is the consensus of all muslim scholars on a specific issue. 4) qiyas; means “analogy” and this for the issues that were not explicitly mentioned either in quran or in sunna and consequently in this case it is declared by qualified scholars who evaluate a measurement through studying rules applied for similar issues. islamic finance from an economic point of view refers to a system which identifies and promotes economic and financial orders that are consistent with the principles of sharia [7]. these principles differentiate islamic finance from the conventional finance. specifically, islamic principles require that muslims earnings must come from permissible means, and paolo pietro biancone 1 and maha radwan 2 mailto:paolo.biancone@unito.it mailto:maha.radwan@unito.it ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 2 must also be spent on acceptable categories of expenditure that are sharia compliant “adhering completely to sharia principles”. consequently, islam prohibits investing in businesses that are considered unethical or contrary to the islamic ethical teachings and values. islamic economics is mainly concerned about the distribution of wealth as a mean for achieving justice, equality, fairness, and economic equilibrium among the society. muslims are encouraged to maximize their wealth as long as they do not create a situation that is creating a social distortion or violating the norms of islamic justice [4]. as a result the need for financial institutions, products and services, instruments and contracts that is compliant with sharia and within the constraints of islamic ethical principles. sharia compliant institutions are similar to conventional financial intermediaries in that they are profit maximizing institutions and offer traditional banking services, but differ in some of the principles under which they operate [9]. research from the international monetary fund (imf) indicates that islamic banking appears to be a complement to conventional banks, rather than a substitute. a core concept of finance in islam is that allah “god” is the owner of all wealth in the whole world, however at the same time; muslims have the right to enjoy whatever wealth they acquire and spend it in sharia compliant ways. the most important principles of islamic finance include a prohibition for riba “usary”, prohibition of gharar “uncertainty/speculation”, prohibition of maysir “gambling” and prohibition on investment in nonhalal that is equivalent to haram “unethical” businesses products or services (such as alcohol, tobacco, pork, adult entertainment, and weapons). sharia compliant products must be backed by or based on an identifiable and tangible underlying asset; it is also important that the investor and investee adhere to the concept of profit and loss sharing which is in other terms sharing the risk of all financial transactions. islamic financial products, while they are derived from islamic ethical laws, are not limited to muslims population only but they are available to everybody. it is a technical financial system that is operating on an ethical basis that is very similar to the social responsibility investments that promotes for an ethical finance. islamic finance is considered to be the fastest growing sector of finance in the world. the islamic finance industry has experienced in recent years (estimated at 10%-20% annual growth) [3]. industry experts estimate that assets held under islamic finance management doubled between 2007 and 2010 to each around $1 trillion [10]. a survey of the top 500 islamic financial institutions shows that sharia compliant assets in these institutions rose from $822 billion in 2009 to $895 billion in 2010. iii. fundamentals and financial instruments of islamic finance islamic finance institutions operate with reference to principles of sharia. those principles have got specific characteristics and prohibitions that regulate it which are different from the traditional conventional financial institutions features. 1. prohibition of riba “usury or interest”: from a sharia prospective, riba “interest” is considered to be usurious and is prohibited. riba refers to the premium that must be paid by the borrower to the lender along with the principle amount as a condition for taking the loan. scholars have classified riba into two types that could be seen in;  inequality of quantity or weight and dissimilarity of quality exchanged between parties  the extension of the repayment period of a loan for additional amount of money. it makes no difference whether the loan is for consumption, or business purposes, or whether the return is a fixed or a variable percentage of the principal. it also makes no difference whether an absolute amount to be paid in advance or on maturity, or received in the form of a gift or a service if stipulated as a condition in the loan contract or an extension in its maturity" [2]. 2. prohibition of gharar “uncertainty or speculation”: gharar “uncertainty” in arabic refers to excessive risk, uncertainty and hazard. gharar can be seen into two types: gharar in the object of the contract and gharar in the terms of the contract. the rationale behind the prohibition of gharar is that to ensure the full consent of all parties in a contract. 3. prohibition of maysir “gambling”: maysir in arabic means gambling which is hazard game of chance and it is considered as an extreme form of gharar. it refers to all transactions that have the element of gambling i.e. based merely on chance. the logic behind the prohibition of maysir is that the unjustified gains and increase of wealth through games of pure chance is a transfer of wealth from one to another and this kind of transfer is done on the expense of the society. 4. principle of profit and loss sharing (pls): the islamic ethics and sharia has encouraged the increase of wealth however this increment should be done with reference to a very important principle which is profit and loss sharing (pls). this principle specifically refers to an equitable sharing of risks and profits between the parties involved in a financial transaction. earnings of profits or returns from assets are permitted as long as the business risks are shared by the lender and borrower. ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 3 5. prohibition of haram “unethical” versus halal “ethical investments”: sharia has prohibited haram “unethical activities”. haram unethical activities are represented not only in the riba, gharar, maysir but also for specific businesses and industries that are forbidden in socially and ethically manner that do not work in the direction of benefiting the society. these include, for example, pornography, alcohol, weapons, pork based products...etc. it is also not allowed to acquire the shares of the companies providing financial services or business that is not sharia compliant. 6. necessity of underlying tangible asset: sharia defined that each financial transaction must be tied to a “tangible, identifiable underlying asset,” i.e. real estate or commodities, etc. money is recognized in islam as a means of exchange, but not as a commodity because it is not capable of fulfilling human needs unless converted into a commodity. sukuk which are islamic financial instrument that are similar to those of conventional bonds but a key difference is that they are backed with underlying asset. 7. obligation of zakah “purification”: zakah is one of the five pillars of islam and is a religious duty for muslim as a charitable activity for the needy and poor. zakah has a strong rationale behind being an obligation as for its great benefit for the society and the reinforcement of the social responsibility towards the poor and needy. iv. financing mechanism and islamic financial contracts the previously mentioned fundamental principles in sharia concerning the financial transactions and operations should be transformed into a set of rules and contracts or financial instruments to be practically used. a. equity-based financing mechanism the most widely used contracts in the equity-based modes are the musharaka “joint venture or partnership of equity participation” and mudaraba “partnership”. they are mainly based on the modes of profit and loss sharing, where the profitability of islamic institutions is directly linked to their physical investments. this constructs the main difference between the islamic banks and the conventional banks that get the return in the form of interest on the loans provided to the customers regardless the fact that they invested this loan and whether it generated any profit or not [8]. b. debt-based financing mechanism the debt-based financing is a mechanism that depends on the idea of a fixed return on investment. in order to achieve this concept with a sharia compliant way without breaking the rule of prohibition of riba “interest” it must be done in a particular mechanism. this mechanism is done by mark up cost plus concept and this can be used in contracts that are based on sale with a deferred payments or purchase or that are based on leasing. most well known contracts are murabaha “cost plus mark up”, ijara “leasing”, salam and istisna. v. sharia compliant screening methodology investments should be always a sharia compliant, which requires screening for its eligibility for qualitative and quantitative criteria. the qualitative criteria are mainly related to the business activity of the company and it permissibility according to sharia. regarding the quantitative criteria they are a set of financial ratios and levels that had to be examined and their results should not exceed specific threshold. 1. qualitative screening criteria companies must have their activities within the permitted activities which are named halal and avoid all non permitted activities which are referred as haram activities. activities should of course include all of the production and sales of the company‟s products. screening for those activities in the companies is considered a fundamental step and crucial phase. this step represents the classification of the core business of each company. passing this initial qualitative screening phase means moving towards a quantitative financial screening. non permissible activities are those:  alcohol  pork related products  pornography  tobacco  gambling  interest bearing financial services (i.e. conventional banks and insurance companies)  weapons and defense  biological human and animal genetic engineering (ex: cloning)  media and advertising companies with exception to news channels, newspapers, and sports 2. quantitative screening criteria the second phase is the quantitative screening in which the financial ratios of the companies are tested for not exceeding specific threshold that are different among the different global indices. the three main aspects that should be tested are the leverage level (debt level ratio), interest ratio, and the liquidity ratio (cash and account receivables), and finally the portion of revenue that is generated from non compliant operation. ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 4  level of debt: any interest based debt is not permitted according to sharia principles and this ratio verifies that the interest based debt is not exceeding the specified threshold.  interest ratio: the second ratio is the interest one which tests practically the investment in interest bearing securities and assuring that the income generated is not considered riba.  liquidity ratio: the third ratio is the liquidity ratio that is mainly focused on testing the liquid assets in the company (i.e. cash and accounts receivables).  non permissible income: there is a final criteria of financial ratio to be verified as well which is the level of non permissible income ratio. there is a minimum level of tolerance to accept some income that is generated from impermissible operations as long as the business sector is sharia compliant. vi. sharia compliant different indices the most famous worldwide islamic indices are: 1s&p 500 sharia index 2dow jones islamic market indices 3ftse 4msci islamic index series 5security exchange commission (sec) shariah advisory council of malaysia (sac) the main differences applied among them in the qualitative and quantitative criteria could be seen and summarized in the following two tables: table i. qualitative criteria activity s&p dow jones ftse msci sec alcohol ai ai cb cb cb tobacco ai ai cb cb cb pork ai ai cb cb cb pornography ai ai cb cb cb gambling ai ai cb cb cb media ai ai conventional financial services ai ai cb cb cb conventional insurance services ai ai cb cb cb weapon / defense ai cb gold & silver hedging ai entertainment ai ai cb cb cb hotels ai ai cb cb cb *ai refers: to exclude any involvement **cb refers to: exclude core business involvement) ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 5 table ii. quantitative criteria s&p dow jones ftse msci sec level of debt total debt / market capitalizatio n(avg 36 months) < 33 % total debt / market capitalizatio n(avg 24 months) <33 % total debt / total assets < 33 % total debt / total assets < 33.33 % total debt / total assets < 33 % interest ratio cash & interest bearing securities / market capitalizatio n (avg 36 months) < 33 % cash & interest bearing securities / market capitalizatio n (avg 24 months) < 33 % cash & interest bearing securities/ total assets < 33 % cash & interest bearing securities / total assets < 33.33 % liquidity ratio accounts receivables / market capitalizatio n(avg 36 months) < 49 % accounts receivables / market capitalizatio n(avg 24 months) < 33 % accounts receivable s & cash / total assets < 50 % accounts receivable s & cash / total assets < 33.33 % cash / total assets < 33 % non permissible income (npi) npi (excluding interest) / total revenues < 5 % npi (including interest) / total revenues < 5 % npi / total revenues < 5 % two classes of npi / total revenues class 1 < 5% class 2 < 20% vii. empirical research sharia compliant screening for italian smes small and medium enterprises (smes) are the basic stones in most of the economies. they contribute heavily to the economic growth worldwide. most of the countries always try hardly to encourage development of smes as it contributes a lot not only to economic growth, capital accumulation but also through the employment opportunities that they create. small and medium enterprises (smes) are entrepreneurial organizations with limited number of employees and specific financial threshold. the definition of parameters threshold is different from one country to another. smes have problems in accessing finance, and banks are always reluctant in financing them. the italian smes current parameters definition compared to its existing share in the economy as follows: table iii. italian smes parameters – economy share number of employees % of companies micro : 19 94.6 % small: 10 – 49 4.8 % medium: 50 – 249 0.5 % large > 250 0.1 % the italian smes are the main composer of the italian enterprises as they represent 99.9 % of the total enterprises. despite of this strong presence but their performance and access to finance are the major problems facing the italian smes. since 94.6% of the smes are of micro enterprises which are the most companies that face difficulty to access finance from banks since they are too small and are considered risky business, moreover they lack international exposure, and business development [5]. the huge share of smes in the total of italian enterprises makes it of great importance to try finding new possible alternative for financing them. this could be found in the islamic financial system. the islamic finance has got many available mechanisms for financing enterprises whether equity based financing mechanisms or debt based financing mechanisms. in order to be able to use islamic finance for financing italian smes, they should be approved as sharia compliant and here comes the significance for testing and measuring the italian smes for being sharia compliant. viii. research tool this empirical research is conducted based on several assumptions to be tailored and applied on the italian smes to test their eligibility for being sharia compliant. the assumptions that had been used are covering both the qualitative and quantitative criteria for sharia compliant screening. the used search database bank for reaching information regarding all italian smes is aida which is an italian company information and business intelligence that is a huge databank source that provides full details about italian companies. the pool that is to be examined is the italian companies in specific the unlisted ones that are of them smes. this is considered a new assumption that this paper propose, since the test will be applied for the unlisted companies only so for example there is no available market capitalization for them (that was previously mentioned in testing the quantitative criteria). ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 6 ix. research hypothesis  first hypothesis is imposing a criterion that companies should be owned by ultimate user and specifying its characteristics of their ultimate owner to be domestic so this assures that it is italian and then another filter for the type that is owned by one or more individuals or families. this is to stress on the fact that it is not consolidated to another group.  second hypothesis is an additional filter for the stock data and was imposed to select unlisted companies only.  third filter is related to the type of industry of the companies and that will be the first step in the qualitative screening as it is set to exclude all haram (non halal) activities that are considered not permitted according to sharia.  the quantitative screening starts with the financial variable index for verifying the liquidity ratio. as it was mentioned before that we are testing a new assumption for the unlisted companies so there is no available market capitalization. as a result the formula was set to measure relatively to the shareholders equity. the idea behind the choice of using the equity shareholders instead of using for example total assets as mentioned in some indices is that the value of shareholders equity is indeed lower in its amount that the total assets, which by diving the value of debt or interest will give a higher value and this makes this filter much more rigid in its verification. so starting liquidity, the formula used is: total accounts receivables / total shareholders equity “with the imposition of threshold: < 33%”  the second financial variable index is for verifying the interest ratio. the filter was set to impose the formula and limit it to the accepted threshold. the formula is: cash & interest bearing securities / total shareholders equity “with the imposition of threshold: < 33%”  the third financial variable index is for verifying the debt level ratio. the filter was set to impose the formula and limit it to the accepted threshold. the formula is: total debts / total shareholders equity “with the imposition of threshold: < 33%”  the fourth and last financial variable index is for verifying the non permissible income ratio. this filter was set to impose the formula and limit it to the accepted threshold. the formula is: non permissible income / total revenue “with the imposition of threshold: < 5%”  the exclusion of all inactive companies and to limit the pool to legally active companies.  x. analysis of findings important results and findings were seen after applying all the imposed filters and looking to the final outcomes of the research. those results are extremely important whether on the level of eligibility to sharia or on the level of those companies profitability. first focusing on the screening process regarding the type of business and sector when it was imposed the filter for excluding the non halal i.e. haram activities which are prohibited according to sharia it was only excluded few companies despite of excluding many impermissible activities and despite also that it was excluded some industry as a whole for example the meat industry was excluded as a whole not only pork related products and this was just to ensure that the prohibition is totally covered. the companies that were excluded from the pool in the filter imposing the qualitative criteria were very few. the total companies prior to qualitative criteria were 389,970 and the total number after applying the filter was 371,268 that successfully passed the screening. this means that only 18,702 companies were excluded. this indeed gives a strong message regarding the business activities of the italian smes that they are not having a problem with the qualitative criteria of sharia compliance and there is a great pool and a sufficient market share to start with. moving to the filters of financial data that were imposed for the verification for the financial ratios, important findings were seen. here it started to fall down with the numbers significantly as the financial and accounting structure of the italian smes is not fitting so much with the sharia requirements. after applying the quantitative screening, the results showed that the real problem that would face the italian smes in case of applying for being a sharia complaint would be in facing difficulty because of their financial structure as first it is based on liquid current assets (accounts receivables) which is not highly appreciated with reference to sharia that requires tangible fixed assets on the contrary to the conventional system. the second point is related to debt level which gives an idea about the financial risk (total debts/market capitalization) both sharia and conventional appreciate low levels. herein that particular ratio more than half of the total companies that gone through this filter had been excluded. this conveys that the 52% of the italian smes is financed through debt which is ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 7 basically done through conventional financial system which is rejected by the filters as mentioned before; moreover it reflects high financial risk. reviewing the other two ratios which are the interest ratio and the non permissible income ratio, findings showed that the companies which were excluded because of the interest ratio imposition were not huge as the other two financial ratios. the interest ratio is to look for the cash and interest bearing securities portion in the company but since our pool is smes and providing the exclusion of the high level of debt and accounts receivables so the portion of the interest ratio was not so high and had almost met the threshold. the last ratio was for the non permissible income correlates to the non sharia compliant income portion in the generated revenue. since the research was done excluding totally all non sharia compliant activities then it was evident that the non sharia compliant income portion in the financial statements of the remaining companies would be sorted out in the interest of the financial income coming from conventional sources. the results of the imposed filters could be seen in the following table: table iv. research results product name aida update number 209 software version 81.00 data update 19/06/2014 (n° 2093) username armando/clienti/bess/uni-1041 export date 27/06/2014 cut off date 31/03 step result search result 1. cos owned by an uo: def. of the uo: min. path of 50.01%, known or unknown shareh. 390.020 390.020 uo of one of the following types: one or more named individuals or families; duo only 2. unlisted companies 1.108.034 389.970 3. code search: not nace(1011,1013,104,109,1101,1102,1104,1105,110 6,12,4722,4725,4726,4729,4762,4781,563,5814,591 ,602,64,65,66,721,77,842,92) 1.054.187 371.268 4. accounting model: unconsolidated accounts detailed, all the selected years, last available year, last year -1 63.853 16.271 5. liquid r: last available year, last year -1, max=33, for all the selected periods 319.853 2.677 6. interest: last available year, last year -1, max=33, for all the selected periods 580.015 2.013 7. debt: last available year, last year -1, max=33, for all the selected periods 218.348 971 8. non per inc: last available year, last year -1, max=5, for all the selected periods 1.082.080 885 9. legal status: active 917.869 775 10 . total shareholders' funds (th eur): last available year, min=0 960.357 454 boolean search : 1 and 2 and 3 and 4 and 5 and 6 and 7 and 8 and 9 and 10 total 454 in analyzing the outcomes of the empirical research after having displayed all the used assumptions and hypothesis it was found many important facts that helped to understand better the nature of that companies, their activities, and the problem that mostly shared of including or excluding them. below are the most significant observations: business sector the business characteristics of the 454 italian sharia compliant smes include companies of diversified sectors. in specific, it is noticed that the majority of companies that had passed the screening and has been eligible to be sharia compliant and present in the 454 companies are real estate companies which are taking a big portion of the companies representing 161 out of 454 which means 35% of the total companies and is definitely one of the typical investment activities compatible with islamic law. indeed, it is reflecting the investment in real assets halal. it is worth mentioning that the total number is not particularly high in absolute terms (161 companies) is due to the exclusion occurred after the quantitative screening because very often that the real estate companies that are operating in italy use a significant leverage strategy to acquire real property. however, remains the real estate sector as perfect fitting investments to the islamic financial instruments. as for the category of management and consultancy is occupying 12% of the total sharia compliant companies and this is due to the fact that their financial structure does not depend on debt and is composed of investments in human capital as a fundamental source of this type of companies. an overview of the most important sectors is displayed in the following table: table v. bussiness sector findings sector number of companies % accommodation 13 3 retail trade 19 4 wholesale trade 28 6 constructions of building 37 8 management & consultancy 54 12 real estate 161 35 companies classification almost 84% of the resulted eligible companies are micro size companies that its threshold of employees 1-9 and this is perfectly reflecting the real current italian smes companies‟ situation as the majority in general are of micro size and a perfect example for this type of companies are the real estate companies as these companies mainly depend on hiring few number of employees however generates high profit. on the other hand the small size companies had took a share of almost 12% while medium had a share of only 4.8 %. micro companies face huge difficulties for getting finance for their business especially in the conventional institutions however in the islamic financial institutions it is much more likely to have finance for their business. one of the most significant points of islamic finance that could play a major role for the smes is ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 8 that the islamic finance focuses on the microfinance and one of the main principles in sharia is poverty alleviation. the following table summarizes the companies according to their size: table vi. companies classification category according to number of employees number of companies percent micro (1 9) 379 83.5 % small ( 10 – 49) 53 11.7 % medium (50 – 250) 21 4.8 % large ( > 250) 1 profitability measures one of the most important findings that characterized the 454 sharia compliant italian smes companies was the high roe as a measure of profit for those companies in the last successive three years in comparison to the whole italian companies (non sharia complaint). the analysis revealed that 61% of the sharia complaint smes have got positive (roe > 0%), 36% have got roe> 5%, 22% have got roe >10%, and finally 13% have got roe> 15%. those results really reflect how much profitable are the sharia complaint companies are as by adopting the same measures over the last 3 years to whole italian companies reflected a significant lower roe in every category; as only 22% has roe >0%, 11% has roe > 5%, 7% has roe > 10%, and finally 5% has roe > 15%. the following table summarizes the companies according to their roe: table vii. profit measure roe italian sharia complaint companies percent total italian companies percent roe > 0% 61 % 22 % roe > 5% 36 % 11 % roe > 10% 22 % 7 % roe > 15% 13 % 5 % regional classification about 61% of the resulted eligible companies are located in the north of italy which is represented in the following regions: (valle dáosta, piemonte, liguria, lombardia, trentino alto adige, veneto, friuli, and emiliaromagna). the center of italy represented 20% of the companies and can be seen in the following regions: (toscana, marche, umbria, lazio, abruzzo, and molise). the third part which is correlated to the south of italy has taken a share of 19% and is representing the following regions: (sardegna, campania, puglia, basilicata, calabria, and scilia). the following table summarizes the companies according to their regional location: table viii. regional classification category according to location number of companies percent south 88 19 % center 91 20 % north 275 61 % xi. conclusion the islamic finance has been growing rapidly in the recent years and it has seen wide expansion not only the arab or even muslim countries but also non muslim countries. this is due its estimated high growth rate as it is considered the highest growing financial instruments. its stability in the financial crisis and its ethical principles had been the major reason for the western countries to get introducing it. the numerous benefits and opportunities for italy that could be generated with it like opening up to attract arab sovereign funds to invest in italy is a huge opportunity, the liquidity that could be generated is of a great importance more over the creation of employment opportunities that could be created. moreover, the positive impact on the immigrant‟s integration polices through providing them with a sharia compliant financial system on one hand and benefiting from their funding liquidity on the other hand. in order to introduce the islamic finance system it is of a great importance constructing a good base to start from. in order to let the islamic finance work and generate the aimed opportunities it should have all the structure in which it would work with. as the islamic investments would not come before italy has got a sharia compliant businesses and investments. the sharia complaint would be needed in several aspects like attracting arab sovereign funds, retail banking services for muslim clients, sukuk in the stock exchange, and for one important reason which is financing and investmenting opportunities in smes. the study has also revealed the importance of the smes in the economic growth and has seen that the smes in italy compose 99.9% of the italian enterprises. and one of the most important facts about them is that there 94.6% of those smes are micro enterprises which have huge difficulty in accessing finance that problem could be resolved through islamic finance that gives a particular weight to the microfinance. in the empirical research it was observed how italian companies are considered to a great extent eligible for sharia complaint from a qualitative criteria screening prospective and ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 9 this is a very encouraging outcome. this outcome actually is of a great impact and significance because this is the main core and primary stage of screening and without being eligible in the qualitative criteria there is nothing to be done but to change totally the business sector or the industry. after this encouraging outcome the empirical research showed that the real problem facing the italian smes to be a sharia compliant is the quantitative screening. this conveys the real challenge for the smes in which how to have some changes in their financial structure to be compatible with sharia. another important finding was the high profitability of those smes which is a key element in making them attractive for investors. as they proved to be have higher roe than the non sharia compliant italian companies. based on those findings islamic finance would be of a great opportunity to the italian smes and especially the micro enterprises as sharia promote poverty alleviation and they promote financing the microfinance activities. this would represent a beneficial step for both the italian economy and the investors who are using the islamic financial tools as this will create growth and prosperity to the italian economy and on the other hand a successful profit maximizing investments. references [1] aaoifi, (2004), shari‟a standards, accounting and auditing organization for islamic financial institutions, bahrain. [2] al-jarihi, m., a., and iqbal. m., „islamic banking: answers to some frequently asked questions‟, islamic development bank (idb). occasional paper no.4, 2001. [3] david oakley, shannon bond, cynthia o‟murchu, and celve jones, “islamic finance explained,” financial times, may 30, 2008. [4] dusuki, a.,w., „corporate governance and stakeholder management of islamic financial institutions‟, national seminar in islamic finance, kuim, nilai, aug. 20th -30th, 2006. [5] european comission, enterprise and industry, sba fact sheet 2012, italy. [6] jennifer jacobs, "special focus: islamic finance gains ground," the edge malaysia, october 25, 2010. [7] paolo pietro biancone, “il bilancio della banca islamica e la rappresentazione dei principali contratti finanziari”, francoangeli, 2012. [8] paolo pietro biancone, “ islamic services and their application to the italian financial system”, 16th toulon-verona conference “excellence in services”, university of ljubljana, slovenia, 29-30 sugust, 2013. [9] patrick imam and kangni kpodar, islamic banking: how has it diffused?, international monetary fund (imf), wp/10/195, august 2010, p. 3. [10] reuters, "islamic finance set to cross $1 trillion: moody's," the economic times, october 21, 2010. [11] siddiqi, m.n., „riba and bank interest, the rational of its prohibition‟, islamic research and training institute, idb, 2004. [12] usmani, m., (2009), examining the prudence of islamic banks: a risk management perspective, islamic finance review, euromoney yearbooks. [13] zamir iqbal, abbas mirakhorm, “an introduction to islamic finance: theory and practice” , 2nd edition, john wiley & sons, october 2011. [14] zubair eqbal and abbas mirakhor, “islamic banking” washington, dc: international monetary fund publication, 1987, p. 23. websites [15] aaoifi standards and membership body information (http://www.aaoifi.com/). [16] aida , italian company information and business intelligence (https://aida.bvdinfo.com). [17] dow jones: http://www.djindexes.com/. [18] ifsb standards and membership body information ( http://ifsb.org ). [19] islamic finance in organization of islamic cooperation “oic” member countries, may, 2012, (www.sesric.org). [20] morgan stanley capital international (msci) official website. http://www.msci.com/. [21] securities commission of malaysia, (http://www.sc.com). [22] standard & poor. s&p shariah indices methodology. http://www.standardandpoors.com. [23] the world bank official website. see http://www.worldbank.org/. http://eu.wiley.com/wileycda/section/id-302479.html?query=zamir+iqbal http://eu.wiley.com/wileycda/section/id-302479.html?query=abbas+mirakhor http://www.aaoifi.com/ ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6502 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 31/01/2022 accepted for publication: 04/06//2022 published: 29/07/2022 27 the impact of macroeconomic and fundamental ratios against sharia stock returns at jii 1 islamic economics department, faculty of economics and business, universitas pembangunan nasional veteran, jakarta 2 islamic economics department, faculty of economics and business, universitas pembangunan nasional veteran, jakarta contact author 1: muhamadjihad4@gmail.com corresponding author 2*: mfathoni@upnvj.ac.id abstract— this research aims to explain the correlation between macroeconomics and company fundamentals on the returns from the placement of funds in islamic stocks against the jakarta islamic index (jii) from 2011 to 2020. the method used in this study is quantitative. the sample used considers eight sharia issuers using the purposive sampling method. the data analysis technique used is panel data regression analysis. the results of this study indicate that macroeconomic factors and company fundamentals simultaneously influence sharia stock returns. meanwhile, this study partially found mixed results, including inflation and roa having a significant effect on islamic stock returns. in contrast, gdp and der don’t significantly affect islamic stock returns. keywords: corporate fundamentals, sharia capital market, macroeconomics, return i. introduction in islam's teaching, rejecting excessive wealth accumulation and not using wealth is wrong and is not recommended. because of this, islam teaches us to carry out investment activities under sharia rules and laws [1]. investments can be used for the construction and development of new things in the future and to get maximum benefits for investors or fund owners [2]. in indonesia, investment nowadays requires media and the means to place investment funds. currently, indonesia has two market classifications, namely the conventional capital market and the sharia capital market [3]. investors in the capital market carry out investment activities to gain returns or profit in the form of dividends or profit sharing and capital gains. dividends, , are profits owned by investors from the results of profit sharing. meanwhile, the capital gain is the acquisition of the purchase price less the selling price in the form of a positive difference [4]. of the many benefits and results that will be obtained by the community when carrying out investment activities, it is unfortunate that the public's interest in investing in the capital market is minimal. the central statistics agency (bps) released the total population of indonesia in 2021 as many as 271.34 million people. however, according to data released from the indonesian central securities depository (ksei) in 2021, the total number of investors in the indonesian capital market is only 3.88 million investors. this means that the number of investors in the capital market is only 2.11% compared to the total productive population in indonesia [5]. to support and assist the indonesian people in investing in the islamic finance sector, the indonesia stock exchange (idx) created a sharia stock index, including the jakarta islamic index (jii) [6]. with the presence of this index, it is hoped that it can serve as a guideline and benchmark for obtaining the performance of listed stocks as the basis for indonesian sharia shares to develop the islamic capital market further. investors who invest funds in the islamic capital market are currently limited to the muslim community and non-muslim communities who have placed their funds because they believe that islamic stocks can be more resilient to economic changes. this is supported by the growth of sharia shares in 2015-2019, which is considered to have increased significantly [7]. return is an essential part for fund owners or investors. the rate of return that tends to be unstable shall raise doubts among investors in placing their funds. however, every investment instrument has different return and risk characteristics [8]. in the context of investment returns, there is no conclusion agreed upon by the researchers regarding the determining factor. muhammad jihad rusnanda sya’bani1 , muhammad anwar fathoni*2 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6502 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 31/01/2022 accepted for publication: 04/06//2022 published: 29/07/2022 28 research conducted [9] and [10] shows that return on assets (roa) has a significant positive effect on the rate of return obtained by companies listed on the indonesia stock exchange. that is, if there is an increase in roa, the return obtained will also increase and vice versa. different from the research results [11], roa did not affect the return investors would receive. while on research [12] shows that the debt-toequity ratio (der) indicator has no significant effect on the return received by investors. but study [13] states that the der significantly affects the return that investors will receive. not only roa and der are still debatable about investment returns, but researchers are also still debating the relationship between gross domestic product (gdp) and inflation with investment returns. study [14] states that gdp and inflation have a negative and significant effect on the stock returns of banking companies. analysis [15] also concluded that inflation affects stock returns because it is related to government policies that maintain monetary stability. another contradictory research was conducted [16] that states that inflation has no effect on stock returns, but gdp has a significant impact on stock returns obtained by investors. due to the influence of those variables on stock return, we also believe that they can explain stock return predictability [39]. this paper aims to examine and estimate the correlation between external and internal factors represented by the variables gdp, inflation, roa, and der on islamic stock returns in indonesia during the 2011-2020 timeframe. based on the explanation above, it is seen that there are still gaps in phenomena and theories, as indicated by the absence of previous research consensus regarding the determinants of return in islamic stock investment. therefore, researchers are interested in investigating internal and external factors affecting the recovery of sharia shares listed on the jakarta islamic index (jii). the novelty contained in this study is stated in the object of research, namely sharia shares registered in jii and the research period, which is in the 20112020 period. through this research, it is hoped that it can contribute to strengthening the results of previous studies related to the determinants of sharia stock returns in indonesia. the limitation of this study is that it cannot accommodate all of the factors contained in the financial statements or macroeconomic factors; the researcher only takes a few samples that are considered to represent internal and external factors in stock price returns. ii. literature review a. signalling theory signalling theory explains that parties are senders and owners of information, acting as givers of a signal or signal in the form of certain information that describes the condition of a company, whether it is beneficial or not for the recipient or investor [17]. there is a signal for a process step taken by the company's management. the signal is given as a guide for investors to know and understand how management sees and analyses the perspective of the company's prospects [18]. signalling help each other to resolve the known puzzle in the data [38] the information conveyed and published can ultimately influence the decisions of the fund owner or investor [11]. the data can be in financial reports, company insider information or other relevant information. signalling theory can be used as a reference in research because the signals can influence action and decision taken by investors, especially in determining the target return of capital market investors. information disclosure will affect stock price rise and fall depending on whether the signal is classified as good news or bad news [19]. b. sharia capital market a capital market is a forum in which transactions and purchases of investment instruments can be made, such as units of equity ownership or share, debentures or bonds, and other tradable securities. a real and concrete place where there are parties who make offers, and there are parties who want to buy these instruments and can trade their securities with each other [20]. one of the legalities of the sharia capital market is based on the dsn-mui fatwa no.40/dsn-mui/x/2003 concerning the capital market and general guidelines for the implementation of sharia principles in the capital market sector. basically, there is no difference between the capital market and the islamic capital market. the difference is that the instruments traded in the sharia capital market must comply with sharia principles and rules [21]. the islamic capital market has principles that should be fulfilled and obeyed by all parties, from the financiers (investors) and companies that list on the stock exchange. several things that must be complied with include, among others, securities traded in the capital market must come from goods and services, which is “halalan toyiban”, as well as the prohibition of short selling transactions and margin trading [22]. one of the investment instruments in the islamic capital market is islamic stock. sharia stocks can be seen in one of the indonesia stock exchange indexes, the jakarta islamic index (jii). this index is one of the stock indices whose calculation basis is the average stock price and market capitalisation of stocks included in the sharia shares criteria. with the presence of this index, it is hoped that it can be the first step in measuring the performance of stocks that are included in the sharia classification to develop the islamic capital market [23]. based on the dsn fatwa no. 40/dsn-mui/x/2003 concerning capital markets and general guidelines for the implementation of sharia principles in the capital market sector, there are provisions and criteria for issuers whose shares can be included in the jakarta islamic index based on financial ratios, including: european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6502 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 31/01/2022 accepted for publication: 04/06//2022 published: 29/07/2022 29 1. if the company obtains financing or funding assistance from debt, the ratio is not more than 30 percent per cent compared to capital. 2. if the company has interest-based income, that income does not exceed 15 per cent of the total revenue. 3. companies with cash assets or receivables with the total accumulation of all receivables at their trading posts or the number of receivables less than 50 per cent. c. stock return return is the acquisition of profits on the investment process by investors or fund owners. thus, return is a payment obtained and received for each owner of the funds owned, plus changes in the market price which has been reduced by the initial purchase price [24]. return is the ultimate goal of an investor in carrying out investment activities in the capital market [16]. investors can carry out various processes to obtain returns, either through self-analysis and decision-making based on investment behaviour or through professional advice that will guide them to get the maximum expected return [12]. however, it is essential to consider that to get a high return; it is also necessary to be aware of the increased risk [25]. so, it can be said that return and risk have parallel lanes. d. gross domestic product (gdp) gdp is the summation of various products into one instrument realised based on domestic factors and property of foreign nationals in a country, which will later measure the value of these economic activities [26]. gdp is one indicator that can be said as a determinant of a country's health factors [27]. gdp is the acquisition of the value of goods and services in a country that produces production within one year, which is taken based on the production factors in the last timeframe, both originating from that country or originating from foreign countries. there are two methods for calculating gdp: current and constant prices [28]. e. inflation inflation is a continuous increase in prices. according to [26], inflation is an increase in costs due to demand that continues to increase but is not balanced by the supply of goods in the market instead. this thought is also in line with taqyudin ahmad ibn al-maqrizi (1361-1441) stated that inflation occurs when the prices of goods in general experience an increase that takes place continuously over a certain period. inflation might occur temporary (noise inflation), which is part of the inflation rate whose cause is an occasional disturbance (one timezone-time shock). based on the cause, inflation can occur due to an increase in the cost of production and distribution chains, an increase in funds spent on energy and transportation, and other economic factors such as riots or even natural disasters [29]. f. return on asset (roa) return on assets (roa) is one of the profitability analyses. roa is a ratio that compares the return on the overall value of the company's wealth or assets that can generate future profits [30]. return on assets (roa) is assessed as the ratio between a firm's net income and the book value of total assets [40]. profitability ratios aim to obtain knowledge about the capability of the company or issuer in getting profits in specific periods, which will be compared with the total assets of the related company. roa is a ratio that can show the ability of a company to use the total assets owned to earn profits after tax breaks [10]. this ratio is advantageous for company management to monitor and evaluate and analyse the effectiveness and efficiency of the issuer to maximise the use of all assets owned. the higher the value of the roa owned, it can be said that the company is more efficient regarding using these assets, and with the same number of support, it can generate more significant profits [31]. g. debt to equity ratio (der) der is the ability of a company to pay all of its debts and shows the company's solvency. a business is said to be solvable if the company has sufficient total assets and wealth to make payments on all its debts [32]. der is a ratio that can be used to assess debt to be compared with equity. this calculation compares the company's overall debt with all of its equity. it can be said that this ratio serves to obtain knowledge about how much each rupiah of capital owned is to be pledged as debt. therefore, this ratio is called the leverage ratio [33]. this leverage ratio or solvency is a ratio that can measure a company's capacity and capability to fulfil its obligations, be it long-term or shorter-term. [34]. iii. research methodology this research is quantitative, where the data obtained comes from the second level or secondary data. this study uses data on the movement of islamic stock prices registered at jii30, macroeconomic data such as national income and inflation rates, and financial report data consisting of roa and der ratios with an observation period from 2011 to 2020. this research uses the panel data regression technique, which is processed using eviews9 software. this is supported because the type of data studied consists of time series and cross-section data, eviews9 software is also available workfile to estimate panel data regression with accurate results the method used in selecting the sample is the purposive sampling method with several predetermined criteria, namely that it is consistently listed in jii from 2011 to 2020 and always issues financial reports regularly. from these criteria, it was found that eight sharia issuers were the samples of this study, as shown in table 1 below. table 1. list of jii 30 sharia shares the research sample european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6502 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 31/01/2022 accepted for publication: 04/06//2022 published: 29/07/2022 30 no stock code company 1 asii pt astra internasional tbk 2 adro pt adaro energy tbk 3 akra pt akr corporindo tbk 4 icbp pt indofood cbp sukses makmur tbk 5 klbf pt kalbe farma tbk 6 tlkm pt telkom indonesia (persero) tbk 7 untr pt united tractor tbk 8 unvr pt unilever indonesia tbk source: indonesia stock exchange 2021 iv. result a. chow test table 2. result f restricted (chow test) effect test statistic d.f prob cross-section f 0.116681 (7,68) 0.9970 cross-section chi-square 0.955177 7 0.9955 source: eviews9, author's elaboration based on the results above, the probability value of the cross-section chi-square in this study is 0.09955 > 0.05. so it can be concluded that h0 is accepted and h1 is rejected, so a suitable model to be used and continued in further research based on the chow test between the common effect model and the fixed effect model is the common effect model. because the result is the common effect model, then it was continued to carry out the langrange multiplier test. b. langrange multiplier test table 3. result langrange multiplier test effect test cross-sec d.f prob cross-section f 0.116681 (7,68) 0.9970 cross-section chi-square 0.955177 7 0.9955 source: eviews9, author's elaboration by table 14 above, the overall breusch-pagan probability value in this study is 0.0627 > 0.05, so it can be explained that if h0 and h1 are acceptable, the suitable model in this study is the common effect model. c. coefficient determination test table 4. result r-squared test r-squared 0.302344 source: eviews9, author's elaboration based on the data above, it is found that the value of rsquared is the result of the r2 test, which has a value of 0.302344 or 30.23%. it can be concluded that the value of 30.23% can represent that the variables gross domestic product, inflation, return on asset, and debt to equity ratio affect the rate of return and contribute to the rate of return of 30.23%. and for the 69.77% rest, which can be explained and influenced by other factors and variables that are not listed or included in this research series. d. simultaneous test tabel 5. result f test f-statistic 8.125708 prob (f-statistic) 0.000017 source: eviews9, author's elaboration the value of f-statistics is a value of 8.125708 with values from the f table: df 1(k), and df 2(nk-1) which means that df 1 (5), df 2(80-5-1) = 74 is 2,338. this means that the f statistic is 8.125708 > 2.338; other things can be reviewed through the prob (f-statistics), which is 0.000017 and has a smaller value than the alpha of 0.05. from the output issued above, it can be seen that the results of this simultaneous test can be concluded that h0 is rejected, which means that all variables gross domestic product, inflation, return on asset, and debt to equity ratio have a simultaneous influence on the return of sharia shares at jii. e. partial test table 6. result in partial test variable coefficient tstatistic prob. gdp 0.523939 0.854979 0.3953 inflasi 3.207817 2.826807 0.0060 roa 0.632485 3.996462 0.0001 der 0.153507 1.569526 0.1207 return -0.071484 -1.298447 0.1981 source: eviews9, author's elaboration 1) effect of gross domestic product (gdp) on return based on the results or output generated through the e-views application in table 6, it can be analysed and interpreted that the gross domestic product (gdp) variable partially does not have a significant effect on sharia stock return in jakarta islamic index 30. it can be seen from the prob. value, 0.3953 > 0.05 with a tstatistic of 0.854979, and the t-count value is smaller than the t-table value of 1.99254, with df=80-5-1 = 74, and the significance level is 5%. so from these results, it can be seen that hypothesis 1 of this study is rejected, which means that gross domestic product does not have a significant effect partially on sharia stock return. this can be indicated because the return value of islamic stocks indexed by the jakarta islamic index 30 is diverse. in this study, eight issuers were always in the jii index during the observation period from 2011 to 2020, which had a very fluctuating rate of return every year. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6502 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 31/01/2022 accepted for publication: 04/06//2022 published: 29/07/2022 31 it differs from the macroeconomic variable the researcher chose, namely gross domestic product (gdp), which continued to increase during this research period and can be said to be significant and constant every year. indonesia's gdp has continuously recorded a high value, and 9 out of 10 years of observation of this research always obtained a positive growth value. in contrast to islamic stock returns, which fluctuate up and down every year. the results of the analysis of this output can be concluded that changes in the value of gross domestic product (gdp) can provide a positive but insignificant contribution to changes in stock returns. however, it is since an increase in gdp will increase the value of consumption and investment, which of course, can affect the company's performance. so, this is in line with research conducted by mayfi and rudianto states that this gdp can only affect the consumption of its products which increases the company directly, but this does not have an impact on the effect of rising stock prices now. 2) effect of inflation on return based on the results or output generated through the e-views application in table 6, it can be analysed and interpreted that the inflation variable partially has a significant influence on sharia stock returns in the jakarta islamic index 30. the sig value is 0.0060 <0.05 with t-statistic, which is 2.826807, and the t-count value is greater than the t-table value of 1.99254, with df=80-5-1=74 and the significance level is 5%. so it can be concluded that the presence of the inflation variable in this study can significantly affect the return of islamic stock. then based on the value of the regression coefficient, it is known that this inflation variable has a value of 3.207817, so it can be ascertained that the influence that inflation has on the rate of return is positive. so from these results, it can be seen that hypothesis 2 of this study is accepted, which means that inflation has a partially significant effect on sharia stock return. so it can be said that the contribution of inflation with its increase or decrease in the value can significantly impact increasing or decreasing stock returns on the jakarta islamic index 30. according to mayfi and rudianto, the value of inflation that is recorded to be very high tends to have a low rate of return on investment, and vice versa with a low inflation rate, the rate of return contribution of a stock investment will be higher. likewise, it was conveyed by wulandari that a considerable inflation value can reduce a company's actual income level and will impact what investors get. with a low level of income from the existence of high inflation, it can be said that the returns owned by investors will be lower if it is compared when the inflation value is at a small number. when the inflation rate is low, it will increase the company's income, undoubtedly contributing to the return returns investors receive. 3) effect of return on assets (roa) on return based on the results or output generated through the e-views application in table 6, it can be analysed and interpreted that the return on assets (roa) variable partially has a significant influence on sharia stock returns in the jakarta islamic index 30. it can be known from the significance value of 0.0001 <0.05 with the t-statistic, which is 3.399462, and the t-count value is greater than the t-table value of 1.99254, with df=80-5-1=74 and the significance level is 5%. so, it can be concluded that in this study, the presence of the return on assets (roa) variable can significantly influence the return on islamic stocks. then based on the value of the regression coefficient, the result is that this inflation variable has a value of 0.632485, so it can be ascertained that the influence of roa on the rate of return is positive. so from these results, it can be seen that hypothesis 3 from this study is accepted, which means that return on assets (roa) has a significant influence partially on sharia stock return. this research is in line with the study conducted by mayfi and rudianto state that an increase in return on assets can have a positive and significant on changes in stock prices which are proxied to investment returns. a higher roa value will have an effect by increasing the investment value of the returns made by investors and vice versa. if the roa is low, the return value owned by investors will be lower. according to indah puspitadewi and rahyuda, a company will continually improve and strive for roa to continuously increase and record positive numbers because the higher the roa value, the more influential the company is in utilising its assets to generate net profit after tax. in other words, the higher the roa value, the better the company's profitability. the company's ability to manage assets and generate profits is undoubtedly a unique attraction for investors. it can influence investors to buy shares and place their funds in companies with a high roa value. and this is what causes the company's stock price to rise, so it positively impacts the returns on the investment return. 4) effect of debt to equity ratio (der) on return based on the results or output generated through the e-views application in table 6, it can be analysed and interpreted that the debt to equity ratio (der) variable partially has a significant influence on sharia stock return in the jakarta islamic index 30. it is european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6502 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 31/01/2022 accepted for publication: 04/06//2022 published: 29/07/2022 32 known from the sig value, which is 0.1207 > 0.05 with the t-statistic, which is 1.569526, and the t-count value is smaller than the t-table value of 1.99254, with df=805-1= 74, and the significance level is 5%. so it can be concluded that the debt to equity ratio (der) variable does not significantly affect the return of sharia shares. then, based on the regression coefficient, the variable debt to equity ratio (der) results are worth 0.153507, so it can be ascertained that the effect obtained on the rate of return is a positive influence. so from these results, it can be seen that hypothesis 4 of this study was rejected, which means that the debt to equity ratio (der) does not significantly affect the sharia stock return. according to basalama, the debt to equity ratio value should have a negative value on investment returns in stocks. still, this study found that the der value has a positive value on investment returns. so, this can indicate that various types of considerations differ from one investor to another in assessing this der. another thing the view of indah puspitadewi and rahyuda states that as long as the debt owed by the company is needed to increase capital from the company's operations and if the use of the debt can be optimised and utilised as best as possible by the company, of course, it can increase sales figures, with increased sales it will result in high profits so that it gets a positive response from investors. v. conclusion based on the data analysis that has been carried out, the results of hypothesis testing led to the following results. gdp does not affect sharia stock returns; gdp growth only increases product consumption and does not mean directly affecting stock price movements. inflation significantly affects islamic stock returns because, with high inflation rates, there is a tendency for low return values and vice versa. with low inflation rates, the desire to invest will increase and affect high returns. roa has a significant effect on sharia stock returns, increasing the efficiency of the use of assets which will have an impact on increasing company profits, which can affect investor returns. der does not have a significant effect on islamic stock returns because investors consider different views regarding the debt owed by the company and 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(2021). pengaruh tingkat suku bunga dan inflasi terhadap european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/6502 published by the university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license received: 31/01/2022 accepted for publication: 04/06//2022 published: 29/07/2022 34 return saham pada perusahaan manufaktur terindeks lq 45 periode 2016-2020. 5(2), 1043–1049. [38] bulbulia, j., & sosis, r. (2011). signalling theory and the evolution of religious cooperation. religion, 41(3), 363-388. [39] phan, d. h. b., sharma, s. s., & narayan, p. k. (2015). stock return forecasting: some new evidence. international review of financial analysis, 40, 38-51. [40] secinaro, s., brescia, v., calandra, d., & saiti, b. (2020). impact of climate change mitigation policies on corporate financial performance: evidence‐based on european publicly listed firms. corporate social responsibility and environmental management, 27(6), 2491-2501. paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 the fundamentals of islamic banking and finance: a prologue abd hakim abd razak 1 1 school of law, trinity college dublin, abdrazaa@tcd.ie abstract—the raison d'être of this article is to supply basic insights on the origin and characteristics of the islamic banking system, its distinguishing features, and related contentious issues that have remained the subject of on-going debates among sharia' scholars and members of the academia. these were analyzed by referring to the principles of muammalat (islamic economic transaction), which are derived from the holy quran, sunnah of prophet muhammad (p.b.u.h.), and ijma’ (consensus) of prominent sharia' scholars. contrary to the conventional banks, islamic banks are required to operate according to the principles of muammalat, which are identified as the avoidance of riba’, gharar, maysir, hilah, and the promotion of ethical business practices such as justice, fairness and transparency. the 2008 global financial meltdown has created a unique awareness among banking consumers on the need of an alternative to complement the conventional banking system, which was viewed by financial scholars as suffering from a crisis of failed morality as a result of greed, exploitation, and corruption. likewise, many may viewed that the islamic banking system is merely another attempt to capitalize on the pulling power of religion towards people, yet there are a number of interestingly unique features that accentuate it from the other banking alternatives. in essence, it is aspired that this article may assist fellow readers, especially those who are still new to this alternative financial system, in understanding and appreciating its unique features, and further stimulate future research in this field. insha’allah (god’s willing). keywords; islamic banking; maqasid as-sharia'; sharia' compliance; riba'; gharar; socially-responsible investing i. introduction prior to the devastating global financial crisis in early 2008, the inter-relationship between religion and finance was considered irrelevant [1], which partly owes to modern capitalism‘s separation of religion from politics, economics, and governmental administration. the crisis, however, has exposed the weakness of the current financial system and there has been ―public outrage over the excesses and support for more conservative and ethical finance”[2, 3]. in reality, the concept of finance is very much closely related to religion, especially within the three abrahamic faiths, i.e. judaism, christianity, and islam, which share nearly identical philosophies on finance. these bonds between the three samawireligions are further illustrated as follows (see figure 1): judaism christianity islam exodus 22: 25-27 "25. when you lend money to any of my people, to the poor among you, you shall not be to him as a creditor, nor shall you impose upon him any interest. 26. if you take your neighbor‟s garment as a pledge (collateral), you shall return to him by nightfall. 27. for that is his only covering; it is his garment for his skin. in what shall he sleep? and it shall come to pass, that if he cries unto me, i will hear it, for i am compassionate." deuteronomy 23: 19-20 “19. you shall not charge interest on loans to your brother (israelites); interest on money, interest on provisions, and interest on anything that is lent. 20. on loans to a foreigner you may charge interest, but on loans to your brother (israelites) you may not charge interest.” leviticus 25: 35-37 "35. and if your brother fall into difficulty and become dependent on you, then you should support him and take him to live with you although he may be a stranger. 36. do not take interest in advance or make profit from him, but fear god; let your brother live with you. 37. you shall not lend him money at interest taken in advance, or provide him food at a profit." ali imran 3: 130 “130. o ye who believe! devour not usury, doubled and multiplied; but fear god; that ye may (really) prosper.” al-nisa‘ 4: 161 “161. that they took usury, though they were forbidden; and that they devoured men's substance wrongfully; we have prepared for those among them who reject faith a grievous punishment.” figure 1: prohibition of interest in judaism, christianity and islam [4] in recent decade, the application of religious laws to finance is no longer an alien belief – as evidenced by the introduction of the dj dharma index in 2008 for hindu banking, the launch of stoxx europe christian index in 2010 ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 for christian banking, and investment companies such as the roman catholics ave maria rising dividend, or aquinas investment company, to name a few[5-7]. however, out of these, one certainly exhibits promising global popularity; strengthened by its steady market growth of 15-20% per annum and current industry size of $2 trillion that is further estimated to reach $3.4 trillion in 2018 – islamic banking [8, 9]. indeed, such a rapid progress has never been achieved by any other religion-associated financing, which causes one to wonder the uniqueness of islamic banking over the other systems. in fact, there were also speculations that it is the anecdote to the financial crisis problems, though there has yet to be any concrete evidences that justify its resilience towards the devastating 2008 financial crisis. ii. historical perspective it is generally believed that the modern concept of islamic banking was first introduced in 1963 by egypt‘s mitghamr savings banks, which initially started as a microlending finance operation[10, 11]. it has since continued to develop financial products that are based on the islamic principles of profit-sharing and prohibition of interest. since then, the push for islamic banking had gained both attention and momentum worldwide. malaysia followed shortly after with the establishment of the lembagaurusantabung haji (luth) in 1969; which was the first institution that utilized the sharia' principles in its fund management operations for muslims going on pilgrimage and was considered the first of its kind in the world[12]. by december 1973, the islamic development bank (‗idb‘) was incorporated in jeddah, saudi arabia pursuant to the declaration of intent issued by the conference of finance ministers of muslim countries to further assist in fostering economic development and social progress of muslim countries in adherence to the sharia' law; which landmarks the first collective efforts by muslim countries to promote islamic banking [13]. the following year, king faisal of saudi arabia pledged to initiate a banking system that adheres to the tenets of sharia' law and ethics in a bid to bridge the gap between the islamic concept of banking with the 600-years-old conventional banking system. this saw a number of islamic banks, both in letter and spirit, came into existence in the middle east, i.e. the dubai islamic bank in 1975, the faisal islamic bank of sudan and egypt in 1977, the bahrain islamic bank in 1979, and etc., to name a few[14, 15]. along with malaysia, indonesia, and turkey, the gulf cooperation council (‗gcc), which consists of bahrain, kuwait, oman, qatar, saudi arabia, and the united arab emirates, is now home to several renowned financial powerhouses, inter alia, the deutsche bank, citi, ubs, and barclays, which have already begun to offer their own sharia'-compliant products and services[16]. with a combined banking customers‘ population of 252 million, it is suggested that these regions will be the main thrust for islamic banking expansion in many years to come. it is without a doubt that since its emergence in the 1970‘s, the global islamic banking market is growing steadily at 1520% per annum while global sharia‟-compliant assets are forecasted to grow from over us$500 billion in 2009 to beyond the milestone of $2 trillion by 2014[8] and is further expected to cross the us$ 6.5 trillion mark by 2020[17] (see figure 2). figure 2: projected size of the islamic banking industry 2005 – 2015[11] yet, despite all these remarkable figures, islamic banking faces mounting challenges to remain firm to true islamic principles while expanding internationally. it is apparent that the role and responsibilities of ifis are to serve the financial needs of their various stakeholders and to give proper consideration to the legitimacy of their operations from a sharia‟law point-of-view[18]. however, in recent years, the industry was heavily criticized for failure to ensure consistency, uniformity, and strict adherence of the products and services offered with the sharia‟law[19-21]. furthermore, its authenticity and merit were even questioned by several islamic banking practitioners; citing them as mirroring the conventional banks‘[15, 22-24]. iii. the concept of banking in islam generally, banking institutions exist to fulfil the financial needs of the society. it is parable to a knife, which usufruct can either be used for permissible matters such as slaughtering an animal for its meat, or forbidden ones such as homicide. prior to the introduction of islamic banking, muslims around the world were restricted from making use of the conventional banking‘s products and services. it is in this regard that islamic banking began to offer a different concept from the conventional banking system in the sense that it is guided by the sharia' law, which segregates between what is permissible and what is not. according to ibn al-ukhuwwah, it is a banking concept that satisfies the divine law in both form and spirit[25]. once a taboo practice, the islamic banking concept has started to serve as a gateway for muslims to finally enter the formal world of finance. ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 in definition, an islamic bank is a financial institution that officially and practically abides by the precepts of sharia' law, which prescribes guidelines for moral economic transactions[26]. it encapsulates a banking practice that transcends the doctrine of separation of powers between religion and the state[10]. in other words, its objective, mission and vision are all dictated by the sharia' law, which encompasses the holy quran, and the sunnah (the doings and sayings of prophet muhammad (p.b.u.h.)). iv. the main theme of islamic banking – sharia' compliance in essence, islamic banking is a financial practice that places similar regards in enforcing the rule of god on muammalat (financial transactions). this is executed by deriving sharia' rulings from the various sources of islamic law; which are primarily the holy quran and the sunnah, and ensuring strict compliance of any financial products and services with the said rulings – which is commonly termed as sharia' compliance. for this purpose, those who are responsible for the interpretation of the sharia' rules; known by many names the ulama‟, the ustadz or ustadzah, the mufti, the imam, and many others, are seen to hold the decisive key in determining what is permissible and what is not, and are subsequently held accountable under the sharia' law for their decisions in the hereafter. abdullah bin umar narrated that: prophet muhammad (p.b.u.h.) said, “surely! every one of you is a guardian and is responsible for his charges; the imam (ruler) of the people is a guardian and is responsible for his subjects; a man is the guardian of his family (household) and is responsible for his subjects; a woman is the guardian of her husband‟s home and of the children and is responsible for them; and the slave of a man is a guardian of his master‟s property and is responsible for it. surely, every one of you is a guardian and responsible for his charges.”[27] in matters relevant to business and financial transaction, islam imposes a high degree of accountability towards the sharia‟ boards of ifis, particularly the sharia' scholars because they are the gatekeepers to the sharia‟-compliant accreditation of ifis‘ financial products and services; which are vastly unique due to their compliance with the sharia‟ law. as a result, any fatwas (sharia‟ rulings) issued by the sharia‟ board must strictly adhere to the holy quran and the sunnah. however, this is easier said than done since it involves prioritising the rule of god over the financial institution‘s interest. without strong regulatory and corporate governance frameworks, this conflict can potentially marred the image of ifis as a working embodiment of the rule of god in finance. v. first principle: prohibition of riba' (receipt or payment of interest) the first principle of islamic banking demands for the financial transaction to comply with the sharia' prohibition of riba'. terminologically, riba' is an arabic word that implies excess, expand, extra or addition[28]. technically, it can be defined as any unjustified excess above and over the capital that occurs either in a loan transaction or an exchange of commodity. contrary to the conventional banking system that regards money as tradable as any other commodity, the islamic banking system considers money only as a medium of exchange and nothing more. comparatively, islam also views money as having no intrinsic value since it cannot be directly utilised to satisfy human‘s need; which is in contrast with commodity that can rather be consumed directly[29-31]. in christianity, this view was also corroborated by st thomas acquinas, who justified the prohibition of interest in his famous summa theologica[32]. surprisingly, the ban on interest has even its own footings in secularism teachings as emphasized by aristotle and plato, who regarded money as sterile[30, 33] and that the ‗making of money from money‘ as unnatural and problematic[34, 35]. for this reason, the sharia' law prohibits the utilization of money as a medium of profit from money-lending practices such as an ordinary interest-based loan since it causes the borrower to pay more than the amount initially borrowed. the amount can also continue to increase if the payment is made beyond the specified date in the loan agreement due to the presence of a late payment interest clause, which is common in all standard loan documentation. practically, it implies that customers with either an islamic savings account or current account are not to expect to be paid interest or dividends on their deposits. this also applies to borrowers with an islamic mortgage who are not to pay interest on their debt[36]. accordingly, the ifi must only engage in non-interest bearing business activities to ensure mutual adherence of such prohibition[37]. the prohibition of interest had also garnered significant backing by maurice allais, the 1988 nobel prize winner of economic science, who argued that one of the structural reforms that can be undertaken to address future economic crisis is, inter alia, the adjustment of the rate of interest to 0 per cent; which incidentally coincides with the express prohibition of riba' in islam [3, 38]. vi. the divergent views on the prohibition of riba' there are divided opinions as to the rulings of riba' under the sharia' law. traditional sharia' scholars have concluded that the sharia' law injunctions over riba' demand for the total prohibition over the receipt and payment of interest regardless of its amount[39-41]. this coincides with the following provisions of the holy quran and hadith of prophet muhammad (p.b.u.h.): ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 “those who devour usury will not stand except as stand one whom the evil one by his touch hath driven to madness. that is because they say: "trade is like usury," but allah hath permitted trade and forbidden usury. those who after receiving direction from their lord, desist, shall be pardoned for the past; their case is for allah (to judge); but those who repeat (the offence) are companions of the fire: they will abide therein (forever).” (surah al-baqarah 2: 275) “o ye who believe! devour not usury, doubled and multiplied; but fear god; that ye may (really) prosper.” (surah ali imran 3: 130) “that they took usury, though they were forbidden; and that they devoured men's substance wrongfully; we have prepared for those among them who reject faith a grievous punishment.” (surah an-nisa‘ 4: 161) ibn mas‘ud narrated that: “the messenger of god p.b.u.h. cursed the one who consumed riba', and the one who charged it, those who witnessed it, and the one who recorded it.”[42-44] accordingly, this strict interpretation of riba' is influenced by the fact that such practice is causing the circulation of wealth to be only in the hands of a few[45]. consequently, this widens the gap between the rich and the poor. in addition, the sharia' law views that the financier in a particular transaction has no right to be guaranteed profit, unless it shares the same risk of potential losses as the borrower does[46]. this reiterated the stance taken by previous sharia' scholars such as imam razi, who viewed that the payment of something definite such as interest against something uncertain such as the borrower‘s ability to make profit and repay the loan is haram according to the sharia' law: ―while the earning of profit is uncertain, the payment of interest is predetermined and certain. the profit may or may not be realized. hence, there is no doubt that the payment of something definite in return for something uncertain inflicts a wrong (haram).‖[39] contemporary scholars, on the other hand, preferred to view interest or usury in the context of ‗excessive interest‘ and reckoned the consumption of a small amount as admissible[37, 47-49]. this is evident from the practice of murabahah (markup sale contract) in islamic banking, which is viewed by scholars as a permissible financial instrument, and the markup amount is deemed as a fair profit towards the financier[20, 50]. nevertheless, the ban on interest does not infer that profit maximization was never on the agenda of ifis for islamic banking is just as any legitimate business activities that attempt to maximize the value of its shareholders[18]. in fact, the concept of time value for money is indeed recognized by the sharia' law. however, it can only be realized as part of a real transaction instead of a loan contract. for instance, the bank is prohibited from profiting out of loans, but it may do so from other alternatives such as a lease or hire purchase contract, in which the return increases as the lease prolongs. alternately, the bank may also opt to apply safekeeping charges as a replacement to interest paid to savings account. this practice was implemented by qasr al-haj, an ancient islamic bank in libya that was frequently used by pilgrims during the 13 th century to store valuable goods whilst they were away for the hajj. uniquely, the bank did not charge any interest apart from taking one-fourth of the value of goods stored as a safekeeping fee, which was subsequently donated to islamic education institutions around the area. although this method is perhaps impractical in modern banking practices due to the number of employees involved and complexities of financial products and services, it highlights the original banking operation from sharia' law perspective. on the other hand, low or zero interest rates do not necessarily render a bank as unprofitable. this has been recently exemplified in a recent report that gulf banks have been experiencing healthy earnings growth over the last fiscal year despite their low interest rates, and is expected to remain so over the next few years[51]. accordingly, this may prove the contention that the sharia' law prohibition on riba‟ will not automatically inflict losses to the banks. above all, the wisdom behind the prohibition of riba' is rather to eliminate any form of exploitation and the practice of unjust enrichment. under the sharia' law, in order for a contract to be valid, three elements must exist, i.e. risk (ghurm), work and effort (ikhtiar) and liability (daman)[46]. in a riba'-based financing, one or more of these elements are missing, rendering such a contract to be invalid under the sharia' law. to illustrate, in an ordinary loan contract, the bank is guaranteed a return on capital and profit without the need to share any risk. in addition, the bank possesses the right to sell the collateral or hold the guarantor liable in the event of default by the borrower. on the other hand, the borrower does not enjoy such a guarantee. yet, he is required to pay an extra amount in addition to the loan. therefore, the islamic banking system aspires to rectify this injustice by requiring all parties to equally share the risks in order to create a win-win situation between the bank and the customers. vii. second principle: prohibition of gharar (uncertainty) the prohibition of riba' has indeed counterparts in other religions, but the second principle is solely exclusive to islam, i.e. the prohibition of gharar. it is an arabic word that connotes ―uncertainty over the existence of the subject matter of sale‖[52]. sharia' jurists such as al-babarti defined it as ―…when the subject matter is unknown‖[53], whereas ibn taymiyyah and al-sarakhsi viewed it as ―…unknown consequences‖[21] and ―...when the consequences are concealed‖[54] respectively. in simple words, the ban on ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 gharar implies that the parties to a contract must be aware of the counter-value offered in the transaction. in practice, it requires for the important terms and conditions of contract such as, the price, deliverability, quantity, quality, and existence of the goods and services[55, 56], to be fixed and reduced to writing in order to minimize the risk of uncertainty. this is in line with the following provisions of the holy quran and the sunnah: “o ye who believe! when ye deal with each other, in transactions involving future obligations in a fixed period of time, reduce them to writing, let a scribe write down faithfully as between the parties: let not the scribe refuse to write: as god has taught him, so let him write. let him who incurs the liability dictate, but let him fear his lord god, and not diminish aught of what he owes. if the party liable is mentally deficient, or weak, or unable himself to dictate, let his guardian dictate faithfully, and get two witnesses, out of your own men, and if there are not two men, then a man and two women, such as ye choose, for witnesses, so that if one of them errs, the other can remind her. the witnesses should not refuse when they are called on (for evidence). disdain not to reduce to writing (your contract) for a future period, whether it be small or big: it is more just in the sight of god, more suitable as evidence, and more convenient to prevent doubts among yourselves but if it be a transaction which ye carry out on the spot among yourselves, there is no blame on you if ye reduce it not to writing. but take witness whenever ye make a commercial contract; and let neither scribe nor witness suffer harm. if ye do (such harm), it would be wickedness in you. so fear god; for it is god that teaches you. and god is well acquainted with all things.” (surah al-baqarah 2: 282) abu hurairah narrated that: “prophet muhammad (p.b.u.h.) prohibited sale that is based on hasah (throwing of pebbles) and gharar (uncertain sale).”[43, 57] however, in order to minimize injustice and potential dispute, the mere writings of the terms and conditions of contract will not suffice, for they must also be comprehensible to average customers. one with legal or business astute may be able to understand the documents with ease, but it may not be the case for average customers considering the lengthy nature of modern contracts, in addition to numerous business and juristic jargons, and small prints[58]. in principal, there are two forms of gharar, i.e. gharar fahish (major gharar) and gharar yasir (minor gharar). according to ibn rushd, gharar fahish refers to excessive uncertainty and exists in the following situations: (a) uncertainty over the subject matter of the contract; (b) uncertainty as to the sale or purchase price; (c) uncertainty as to the existence of the subject matter of the contract or ability of the seller to deliver it; and (d) uncertainty as to the condition of the subject matter of the contract[59]. examples of gharar fahish are the sale of fruits before ripening (mukhabarah), buying on the basis of touching a commodity (mulasamah), sale by throwing a commodity towards a buyer (munabazah), conditional sale, sale of goods before obtaining possession, and sale of non-existent matters such as a genie in the bottle[59]. on the other hand, gharar yasir refers to the uncertainty of slight nature. for example, the monthly lease of a house, of which the days can either be thirty or thirty one; or the sale and purchase of wrapped items, or simply a restaurant menu with no price stated. admittedly, gharar is difficult to be completely avoided, or as al-shatibi had put it, ―to remove all gharar from contracts is difficult to achieve, besides, it narrows the scope of transactions‖[60]. however, sharia' jurists agreed that only gharar fahish is prohibited due to its inherent uncertainty and impairment on the validity of contract as compared to gharar yasir, which impacts are too minimal and difficult to be assessed in quantitative value[48, 60-63]. viii. third principle: prohibition of maysir (gambling or speculation) the third principle of islamic banking necessitates the avoidance of maysir, i.e. gambling or the speculative nature of transaction. this can be understood as an attempt to predict the future outcome of an event or simply conceding to a game of chance. algaoud viewed maysir as “… to undertake a venture blindly without sufficient knowledge or to undertake an excessively risky transaction”[48]. the sharia' law prohibits such practices as they are often not backed by any analysis or interpretation of relevant information[64]. in one hadith, prophet muhammad (p.b.u.h.) stressed on the importance of proactive reasoning before leaving nature to its work: it was narrated that prophet muhammad (p.b.u.h.) once asked a bedouin, who left his camel untied, “why don‟t you tie your camel?” the bedouin answered, “i put my trust in god”. the prophet then said, “tie up your camel first then put your trust in god.”[42] in theory, there is a resemblance between gharar and maysir in the sense that the latter can be deemed as an active act upon the prohibited ghararfahish or excessive uncertainty. for instance, the pre-islamic practice of bai almunabazah (sale by throwing a commodity towards a buyer) involved a high degree of uncertainty since the buyer could not properly assess the quality of commodities thrown to him. also, the contract is deemed to be concluded once the buyer touches the commodity. yet again, the pre-islamic society was willing to gamble on such a risky transaction due to the hope of acquiring valuable commodity from the other party. likewise, this would also apply to investments such as trading in futures on the stock market, or forex (foreign exchange). ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 albeit the risk in these transactions may possibly be mitigated by utilizing modern financial softwares, the unpredictable nature of world economics such as the notable 1997 and 2008 global economic crisis have only proven that the two prohibited elements remain the biggest obstacles to the financial community. nevertheless, this does not imply that the sharia' law proscribes the taking of risk in investment. in fact, investment is very much encouraged in islam, provided the risk environment is properly studied beforehand. for example, the sharia' allows risk-taking in entrepreneurship and those that naturally occur as a result of natural disasters and calamities, which are reflected in several islamic banking products such as mudarabah (profit-sharing contract), musharakah (partnership contract), and takaful (islamic insurance). by the same token, islamic financial units such as ifis are required to properly assess the variant risks in banking, which do not only include generic risks such as credit, market, liquidity and operational, but also those that are specifically unique to ifis risk profile such as rate of return, sharia' non-compliance, displaced commercial, and equity investment risk (see figure 3). figure 3: risk profile of ifi in addition, each financial transaction by ifis must be tied to a tangible underlying asset in ensuring that ifis remain connected to the real economy[61, 65]. in an islamic banking transaction, the return on investment is obtained as a result of the investment process or the leasing process of a tangible asset, which further justifies the return on such investment as the real measure of the value of the investment activities[10]. an immediate example is sukuk – a certificate of equal value representing undivided shares related to the ownership (not debt) of tangible assets, usufruct and services or to the ownership of the assets of particular projects or a special investment activity, extending even to contractual rights, which are held in trust for the sukuk-holders[61]. it is akin to the conventional asset-backed securities transaction, which includes the sale of tangible assets and generates returns and risk associated therewith[66]. ix. fourth principle: socially responsible investment (‗sri‘) fourthly, the principle of islamic banking emphasizes on the socio-economic aspects of economic activities that benefit the society at large (tahqiq al-khidmah al-ijtima‟iyah); which is similar to the conventional concept of socially responsible investment (‗sri‘)[67]. inspired by the sharia' law injunction of ‗human accountability before god‘, individual or financial investors such as an ifi must seek for suitable avenues for money as a medium to generate social value and ease the burden of the needy via its economic activities[68]. by all means, islam regards the overall interest of the society as of equal importance as generating high profits for corporations. “what god has bestowed on his messenger (and taken away) from the people of the townships, belongs to god, to his messenger and to kindred and orphans, the needy and the wayfarer; in order that it may not (merely) make a circuit between the wealthy among you. so take what the messenger assigns to you, and deny yourselves that which he withholds from you. and fear god; for god is strict in punishment.” (surah al-hasyr 59: 7) to this end, the sharia' law ordains for islamic funds to be invested in industries that benefit the public such as, inter alia, telecommunication, technology, engineering, health care, construction, transportation, and education, whilst it prohibits the involvement in industries of questionable ethics such as alcohol, pork processing, gambling, prostitution, pornography, firearms, entertainment, music, and weapons of mass destruction[69, 70]. “they ask thee concerning wine and gambling. say: "in them is great sin, and some profit, for men; but the sin is greater than the profit." (surah al-baqarah 2: 219) “o ye who believe! intoxicants and gambling, (dedication of) stones, and (divination by) arrows, are an abomination, of satan's handwork: eschew such (abomination), that ye may prosper. satan's plan is (but) to excite enmity and hatred between you, with intoxicants and gambling, and hinder you from the remembrance of god, and from prayer: will ye not then abstain?” (surah al-ma‘idah 5: 90 – 91) the realizations of the above notion have been displayed by several islamic banks, notably bank al-bilad of saudi arabia, which has recently opened a new branch in riyadh that provides banking facilities to people with sight, hearing and other physical disabilities[71]. more recently, the abu dhabi islamic bank (‗adib‘) has donated a new mosque to the local fujairah community as part of its csr activities, which also provides residences for the imam and muazzin (the caller of prayer)[72]. the same can also be said of noor islamic bank of the united arab emirates, which offered bank services through post office to capture the 50 per cent of the country‘s population and low-paid workers who have no access to formal banking account[11]. likewise, the bangladeshi grameen bank‘s microfinance project that had witnessed islamic banking‘s effectiveness as a working tool in alleviating poverty was also another commendable initiatives ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 by ifis around the world in blending social welfare with banking services[58, 73-75]. x. fifth principle: avoidance of hilah (tricks) in trade fifthly, the principles of islamic banking prohibits the practices hilah (tricks or deceptions), e.g. fraud, misrepresentation, juristic ruse, etc. for example, a simple sale and purchase transaction over fisheries is permissible, while a similar transaction over ‗fish in the ocean‘ is not, due to uncertainty over the type, weight, quality and quantity of the subject matter. the same can also be said over a she-camel, which is again permissible, but not the sale and purchase over the she-camel and her unborn calf[60, 76, 77]. in essence, the sharia' law ordains that profits can only be attained in business ―…so long as it stays within the rules of the game, and engage in open and free competition without deception or fraud‖[78]. in one hadith, abdullah reported that prophet muhammad (p.b.u.h.) mentioned: “it is obligatory for you to tell the truth, for truth leads to virtue and virtue leads to paradise, and the man who continues to speak the truth and endeavours to tell the truth is eventually recorded as truthful with god, and beware of telling of a lie for telling of a lie leads to obscenity and obscenity leads to hell-fire, and the person who keeps telling lies and endeavours to tell a lie is recorded as a liar with god.”[42, 79] in another hadith, the holy prophet (p.b.u.h.) was also narrated saying: “when two people trade, they have the choice (to proceed with or cancel the transaction), so if they are honest and clarify (e.g. the defects in their merchandise) their trade will be blessed, but if they lie and conceal (defects) there will be no blessing in their trade.”[27] in general, there is a mixture of views among islam‘s four major schools of thought with regards to the issue of hilah. the maliki and hanbali‟s schools opined that all hilah are impermissible, while the hanafi and shafie maintained that hilah is allowed as long as there is no fraudulent intention to neither deprive the rights of the society, nor demean the reputation of islam [80]. however, some scholars have expressed their concerns over the application of hilah in islamic banking. for instance, the issue of hilah is evident in bay al-inah (sale and buy back contract), an islamic financial instrument that has so far been permitted in two countries, i.e. malaysia and brunei[81]. in this instrument, the bank would purchase an asset from the client on a cash basis and then immediately resell the asset to the customer at a marked up price on a deferred payment basis. the hanafi, maliki, and hanbali‟s school of thought regarded it as a legal device to circumvent the prohibition of riba'-based financing by providing ifis with a ‗back door‘ to riba' since the main intention is to obtain cash rather than the commodity itself[8284]. moreover, this instrument can also be misused by the banks to take advantage of the customers‘ plea for cash and subsequently subjugate them to debt[19, 20]. however, this view was rebutted by countries that subscribed to the shafie‘s school such as malaysia and brunei, which opined that the customer‘s motive is an irrelevant factor in declaring bai alinah as impermissible[21, 62]. admittedly, these conflicting views on hilah are confusing to customers, who are looking towards islamic banking as a unique financial service provider over its conventional counterparts. with the permissibility of bai al-inahand several other controversial instruments, there are probabilities for the public, especially those who are religious-averse, to reevaluate their selection of islamic banks as their banking institution of choice. more importantly, it is academically fascinating to see whether the permissibility of these instruments, coupled with a number of other pressing issues the industry is currently facing, will have any adversarial effect towards the reputation of islamic banking in the years to come. xi. sixth principle: justice and fairness in trade finally, the practice of islamic banking must always uphold the notion of justice, balance and fairness in trade (al„adluwa at-tawazun). sharia' scholar such as ibn taymiyyah considered justice as an integral outcome of the islamic monotheism that integrates both the muslims and nonmuslims. ―justice towards everything and everyone is imperative for everyone and injustice is prohibited to everything and everyone. injustice is absolutely not permissible irrespective of whether it is to a muslim or a non-muslim or even to an unjust person.‖ ibn taymiyyah[21] islam recognizes that to god belongs the dominion of heaven and earth, and whatever mankind possesses, is none but only a trust from god. as the vicegerent of god on this earth, mankind are repeatedly reminded in the holy quran to administer justice at all times, even if it may jeopardise the life, financial status or reputation of the parties involved. in islamic jurisprudence, this exercise of justice is known as suisti‟malal-haq. according to al-khafif, a renowned hanafi scholar, the administration of justice or the exercise of one‘s right may by itself be valid and lawful, but it may also cause harm or damage to others[85, 86]. undoubtedly, islamic views the concept of justice as not a matter of choice, but rather a divine obligation that has been deeply rooted in the holy quran and prophet muhammad (p.b.u.h.) teachings. “say: "my lord hath commanded justice; and that ye set your whole selves (to him) at every time and place of prayer, and ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 call upon him, making your devotion sincere as in his sight: such as he created you in the beginning, so shall ye return." (surah al-a‘raf 7: 29) “god commands justice, the doing of good, and liberality to kith and kin, and he forbids all shameful deeds, and injustice and rebellion: he instructs you, that ye may receive admonition.” (surah an-nahl 16: 90) “o ye who believe! stand out firmly for god, 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 god. for god is well-acquainted with all that ye do.” (surah al-ma‘idah 5: 8) as far as commercial trade is concerned, the manifestations of justice are exemplified in practices such as, inter alia, transparency in terms of measurement, price, and quality of the commodities; mutual consensus in trade agreement; free-will; impartiality, and generosity towards the customers. these can further be illustrated in the following provisions of the holy quran and the hadith, which highlighted prophet muhammad (p.b.u.h.)‘s advices on the issue of generosity in trade and the prohibition of meeting merchants from neighboring village and towns[87]. in the latter, the prophet denounced such a practice in order to guarantee a fair and transparent economic dealing. however, the transaction is allowed if the seller is given an option to terminate the contract if he finds that he has been unfairly treated after knowing the real market value of his goods. “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 god hath been to you most merciful!” (surah an-nisa‘ 4: 29) jabir bin abdullah reported that prophet muhammad (p.b.u.h.) mentioned: “may god have mercy on the person who is lenient when he sells, lenient when he buys, and lenient when he demands his payment (debt).”[57] uthman bin ‗affan narrated that prophet muhammad (p.b.u.h.) said: “god will admit to paradise a man who was lenient when he sold and when he bought.”[57] abdullah bin tawus narrated from ibn abbas that prophet muhammad (p.b.u.h.) said: “do not go to meet the caravans on the way (for buying their goods without letting them know the market price); a town dweller should not sell the goods of a desert dweller on behalf of the latter.” i asked ibn abbas, „what does he mean by not selling the goods of a desert dweller by a town dweller?‟ he said, „he should not become his broker.‟”[43, 79, 88, 89] above all, the application of justice in modern islamic banking context can be seen in the various islamic financial contracts such as mudarabah and musharakah, which, inter alia, emphasise on the concept of profit-and-loss sharing and the mandatory disclosure of information in such contracts such as profit-and-loss margin, contribution ratio of each party, risk management policies, and other aspects[90].since disclosure of information and transparency are among the most vital characteristics of islamic banking, it is necessary for all of the staff in ifis‘ division, from ceo to even the security guards, to have adequate knowledge on the tenets of ifis‘ financial products and services in ensuring that the customers are wellinformed of everything that they are about to subscribe to[5, 91]. xii. conclusion to summarize, this article has attempted to explain the conceptual dimension and theoretical framework of islamic banking from the sharia' law perspectives, which are imperative in enlightening fellow readers on the overall concept of islamic banking. contrary to the conventional banks, ifis‘ operations must be based on the maqasid assharia' (sharia' objectives), which are identified as the prohibition of riba‟, gharar, maysir, hilah, and the promotion of ethical business practices such as justice, fairness and transparency. the 2008 global financial meltdown has created a unique awareness among banking consumers on the need of an alternative to complement the conventional banking system, which was viewed by financial scholars as suffering from a crisis of failed morality[3, 16, 47, 92-95]. meanwhile, the islamic banking system, which was identified as a viable banking alternative, have long preached on the concept of banking institution as a medium that generates not only profit, but also a tool that integrates and prioritizes the maslahah (public interest) and ethical values in banking practices[96]. nonetheless, it remains whether islamic banking is truly deserving of such an accolade – at least amidst the presence of revolving issues that necessitate further clarification and understanding such as, inter alia, the independence of the sharia' board, conflict of laws and schools of thought, education and qualification of the sharia' board members, non-standardized sharia' rulings and guidelines, conflict of interest, etc. god knows best. ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 references [1] tawney, r.h., religion and the rise of capitalism. 1998: transaction publishers. 319. 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[96] totaro, l., vatican says islamic finance may help western banks in crisis, j. fraher, editor. 2009, bloomberg: new york. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france 7178-article text-26738-1-18-20230729 european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7178 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 13 the contribution of the islamic and social banks to the concept of sustainable development karim mohamed ali aboul-dahab (1) 1 graduate school of business (gsb), arab academy for science, technology and maritime transport, cairo, egypt. goldenntra@gmail.com received: 12/08/2022 accepted for publication: 13/07/2023 published: 28/07/2023 abstract islamic banking is a financial structure based on islamic law (sharia law) and driven by islamic economics. the islamic financial system, which offers alternative funding sources, is supported by four major pillars: the islamic banking system, the islamic money market, islamic insurance, or takaful, and the islamic capital market. on the other hand, social banks are founded on using financial services to “create a positive impact on the society and the environment; respectively, customers see islamic banks, depositors, and the broader community as having a social as well as an economic role. in this respect, the main pillars of the united nations sustainable development goals (sdgs) include ending poverty and promoting sustainable development. this paper will investigate the similarities between islamic and social banks. furthermore, this research will highlight the contribution of the two banks toward achieving the un sustainable development goals (sdgs). keywords: sustainable development goals (sdgs); islamic banking; islamic finance; social banking; corporate social responsibility (csr); charity bank 1. introduction islamic finance is one of the fastest-growing segments of the global financial industry. in some countries, it has become extremely important; in others, it is too big to be ignored. it is estimated that the size of the islamic banking industry at the global level was close to $820 billion at end-2008. the largest islamic banks are located in the countries of the gulf cooperation council (bahrain, kuwait, oman, qatar, saudi arabia, and the united arab emirates). the total asset of the indonesian islamic banking sector grew by 43.43% from 2015 to 2018, and there are now 13 islamic banks, up from 12 in 2015. the assets of islamic banks were 213.423 billion in 2015; however, by 2018, they had grown to 306.121 billion. in indonesia, the market proportion of islamic banks increased from 0.25% in 2001 to 3.98% in 2011, 4.86% in 2015, and 5.74% in 2017. although islamic banks perform functions that conventional banks do as well, the two banks vary fundamentally. the primary distinction between islamic and conventional banks is that the former adheres to shariah, the legal code of islam. the central concept in islamic banking and finance is justice, which is achieved mainly through risk sharing. stakeholders are supposed to share profits and losses, and charging interest is prohibited. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7178 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 14 in this regard, islamic banks operate under the supervision of shari`ah supervisory board that guides that bank or the islamic window in designing and implementing its products and conducting its banking activities., accordingly, the three main objectives of shariah (maqasid al-shariah) are broken down into three main goals. firstly, educating the individual, which is related to awareness and knowledge to make an improved living for sustained well-being. the second goal is establishing justice, which calls for treating everyone equally in our community. the third goal is encouraging welfare that contributes to the formation and growth of people in our area of influence. therefore, it is essential to have a high level of transparency in internal controls by the council of shariah, which performs a role similar to that of ethics committees but in accordance with islamic ethical-legal rules. on the other hand, social banks’ entails to provide greater value to society and environment indirectly through the lending projects that help the poor and needy people. social banks create impact indirectly through lending activities, whereas social entrepreneurs create impact directly through business activity. in that respect, social banks are similar to mainstream (conventional) banks in that they require the project to be financially sound, but they do not focus on a single goal of profit maximization. social banks “are prepared to accept lower margins or higher risks to stimulate certain activities” the poor are usually perceived by conventional banks as high-risk borrowers due to the difficulties in assessing their credit worthiness and their inability to provide collateral to pledge against potential risk .accordingly, providing services to the poor was one of the main arguments for the formal creation of the islamic banking sector. in that regard, it is anticipated that islamic banks, which typically manage sizable sums of money, will contribute to making such charitable donations. islamic society and the bank's shareholders both have a right to know how the bank contributes to society's well-being by assisting the less fortunate and whether it meets these standards. islamic banks are required to make public the following information: (a) the charitable and social activities they finance; (b) the amount spent on these activities; and (c) the sources of the funds used for charity (which may include the bank's own funds and earnings from sources that are forbidden by sharia. alternatively, the islamic bond market has grown significantly in popularity over the past ten years, even among traditional investors, due to the fact that these instruments are connected to tangible assets and therefore offer a high level of security. given the financial crisis in 2008 that was primarily brought on by the circulation of instruments with unsafe mechanisms, despite their official adherence to islamic principles, these securities are currently traded in the biggest marketplaces due to their security features and simplicity of use. the development of islamic banking became a successful story by showing continued growth and being stable during crises. a recent imf study compared the performance of islamic banks and conventional banks during the 2008 financial crisis, and finds that islamic banks, on average, showed stronger resilience during the global financial crisis. however, compared to conventional banks, islamic banks employ less debt, which calls for a review of islamic banking's capital structure models. however, the paradigm change calls for more research because some studies have claimed that the products of islamic and conventional banks are similar. according to some studies, the return on the average for assets was higher in the islamic banks than in the conventional banks. the reason was that the islamic banks were more invested in assets and less involved in debt contracts while the return on the average equity was the same for both bank systems. the revenue ratios, other operating income, net interest margin, and return on investment were higher in the islamic banks than in the conventional banking system. it is worth mentioning that the first established islamic bank “nasser social bank” was established as a social bank that aims 1971 to provides social services to the poor and low-income, the reason of establishing the first islamic bank as a social bank might be for political reasons or to gain the required acceptance to the idea of establishing a bank that doesn’t provide fixed interest rates on the deposit accounts, consequently , the establishment of the first islamic bank as a social bank doesn’t mean that they are same but it might indicates that the two banks have many things in common regarding the main objectives of the two banks . a main difference between islamic and conventional banks is the prohibition of all transactions in which some or all of the following components are present: any return on money that is predetermined in amount (or percentage) and therefore includes interest. (riba) uncertainty (gharar), which means prohibition on the sale of items whose existence or characteristics are not certain, and which are ambiguous upon contractual terms. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7178 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 15 the qur'an and hadith specifically mention economic, social, and environmental factors that promote sustainable development, such as aiding the needy and poor, enhancing social justice, and building capacity at both the individual and societal levels. environmental issues like protecting the environment and animals are also mentioned. in addition, islamic ontology forbade wasting natural resources because they are regarded as a gift from allah, suggesting a moral standard for economic and social behavior. to identify the mutual role of islamic and social banks in promoting social development initiatives, this research will deploy a comparative research approach to illustrate the main similarities and differences between islamic and social banks. moreover, this study will highlight the two banks' potential to contribute to attaining the un sustainable development goals (sdgs). 2. literature review corporate social responsibility (csr) is a voluntary integration by companies of social and environmental concerns into their commercial activities and their relations with stakeholders. historically, the csr method had to be based on three main elements: economy, growth, environmental protection, and social justice, which served as an economic driver and an institution concerned with the social environment. whether it encompasses the environmental sustainability sector and the building and improvement of community welfare. tok & yesuf (2022) classified banks into investment banks, global banks, local banks, retail banks, social banks, green banks, community banks, church banks, and development banks. social banking services are often referred to as a type of bank that collaborates with various stakeholders in interactive social networks to provide complete banking services, with many competitive advantages. some of these benefits include: elevating the bank's status as a pioneer in the field of social networks; developing a long-term strategy for sustainable development, having a distinct, consistent, and reliable online presence that boosts the bank brand; and providing integrated and comprehensive banking services on a consistent social platform. respectively, bosheim & aspevik (2013) considered social banks as interconnected to ethical banking, socially responsible investment (sri), corporate social responsibility (csr), and impact investing. accordingly, social banks are designed to offer banking services using the triple bottom line of people, profit, and the environment as their main business strategy. profit is necessary but not the only or even the main objective. the mission statements of social banks emphasize positive effects and sustainable human and environmental development through a transparent business process. in a similar context, san-jose et al. l (2009) defined ethical banking as having two main characteristics: obtaining social profitability, funding economic activities with social-added value, and obtaining economic profitability. on the other hand, the early islamic banks, such as the farmers’ credit union (established in pakistan in the late 1950s) and the mit ghamer savings bank (established in egypt in 1963), were based on social initiatives to achieve social objectives, islamic banks, therefore, are seen by customers, depositors, and the broader community as having a social as well as an economic role. due to its ethical business practices and resemblance to socially responsible investments, islamic banking has gained popularity in western countries, as well as .its ability to attract investors, regulators, and financial institutions as an alternative option to conventional banks. accordingly, luthfi hamidi & worthington (2018) investigated the principles and practices of both islamic banking and social banks to examine the potential of incorporating some elements into a new type of banking known as islamic social banking (isb). the study concluded that three major operations must be considered to convert the islamic bank into a social islamic bank, which are profit, planet, and people. relaño (2011) finds that social banks have more assets in client transactions, whereas conventional banks have most assets in financial transactions. this supports the argument, as allocating the money to clients is to allocate credit to the real economy – whereas the financial transactions illustrate detachment of conventional banks from the real economy. in this regard, the two banks have in common a claim of contributing to positive social and environmental impact. they both have transparency as a strong value connected to their business activity and provide information on specific projects they lend to through storytelling. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7178 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 16 according to alwabel (2013), islamic accounting depends on the macro-economy while conventional accounting depends entirely on the micro-economy due to its dedication to growing the economic unity interest itself, disregarding the whole structure, so it was impossible to provide the desired benefits. the islamic sharia, on the other hand, has achieved social justice on the level of society by implementing the "zakah: alms" system and on the level of the household by implementing the "nafakah: expenditure" and "mawareeth: legacy" systems. the transition from a collective obligation to an individual duty creates a distinct line (interface) between social accounting and economic unity accounting. another main objective that commonly connects social and islamic banks is “poverty alleviating,” which is expected to be considered a primary objective in countries with lower scores on the human development indicators (hdi) and focus on sustaining access to credit and human development. in this respect, most banks nowadays aspire to be more socially and environmentally responsible and are encouraged to apply sustainable financing based on sustainable development goals (sdgs). no doubt that imperialism and global capitalism limit the ability of islamic banks and an islamic financial system to bring the spiritual and secular concepts of social justice found in islamic teachings to life. therefore, expecting islamic banks to end poverty and advance social equity independently is unrealistic. they must be a part of a vast network that activates the various islamic finance system options. 2.1 the adoption of the concept of corporate social responsibility (csr) in islamic and social banking from an islamic perspective, human, social, economic, and environmental development are all part of the circular economy model and are scientifically linked with maqasid al-shariah (islamic principles). subsequently, there is a significant overlap between socially responsible investment principles and islamic principles or maqasid-al-shariah objectives. alternatively, from an islamic point of view, sustainable development means achieving the ideal balance (mizan) between economic and social progress and the effectual and efficient exploitation of natural resources. in this respect, islamic and conventional finance support the main concepts of corporate social responsibility (csr). moreover, islamic principles promote social responsibility initiatives by inspiring muslims to make charitable contributions to benefit the individual and the community (waqf). to accomplish these obligations, both on an individual and institutional level, the sharia law encourages charitable giving and extremely precise acts of philanthropy. maali et al. (2006) insisted that the concept of social responsibility is one of the main values of islamic shariah concepts; accordingly, the term ‘brotherhood’ (akhowa) is widely used in islamic societies. all muslims are considered brothers and should take care of each other, and no cheating or exploitation is allowed, whatever the reasons. muslims are supposed to take care of others in society—the prophet mohammed said: ‘the muslims in their mercy towards each other are like a body, if a single part of it complains, the other parts would be affected’ (sahih al-bukhari—ali, 1961). the concept of social accountability is broad in islam. islam emphasizes that the rights of allah are primary, followed by the rights of society. hence, by considering the rights of allah, muslims should act and behave accordingly. muslims should always ensure that everything he or she does, including their deeds and words, comply with islamic values. from this point of view, muslims should maintain their good relationship with each other and islamic society to fulfill their rights. to fulfill these rights, muslims will encourage themselves to be accountable for their actions, including to society. according to ahmad (2021), the philosophy of csr in islam is based on the qur'an and sunnah and the habits that develop in muslim society. so that the study of csr methods originating from the values of islamic teachings becomes an obligation, especially related to companies such as the islamic banking sector. the notion of csr is also an implication of islamic ownership principles, because allah is the ultimate owner. humans, on the other hand, are simply transitory owners who serve as beneficiaries of trust. humans are urged to seek survival, but not at the expense of the interests of the hereafter, hence allah orders humans to transfer some of their property to those who are entitled to it. essentially, islam emphasizes philanthropic principles in order to create a space and opportunity for a muslim with surplus riches to communicate his feelings with people around him, one of which is through zakat. according to aracil (2019) to compete with conventional banking, islamic banks must implement a long-term strategy that includes csr, which should be a fundamental component of islamic finance by nature. furthermore, islamic banks must address formal institutional voids such as financial exclusion. furthermore, a shift away from philanthropy and towards european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7178 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 17 specialized forms of csr related to their primary business may assist islamic banks in contributing to human well-being by shariah. respectively, social finance (sf) was founded to help social enterprises with their financial needs. even though sf can generate both social and commercial benefits, in this regard, social finance creates an ideal environment for the expansion and demand for corporate social responsibility (csr) in the financial and banking sectors. according to krause & battenfeld (2017), consumers obtain a mixed value return by investing in social banking products, combining financial and social gains. social banking, having a significantly different business model, goes beyond the logic of corporate social responsibility, which is sometimes utilized as a mere window-dressing device focused on profit maximization. in the literature, many studies (cornée et al., 2022; hussienet al., 2019) investigated the performance of islamic and social banks during the 2008 global financial crisis. additionally, a growing body of literature (carè, 2018; sadiq & mushtaq, 2015; dourtmes & andrikopoulos, 2021) demonstrated the contribution of the islamic and social banks to the sustainable development concept, respectively. many studies (kamdzhalov, 2022; maali et al., 2006) have reviewed the social responsibility values incorporated by the two banks, previous study has tended to focus on the contribution of islamic or social banking to social development, sustainable development or economic growth. this article uses a comparative method to demonstrate the potential contribution of the two banks toward achieving the un sustainable development goals (sdgs). in the subsequent section, we demonstrate the main features of the social and islamic banking system. 2.2 islamic and social banks' main values mohd nor (2016) referred to the following characteristics demonstrated in table 1 as the main features that differentiate social banking operations from conventional banking operations, interestingly many of the social banking features are similar or included in islamic banking operations, for instance, to ensure transparency, cornée et al. (2016) suggested that to give investors concrete evidence, the majority of social banks should share thorough lists of the projects they fund. additionally, social banks typically forbid complex financial transactions; in this respect, social banks provide evidence for their "internal interest rate channel" and demonstrate how they allocate assets and manage risks; accordingly, lahrechet al. (2014) assert that islamic institutions typically follow the norms and guidelines set forth by the islamic financial services board (ifsb), these standards enable financial market participants, such as investors and financial institutions, to assess the main business operations carried out by islamic financial institutions while taking into account the profit-and-loss sharing (pls) principle, which is necessary to adhere to shariah regulations. profit-sharing investment account holders (psiahs) require greater access to the degree of risk and return associated with their participation in evaluating their investments. in this respect, the two banks also refuse to operate in speculative operations of the financial market. according to benedikter (2010), social banks are defined by reviewing three different criteria to assess investment and lending opportunities; profit (correspondingly, economic prudence; losses cannot jeopardize the bank's overall growth), environment (natural habitat, protection, and resource management in a sustainable manner), and people (the primacy of the community and the balanced advancement of society, seen as a whole), consequently, according to hussien et al. (2019), sharīʿah law bans islamic banks from financing socially immoral activities and those forbidden in sharīʿah, such as alcohol, gambling, speculation, etc. islamic banking transactions also assume a minimum of imperfect information (asymmetric information and moral hazard). respectively, according to dourtmes & andrikopoulos (2021), the two banks considered the social and environmental aspects of the financed projects. unlike conventional banks, which solely focus on profit maximization, social banks offer loans to create a social or environmental value. furthermore the two banking systems focuses in the operations that have impact in the real economy, for instance, cornéeet al. (2022) acknowledged that social banks' financial activities are more focused on supporting the real economy than trading in speculative markets, as was evident during the 2007–2008 financial crisis, when many regular banks were found to have insufficient capital and had to be bailed out by taxpayers after taking excessive risks. accordingly, gani et al. (2021) examined the contribution of the islamic banking sector to the malaysian real economy; the research found that islamic banking has a significant impact on malaysian economic development based on gdp growth data from 1998 to 2017. according to study findings, a rise in islamic bank deposits of 1% results in a 0.62% increase in malaysia's gdp. however, some differences between the two banking operations primarily distinguish islamic and non-islamic banks. for instance, islamic regulations forbid any fixed interest rates on bank savings accounts; in this aspect, zucchelli (2022) proposed that in islamic philosophy, obtaining interest discourages charitable giving because those who do so are less encouraged to european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7178 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 18 produce value and, consequently, less motivated to create cohesive societies that benefit everyone. additionally, many errors are thought to result from interest-based financing. for instance, high debt and hazardous risks linked to trading on financial markets expose economies to instability. on the other hand, sharing risks and benefits enables the parties involved to reduce risk and benefit from it collectively. additionally, islamic law forbids any form of bank financial intermediation activity based on the profit and loss sharing (pls) principle., in this regard, hassan & aliyu (2018) suggested that the founding scholars of the concept of islamic banking constructed a profit and loss sharing system (pls) to provide an alternative to a fixed rate of return on loans. in contrast, social banks encourage loans at reduced interest rates for projects worthy in social, ethical, or environmental terms. in this respect, mitić et al. (2017) revealed that many social banks, like charity bank and gls bank, provide unique savings invested in social protection projects. if the customers agree to a lower interest rate, then the difference in the interest rate, from lower to standard, is invested in these projects. due in large part to their exceptional resilience under conditions of financial problems, considerably, social banking gained popularity during the 2008 financial crisis. further, sadiq & mushtaq (2015) investigated the commitment of islamic financial institutions to environmental and social objectives that more or less align with the main objectives of islamic finance (maqasid). moreover, the research highlighted that the "takaful" concept in islamic banking encourages investors to direct their investments toward projects that upgrade the versatility of the poor. however, the research suggested that the role of islamic banking in sustainable development projects requires further investigation. table 1. main similarities and differences between islamic and social banks no characteristics of social and islamic banks social islamic 1 refuse to operate in speculative operations of financial market. benedikter (2010) hussien, m. e., alam, m. m., murad, w., &amp; abu n.m. wahid. (2019) 2 concentration on real economy example; savings collections and credit distributions. cornée, kalmi, & szafarz (2022). gani & bahari (2021) 3 give privilege to social, ethical, or environmental aspects of projects they financed, henceforth, solidarity is encouraged between depositors and borrowers. (dourtmes & andrikopoulos, 2021) sadiq, & mushtaq (2015) 4 encouraging loans at reduced interest rates for projects that are worthy in social, ethical or environmental terms. mitić & rakić (2017) 5 transparency in business management. cornée, kalmi and szafarz (2016) lahrech, n, lahrech, a., & boulaksil (2014). 6 give privilege to social, ethical, or environmental aspects of projects they financed. bosheim & aspevik (2013). tok, & yesuf (2022) 7 the different types of financial intermediation activity of banks are based on the principle of profit and loss sharing (pls). hassan, & aliyu (2018); maali, casson, & napier (2006) 8 the prohibition of all forms of risk-free "increases" set beforehand. zucchelli (2022) source: author elaboration 3. effectiveness of islamic and social banking to the reduction of income inequality the rising rate of global inflation has impacted not just developing countries but also developed countries. as of august 2022, inflation has reached or approached double-digit levels in the european union (10.1%) and the euro area (9.1%), and surpassed 20% in several baltic and eastern european member states. as current inflation is driven mainly by soaring food and energy prices, households in less wealthy eu countries or with low income are impacted more strongly, due to higher relative spending on such essential items. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7178 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 19 higher interest rates will result in greater debt costs and leave consumers with fewer financial resources to spend on other categories. fiscal measures implemented by governments, which helped to cap some of the inflationary effects for consumers and support purchasing power, especially of lower-income families, are also expected to come under scrutiny, as countries will face higher borrowing costs. in general, the poor tend to save their money at a diminishing rate of return in comparison with the wealthy people, especially during high inflation. moreover, they need more access to the bank's financial instruments. on the other hand, the wealthy are more creditworthy and have better access to financial instruments that allow currency depreciation hedging. as a result, a decline in the currency's value is sometimes viewed as taxation that takes from the poor and gives to the rich. when inflation happens, the poor are typically the most disadvantaged group. henceforth, the conventional bank business model might contribute in one way or another to the increasing gap between the poor and rich within the same country, or in other words, make the rich get richer and the poor get poorer. a significant income disparity prevents the poor from accessing loans in an imperfect credit market. asymmetric information, in which the lender and borrower know little about each other, limits the capacity to make well-informed judgments. this restricts borrowing capacity and investment returns. furthermore, faulty rules make it harder for creditors to collect on failed loans because the law may prevent the borrower's assets from being repossessed as collateral. such regulations limit debt collection, resulting in the harsh terms and conditions that potential creditors confront. this makes credit unavailable to some people, particularly the impoverished. given that investment is determined by an individual's income and assets, the impoverished (with fewer assets) are disadvantaged. finance or credit availability drives the rich-poor divide and influences how much that divide widens or closes across dynasties. credit shocks to some industries can also alter capital distribution, economic growth rate, and the search for production inputs (especially manpower), negatively affecting poverty and income inequality. respectively, entrepreneurs have limited access to financial instruments that help them to create employment opportunities, increase output, and improve the welfare of the previously poor, because the current conventional banking system promotes inequitable distribution by shifting all the risks to the borrowers. according to setiawan (2016), poverty is one of the challenges connected with wealth in society. the causes of poverty can be explained in a variety of ways. first, micro poverty arises due to unequal resource ownership patterns, which results in unequal income distribution. poor people need more adequate resources. second, poverty results from disparities in the quality of human resources. low productivity results from low human resource quality, influencing low salaries. a lack of education causes low human resource quality, the fate of the less fortunate, discrimination, or inheritance. third, poverty results from disparities in capital access. according to dourtmes & andrikopoulos (2021), social banks tend to follow two core pursuits (1) a positive impact on the communities, the environment, and sustainable economic development and (2) a sustainable financial profit. moreover, discounted interest rates are offered, especially for social or environment-friendly construction projects. clients may also, for instance, choose to exchange part of their interest income that they would receive from deposits to contribute to environmental projects with stable interest rates. the following three charts (figure 1-2-3) demonstrate the economic or business cycle in the islamic, conventional, and social banks; one of the main differences between the conventional banks and the social and islamic banks is the value creation approach implemented by each bank, as the social and islamic banks economic model or value creation process are structured to encourage financial transactions with a principal focus on charity and community development, while, the high-interest rates that the conventional focuses on the economic value regardless of the business nature, the economic model or value creation model adopted by each bank affect the gap between the rich and poor within the same society. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7178 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 20 figure 1. islamic banks’ economic cycle source: author elaboration figure 2. commercial banks’ economic cycle source: author elaboration depositor bank partnership economic and social value profit-share depositor bank loans borrower economic value pay back +interest rate european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7178 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 21 figure 3. social banks’ economic cycle source: author elaboration 4. islamic and social banks role in sustainable economic development all un member states agreed to the 2030 agenda for sustainable development in 2015, which offers a shared road map for peace and prosperity for people and the earth both now and in the future. the sdgs are a follow-up to the millennium development goals (mdgs), which were established in the year 2000, and are comprised of 17 quantitative and qualitative sdgs. to promote peace and prosperity for people and the planet while forming a strong global network of collaboration movements between countries. the eight millennium development goals (mdgs) had 21 goals set for eradicating poverty (mdg 1), human deprivation in education, gender, and health (mdgs 2-6), and promoting sustainable development (mdg 7), all to be supported by a global partnership. islamic finance has the potential to play a role in supporting development, particularly as found in the sdgs, as it can allow for more robust growth, support outcomes with positive social impact, improve financial inclusion, and enhance financial sector resilience. muslims are urged to benefit their local communities and ensure that the impoverished are cared for in the first instance. according to the 2020 oecd report on islamic finance, islamic finance works to equalize wealth allocation by redistributing assets among communities., in this respect, islamic social finance concepts like zakat and awqaf are a way to fulfill this requirement through ongoing altruism and are one of the religious duties that muslims have (and the only one having a financial dimension). as a result, islamic social finance's redistributive and social equity components are crucial to achieving sdg1. zakat directly translates as "to increase," in terms of meaning; it denotes "that purifies money" islam's fundamental principle suggests that a person's annual income should be purified. any excess income, including cash on hand or in a bank account, gold or silver jewelry, farm products, livestock earnings, stock, and investment profits, must be included in the zakat calculation. zakat, as one of the fundamental pillars of islam, directly impacts how money is distributed and how the impoverished are freed from poverty. muslims who have wealth above a certain threshold (nisab) are required to yearly share a certain proportion of their wealth and income among certain heads, and this is regarded as one of the fundamental forms of worship. the amount of zakat differs, ranging from 2.5% paid on financial assets like cash, gold, and silver to 5% on agricultural products if the depositor bank loans borrower social and enviromental impact pay back +discounted interest rate european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7178 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 22 crops are irrigated to 10% if they use water from natural sources like rivers, springs, or rain. early islamic history demonstrates that zakat was used as an effective distributive scheme in caring for the poorer sections of the population in muslim societies. in this respect, zakat and csr are mutually because csr will expose the zakat money that corporations manage and employ for csr initiatives. with such a policy, it is possible to conclude that state institutions such as sharia banking serve a dual function, particularly in terms of distributing zakat to the masses, as well as legal entities charged with collecting social funds such as zakat, grants, infaq, and sodaqoh originating from the public. according to kamdzhalov (2022), conventional and islamic finance are important to corporate social responsibility (csr). the function of philanthropy is the crucial difference between traditional corporate social responsibility and its islamic counterpart. sharia law promotes philanthropy and charity by advocating specific actions in carrying out these duties at the individual and institutional levels. on the other hand, islamic waqf is a type of investment intended to benefit both muslims and non-muslims for a very long time (perpetuity investment). in this regard, waqf was created to provide financial assistance to the poor and the needy and social benefits like public utilities, education, health care, research, service animals, and environmental protection. in most muslim countries, the sizable stock of waqf assets is stagnant and not utilized for socioeconomic development. for instance, indonesia has 1400 sq. km. of waqf property worth us$ 60 billion. $3 billion in us dollars could be used for different socioeconomic purposes if these assets return 5% annually. considering other forms of waqf assets, the potential of utilizing waqf for effective social development schemes is huge but still needs to be explored. carè (2018) suggested that social banks are, by nature, sustainable banks, while the opposite is not true. sustainable banks are by nature, “profit-oriented banks” that pursue their sustainable aims strategically. the sustainable banks are attempting to be sustainable, as evidenced by their new sustainable products, risk management techniques, and disclosure policies, but they also have an eye on their success overall, as well as their reputation, brand image, and market share. accordingly, the global reporting initiative gri guidelines have prompted businesses to publish a stand-alone sustainability report. the integrated report is crucial for businesses to make more sustainable decisions and for investors and other stakeholders to understand how well a business is doing. additionally, it creates a fuller image of the organization within the parameters of the materiality criteria. in this respect, novokmet & rogošić (2016) analyzed the sustainability reports prepared by the commercial banks listed on the stock markets of ten european countries denmark, finland, france, germany, italy, the netherlands, norway, spain, sweden, and the united kingdom during the period 2001-2013; the research findings demonstrated the need for the banking sector to continue progressing with its commitment to sustainability. and consequently, there should be joint efforts by financial institutions, national governments, and international organizations to commit to sustainability to gain quality, visibility, and credibility for the investment community. 5. discussion the successive decisions taken by the american federal bank to increase the interest rates make the value of the dollar soar that increase in the interest rate didn’t only affect inflation in the united states even as it raises the costs of many dollar-priced imports for other countries, with the worldwide inflation rate rises to the highest level in decades, under this circumstances accomplishing sdg 1 that aims to end poverty became more challenges, in this respect, the business approach of the conventional banks focuses in maximizing wealth or utility which calls for an alternative business approaches that are more committed to the societal and environmental values, in this respect, the islamic and social banks consider the social and environmental impact of the financed projects. however, islamic bank follows cost-plus financing “murabaha” instead of discounted interest rates in financing sustainable projects, and it is good to mention that the largest growth of islamic banking assets relevant to the social banks might be due to the commitment of the islamic banks towards it values by having shariah supervisor (islamic scholar ) on board to provide consultancy and advise on the funded projects. 6. conclusion islamic banks that follow shariah law don’t finance uncertain activities nor take excessive risks. moreover, shariah law bans islamic banks from financing socially immoral activities and those forbidden in shariah, such as alcohol, gambling, and speculation, representing a major difference between islamic banks mainly and conventional banks. european journal of islamic finance issn: 2421-2172 doi: 10.13135/2421-2172/7178 published by university of turin https://www.ojs.unito.it/index.php/ejif/index ejif content is licensed under a creative commons attribution 4.0 international license 23 impact investing, socially responsible investing (sri), business social responsibility (csr), and ethical banking are all related to social banks. as their primary business strategy, social banks offer banking services while focusing on the triple bottom line of people, profit, and the environment. profit is necessary but not the only or even the main objective. the mission statements of social banks emphasize positive effects and sustainable human and environmental development through a transparent business process. islamic banks can be viewed as entities that promote social justice and responsibility. social duties in the islamic setting represent the concept of brotherhood, "ukhuwah" from one to another. as a result, islamic banks play a vital social function and might be defined as banks with a social duty. the social and islamic banks share similar values in this regard, such as refusing to engage in financial market speculation, giving preference to social, ethical, or environmental aspects of the projects they finance, and encouraging cooperation between depositors and borrowers. however, the islamic banks' distinctive operations through murabaha and mudaraba primarily set them apart from the social banks. the 2030 sustainable development goals sdgs adopted by all united nations member states in 2015 include environmental sustainability, economic prosperity, social equity, human, social, economic, and environmental development, which are linked in one way or another with islamic and social banks' main objectives. the evidence from this study suggests that the two banks could positively contribute to the united nations 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(2022). recent trend of deposits in islamic banks. european journal of islamic finance, 9(1), 56–64. https://doi.org/doi: 10.13135/2421-2172/6260 paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif 1 channeling asset-managed sukuk towards smes financing: sukuk mudaraba prototype applied to a french sme a. patel* *paris 1 sorbonne university – founder of 570 asset management abstract — asset-managed sukuk is a pure innovation that we prototyped in the french market where smes financing is a national priority due to the bad economic conditions. this paper aims at presenting the result of the research and structuring exercise over a prototype for a mudaraba sukuk which is being proposed to the market, hoping to open the doors to more project finance type sukuk issuance, especially for (small) euro denominated ticket. we discuss how the main issues arisen to smes financing such as opacity of information, lack of historic track-record, adverse selection in the theoretical framework of asymmetry of information can be resolved using an incentivized scheme of asset management along with a strong security package that holds ownership access rights in the hands of investors. key words : islamic finance, sukuk, asset management, sme, asset finance, france study i. introduction the history of the epic lehman brothers‘ crash as a conventional bank is much well known and reported than the crash occurred in the sukuk market in the year 2007-2008. the latter is not due to a single player fading away on the pile of its debt but it represents the systemic impact of a statement and a later clarification from the global standards‘ setting body in the islamic finance world, the aaoifi (accounting and auditing organization for islamic financial institutions). aaoifi‘s previous president of the sharia council 1 , a well-respected scholar in the market, declared in a statement in november 2007 that some ―85 per cent of outstanding sukuk had failed the shariah-compliance test on the basis that they were ‗asset-based‘ rather than ‗asset-backed‘ with the guaranteed return of the face value of the sukuk on maturity and in the absence of a transfer in asset ownership to sukuk holders‖. this statement had many impacts, first on the volume of sukuk issuance in the market and second, on the juridical validity of sukuk which became unstable. in effect, this statement surprises the whole islamic finance market and triggered a backlash on all sukuk structures that were mere copy of their conventional counterparts. later on, in february 2008, aaoifi issued a guidance statement on accounting for 1 pr. taqi usmani, speech on sukuk and their contemporary applications, 2007 investments and amendment in fas 17. summary of important issues raised in this guideline are: sukuk issuances have to be backed by real assets, the ownership of which has to be legally transferred to sukuk holders in order to be tradable; sukuk must not represent receivables or debts, except in the case of a trading or financial entity selling all its assets or a portfolio with a standing financial obligation, in which, some debts owing by third parties, incidental to physical assets or usufruct, are unintentionally included; the manager of the sukuk is prohibited from extending ―loans‖ to make up for the shortfall in the return on the assets, whether acting as a mudarib (investment manager), or sharik (partner) or wakil (agent); guarantees to repurchase the assets at nominal value upon maturity with the exception of ijarah sukuk structures are also prohibited; and closer scrutiny of documentation and subsequent execution of the transaction is required by shariah supervisory boards. maurer (2010 [1]) investigated this controversial issue and concluded that for some, usmani‘s declaration was a much needed corrective because of bad market practice due to the excesses of sukuk issuances and structured financing vehicles too close to conventional bonds. to others, it was an overreaction, born of impatience with the pace of development of islamic financial institutions and markets, and a too optimistic view of the state of islamic finance that needs to depend less on the globally interconnected and interdependent conventional world. from this date, islamic finance academics and practitioners came to be more thoughtful on issuing sukuk on the basis of the ethics of islam which is among the objectives of islamic banking and finance, and is also one of the greatest means of establishing islamic economies in society. this would be possible only if the tools used to develop and structure sukuk are in consonance with the fundamental principles which distinguish islamic economic systems from others. the basic concept behind issuing sukuk is for the sukukholder to share in the profits of commercial enterprises. if sukuk are issued on this basis, they will play a major role in development of islamic ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 2 banking and finance and thereby contribute significantly to the achievement of the noble objectives sought by islam. in practice though, if sukuk are clearly not defined as conventional shares or bonds, they are somehow defined according to the aaoifi standard norm number 17 as ―certificates of equal value representing undivided shares in the ownership of tangible assets, usufructs and services or (in the ownership of) the assets of particular projects or special investment activity‖. this is unfortunately not a language that financial markets use, and practitioners 2 have difficulties in scoping to what extent sukuk can or should be considered as equity or debt products. there is probably a missing gap between general standards such as aaoifi ones and more practical guidelines driven by professional associations such as the loan market association (lma). if sukuk have reached the point to be a necessary liquidity tool for the islamic financial system, it poses still many challenges in their structuring and usage. they can be in numerous formats 3 , but are perceived by the market depending on their risk profile and their financial nature. indeed, they are categorized on the one hand, from a legal and islamic structuring level as asset-based (corporate risk and recourse to the originator) or as asset-backed (project risk with recourse to the underlying asset protected against the issuer‘s bankruptcy risk). as part of the fixed income family, sukuk requires tradability for their liquidity, which depends on their underlying assets together with the islamic contractual relationships performed at the asset origination phase (sales, leasing or partnership islamic type contracts). on the other hand, from a risk and finance structuring level, sukuk fall easily in the comparison with asset backed securities (abs), profiled in terms of rating as secured or unsecured financing with senior ranking in the sense that a claim can be done on the assets directly or over the guarantor‘s balance sheet liabilities, where the original assets stand. our intention in this paper is not to redesign a new sukuk structure or to argue whether sovereign sukuk are as performant as conventional bonds but rather, to study the different applications of sukuk as we believe not enough has been made on the ground to democratize the access of innovative and risk sharing instrument in favor of smes. we aim at introducing more transparency and clear cut nature of sukuk where investors understand the risk sharing purpose while issuers are channeled in a simpler execution mode with aligned asset management guidelines. as the overall market is evolving towards more ambitious structures such as perpetual or hybrid sukuk, or even trying to replicate the features prevailing in european jurisdictions such as covered bond or eurobond, we developed a simple yet ambitious experimentation of a sme sukuk as close as the partnership format required by islamic ethics. we aim at exploring a third path, aside from the existing asset-based and asset-backed options, rendered in the form of an asset-managed 2 the author is a market practitioner who has structured the first sme sukuk in france (listed on bloomberg, 2012) 3 aaoifi suggests more than 14 types of sukuk depending on their underlying contracts sukuk. the case we are detailing in this paper uses the cash flow to be generated from the project as a device which can be asset-managed by independent specialists and not the issuers‘ related entities in order to move away from potential conflict of interest. regardless of the size of the originator, it can be a sme as we like it to be, the attractiveness of such sukuk stand in the robustness of the project cash flow and the capacity of the third party to ensure the proper execution of the business plan using an incentivized profit sharing ratio model in the true spirit of mudaraba agreement. we use simple yet innovative agreement through asset management mandates in a mudaraba setup rather than plan vanilla asset-based sukuk that replicates conventional risk return profile. the paper is organized as follows. we discuss asset securitization features and comparison with the islamic version in section 2 and 3. in section 4, we analyze whether securitization can be applicable to smes needs and under which conditions. our experimentation on a real case for a french smes is used in section 5 to highlight the features of such asset-managed sukuk along its challenges. we conclude in section 6 on to how new avenues can be explored by market participants for smes financing alternatives. ii. asset securitization: a risk management and funding device securitization is the transformation of an illiquid asset into a security, this is a broad definition accepted by the economic literature. this process of creating securities can be done for public or private markets from an individual portfolio or from multiple portfolios of assets (type of assets that we will develop later). asset securitization, more precisely, is a structured finance technique that consists of taking credit to be provided directly to market institutional investors rather than through financial intermediaries. the rationale behind securitization is quite simple. it is based on the assumption that assets are, in certain conditions, worth more off the balance sheet of the creditors than on it (giddy, 2001) 4 . but the way securitization is done has evolved over the years. one can undisputedly say that the financial crisis of 2008 has changed both the way conventional and islamic securitizations are performed. we will discuss in detail one after each other the conditions in which these processes work, highlighting their positive impact in terms of funding and risk management. a. what is the value proposition of securitization? securitization transfers financing from the firm to capital markets. it is clearly one of its best value propositions to act as a disintermediation from the financial intermediaries such as banks or credit institutions. the whole question is to evaluate the nature of this transfer and the potential shortcomings in terms of asymmetry of information and conflict of interests from the parties involved in the process. 4 presentation on the securitization process, stern school of business, nyu, i. giddy ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 3 by engaging in securitization, both conventional and islamic institutions are looking for debt refinancing alternatives, thanks to capital markets which have proven their capacity to efficiently allocate funds to assets‘ exposures. research conducted by imf staff (čihák and hesse, 2008 [2]; hesse, jobst and solé, 2008 [3]; jobst, kunzel, mills and sy, 2008 [4]) show that securitization serves as a refinancing mechanism to diversify external sources of asset funding and to transfer specific risk exposures. according to the authors, asset securitization converts regular cash flows from a diversified portfolio of illiquid present or future receivables (liquidity transformation and asset diversification process) of varying maturity and quality (integration and differentiation process) into negotiable capital market paper (―tranches‖) issued by either the originator of the securitized assets/receivables or a non-recourse, single-asset finance company (―special-purpose vehicle‖ (spv)). so these tranches are contingent claims on a designated portfolio of securitized assets, which can be ―divided into different slices of risk to appeal to a range of investors‖ (wighton, 2005 [5]). issued debt securities differ in seniority and risk exposure (―stratified positions‖), whose subordination creates leveraged investment on the performance of securitized assets (―reference portfolio‖). both investment return (principal and interest repayment) and losses associated with the underlying reference portfolio are allocated among the various tranches through prioritized contractual repartitioning according to subordination (telpner, 2003 [6]). this risk sharing mechanism sustains a fine-tuned security design of customized debt securities with optimal meanvariance properties. hence, issuers of asset-backed securities improve overall market efficiency by offering marketable financial claims on securitized asset exposures at merchantable quality (kendall, 1996 [7]). from a broader economic perspective as asserted by the imf research team, the evolution of efficient securitization markets has served to mitigate disparities in the availability and cost of credit in primary lending markets by linking singular credit facilities to the aggregate pricing and valuation discipline of the capital markets. b. risk management and information transparency issuers are enablers of asset risks diversification through disintermediated debt refinancing. the economic reasoning of securitization is based on the ability of issuers as profitable enterprises to maximize shareholder value as the principal goal of economic activity. management decisions evaluate the economic impact of different business ventures on shareholder value. financial activities within business entities have to use their expertise and funds into the execution of business plans that can be understood by capital markets which are the ultimate source of capital. there are benefits of the securitization to the originators as well as investors and how it could mitigate the risks in the capital market which are as follows: for originators: transforming relatively illiquid assets into liquid and tradable capital market instrument. cheaper financing cost due to higher rating via credit enhancement. allows diversification of financing sources. facilitates removal of assets from the organization‘s balance sheet. reduces cost of finance if spv is serving as multiple originators by pooling assets. for investors: provides a variety of products choices at better spread that attract a diversified investor profile. variety and flexibility of credit, maturity and payment structures and terms via securitization techniques that allow investment products to be tailored to specific needs. pooling of diversified assets with heterogeneous risk mitigates‘ earning risk. undivided ownership of the assets is an added protection. for capital markets: the existence of secondary securitization markets facilitates benchmark purposes. facilitates and encourages efficient allocation of capital. enables reduction of risk within the banking system. securitisation confers upon issuers mainly financial advantages related to more competitive capital management through efficient asset funding. further objectives of securitisation might also include active balance sheet restructuring, market-oriented risk management of credit risk and diversified liquidity. according to the imf research, risk management is a transmission and control mechanism, which encapsulates different approaches by firms which choose between the riskreturn profiles of alternative (investment) strategies to maximize shareholder value. asset securitisation is one operational means of risk management, which allows issuers to reallocate, commoditise and transfer different types of risks (e.g. credit risk, interest rate risk, liquidity risk or pricing risk) to capital market investors in return for some fair market price. while banks and other financial institutions view securitisation as a way to alleviate the regulatory capital charges for credit exposures of similar risk (―optimisation of regulatory capital‖), non-financial entities would employ securitisation primarily for the liquidity management of existing trade receivables. and this is a pressuring demand from the smes, whether it relates to existing or future trade receivables, as we will see later. c. capital structure choice and incentive problems in asset securitization asset securitisation might also redress conflicts of interest between creditors and shareholders in the capital structure choice of firms concerning possible agency costs from ―underinvestment‖ (myers, 1977 [8] and 1984 [9]) and ―asset substitution‖ (jensen and meckling, 1976 [10]) due to ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 4 excessive levels of debt or the presence of non-value maximising investment behaviour respectively. benveniste and berger (1987 [11]) show that securitisation tranches resemble secured debt, whose agency costs may be lower than for unsecured debt. similar to secured debt, securitisation allows issuers to appropriate partial debtholder wealth by carving out a defined pool of assets to satisfy securitised debt claims, which do not capture gains from the firm‘s future investments. this prioritisation of debtor claims potentially alleviates underinvestment and renders existing debt less inhibitive on the realisation of new investment opportunities. as a consistent consequence of the thinking about the capital structure choice, issuers, large or small companies, with high agency costs of debt and/or low growth prospects should be more likely to engage in asset securitisation. analysing the effects of asset securitisation on the capital structure decision as a funding choice under asymmetric information holds also true. under the pecking order theory (myers and majluf, 1984 [12]) issuers with severe information asymmetry problems would prefer to issue secured debt (i.e. asset backed), which carries lower agency cost, because investors receive their repayment directly from a diversified pool of asset exposures insulated from the issuer (shyamsunder and myers, 1999 [13]). the trade-off theory would restrict this choice only to cases where the marginal benefit of debt outweighs the associated amount of agency and financial bankruptcy cost. hence, under the pecking order and trade-off theory, asset securitisation is the refinancing instrument of choice for issuers looking to commoditize their asset book, but issuers who are suffering from high agency costs of asymmetric information. the complex security design of securitised debt also suggests superior information of issuers about the true valuation of securitised debt. hence, rational investors would form negative beliefs about the actual quality of securitised assets and expect the adverse selection of securitised debt with poor reference portfolios similar to the lemons market problem famously proposed by akerlof (1970 [14]). since investors assume all (or most) transactions to be of poor quality, they request a reservation utility in the form of a lower selling price and/or higher return (―underpricing‖) as compensation for the anticipated investment risk of a disproportionately large share of poor transactions in the securitisation market. recognizing the asymmetric information, issuers suppress the pecuniary charge associated with the lemons premium by soliciting increased transparency about the true value of securitised assets through signalling and screening mechanisms. commonly issuers commit additional internal and external resources to a securitisation transaction, such as reserve funds, variable proceeds from excess spread as well as second loss positions and liquidity facilities, as a costly signal of asset quality. asset securitization is generally performed through two techniques, which is a good way to understand where islamic securitization stands in this perspective, subject of our next section. an asset-backed bond (abb) is a debt obligation collateralized by a reference portfolio of on-balance-sheet assets of the originator. abbs are over-collateralized as a form of credit enhancement, i.e., the value of securitized assets exceeds the notional value of issued debt obligations. as opposed to pass-through transactions, the cash flows from the reference portfolio are not dedicated to investors, who have no direct ownership rights to them. frequently, the underlying reference portfolio is reconfigured, with a residual claim held by the issuer/originator. a pass-through payment structure conveys direct ownership of investors in a reference portfolio of off-balance-sheet assets, which are similar in maturity and quality. the originator services the portfolio, makes the collections and passes them on, less servicing fee, to investors—without reconfiguration of the cash flows. a paythrough bond combines security features of both a pass-through and an abb. one can argue that the originator‘s role is yet to be asserted in the true spirit of islamic finance regarding transparency and avoidance of uncertainty providing ground to conflits of interest (gharar). iii. islamic securitization: an enforced risk-sharing device securitization is probably one of the most important financial innovations that occurred in the last part of the previous century. the economic development of the conventional financial markets relied for a great part on securitization, which introduced a fundamental change in the banking industry. indeed, it allows banks and also nonfinancial firms to access a great liquidity management tool for a better use of their assets tied in their balance sheet. with the new funds raised off the sale of the loans, they can increase new lending. at the same time, risk transfer has increased significantly due to securitization. in fact, as illustrated by the subprime crisis, there was a pressure for the banks to gear up their loan origination capacity and the distribution of their risk: soon after the loan has been granted, it is packaged into a bundle of other mortgages, given a risk assessment by a rating agency and sold out through asset backed securities. securitization has somehow shaped a new type of banking called the originate to distribute (otd) model, where relationship with the customer is reduced in favor of a transaction-based bank where its main proceeds come from the fees they earn originating and packaging loans. this otd model is not free of risks as the subprime and general financial markets crisis has shown. the main issue stands from the incentives that the lender is given, in order to properly screen and monitor borrowers, since it is going to get rid-off the credit risk as soon as possible. on a different perspective, islamic finance has grown up on the tenets of some moral background that favors risk sharing principles (al-ghunm bi al-ghurm) and transparency prescription (gharar). other principles such as the prohibition of interest-bearing activities (riba), speculation (maysir) and the obligation to engage in entrepreneurship type of investment away from bad faith behaviors (alcohol, pornographic, casino, etc.) have led islamic financial institutions trying to replicate the conventional finance via more complex structural arrangements of contingent claims (mirakhor and iqbal, 1988 [15]). ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 5 although both islamic and conventional finance are in substance equivalent to for-profit finance and yield the same lender and investor pay-offs at the inception of the transaction, they differ in legal form and might require a different valuation due to dissimilar transaction structures (and associated legal enforceability of investor claims) and/or security design (jobst, 2006 [16]). most importantly, islamic finance substitutes a temporary use of assets by the lender for a permanent transfer of funds to the borrower as a source of indebtedness in conventional lending. retained asset ownership by the lender under this arrangement constitutes entrepreneurial investment which is the key towards both smes finance and islamic finance. the financier receives returns from the direct participation in asset performance in the form of statecontingent payments according to an agreed schedule and amount. this is a main pillar of islamic finance techniques which pose challenges to be applicable in the different jurisdictions or banking system too much geared towards collateral-based debt, and it is especially true for smes looking for islamic finance alternatives. a. adapting the principles of islamic finance to securitization since most islamic financial products are based on the concept of asset backing, the economic concept of asset securitization is particularly adaptable to the basic requirements of islamic finance. islamic securitization refers to the process in which ownership of the underlying assets is transferred to a large number of investors in the form of instrument, namely sukuk. the ownership of the securitized assets is transferred to a separate entity that is set up for dual purpose of managing the assets on behalf of the sukukholders and for issuance of the investment certificates. the contractual rights attached to sukuk determine the mutual ownership and benefits of the securitized assets for the individual investors who subscribe to the sukuk. the sukuk holders earn any revenue generated by the project in the form of sale or leasing agreements (murabaha, ijara, salam, istisna) and/or capital appreciation of the assets involved through partnership-based agreement (mudaraba, musharaka, wakala bil istithmar). islamic securitization transforms bilateral risk sharing between borrowers and lenders in islamic finance into the market-based refinancing of one or more underlying islamic finance transactions (hesse, jobst and solé, 2008 [3]). in its basic concept, originators would sell existing or future revenues from lease receivables (asset-based), sale-back profit (debt-based at nominal value) or private equity from a portfolio of islamically acceptable assets (asset-backed) to a special purpose vehicle (spv) which refinances itself by issuing unsecured securities to market investors, most of the time represented by a trustee or an outside manager. the investors assume the role of a ―collective financier‖ whose entrepreneurial investment does not involve guaranteed, interest-based earnings. islamic securitization must confer upon investors clearly identifiable rights and obligations in securitized assets in order to ensure direct participation in the distribution of risk and reward of the contractual agreements with limited risk mitigation. hence, from a procedural and substantive perspective, islamic securitization would need to involve the conversion of uncertain, business related proceeds of direct investment in real economic activity compliant with the islamic ethics. based on the requirements set out by islamic scholars, the conventional pass-through payment structure (i.e., equity participation) of traditional securitization seems to be closest to the strict interpretation of islamic principles, which require the transfer of a minimum level of ownership to ensure direct investor participation in the business risk associated with the performance of a dedicated collateral pool of securitized assets. if the pass-through transaction removes the securitized assets from the originator‘s balance sheet (off-balance sheet), ownership conveyance through true sale should satisfy the required criteria from islamic law to compute the exclusive dedication of cash flows from the underlying asset to establish the linkage of ownership interest to identifiable economic activity. b. sukuk as a way to approach asset securitization sukuk are not new for the international capital markets anymore with all major institutions looking to grasp a share of this growing market. over the last few years, sukuk have evolved as a viable form of capital market-based islamic structured finance, which reconciles the concept of securitization and principles of the shariah law on the provision and use of financial products and services in a risk-mitigation structure subject to competitive pricing (el-qorchi, 2005 [17]). sukuk are not only issued by entities from the islamic world but also from the non-islamic, the latest participants on the launch list being the uk, luxembourg, south-africa, senegal, following multinational companies initiated by shell in the 1990s, ge in 2009 and the latest international banks such as hsbc, société générale, etc. according to moody‘s 5 , due to the nature of sukuk, all transactions are likely to involve a set of underlying assets. both parties – the issuer and the investors – share the risks in the transaction. where investors enjoy asset-backing, they benefit from some form of security or lien over the assets, and are therefore in a preferential position over other unsecured creditors. in other words, in the event that the issuer were to default or become insolvent, the sukuk holders would be able to recover their exposure by taking control of, and ultimately realizing the value, from the underlying assets. in such a case, the transaction may achieve a higher rating, compared to the unsecured issuer rating of the originator, subject to certain conditions. where the transaction is asset-based (which has been the case for the vast majority of bank sukuk so far), the originator undertakes to repurchase the assets from the issuer at maturity of the sukuk, or upon a pre-defined early termination event, for an amount equal to the principal repayment. in such a 5 understanding moody‘s approach to unsecured corporate sukuk, special comment, 2007 ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 6 repurchase undertaking, the true market value of the underlying asset (or asset portfolio) is irrelevant to the sukuk holders, as the amount is defined to be equivalent to the notes. in this case, investors in sukuk rely wholly on the originator‘s creditworthiness for repayment. this class of skuk is identical to unsecured lending from a risk perspective and hence attracts a similar capital charge as reminded by moody‘s. further, if we refer to moody‘s analysis for such structures, sukuk ratings comply to the following methodology: asset-backed sukuk, for which the ratings are primarily dependent on a risk analysis of the assets; unsecured (repurchase) sukuk, for which ratings are primarily dependent on the riskiness of the borrower/sponsor/originator/lessee. c. sukuk as a tool to structure return out of risk profiling the requirement of a direct linkage between identifiable assets and investors‘ funds under islamic law belies the commercial interest of establishing a legal separation of assets from the bankruptcy estate of the asset originator. from a market practitioner‘s point of view, we distinguish between the two structures of sukuk contracts that convey shariah-compliant asset ownership to investors: either (i) asset originators themselves issue notes backed by existing islamic assets, or (ii) the originator sells islamic assets (and/or the proceeds thereof) to an unaffiliated spv, which issues notes with a put/tender feature to fund the acquisition of assets. the notes are funded by the proceeds from the underlying assets paid to the spv as part of the repurchase obligation by the asset originator. depending on the claim-generating asset type of islamic finance, the spv acquires ownership rights on either (i) existing assets within a lease-purchase or sale-repurchase agreement, or (ii) future assets as equity investor, and structures the anticipated cash flows from these assets into sukuk payment obligations of different risk and maturity. these obligations entitle investors to a pro rata ownership in the spv and the proceeds generated from the net revenue of a loan, a lease or an investment project. the amount of debt issued is limited to the value of assets held by the spv. so far, research studies (jobst, 2006 [16]) indicate that many sukuk issues have utilized sovereign guarantees to redress the prohibition of credit enhancement or any other form of provision that mitigates business risk. while tranche subordination can be replicated by the combination of saleleaseback contracts in conformity to islamic law, other forms of credit enhancement in conventional securitization, such as over collateralization, reserve and spread accounts (―excess spread‖), and the retention of equity claims appear more difficult to implement within the limits of shariah compliance. if the issuer acts as residual claimant and retains undistributed cash flows generated from securitized assets as excess spread, the transaction would not qualify as a complete pass-through structure with full ownership by investors and might be deemed incompatible with shariah principles. instead, under the tenet of direct participation in underlying business risk islamic investors would need to contribute own income to fund a reserve account to cover possible losses. securitisation is commonly understood as an important risk management tool, mainly because its inherent differentiation and integration process (risk restructuring) allow issuers to reduce their cost of investment funding by segregating the risk exposure of a designated pool of assets. however, the conversion of balance-sheet risk into marketable securitised debt involves refined and complicated financial structures, which affect how credit (or asset) risk, market risk, liquidity risk and operational risk. the degree of investment risk in asset securitisation stems from two areas, namely (i) the characteristics and performance of existing and/or future receivables and other financial assets as sources of payments to the securitisation transaction (collateral level) as well as (ii) the allocation and distribution of payments from securitised assets to holders of the various tranches of issued debt securities (security level) in accordance with specific payment priorities and loss tolerance levels. when investors are looking at securitisation transactions such as sukuk deals, they are concerned with the credit (or asset) risk of fully and timely repayment of securitised assets in the underlying reference portfolio. although credit risk transfer by means of structured finance debt obligations lies at the core of risk management through securitisation, there is a host of further credit risk contingencies beyond the collateral level, such as the servicing function of securitised assets, the payment of administrative fees to the spv, the transfer of payments from debtors to investors and counterparty risk. issuers apply structural provisions to mitigate credit risk, such as (internal or external) credit enhancement and risk sharing mechanisms (through the subordination of issued debt securities) to attain a desired credit risk profile for issued debt securities. the islamic securitization market is still plagued by illiquidity due to limited depth and breadth, which inhibits efficient price discovery and information dissemination (archer and karim, 2002 [18]). although the commoditization of illiquid asset exposures through securitization facilitates the disciplining effect of capital markets on risk management, the lack of information from private sources about securitized assets in many sukuk impairs fair market valuation. moreover, the distribution for smaller corporate deals has often been restricted to one ―buy-and-hold‖ investor in the past, while the prevalence of sovereign guarantees has made asset risk incidental to counterparty risk and credit support mechanisms sponsored by sovereign goodwill, hampering market maturity and investor sophistication. beyond this economic and market maturity challenges, it is important as well to see if islamic securitization, in one form or another, can be an alternatives to smaller entities in the long run, part of the mission of islamic finance to serve the real economy. iv. smes financing and alternatives: is securitization an appropriate response? as a short introduction to this section, it is important to recall that smes (small and medium enterprises) are at the heart of european industrial r&d and innovation. far from ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 7 being the left over from business entities, they are a vibrant and innovative part of the european economy. smes account for 99% of all firms in europe, approximately two thirds of total private sector employment and play a disproportionately important role in generating employment. in france and as elsewhere, there has been lengthy debate on whether the banks are still providing enough credit to smes during this time of recession. on the one side, banks argue that new capital adequacy requirements such as basel ii and iii are a putting strain on their capacity to allocate loans to riskier and smaller corporates like smes. on the other side, governments are thriving to provide liquidity and guarantees to the market in order to sustain the origination of credit to smaller players that cannot have a direct access to capital markets. the question comes then to whether smes can tap into alternative sources of funding, from non-financial institutions or from institutional investors directly. to this end, many academic and government-led research have been conducted, probably the most comprehensive report has been done at the european commission level with the latest sme loan securitization initiative 6 . from this perspective, it is understood that banks do not lend to smes to support the economy but make a complex calculation of the profitability of their sme business, especially in relation to their other activities. in these calculations there are multiple parameters such as origination, credit assessment and servicing costs (kraemer-eis et al, 2010 [19]). however, the degree to which banks can transfer their assets (market liquidity) is a fundamental driver for banks‘ asset allocations and lending decisions. acknowledging that sme loans are amongst the least liquid assets in all of the european countries, the sme loan securitisation has been launched in order to ease the current situation. a. european commission’s approach to smes financing the european commission and especially the european investment fund, smesec ―creates indirectly a secondary market for sme loans, combined with funding for the originator: a bank acting as the originator extends loans to its sme customers, bundles them together in a pool and sells the portfolio to capital market investors through the issuance of notes by a special purpose vehicle backed by such a loan portfolio (asset-backed securities)‖ (kraemer-eis et al, 2010 [19]). what was true for securitization in general as discussed earlier, is true for smes as well. securitization of sme loans is the most efficient means to enhance access to debt finance by smes: by transferring their credit risk to the capital markets in an effective manner, banks achieve capital relief and free up capacity for new loans to smes. again, the question is what is meant by transfer of risk which would need to comply to islamic rules if islamic funding is to be call upon to be 6 sme loan securitisation (smesec) www.eif.org/eif_for/sme_finance/index.htm accessed on may 10th, 2014 allocated to european smes. in short, any initiative has to have features of a risk sharing instrument which means to engage not only the liabilities side of the security but the asset side as well, in effect, sharing the tangible underlying assets that provide the necessary ground for any claims and the substance of the profit share. risk sharing is the new mantra for the financial world, whether we are ready or not, it is collective challenge to overcome its fair assessment within acceptable level of transparency and costs. b. information asymmetries and transaction costs for smes information asymmetries are a key determinant of the problems experienced by smes in accessing funding, as they are the basis for a structural hesitancy of providers of sme finance. transaction costs first and foremost tend to magnify the impact of information asymmetries in financial transactions, thereby aggravating the conditions faced by smaller firms. asymmetric information is a more serious problem in sme financing than in banking activities of larger firms. oecd (2006 [20]) states that ―the entrepreneur has access to better information concerning the operation of the business and has considerable leeway in sharing such information with outsiders. however, the entrepreneur is also likely to have less training/experience in business than those in a larger company, although more adapted to operating in an uncertain environment. hence, it may be difficult for the outside provider of financing to determine whether the entrepreneur is making erroneous decisions or for the outsider to understand the business adequately. in addition, the entrepreneur may have incentives to remain opaque, not only in dealings with financiers, but also with outsiders such as regulators and tax authorities.‖ the literature on information asymmetry suggests three ways to reduce it: a firm‘s ability to signal its credit worthiness (including an institutional assessment or rating by an independent agency and the provision of collateral), a strong relationship between lender and borrower (proximity), and through due diligence/lenders‘ examination (screening). small enterprises, young companies or start-ups by definition have no track record, often only limited collateral, and no long standing relationship with lenders. one could even simplify that: the smaller the company, the bigger the information asymmetry and thus the higher the transaction costs in relative terms (pelly and kraemer-eis, 2011 [21]). moreover, the use of collateral increases the cost of lending (from the perspective of the borrower, e.g. legal and administrative cost), and the collateral may be worth more to the borrower than to the lender. credit guarantee mechanisms are intended to address these market failures as they reduce the financial loss of the lender in case of default of the borrower (oecd, 2013 [22]). sme loans are, in principle, less homogenous than residential mortgages (with regard to size, legal forms, collateral etc.) and the underwriting criteria are less standardised. on the other hand, sme loans are typically http://www.eif.org/eif_for/sme_finance/index.htm ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 8 thoroughly analysed by credit experts and systems (e.g. most banks apply detailed quantitative internal rating methodologies on top of more qualitative assessments). moreover, banks normally use a relationship banking approach and know their customers very well, thus enabling them to manage the risk of the customer over the long term in contrast to the more automated lending decisions seen in the mortgage and credit card markets. this distinguishes the european initiative smesec from those other securitised asset classes. in order to restore confidence in this market and to revive primary market activities, greater standardisation and transparency is needed, as well as the avoidance of overly complex structures. due to the challenges that the sme abs market has been facing since the crisis, financial institutions have been seeking alternative means of funding sme loans. in germany, commerzbanks‘ issuance of a structured sme covered bond has attracted quite a lot of coverage and renewed the discussion of the participation of sme loans in the covered bond space, although this is a topic of hot debate at the moment. moreover, in france a scheme is under discussion and development under the lead of the bank of france to help banks to package sme loans into tradable securities via a special purpose vehicle (spv). the approach combines elements of securitisation (i.e. french fonds commun de titrisation (fct) rules) and the covered bonds law (i.e. societiés de financement de l‘habitat (sfh)), in order to boost sme funding (sanderson, 2013 [23]). these transactions can help to support sme financing via funding advantages for the originating banks, and it might well be that in many countries legislators are going to introduce covered bonds legal frameworks. achieving the same for islamic securitization would be a great step forward. c. direct lending funds to smes and asset management of smes portfolio given the sustaining credit crunch that is impacting heavily the smes, regulators and market professionals have been looking to banking alternatives to propel other forms of financing to this sector of economic activity. as a consequence of this context of prolonging european banking crisis, and the consequent changes in banking regulation and structures, a new asset class called smes direct lending is emerging. report from eurocredit exchange 7 suggests that smes direct lending is europe‘s newest and most exciting real asset class and has the potential to become one of the largest. the structure of the debt tends to be bilateral loans secured on the operational businesses, with either a single lender or club of lenders participating. in broad terms, there are three typical types of structures most prevalent: lending alongside a bank: an institutional tranche with either a longer tenor or bullet structure alongside a bank‘s 7 http://eurocreditexchange.com/wpcontent/uploads/2014/01/mm-direct-lending-overview-jan2014.pdf accessed on may 14, 2014 senior secured, covenanted, amortising loan tranche. alternatively an institution provides similar bank-type financing directly. replacement of bank: unitranche or stretched senior product. higher total commitment, higher leverage, additional covenant headroom and more flexible use of proceeds. a bank normally provides a super-senior revolving facility or perhaps a ―first out‖ piece. junior or subordinated lender: mezzanine or with an equity kicker or preferred equity. direct-lending can have three distinct advantages over the traditional bank lending offer, namely longer term-financing, as well as more flexibility in both the structure (e.g. senior, mezzanine, unitranches and even equity contributions, nonamortising, greater covenant headroom) and in the use of proceeds (e.g. growth, acquisition, capex and dividend recaps). direct-lenders are also often willing to explore industry sectors and geographical jurisdictions that the main banks are now more reluctant to lend to. naturally such flexibility may come at a higher cost to the borrower but this generally reflects an appropriate price and compensation for the higher respective risk. direct-lending funds often have long lock-ups of committed capital, i.e. 5-10 years, and can therefore provide longer term financing (especially to levered corporates) than most banks (as a bank‘s capital requirement is a direct function of tenor and credit quality). private placement bond investors can envisage even longer tenors, especially pension schemes and insurance funds looking to match long-term liabilities. as the tenors are longer for these loans, and direct-lenders are hold-to-maturity lenders, then respective borrowers and lenders become highly aligned to the long-term success of the business. borrowers with access to more flexible, longer-term financing from non-bank institutional lenders can benefit from a more stable business outlook and greater operational flexibility. direct-lenders do not require a borrower to have an official credit rating which represents a significant cost saving compared to the public corporate bond market. on the supply side, there are some growing advantages for long term institutional investors to allocate funds to smes over competing asset classes for different reasons: it exhibits less volatile asset pricing it enables increased diversification of corporate exposure it provides better management of the illiquidity risk premium with the expertise of asset management team specialized in smes investment, funders such as insurance and pensions companies, can gain exposure to better risk-adjusted portfolio return, increased diversification of risks to corporate exposure (compared to existing large cap public bond and equity capital markets), lower pricing volatility (held at amortised cost) and be able to match direct-lending assets to liabilities in a more stable and transparent manner. this is a typical model setup in france with asset managers specialized in smes debt origination such as acofi am or tikehau am. http://eurocreditexchange.com/wp-content/uploads/2014/01/mm-direct-lending-overview-jan-2014.pdf%20accessed%20on%20may%2014 http://eurocreditexchange.com/wp-content/uploads/2014/01/mm-direct-lending-overview-jan-2014.pdf%20accessed%20on%20may%2014 http://eurocreditexchange.com/wp-content/uploads/2014/01/mm-direct-lending-overview-jan-2014.pdf%20accessed%20on%20may%2014 ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 9 v. smes alternatives financing in france: prototype of a local sukuk issuance smes financing issues in france are not new, different initiatives have spawn around from market professionals in order to come to adequate and accessible solutions. in an attempt to structure a mudaraba-based partnership financing instrument specifically for smes, called a ―hybrid sukuk model‖, we achieved to launch the first private sukuk in the french market in 2012 (patel, 2014 [24]). we demonstrated that, this setup makes transaction costs incrementally insignificant and as such, it does provide a credible alternative to conventional loans which are increasingly costly and inaccessible to smaller smes or entrepreneurs due to the credit crunch. in short, this first model was neither an equity partnership where the capital investors take most if not all power and upside gain nor a pure collateral-based debt with a pre-defined interest rate disconnected to the performance of the project. but it is a true value-sharing instrument between an entrepreneur (mudarib) with its expertise and business idea, and investors (rab al maal) committing to a participative debt funding component (sak) completely modeled on the business plan and potential value of the underlying assets making it truly a risk sharing transaction. it is not a win-lose situation as for a classical lender to borrower relationship but a participative financing method dependent on the success of the project to generate the necessary cash-flow that gives a chance to the entrepreneur to grow and be successful with a performance shared with its capital partners (sukuk holders). but this experience allows us to reflect on a broader perspective, and especially for smes that may not be able to provide tangible assets as collateral or a capital structure for quasi-equity financing. indeed, we had to face many demands from french smes looking to working capital finance, trade finance, on a short to medium term needs with increasing size of capital allowance. we are detailing the salient points of our experience in the following case study. as background information, it is a meeting with an international scholar during the world islamic economy forum in dubai in november 2013 and a page in the report published by zawya reuters at this event called ―air time sukuk‖ being proposed by international scholars in asia that triggered the idea to prototype a new innovative sukuk sme structure in the french market. a. case overview in the late 2014, we have been approached by entrepreneurs looking to build on their trading operations between europe and north africa in the telecom business. the sme has a successful track record dealing with major international suppliers and clients in a niche sector but has to limit its purchasing capacity due to delay in payment from its customers. working capital needs and receivables trading were the key business elements of this candidate for a new sukuk structure. in effect, the solution was to cover the funding gap for the timeframe when cash is submitted to the supplier in exchange of goods and the clients‘ payment cycle time which is ranging from 30 to 60 days. to this end, after a long analysis of its business model and cash flow generation in the telecom industry, we devised a kind of reverse factoring model in order to use investors‘ money to make the trading purchase done on robust ground as we will explain later. sharing the profit obtained when the payments will be received from the customers on a yearly basis is at the core of the structuring exercise, again inspired by what has been called air time sukuk by market practitioners (best examples with mobily in saudi arabia, 2008; etisalat in uae, 2010; celcom in malaysia, 2012). below is the process followed to structure this sme mudaraba sukuk in a form of participating bond in french law which has gotten approval from french sharia scholars and has been attracting potential interests from french speaking countries (france, luxembourg and north africa). the issuer is a french ―société par actions simplifiée‖, i.e. a limited liability company whose shares are held entirely by the sponsor. its sole object and activity is to finance the working capital needs of trading activities for which the shareholders of the sponsor have particular expertise and wish to finance on a limited recourse basis. for this purpose, the proceeds of the issuance of the participating bonds will be made available by the issuer (the mudarib) to a commissioning agent (legal name for the wakil but in practice for our research discussion the asset manager) on a revolving basis under the terms of the investment agreement (wakala) for the latter to purchase services from the suppliers and on-sell them, acting in its own name but on behalf of the issuer, to the clients. one fundamental characteristic which is part of the whole transparency and tracking of the mudaraba operations is that the agent will be entitled to make a cash call to the issuer to pay services to a given supplier only if at or prior to that time, there is an order from a client for a price that is higher than that payable to the relevant supplier. in this case, each cash call with the known buy and sell price will make the basis of the cash flow that will constitute the mudaraba asset in order to compute the profit share between the mudarib and the investors (rab al maal). in effect, amounts received from the agent by the issuer under any operations on a dedicated bank account in any given year shall be applied as the cash waterfall as follows: first as payment of the relevant amount of commission and all other operating expenses of the issuer which are then due and payable; second to the credit of reserve account 1, which is a bank account that collects all the expected remuneration until the credit balance of such account is equal to the yearly required amount; third to the credit of reserve account 2, which is another separate bank account allowing to collect the aggregate of the required balance of that account (i.e. the nominal investment amount from the sukukholders); ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 10 the participating bonds will carry the right to an expected remuneration equal to say 10 % per annum of the principal payable on each anniversary of the date of the issuance (this remuneration is derived from the profit sharing ratio set in the mudaraba agreement which is the essence of the islamic structure). should the proceeds of the trading operations not allow for the full payment of the expected remuneration in a given year, the sukukholders will be entitled to receive a sum equal to the amount of gross profit margin received by the issuer during that year and credited to reserve account 1. provided that no event of default has occurred and is continuing, payment of the shortfall will be carried over to the next date for payment of expected remuneration and will not attract late interest or penalties. if an event of default has occurred and is continuing, the bondholders will be entitled to accelerate the repayment of the participating bonds and all sums owed in that respect. b. structuring constraints from legal and sharia aspects structuring such an ambitious product for a smes not familiar with structured finance required a robust financial and risk analysis with all necessary contracts setup to be agreed by the parties. the tenor of the participating bonds has been derived in order to procure enough capital flows for the issuer while securing the project risks from the investors‘ point of view. on top of the business planning and cash flow detailed analysis, there is a comprehensive security package that ensures that cash invested by the sukukholders or the receivables arising out of the use of such cash is at all times secured for the benefit on the investors. this list of security interests for the benefit of the sukukholders is the result of long discussions between the parties including the sharia scholars in order to achieve a fine balance between acceptable risk sharing engagements and yet suitable to conform to the required form and substance of validation from islamic laws: the shares in the issuer (spv) are charged to the benefit of the sukukholders so as to ensure, as much as possible, the transfer of the project as a going concern in the event of realization and that no change of control can effectively occur at that level; the proceeds of the issuance will be paid into the reserve account 2 which will be secured to the benefit of the bondholders. any payment of the principal of a trading operation from a client will also be made by the commissioning agent into reserve account 2 shortly upon receiving such payment. the client receivables of the commissioning agent against the client and the claim of the issuer against the investment agent for payment of the sums invoiced by the latter to the clients and, more generally, all claims of the issuer against the commissioning agent under the wakala agreement will also be secured in favor of the sukukholders so that in effect the principal of the participating bonds is always secured be it in the form of cash in reserve account 2 or in the form of the above mentioned receivables; the capacity of the issuer to fulfil its obligations towards the sukukholders relies on receiving sufficient amount of margin out of the trading operations, which involves: credit risk over the operators which is mitigated by the credit quality of the existing operators and the criterion for replacement or under consumption (acceptability to factoring companies); performance risk taken on the commissioning agent which is mitigated by the fact that it is managed and controlled by managers with a strong track record in telecom trading and the priority awarded to the expected remuneration on the results of the first trading operations each year operational risks regarding the process for the trading operations that a given client would withdraw a purchase order at a time where the commissioning agent has made a cash call on the issuer and has paid the corresponding services to a supplier. assumption of that risk is necessary in order for the structure to receive approval from the scholars committee. the sukuk certificates will carry the right to an expected remuneration payable on each anniversary of the date of the issuance. should the proceeds of the telecom operations not allow for the full payment of the expected remuneration in a given year, the sukukholders will be entitled to receive a sum equal to the amount of gross profit margin received by the issuer during that year and credited to reserve account 1. provided that no event of default has occurred and is continuing, payment of the shortfall will be carried over to the next date for payment of expected remuneration and will not attract late interest or penalties. if an event of default has occurred and is continuing, the sukukholders will be entitled to accelerate the repayment of the sukuk and all sums owed in that respect as shown in figure 1 below. ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 11 c. shifting sukuk from traditional banking towards direct web-based funding in this case, the mudaraba format of sukuk has been chosen to raise funds for different reasons. mudaraba firstly, is part of the participating contracts that are praised by islamic ethics as it truly engage parties in sharing risks before sharing profits eventually. sukuk mudaraba secondly, allow dividing the mudaraba capital (formed by cash from the investor and expertise from the operator) into equal value units representing shared ownership, each unit from the investors‘ capital is registered under a sukuk holder‘s name, which collectively reflect the common asset in mudaraba capital. sukuk owners acquire a defined proportion of the project profit, which is set out in the sukuk issuance documentation (prospectus). mudaraba sukuk neither yield interest nor entitle owner to make claims for any definite annual interest. this means that mudaraba sukuk are like shares with regard to vary returns, which are accrued according to the profits made by the project. this feature is not really specific to islamic finance as it is increasingly used in risk sharing finance which is especially getting more ground and appeal in the crowdfunding dynamics. new types of loans are emerging among the different crowdfunding categories, not so for equity-based platforms but rather for reward-based or profit/revenuesharing platforms 8 . in effect, all this is reflecting a new direction of finance towards asset and project finance facilitated by third parties (asset management or crowdfunding platform) that execute a trust mandate on behalf of investors. moreover, the other challenge in this case was to cope of the nature of the smes environment with lack of information, higher transaction costs and costs of risks. the approach from the beginning was to develop a first experiment that leverages structured finance and technology platform (called ―fintech‖) and exploring new structure such as an asset managed sukuk class developed on a web-based platform that originates, underwrites and allocates funds from pool of investors to different targets, capitalizing on the variant options of structured financing/ securitization offered by islamic finance. the key aspect here regarding smes and the latency of these business operations is to leverage technology to automate and simplify the whole process in order to gain respectively, speed and reduced operational costs. islamic securitization for project sukuk provides clear benefits to corporates but implies many impediments for smaller ventures. our trial solution and its further developments consist of building a platform that is structured around few key features: an alternative to bank financing for small firms by creating the condition of a « covered pool sukuk » based on project finance techniques (true sale of assets pledged 8 the rise of future of finance, the uk alternative finance benchmarking report, liam collins, nesta richard swart, university of california, berkeley, bryan zhang, university of cambridge, december 2013 against secured business cash flow) that mutualises risks and rewards benefits; the pricing of such project financing should reflect not the credit scoring of the borrower but the rating of the underlying assets with their cash flow risk profile using project finance techniques in addition to the crowd sentiment of the business rationale of the project (issuers incur an obligation to repay sukukholders who, but these payments are variable and are a function of the revenues or profits of the project); transaction costs, thanks to technology, are incrementally reduced while process efficiency brings value to all parties especially investors who can have better transparency enabling better personal and trust relationships on a recurring basis (access to all information, anytime, anywhere, any device). eluding on the dynamics of crowdfunding, it would be very interesting to see its evolution over the years and how islamic finance can mold itself in this new alternative finance. islamic finance can not only be part of the (r)evolution but more importantly, it can drive the risk-sharing model which is at the heart of its ethics. the potential of these new ways of financing, less opaque, less virtual, less disconnected to economic activities can provide great potential for smes and entrepreneurs all over. it can turbocharge the resurgence of the cooperative model, in a digital format this time, and it can enable the decentralisation of global corporate control which today is concentrated in few transnational financial institutions because of their banking monopoly and their power of creating money. it can also be instrumental in implementing lending marketplace such as the success of lendingclub in the us or funding circle in the uk. going back to our prototype facilitating working capital, it is interesting to note many initiatives are addressing the funding gap of invoices from smes with such platforms as market invoice in the uk or finexkap in france, all new fintech actors that are speeding to disintermediate the factoring and reverse factoring business. as we are wrapping up this paper, a new article on reuter 9 announces that tawreeq, based in dubai and luxembourg, is aiming to give smaller firms a funding alternative to bank loans, which can be cumbersome and costly for most. the idea is to provide an islamic trade receivables financing platform catering to the gulf region's small businesses, with plans to tap the capital markets to fund the venture. "conventional factoring is more a form of discounting bills, while our model is about the collaboration of buyers and suppliers to offer complete cash-flow solutions." this is definitely a great move towards better solutions for smes leveraging the securitization techniques to trade receivables. but the challenge is not merely channeling invoices against cash after an interest charge over its payments but more profoundly, rethinking the supply chain of finance and trade, by engaging financial institutions (i.e. direct investors, asset managers…) in the trade process, within 9 http://www.reuters.com/article/2015/01/27/islamicfinance-factoring-idusl6n0v503e20150127 on 28 jan. 2015 http://www.reuters.com/article/2015/01/27/islamic-finance-factoring-idusl6n0v503e20150127 http://www.reuters.com/article/2015/01/27/islamic-finance-factoring-idusl6n0v503e20150127 ejif – european journal of islamic finance no1,dec (2014) http://www.ojs.unito.it/index.php/ejif 12 the buying and selling cycle while sharing the risks and the profits. asset-managed platforms are a great start. vi. conclusion: cooperation towards sukuk mandates carried out by independent asset managers there have been some clear lessons learnt from the financial crisis which impacted substantially the securitization market. for instance, a study conducted by bearingpoint 10 asking market participants for an evaluation of selected measures to resurrect the securitisation market, highlighted some key messages: the focus of future securitization deals will be on receivables from the real economy, especially for smes (78%), but no longer on the repackaging of securitisation tranches. in order to resurrect the securitization market, transparency, standards and less complex transaction structures are required (84%). an essential prerequisite for a functioning securitisation market is the supervision of the rating agencies (73%). in the case of islamic securitization via partnership-based sukuk as discussed in this paper, it has great potential for promoting risk-sharing thereby increasing mobilization of savings and investment, hence spurring growth which leads to enhanced welfare. sukuk are very convenient vehicles of transferring some of this liquidity to people capable of employing it into productive projects as exemplified by crowdfunding platforms. a diverse spectrum of investment vehicles serves persons with different perceptions of risks and returns, again the different crowdfunding models are pleading towards this trend. in this regard, islamic securitization based on partnership principles have directed towards risk sharing due to wealth creation, to be shared between both fund providers (investors) and fund users (sukuk issuers), while both bear the risks involved and the resulting loss. if asset-based sukuk does not hold real assets and assetbacked sukuk are difficult to perform the true sale of assets given legal and tax constraints, a third option is possible through this third way we called asset-managed sukuk. the underlying assets are originated not from financial intermediaries but by asset-managers directly on behalf of investors. this is the virtue of the direct lending model, making all this much more practical, starting from local investors and reaching out to international investors. references [1] maurer, b., 2010, ―form versus substance: aaoifi projects and islamic fundamentals in the case of sukuk‖, journal of islamic accounting and business research, 1, 32-41. 10 asset-backed finance research, future of securitization in europe, 2010, bearingpoint germany [2] čihák, m. and hesse h., 2008, ―islamic banks and financial stability: an empirical analysis‖, imf working paper 08/16. [3] hesse, h., jobst a., and solé, j., 2008, ―trends and challenges in islamic finance‖, imf world economics. [4] jobst, a., kunzel p., mills p. and sy a., 2008, ―islamic bond issuance – what sovereign debt managers need to know‖, international journal of islamic & middle east finance and management, vol. 1, no. 4. [5] wighton, d., 2005, ―credit protection: lightyear set to exploit the cdo market‖, financial times, (january 3), pp. 10. [6] telpner, j., 2003, ―a securitisation primer for first time issuers‖, global securitization and structured finance, greenberg traurig. [7] kendall, l., 1996, ―a primer on securitization‖, mit press, cambridge, massachusetts. [8] myers, s. c. 1977, ―determinants of corporate borrowing‖, journal of financial economics, vol. 5, 147-75. [9] myers, s. c. (1984), ―the capital structure puzzle‖, journal of finance, vol. 39, 575-92. [10] jensen, m. c. and w. h. meckling, 1976, ―theory of the firm: managerial behavior, agency costs and ownership structure,‖ journal of financial economics, vol. 3, 305-60. [11] benveniste, l. m. and a. n. berger, 1987, ―securitization with recourse: an instrument that offers uninsured bank depositors sequential claims‖, journal of banking and finance, vol. 11, 403-24. [12] myers, s. c. and n. s. majluf, 1984, ―corporate financing and investment decisions when firms have information that investors do not have‖, journal of financial economics, vol. 13, 187-221. [13] shyam-sunder, l. and s. c. myers, 1999, ―testing static trade-off against pecking order models of capital structure‖, journal of financial economics, vol. 51, 219-44. [14] akerlof, g, 1970, ―the market for lemons: quality uncertainty and the market mechanism‖, quarterly journal of economics, vol. 84, 488-500. [15] mirakhor a. and iqbal z., 1988, ―stabilization and growth in an open islamic economy‖, imf working paper no. 88/22, international monetary fund (imf). [16] jobst, a., 2006, ―the economics of islamic finance and securitization‖, journal of structured finance, vol. 13, no. 1, 1-22. [17] el-qorchi, m., 2005, ―islamic finance gears up,‖ finance and development, (december), international monetary fund, pp. 46–9. [18] archer s. and karim a.r. (eds.). 2002. islamic finance: innovation and growth. euromoney books and aaoifi. [19] kraemer-eis, h., schaber, m. and tappi, a., 2010, sme loan securitisation. an important tool to support european sme lending‖. eif working paper 2010/007. [20] oecd, 2006, ―the sme financing gap, theory and evidence‖, volume i [21] kelly, r. and kraemer-eis, h. (2011). european small business finance outlook. eif working paper 2012/010. june 2011. [22] oecd, 2013, sme and entrepreneurship financing: the role of credit guarantee schemes and mutual guarantee societies in supporting finance for small and medium-sized enterprises‖. [23] sanderson, o., 2013, ―france sme scheme to fuse securitisation and covered bonds‖. reuters. patel a, 2014, ―can hybrid sukuk be a credible alternative to loan financing?‖, in islamic finance and development, ali n. (eds), ilsp harvard law school, 169 – 96. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france paper title (use style: paper title) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 1 judicial decision-making in islamic banking and finance * syracuse university college of law abstract— in response to the criticism and scant discussion of judicial decision-making in islamic jurisprudence this paper analyzes the judicial decision-making of the jurists on shari’ah supervisory boards. first the paper provides a background into islamic banking and the legal framework of the shari’ah. second paper examines two methods of judicial-decision making, legalism and the economic theory, as applied to islamic jurists. although viewed as distinct theories, i argue that the holistic nature of the shari’ah inevitably weaves the two methods together. finally, the paper calls for a broader discussion on whether western theories of judicial decision-making, and therefore concepts of legal realism, should be used to analyze islamic jurists. keywords-judicial decision-making, ijtihad; legalism; fatwa; fiqh, legal theory i. introduction: an overview of the shari‟ah and islamic banking this paper aims to establish a framework and begin a dialogue for understanding, analyzing, and predicting the judicial decision-making process regulating the islamic banking industry. the islamic banking industry‟s estimated value is over a trillion dollars and has been growing ten percent per year since the 1990‟s [20]. yet islamic banking practices are almost entirely regulated by a select group of jurists and judicial institutions that decide whether or not a financial product, transaction, or contract is lawful under the shari‟ah [20] [48]. generally these decisions are in the form of a single fatwa, or judicial opinion. it is my understanding that the judicial decision-making of these private jurists is highly legalistic, and that a legalist method is the best way to assess and predict judicial outcomes. however i will make an attempt at critical analysis by exploring the economic theory of judicial decision-making and discussing the need for social-science based approaches founded on empirical research, as there are social and psychological factors that may influence rulings. while this article is written primarily for those seeking a deeper understanding of judicial decision-making in islamic banking, there is also secondary purpose to the article that seeks to begin a constructive dialogue among scholars of islamic jurisprudence 1 as to whether or not a critical analysis of modern islamic judicial decision-making is necessary, helpful, or even appropriate. a. why the study of judicial decision-making in islamic jurisprudence regarding banking and finance is important. thus far the study of islamic banking and finance law by western and most islamic scholars has focused primarily on “what” is and is not permissible under the shari’ah. however there has been little research in regards to the “how” and “why” jurists are reaching these outcomes and the process that takes them to their legal conclusion. if there is something other then a legalistic approach being used the question becomes how big an influence is it and whether or not other approaches should be discussed among practitioners of, and actors in, the world of islamic banking law. if not adopted as a form of national governance, like in saudi arabia, the shari’ah is binding on only those who accept it [12] [9]. 2 for the most part it is up to the individual, or bank, to regulate his or her own actions in accordance with the shari’ah. so while islamic banks may operate globally they are expected that to follow religious guidelines of the shari’ah even when engaging in business within secular nations [35]. this concept expands the jurisdiction and role of the jurist in islamic banking, making the study of his judicial decision-making process all the more important. it also increases the importance of studying islamic jurisprudence in western law schools 3 because islamic financial products, and the contracts that accompany them may begin to appear more frequently in western litigation following the recent political shifts in the middle east [35]. 1 jurisprudence is the “process by means of which jurists derive sets of guidelines rules and regulations islamic from the principles of the qur‟an and the sunnah” [22]. 2 al-fahad discusses saudi‟s adoption of hanbali fiqh under a strict, now loosened, “wahhabi” interpretation. 3 “as professor w. m. ballantyne notes, „even where the shari'a is not applied in current practice, there could be a reversion to it in any particular case. without doubt, knowledge of the shari'a will become increasingly important for practitioners, not only in saudi arabia, but in the other muslim jurisdictions‟” [35]. spencer j. coopchik, esq. * ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 2 although research leads me to believe that the legalist method is the primary form of judicial decision-making, testing the other models of judicial decision-making remains relevant as a means of supporting my initial belief. therefore i am suggesting a dialogue as to whether other approaches, including economic models, applied by scholars studying decision-making of united state‟s federal judges should be applied to islamic jurists who regulate the islamic financial market [15]. 4 because the role of the jurist in both legal realms is essentially the same, (as in both types of jurists decide what is and is not lawful conduct within the confines of the law) it is possible that other theories used to analyze judicial decision-making through social sciences may also be applicable in understanding and predicting islamic judicial decisions. this is important for numerous reasons, principally because the islamic banking industry is continuously growing and intends on expanding its cliental basis to religious muslims in secular western nations reaching a projected worth of four trillion dollars [20] [13]. unfortunately, businesses and investors dislike the degree of uncertainty caused by the jurist‟s ability to reconsider rulings [48]. therefore in order to create more confidence in the islamic market it is crucial that judicial decisions regarding financial products are predictable, stable, and representative of future decisions on similar legal issues [48]. in order to illustrate this point i will provide an example of how a single and unforeseen judicial decision by a prominent jurist can create a shift in the islamic market place. in november 2007, an islamic finance scholar, sheikh muhammad taqi usmani, questioned whether the issuance of sukuk 5 was technically in compliance with the fundamental prohibition against interest. usmani stated in a policy paper, “the time has come to revisit this matter, and rid sukuk of these blemishes.” these “blemishes” include, among other things, the now-common practice of marketing assetbacked returns on the basis of the libor rate benchmark, which is a “corruption” according to usmani… up to the time that usmani released this statement, sukuk had been considered the backbone of islamic finance and had allowed the system to grow and expand into more traditional investment arenas. 4 in his research, baum reviews legal, attitudinal, and strategic models. 5 “sukuk are investment certificates. sometime they represent „ownership‟ in the assets underlying the issue. those with variable returns are based on mudarabah or musharakah. more popular are those with pre-determined, fixed incomes. the simplest of these is the one based on ijarah, i.e., lease or hire. a building (or an oil tanker) is purchased and rented out, the money capital for the purchase having been mobilized by selling certificates. owners of these certificates would be entitled to receive a portion of the rent income” [52]. after usmani‟s pronouncement, sukuk issuances dropped off dramatically. while many acknowledge that at least some of this decline may be attributed to the overall decline of worldwide financial markets, it is likely that usmani‟s comments also contributed to the trend. commentators, scholars, and investors were widely surprised and alarmed by how a single speech could set back progress and investment in a product that had proven so successful in recent years [48]. 6 the example above demonstrates the need to study and understand the decision-making process as well as the influences and motivations on this select group of jurists and judicial institutions. understanding how sheikh usmani reached his decision regarding sukuk can be best analyzed through the legalist method as applied in islamic jurisprudence, which i will lay out later in the paper. however one may also try and look at the sheikh‟s decision through other means of critical analysis, like the economic method, to find possible motivators for the timing of the opinion. in order to present those methods of judicial decision-making it is important that the reader understand the basics of the shari’ah, islamic banking, and the jurists regulating the trade. b. the shari’ah generally first, a disclaimer. this is a very broad and simplistic overview of a fourteen hundred year old legal tradition that encompasses all the earthy and divine aspects of an individual‟s life [22]. this section is intended to give the reader a basic overview of the shari’ah in order to comprehend latter analysis of the legalist method in islamic jurisprudence. moreover i will focus only on sunni legal tradition and schools simply because islamic banks governed by sunni islamic jurisprudence and jurists are more prevalent [33] [35]. 7 further research is suggested to those interested in the specific mechanisms of the shari’ah mentioned here, as no single article could sufficiently articulate the workings of any legal system [16]. shari’ah is can be translated in two ways: first, religiously as “god‟s eternal immutable will for humanity,” a divine law encompassing all the spiritual and the mundane, and second by as “islamic law.” 8 the former is more appropriate because while the shari’ah is often legal in nature it sees a sacred component to all actions taken throughout ones existence and therefore all actions, including contracts or financial transactions, are subject to religious legal analysis and 6 sheikh usmani‟s full opinion can be, and should be, downloaded from his website [53] for a better understanding of sukuk and the jurists role in the islamic finance market. 7 in this regard, kettell cites [18]. 8 the oxford dictionary of islam, unlike christian legal traditions islam see‟s no separation between the sacred and the profane, all acts are encompassed and categorized under the shari’ah [26]. ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 3 categorization [33]. contrary to the western idea of an “islamic law” the shari’ah is not codified, nor is there a singular vision on the various legal subjects within it [41]. for the purposes of this article, and in order to avoid more complex theological issues, this article will refer to the shari’ah as a holistic islamic law given by god and exemplified through his prophet muhammad as understood by scholars and jurists and applied in islamic societies throughout history. implementation, understanding, and development of the shari’ah has differed over time and often changes in various regions of the world [51]. like other legal traditions there are different schools of thought, legal theories, and “splits in the courts” so to speak. despite the perceived rigidity of religious law, individuals or institutions who choose the path of the shari’ah have some leeway in following the law as it is often the case that differing judicial opinions will create areas where stricter or loser observance of a particular rule are both equally valid [12]. this is not to suggest that islamic jurist decide “arbitrarily” as orientalists and a supreme court justice have suggested [47], 9 but rather that there is the possibility of having differing yet equally valid legal rules on a particular issue [12]. the concepts of pluralism and public choice, described by liaquat ali khan as elements of the “freemarkets” of islamic jurisprudence will be discussed later as possible influences on the judicial decision-making process [12] [28]. differing opinions are often caused by the fact that jurists in different regions may study legal theory under different schools of law [12]. in sunni islamic jurisprudence there are four main schools of law that were developed in the early eighth and ninth centuries [51]. these four schools or madhhabs (literally paths) are still predominant today and the early treatises of their founders are often cited as theoretical basis in fatwas 10 regarding islamic banking [46]. the four schools are hanafi, maliki, hanbali, and shafi’i named after the founding jurist [31]. for the most part the schools agree on nearly every major aspect of the shari’ah, however, despite reaching similar legal conclusions, their legal theories and methods of interpretation differ. 11 it is often the case that one 9 “terminiello v. chicago, 337 u.s. 1, 11 (1949) (frankfurter, j., dissenting). in reference to justice frankfurter referring to an islamic jurist deciding arbitrarily beneath a tree. “frankfurter's imagery undoubtedly was inspired by the judicial archetypes devised by max weber, who described uncontrolled judicial discretion as “kadi justice”” [47]. kadi‟s or qadi‟s are islamic jurists appointed to a state judgeship and were inaccurately portrayed by orientalists as arbitrary decision makers. 10 i am aware that “fatawa” is the proper arabic plural, however in order to create ease and limit confusion i opted for an anglicized plural where the “s” creates distinction more noticeable to western readers. 11 “over time, the legal methods and conclusions of the most influential scholars evolved into distinct schools of thought. because muslims never created a formal church, islamic legal school of law is predominant in a region; such rules and theories of one school are preferred over the other schools. for example the law of saudi arabia is entirely based on hanbali fiqh, or substantive law [9]. 1) fiqh the western idea of an islamic law is better expressed through the term fiqh. fiqh is the substantive aspect of the shari’ah in which clear legal rules are formed and derived from the shari’ah sources, and unlike the shari’ah, fiqh is mutable [26]. fiqh is the shari’ah as understood and declared by the jurists and therefore it is fallible [26] [47]. it is the “science of the shari’ah” and contains judicial articulations of the law set forth by god and the prophet [33]. the categorizations of lawful and unlawful acts are most easily found in the volumes of fiqh written by jurists and legal scholars rather then the shari’ah sources like the qur‟an where rules are more ambiguous [47] [30]. fiqh should not be confused with siyasa, or state legislation [51] [46]. under the shari’ah all actions fall under five categories: 1.) wajiban obligatory duty, the omission of which is prohibited and punishable [33]. 2.) mustahaban action that is rewarded or recommended but omission of which is not prohibited or punishable [33]. 3.) mubaha permissible act of which the shari’ah is indifferent [33]. 4.) makruhan act that is disliked and should be avoided; avoidance of the act is rewarded but commission of it is not prohibited or punishable [33]. 5.) haraman action that is prohibited and intentional commission of the act is punishable [33]. categories one through four are halal, meaning they are lawful (or permissible) even if disliked, unless it is wajib where omission of an act is unlawful. it is the role of the jurist to define which financial products or transactions are halal and which are haram under the shari’ah. while the shari’ah is often described as “jurists law,” the jurist can only seek to understand and expand applications of the law given by god and the prophet muhammad who comprise the sole legislative body [14]. the jurist states what the accepted law is, or should be, on a matter often deciding whether something is halal or haram. however when a novel issue arises the role of the jurist has best been best described as “searching” for the law rather than creating it, and thus a new rule is found instead of manufactured [55]. orthodoxy formed around those private scholars who distinguished themselves by education, dialectical skill, and popularity with students and the public who consulted them. over the years, many schools of law emerged as students collected the lectures and legal opinions of influential jurists and eventually wrote commentaries upon them. with a sufficient number of disciples preserving and expanding the work of a particular jurist (and especially when accompanied by popular and other external support), that jurist's corpus of opinions and accompanying legal methodology became known as a „madhhab‟” [46]. ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 4 the sources the jurists search and find the laws within are primarily the holy qur‟an, the literal word of god, and the sunnah, which are the sayings (hadith) and actions of the prophet [14]. the qur‟an and the sunnah are considered the primary sources of the shari’ah and secondary sources, like fiqh manuals, cannot contradict them [14]. the qur‟an only contains roughly 500 verses with legal substance out of the 6,239 verses that make up it entirety [14]. 12 the normative verses discuss a wide range of legal subjects that can be broken up into two general categories, ibadat and mu’amalat [14]. ibadat pertains to those actions in the spiritual realm, prayer, fasting and so on. mu’amalat deals with social interactions in nature like contracts, wills, and riba [14]. riba is the concept of interest that is explicitly prohibited by god in the qur‟an and is the underlying unlawful (haram) custom that islamic banks seek to avoid [26]. 2) secondary sources of law while the qur‟an offers the basic guidelines many norms and rulings in islamic jurisprudence are based on or explained by the sunnah [14]. the substance of the sunnah is comprised of sayings uttered by the prophet, and descriptions of his conduct by his companions and family [14]. the purpose of using the sunnah is to clarify and expand on the few laws provided by the qur‟an and find rules on legal issues where the qur‟an is silent. in theory the sunnah cannot contradict the qur‟an for use in legal matters. the same categorizations of ibadat and mu’amalat also apply to rules derived from the sunnah. more often then not the qur‟an and the sunnah do not explicitly state what the law is but rather contain the basis for the rule [14]. however, if the law stated in the two primary sources is explicitly clear it is absolutely immutable by any work of a jurist [11]. thus secondary sources are used to expand, but not contradict, the law contained in the primary sources where the jurists search for rules [14]. secondary sources of the shari’ah include: ijma which is a consensus among scholars on a legal issues; qiya’s which is the deduction or induction of a rule by analogy to the qur‟an and the sunnah; maslaha, the public good; urf, customary practices; and istihsan which is defined “as either (1) the preference for a recognized source of law over reasoning by analogy (qiyas), or (2) the preference for one reasoning by analogy over another that is considered weaker” [39]. the two most important secondary sources of law for islamic banking are those of fatwas and ijtihad [36]. ijtihad is the basis for a fatwa. fatwas are the legal opinions of jurists responding to a particular legal question posed by a party, often a bank manager, seeking guidance on the shari’ah. more often than 12 the number “500” was given by imam al-ghazali who is one of the great islamic jurists and philosophers, however to the average reader of the quran the number seems high since many of the normative verses are repeated or overlap in presenting a general rule. islamic scholar john l. esposito put the number of normative or “legal” verses in the qur‟an at 90 [26]. not, the jurist issuing a fatwa is not affiliated with any state institution [12]. it is typically the case that independent jurist are seen by the public as more inclined to issue honest ruling based on the shari’ah than their counterpart qadi’s, who are appointed by the state. 13 in the case of islamic banking, a fatwa would be issued by a single independent jurist, or group of jurists, who have a background on the financial matter [36]. what is, and is not, permissible under the shari’ah in islamic banking is often decided in the form of a fatwa [36]. a jurist may even use a predecessor‟s fatwa as a form of precedent if it is on a similar issue [14]. thus a fatwa may work its way into a more substantive legal position much like an authoritative case in common law jurisdiction [30]. in the islamic banking industry it is commonplace for fatwas to set normative standards much like substantive law [37]. however, because of regular innovation in the financial market place an issue can be complex, new, and outside the realm of prior rulings. when this is the case it is likely that the jurist will engage in the process of ijtihad. 3) ijtihad in the simplest sense, ijtihad can be viewed as judicial decision-making in the absence of a clear rule within the primary and secondary shari‟ah sources [14]. ijtihad is the process of “searching” for and “finding” the law discussed earlier, and is often described as the most difficult task a jurist can engage in [55] [28]. like the scope of interpretation in the common law, ijtihad can be contrasted and constrained by a form of “imitation,” or non-binding precedent called taqlid [14] [55]. taqlid can be viewed as “the solidification of each legal school into predictable collections of doctrinal rules… with recognized majority and minority rules comprising the doctrine of each school…[t]aqlid eventually became so entrenched in islamic jurisprudence that „the text and the precedent of each school became the source of legitimacy in juristic thinking‟” [47]. ijtihad is often used in fatwas regarding islamic banking, since many of the issues involved with islamic financial products are relatively new and require an expansion of the shari’ah to accommodate or prohibit the action in question [36]. it is crucial for the purposes of analyzing judicial decision-making in islamic banking that the process behind ijtihad is understood because heavily cited fatwas from respected jurists often become substantive law, or fiqh. however because “many islamic countries do not endorse the notion of binding precedent…there is some degree of uncertainty as to whether a financial method or instrument currently considered shari’ah-compliant will remain so for the length of any given project or investment plan” [48]. 13 the public‟s preference for independent jurists and the mistrust of state qadi’s is highlighted and discussed in depth in two interesting articles: [12] and [10]. ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 5 within this vast legal tradition lies a small subset of jurists whose ijtihad expands the application of the shari’ah to the modern financial markets. these jurists are highly respected although not appointed by a state, and still mostly free from government interference as is often the case in modern islamic jurisprudence [12]. these jurists not only regulate the banks in accordance with the shari’ah but help shape the islamic market as a whole. while they do not don wigs or robes, or preside over a courtroom, the history of islamic law has shown us that they are indeed jurists who create fiqh through the process of ijtihad. in the western sense they can be seen as informal jurists whose scholarly status allows them to say what the accepted law is on a matter as well as what it should be a new or novel issue. they act as private in-house arbitrators mediating the banks profit motives and the protective goals of the shari’ah [23]. 14 however under the shari’ah they are typically referred to as private jurist and are often seen as more credible then their state counter-parts because of their distance from the perceived corruption of the government [12]. 15 ii. islamic banking form and function the modern concept of islamic banking in its contemporary institutional form is relatively new in comparison to the traditional commercial transactions that were islamic in nature by their abstention from interest or overly risky trading. 16 islamic banking discussed here is roughly forty years old, and was created to serve islamic communities investing and savings needs in the middle east and south east asia [52]. more recently islamic banks have branched out into global investment banking and insurance markets with approval from the jurists paving the way [20]. furthermore, islamic banking products are now growing in popularity in western nations including the united kingdom and united states [56] [13]. a. prohibitions and guidelines islamic banking is most widely understood by western financial practitioners as banking without interest (riba) and while the abstention of riba is the main concern, all other 14 “it is from this perspective that the shari'ah supervisory board (“ssb”) may be viewed as both an auditor (for the company offering the financial service or product) and a consumer advocate (for the company's clients)” [23]. 15 “thus, all the four founders of the legendary schools of jurisprudence demonstrated through their personal life stories that islamic law must be severed from the power of the government. opinio-jurists, and not rulers, are the guardians of islamic law. opinions delivered in private chambers of honest and god-fearing opinio-jurists are more worthy of consideration than those issued by government judges or government opiniojurists. the inherent mistrust of rulers informs the enterprise of islamic law” [12]. 16 like the section before this is merely a brief overview, please see [33] for a better understanding of islamic banking, contracts and financial products. things prohibited by the shari’ah are also impermissible in the islamic banking industry [33]. therefore it is the opinion of those in the industry that the key defining characteristic of islamic banking is the attempt to have a profitable economic system built on the principles of morality laid out by the shari’ah [2]. simply put interest and risky investing are prohibited because god has declared them immoral and prohibited them [32]. 17 this moral ideal is expressed by various financial products and regulated by the jurists who balance the duality of profit motives and morality as desire for the former can often lead inhibition of the later [34]. an islamic bank, like a muslim person, is prohibited for investing and earning income from things that are prohibited under the shari’ah including: destructive weapons, pornography, tobacco, alcohol, gambling, and prohibited animal products [33]. 18 most importantly islamic banks are prohibited from overly risky investing (gharar) or deriving profit from financial products that contain interest (riba) like mortgage backed securities [52]. this is largely the reason islamic banks faired well in the recent finical crisis and an example of how the shari’ah functions as a shield rather than a wall [48]. according to brian kettell, a scholar on islamic finance, there are six key principles of islamic financial products designed to maintain the morality required by the shari’ah, they are: 1. the prohibition of predetermined loan repayments; 2. the encouraged use of profit and loss sharing; 3. the prohibition of “making money out of money,” meaning all financial transactions must be asset-backed; 4. the prohibition of overly speculative investing (gharar); 5. only shari’ah approved contracts are permissible; 6. contracts are to be made and performed by all parties in good faith as defined by the shari’ah. the basis of these principles can be derived from various verses in the qur‟an and by acts or statements in the sunnah prohibiting interest, gambling, and contracting in badfaith [33]. one can also tell that the islamic fiscal principles often generate more risk for the bank than what would normally be expected in the secular interest based system because of the increased amount of profit-loss sharing [33]. 17 2: 275 (y. ali) “those who devour usury will not stand except as stand one whom the evil one by his touch hath driven to madness. that is because they say: "trade is like usury," but allah hath permitted trade and forbidden usury. those who after receiving direction from their lord, desist, shall be pardoned for the past; their case is for allah (to judge); but those who repeat (the offence) are companions of the fire: they will abide therein (for ever)” [32]. 2:276 “allah will deprive usury of all blessing, but will give increase for deeds of charity: for he loveth not creatures ungrateful and wicked” [32]. 3:130 “o ye who believe! devour not usury, doubled and multiplied; but fear allah. that ye may (really) prosper” [32]. 18 however it is often the cases that bank can invest in companies that deal with those products as long as no more then five percent of the company‟s revenue is from the prohibited products, and such “unlawful” or haram revenue that is received by the bank is donated to charity. ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 6 b. islamic financial innovations in order to comply with the shari’ah and the prohibition on riba the islamic financial industry has introduced a variety of products founded on the principles above. some basic products include: murabaha contracts which is a sale of goods or real property with a pre-agreed profit mark-up on the cost [3]; 19 mudaraba is a contract made between two parties one of whom provides the capital, the other manages the project, the profits of which are split at a pre-determined ratio; musharaka, which is joint venture financing, profits and losses are shared by the investing parties based on a preagreed ratio and equity respectively; salam, which is the “purchase of a commodity for deferred delivery in exchange for immediate payment according to specified conditions or sale of a commodity for deferred delivery in exchange for immediate payment” [1]. takaful, which is essentially a charity based insurance system deemed halal for not being overly speculative [2]. furthermore, despite the variety of contracting options it is estimated murabaha contracts make up eighty percent of islamic financial transactions [5]. although these products may achieve similar goals and have similar outcomes when compared to their secular counterparts, the mechanisms that produce the profit are shari’ah complaint and reflect the morality imposed by the shari’ah. take a murabaha contract for example. if used to purchase a house, it serves the same purpose as a mortgage and concludes with a similar result yet contains no interest in the contract or in the course of dealing. while the outcome may appear the same to a western mortgagor it is the mechanics of the murabaha contract that differ from a traditional mortgage and make the contract halal [23]. under murabaha contract, if family x wanted to purchase a new home they would go to bank y which would purchase the residence at the specified price and pay, $100,000. bank y would then re-sell the residence to family x at an agreed upon profit mark-up of $10,000. family x would pay back bank y during the course of a number of installments while simultaneously purchasing the house from bank y. family x would end up paying $110,000 after all the installments were paid, and then gain full title in the house. while the murabaha contract described creates a mortgage-like product, jurists unanimously agree that this is halal, and riba free, based on the principle that the terms and performance of the contract creates two sales rather then a sale of money [23]. this is based on the principle that god has “permitted trade and forbidden riba,” riba essentially being the sale of money now for money later [32]. 20 19 “[s]eller informs [a] buyer of the cost at which the seller obtained an object of sale [which is to be resold to such buyer] and collects a profit margin either as a lump sum, or the seller may state the profit margin as a percentage or ratio of the seller's original purchase price” [3]. 20 2: 275 “allah hath permitted trade and forbidden usury. those who after receiving direction from their lord, desist, shall be pardoned for the past; their case is for allah (to judge); but those c. shari’ah supervisory boards the approval of an islamic financial instrument is two fold: first it must be lawful in the jurisdiction that the product or contract is being used; and second the product must be lawful under the shari’ah, which in some islamic countries is the only requirement [23]. the judicial decision-making governing the second element is made by shari’ah supervisory boards (herein after “ssb”). the ssb‟s role is “to assure the institutions clients that the business renders services in a shari’ah complaint manner” [37]. an ssb is mandatory for any islamic financial institution [23]. even western institutions like the dow jones indexes, citicorp, and hsbc now have ssb‟s for shari’ah-complaint transactions and investing [33] [50]. 21 it should be noted however that the ssb may give deference to the rulings of other external and independent islamic institutions, namely the accounting and auditing organization for islamic financial institutions (aaoifi) [37]. 22 the primary focus of these boards and organizations is to ensure that islamic financial products and practices are in fact islamic and shari’ah compliant [37]. “whenever an islamic corporate institution wishes to structure a financial transaction in accordance with islamic law, the firm will consult either an external or internal shari'ah board. the initial consultation typically leads to multiple review sessions followed by amendments to the structure and the documentation of the agreement after each review, as well as further monitoring and consultation after the transaction if necessary” [37]. compliance with other institutions like the aaoifi is normally self-motivated, however seven islamic jurisdictions, including bahrain, dubai and qatar, have adopted the aaoifi‟s financial regulations as law governing banking transactions. 23 an ssb can be made up of one or more, regularly three, jurists [37]. they are scholars of islamic law as well as economics and finance [37]. members of ssb‟s are often, academics, former judges or bank managers. 24 however certain jurisdictions have required the members of ssb have a who repeat (the offence) are companions of the fire: they will abide therein (forever)” [32]. 21 seniawski refers to “chase, ubs, and deutsche bank‟s shari’ah complaint ventures” [50]. 22 the best way for me to describe the aaoifi or other fiqh academies is by comparing them and their work to a similar institution in the u.s, namely the american law institute (a.l.i.) and the restatements. 23 aaoifi has gained assuring support for the implementation of its standards, which are now adopted in the kingdom of bahrain, dubai international financial centre, jordan, lebanon, qatar, sudan and syria. the relevant authorities in australia, indonesia, malaysia, pakistan, kingdom of saudi arabia, and south africa have issued guidelines that are based on aaoifi‟s standards and pronouncements [1]. 24 like sheikh usmani, mentioned earlier, who was a supreme court justice in pakistan and has held many other prestigious judicial positions [53]. ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 7 minimum of five years experience issuing religious rulings [33]. there is also an implied “character and fitness” type requirement to ensure that the jurist is mentally competent and pious enough to issue religious rulings [36]. the primary role of the jurists on a ssb is to issue fatwas on financial transactions. however despite the presence trade standards set by groups like the aaoifi disagreements can occur when the standards fall behind market innovation [23]. take sheikh muhammad taqi usmani‟s fatwa regarding sukuk discussed earlier in this paper; it highlights the idea that a jurist can disagree with other jurists on the permissibility of a particular product even after it has been deemed permissible by a number of other jurists and even popular among investors [48]. naturally investors view the risk caused by legal uncertainty negatively [48]. therefore if a disagreement or split among the jurists occurs a bank would subsequently follow the law chosen by its ssb. 25 essentially islamic banking is an exercise in submission. the institution submits to the shari’ah, as does the worshiper, the jurists guide the worshipers, and the ssb guides the institution. just like individuals, banks are often confronted with questions regarding the lawfulness of a particular act under the shari’ah. this is where the ssb will issue an opinion of law, a fatwa, on the matter thereby approving or disapproving of the act and subsequently creating a new regulation for the bank to follow in order to remain shari’ah compliant. this decision-making process is the subject of the following discussion and the general focus of proposed future discourse. iii. judicial decision making in islamic banking the questions this discussion seeks to begin answering are, how do the jurists on an ssb make their decisions, and why do they arrive at their legal conclusions. in answering i will test two possible theories used by legal scholars analyzing judges in the u.s. court systems. these two methods of analyzing judicial decision-making are legalism and the economic theory. despite the “realist” assertion that the islamic banking system is a reaction to islamic revivalism, and that modern fatwas on the issue of finance are promulgating a political ideology [6] it is my hypothesis that the legalist and economic theories, rather then any attitudinal theory, are the most accurate descriptions of the processes used by jurists in the islamic banking industry. essentially, the jurists on ssb rule on the basis of the shari’ah and other influences like global politics are secondary. i am not denying the existence of possible political motives linked to ideological differences stemming from legal education in different schools or regions as research has shown that the judicial decision-making process is surrounded 25 the binding authority of an institution‟s ssb is a regulation set forth by the aaoifi, which member banks have agreed to follow. the presence of agencies like the aaoifi or other fiqh academies is designed to create consistency among banking institutions. by numerous influences outside the law [15] [29] [49] [40]. however, i will not be discussing attitudinal theories in any detail, mainly because the economic theory “overlaps” with other strategic, sociological, psychological, pragmatic, and organizational theories of judicial decision-making [45]. therefore some of the aforementioned theories may be touched on impliedly [45]. a. the legalist theory the legalist method, or legalism, as described by the renowned judge posner, “hypothesizes that judicial decisions are determined by “the law,” conceived of as a body of preexisting rules found stated in canonical legal materials…[t]he legalist model comes complete with a set of rules of interpretation (“canons of construction”) so that interpretation too becomes a rule-bound activity” [45]. essentially legalism presumes that the sole, or most influential, component of judicial decision-making is the law itself. “the ideal legalist decision is the product of a syllogism in which the rule of law supplies the major premise, the facts of the case supply the minor one, and the decision is the conclusion” [45]. this theory of a rule-bound jurists is equally applicable to the islamic legal tradition when a jurist is called on to write a fatwa. although realists and skeptics of islamic finance criticize this formalist approach, i believe the legalist method is indicative of a sincere and humble effort by the jurist to apply divine law to modern financial problems rather then “legalistic acrobatics” circumventing the goals shari’ah [4] [5]. before a jurist can issue a fatwa he must meet a detailed set of procedural requirements [36]. the issue presented must be a real legal question posed by a party, in this case an islamic bank [36] [42]. the question must be submitted to a jurist or jurists, here the ssb, who are familiar with the requirement, premise, and legal background of the issue so that they may arrive at a conclusion that reflects proper juristic form and the modern context of the current event [8]. furthermore if the jurist is on an ssb and the questioner is the bank it will be compulsory for the bank to adhere to the decision of the fatwa, thus equity is required because of the immediate economic effect to the bank [36]. the traditional idea of equity has been ever present in the shari’ah and remains a factor in balancing the goals of the shari’ah and financial goals of the bank and its customers [38] [50]. finally a matter of healthy body and mind, the jurist should avoid issuing a fatwa if he is ill, hungry, thirsty, tired, or if the weather is too hot or cold; essentially the jurist should avoid issuing a fatwa when any emotional or physical reactions may influence the opinion [36]. to most this idea seems like common sense. however it is actually a quite meritorious regulation, as relevant research on american trial judges have shown the affects of the physical state on the soundness of judicial decision-making process [24]. after the initial procedural requirements are met the decision-making process begins. ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 8 1) the legalist theory in the islamic tradition in order to understand the legalist method in any legal tradition, one must first understand the accepted forms of interpretation in that legal system. accordingly in islamic jurisprudence each madhhab has a characteristic legal methodology, reflecting the schools preferences on the use of texts, tradition/customs and independent reasoning [46]. the means of interpretation are applied to the two primary sources of text, the qur‟an and the hadith. today there are three primary modes of interpretation in islamic jurisprudence comparable to common law traditions of statutory interpretation. they are: originalism, based on the legal and normative customs of the people city of medina when it was under the leadership of the prophet; textualism, based solely on the text of qur‟an and authenticated hadith; and purposavism or maqasid al shari’ah, which is ijtihad based upon the purposes of the shari’ah allowing legal reasoning to come directly from a general principle so long as it supports one or more purposes of the shari’ah [46]. 26 purposavism allowed islamic jurists to expand the body of fiqh around five necessary divine purposes: religion, life, mind, family, or property [46] [28]. the use of maqasid alshari'ah became universally accepted after being advocated as a theory of interpretation by the renowned jurist al-ghazali [46]. it was seen as a middle ground between strict textualism and the perceived misuse of maslaha used by the shafi and maliki jurists respectively [46]. 27 “the interpretive approaches… show that islamic law does not permit only one interpretation in any given matter... [b]ut rather, depending on whether a scholar adopts a strict or literal approach to interpretation or a purposive or contextual approach to interpretation in exercising ijtihad, different yet acceptable solutions to legal problems are quite possible” [28]. therefore if the text of the primary sources is ambiguous, a jurist on ssb has generally two approaches under the legalist theory. first he can adopt and support prior rulings on the issue. or second, if the prior works of jurist are inapplicable, split, or incorrect he can engage in ijtihad using the methods of interpretation above and find the rule on his own. if the jurist chooses the latter, the legalistic steps guiding ijtihad have been succinctly laid out by shari’ah scholar bernard weiss in, interpretation in islamic law: the theory of ijtihad, and can be broken down as follows. first the jurist must assess the reliability of text from which he intends to derive a rule; if the text is from the qur‟an it is reliable [55]. if he is interpreting hadith assessing 26 it should also be noted that in the earlier days of islamic jurisprudence the zahiri school used a strict constructionist/literalist approach. this approach did not leave room for ijtihad and was widely (and in my opinion unfairly) criticized by the other schools and has thus disappeared. 27 “shafi'i operated on the premise that the textual materials at hand provided jurists with a full package of the original precepts of the supreme law. but the early malikis rejected this textcomprehensivist paradigm. malikis have insisted on using nontextual evidence in the interpretive enterprise” [46]. reliability is more complicated because the jurist must analyze the chain of narration. 28 after reliability has been accepted he can began interpretation consisting of two tasks: first, the linguistic task, where the jurist determines the meaning of the words in the text; and second, the jurist must interpret the words in their proper context [55]. in doing so he may compare the text with other texts or look at the overall purpose of the text [55]. after interpreting the text the jurist “may also wish to ferret out implications, allusions, nuances, analogical deductions and elliptical elements which he believes to be part of the broader meaning of the law” [55]. finally after the jurist has formulated an opinion, he must ensure that the text used in forming the opinion has not been abrogated [55]. 2) the legalist method in practice: a case study in order to explain the legalist method as applied in islamic banking i will illustrate the method by using a fatwa issued by the ssb of the kuwait finance house [22]. 29 the question posed by the bank‟s management was, “what is the riba that is prohibited by the qur‟an?” [22]. the question, albeit simple in structure, is of the utmost importance as it seeks to create a distinction between types of riba, therefore allowing the bank to charge a type of interest. using the legalist method the jurist aptly answers the question in the fatwa below, concluding that there is only one type of riba and it is prohibited. the fatwa begins by citing to the primary sources of the shari’ah, the qur‟an and the sunnah. first the jurist explains, “all the verses [in the qur‟an] in which riba is mentioned are unqualified, such that they do not differentiate between one form of riba and another. therefore recourse must be had, in interpreting their meanings, to the commonly accepted legal meaning that was derived from the collectivity of verses and hadith texts on the subject” [22]. then based on the sources the jurist goes on to define riba as the “excess for which no compensation is given in the contract” including “both riba for consumption and riba for planting (investment)” [22]. he further explains riba by shedding light on a trade done by a companion of the prophet. however he subsequently excludes the use of the type of transaction by explaining the prophet‟s disapproval of the transaction by other companions and supporting with a hadith condemning the practice. the hadith states “gold may be exchanged for gold, but only in like quantities, and only hand to hand. any excess will be riba…” the hadith continues with the same statement made repetitively however referring to the trade of silver, wheat, and dates in a like manner [22]. the fatwa continues to explain a disagreement in interpretation of 28 despite a detailed science of studying hadith, chains or narration, and ways of measuring reliability, less reliable hadith are often used in ijitihad to the dismay of many islamic jurists [17]. 29 this fatwa was collected and translated by shayk delorenzo from the kuwait finance house, al fatawa al shari‟yah, question 416, p. 402. ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 9 the hadith above between jurists 30 who interpret the hadith literally (as in only applying to the commodities mentioned, gold, silver, etc.) and other jurists interpreting it based on the purpose of the statement (therefore applying prohibition to other commodities traded in a similar manner). the fatwa then states that “the great majority of jurists, however held that the prohibition [of the hadith] extended further” and that detail of their arguments “may be found in the classical manuals of fiqh” [22]. the jurist then goes on to swear by his “life” that those jurist‟s who differentiate between types of riba, thereby allowing some forms of interest, have committed “a lie against allah and his prophet!” and that theirs is a “personal opinion with no basis in truth, and nothing even resembling a basis!” [22]. the fatwa continues with a purposevist argument suggesting that the prohibition of interest creates other avenues of investing such a murabaha contracts [22]. he then cites a hadith admonishing those who engage in interest-based transactions and includes the chain of narration to validate its authenticity [22]. finally the fatwa concludes with the statement “all of the above, in support of the lender and borrower, goes to prove the care of islam in its legislation” [22]. this fatwa is an example of the legalist method, in that it begins with primary sources and works its way through the secondary sources as well as the rules of interpretation and concludes favoring taqlid rather then ijtihad by openly agreeing the majority opinion on legal issue. 31 the scalia-like pathos rebuking those who misinterpret the sacred text is an added rhetorical touch to show the severity of the jurist‟s conviction in his method and possibly an attempt to persuade jurist‟s who deviate from the strict unqualified definition of riba [27]. the jurist in this instance did not engage in in-depth ijtihad. he argued there was sufficient evidence in the qur‟an and the sunnah to conclude that a clear rule existed and that making a distinction to that rule would improper interpretation of the divine legislation. furthermore, the discussion of differences in the opinions of fiqh by the schools as well as the differences in interpretation show a desire to choose between precedents (taqlid) rather then search for the rule independently within the primary sources of the shari’ah. the jurist ultimately arrives at his conclusion by citing the “majority of jurists” and implying a purposevist approach to interpretation of the primary sources while simultaneously justifying it through taqlid [22]. the choice of between the two interpretations can be described as the true decision that requires critical analysis. the jurist could have adopted either of the approaches and the decision would have remained valid. essentially the jurist 30 referring to hanbali jurists and a subset of hanafi. the group of hanafi mentioned here are the minority view on the issue and reach the conclusion through a literal interpretation. 31 the fatwa refers to ijma when mentioning the consensus of the majority of jurists, and refers to the qiyas, or analogy, in the purposivist argument of how the hadith applies to other commodities outside the one listed in the statement itself. could have found a distinction in the definition of riba thereby allowing the bank to use a “permissible” form of interest and derive profit from it. however keeping in principle with the legalist approach, and perhaps contrary to the banks wishes, the jurist adopted the majority approach because it has greater textual support in the primary sources of the shari’ah and the substantive works of fiqh. he further condemns the minority approach allowing types of interest as “a lie” on the basis that it lacks any textual evidence in reaching its conclusion. this fatwa demonstrates the immutability of the shari’ah sources and the prohibition on interest. the use of purposivism in the fatwa is inherently legalistic in islamic jurisprudence (although often viewed by textualists as a front for “judicial activism” in the common law) as the jurist justifies his rigid interpretation by highlighting the success or murabaha contracts [28]. an interesting point of discussion, in that the fatwa does not end with the usual statement “allah knows best,” as is typical in fatwas [47], but rather it ends with statement, “all of the above, in support of the lender and borrower, goes to prove the care of islam in its legislation” [22. this statement further emphasizes the legalistic approach chosen by the jurist in that the fatwa’s conclusion is supported by “islam and its legislation,” the qur‟an and the sunnah. the statement implies that the jurist found the texts so clear that it leaves no room for the alternative opinions. on the other hand, the customary “allah knows best,” signing statement at the end of a fatwa is used to show the fallibility of the jurist in his interpretation; the possibility that the competing view may in fact be correct, and that, in fact, only allah does know the true answer to the legal question [47]. the signing statement is indicative of the pluralistic nature of islamic jurisprudence and the possibility of multiple yet equally valid opinions on a point of law [47]. 32 3) analysis of the legalist method it is my belief that the majority judicial opinions issued by ssb‟s are decided under a legalist theory. for the most part the shari’ah and works of fiqh offer some text or foundation to guide the jurists decision-making process leaving less room for outside influence. however this formalistic approach has been attacked by legal realists as leading overly formalistic ends that ignore desired functional purposes of the shari’ah like social justice [4] [25]. while there may be some merit to the claim from a purposivist perspective, i believe that as formalistic end is a product of legalism, and legalism is itself product of piety, rather then a means of circumventing the shari’ah for profit. yet even when the shari’ah sources are clear the may have options in choosing between minority and majority approaches. as highlighted in the previous fatwa the jurist could have opted for a minority approach that would have 32 perhaps jurist here the jurist is unabashedly stating that the competing views are absolutely false and without merit. this issue of fallibility will be discussed further in the economic theory portion of the paper as it relates to possible motivations. ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 10 eased restrictions on the bank yet did not. the choice the jurist made, although primarily legalistic, may also have been influenced by secondary elements outside the text like moneyincome and piety. the weight the jurist places on these secondary influences can best be hypothesized using the economic theory as laid out by judge posner in how judges think. b. the economic theory in posner‟s seminal piece what do judge’s and justice’s maximize?…, he concludes by suggesting that his economic theory of judicial decision-making should also be applied to “elected judges, to continental european judges, to jurors, and to legislators” [44]. answering judge posner‟s call for the reapplication his theory i suggest that it may also be applicable to the jurists on the shari’ah supervisory board of an islamic financial institution because despite the corporate nature of an ssb, “nonpecuniary income” is a large part of the jurists‟ total compensation [44]. thus i will put forward similar hypotheses that judge posner and others have applied to u.s. federal judges and re-apply them to the jurists of a ssb. in doing so i will look at possible variations or additional hypotheses that apply to economic analysis of judicial decision-making in islamic banking. the economic theory of judicial decision-making is premised on the idea that jurists, like everyone else, are rational, self-interested, and seek to maximize their utility [45]. the economic elements of the judicial utility function include, “money income, leisure, power, prestige, reputation, self-respect, intrinsic pleasure of the work…” [45] and in the ssb‟s case, piety. furthermore these elements can be manipulated by the employer thus modifying the behavior of the job-holder [45]. because of the uniquely religious/corporate position of the jurists on the ssb i believe these elements are weighed differently then the state-appointed jurists that posner‟s theory was originally applied to. first the employer‟s ability to manipulate behavior is greater in a private company, like a bank, then a federal judgeship with life tenure and a fixed income. second the jurist behavior can be viewed as having two manipulators, god and the bank. 33 the jurist can forward or hinder the banks financial goals and conversely the bank can reward or punish the jurist [7]. likewise the jurist can 33 while the idea of god as a manipulator may raise some eyebrows, i do not intend to take god‟s name in vain. i say it only figuratively as means of properly applying the economic model to the jurist. god‟s role can be seen as an manipulator as god has the ability to modify constrain and motivate behaviors of the believer even if such modification is at odds with the employer. god is “al mughnî” (the “enricher”) “ar razzâq” (“the provider”), “al mughîth” (“the sustainer”). because there are two manipulators a religious duty may come into conflict with secular work duty. for example a muslim‟s religious duty to fast during ramadan and her duty to work swiftly at her job may conflict. whether she fasts or not depends on which reward she desires and modifies her behavior for. forward or hinder the goals of the shari’ah and god can reward or punish the jurist. while profit and the goals the shari’ah are by no means mutually exclusive, the line at which profit becomes unlawful is defined by the shari’ah and thus an inevitable conflict will occur as the lines between halal and haram drawn. for the purposes of analysis i have assumed the jurists are more motivated to avoid punishment from god then the bank. i also believe that piety is an additional element functioning as both a motivator and constraint in its interactions with the other elements influencing the judicial decision-making process. although piety is not mentioned in posner‟s theory, no economic analysis of the islamic jurist would be sufficient without discussing an element that has value in life and after death. furthermore in putting forth these hypotheses the elements will overlap with one another in forming a general economic theory of judicial decision-making in islamic banking as it is possible for a jurist to be motivated by multiple elements at once. finally, without empirical research it is difficult to validate these theories. the goal here is to simply approach this unique form of judicial decision-making as i believe judge posner would. while i am cognizant of possible errors in the economic analysis, they are due in part to limited material on the subject and the theoretical nature of economics. as posner described, “…the heart of economic analysis of law is a mystery that is also an embarrassment: how to explain judicial behavior in economic terms…” [44]. and while the ssb is not totally “divorced” from obvious economic incentives like compensation, the dual nature of the ssb makes the value placed on these incentives ambiguous in comparison to the other nonpecuniary-income [44]. 1) money income the first and most obvious possible influence on the judicial decision-making process is money-income [7]. here posner would hypothesize that the influence of money-income is greater for the jurist on the ssb because, unlike federal judges, the jurists of an ssb do not have a permanently fixed income or similar job security. however despite the ssb‟s corporate role and the popularity of modern cynicisms view of organized religion, i believe the motivation for and influence of money-income is outweighed by the preference for the other nonpecuniary elements, like piety. money-income for the jurist and money-income for the institution are firmly related. each party, the bank and the ssb, has the ability increase or limit the other‟s moneyincome [7]. therefore the ssb and the institution are required to function symbiotically and not competitively as strained relations between the two parties will likely decrease the money-income earned by each party. if the jurists prohibit too many transactions or contracts the bank will have less revenue to pay the jurists, or more may terminate and replace them with other jurists who the banks perceives as more equitable to the banks financial needs. on the other hand if the jurist gives way to the banks money-income motivation and adopts the ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 11 motivation as his own he might be setting aside the shari’ah at the expense of other elements. if the latter is the case the jurist may be gaining money-income and lose piety or prestige both of which may be seen as having greater value in the long term. what is more likely is that if a jurist declares a transaction impermissible the ssb will subsequently assist the bank in finding a shari’ah compliant solution. thus equity may require that a jurist function more like an arbitrator and less like clerk with a halal stamp of approval. therefore, the likelihood the jurist will appease a bank and deem the impermissible halal is small because the other competing elements (prestige, piety, reputation etc.) combined and the jurists desire to secure a pleasurable afterlife will outweigh the motivation for money-income. however, leniency is also an accepted legalistic concept based in islamic law‟s view of equity as established under the legalist method as a maxim or “golden rule.” the maxim creates the legal presumption that everything is permissible except what is explicitly forbidden by the shari’ah [20] [3]. this presumption is what i call the “presumption of permissibility,” and it is prominent in islamic banking [2]. this presumption encourages judicial restraint before prohibiting transactions, because unless the basis of the transaction is clearly prohibited by the primary sources it will be allowed. the point of mentioning this legal presumption is to re-affirm the idea that even if the jurist appears lenient it is still likely adherence to the shari’ah and its legal presumptions motivating the ruling rather then money-income [20]. 2) prestige because of the highly privatized nature of islamic jurisprudence prestige should to be quite important to islamic jurists [12]. in a sense, prestige would help the jurist develop a following of believers who rely on the jurist‟s rulings for guidance [12]. thus prestige may increase the jurist‟s power and therefore the jurist can subsequently achieve other more ideological or political goals once a following is secured [12]. however the span of prestige appears limited, as fatwas regarding financial transactions and contracts reach a limited audience of interested individuals. therefore the ability of a jurist on a ssb to gain a significant religious following is muddled by the complex and profane nature of financial transactions and their governing law. consequently it is more likely the jurist would be motivated to obtain prestige within his particular institution or the islamic banking industry rather than for any grand political ambitions. prestige is distinct from popularity because one who motivated by popularity wants to be “liked” by his peers, where as someone who is seeking prestige wants to be respected [44]. for example, if one of the jurists on an ssb is seen as a “yes-man” he may win friends among some of the bank managers but he is unlikely to gain any prestige amongst fellow jurist or scholars of islamic law. similarly, if a jurist is perceived as having a preference for money-income it may lead to criticism from more respected scholars and a loss of prestige as highlighted by the two fatwas cited earlier in the paper. the loss prestige of would limit the precedential power of his fatwas and may subsequently bar them from entering a position of substantive law. therefore a jurist may be motivated to uphold the principles of the shari’ah against money-income in order to maintain his prestige. in the alternative a jurist who is perceived as more lenient may gain favor among the bank managers of other institutions opening the door to possible memberships on other ssb‟s. however this is not prestige, and is something more akin to popularity as it likely to garner little respect from other jurists or academics. while popularity may play some role as an element here, i believe the desire to be popular in private sector differs in its former application to federal judges because of popularities close relation to money-income in commercial settings. essentially, if a jurist desires to earn a reputation as being exceedingly lenient and “liked” for his leniency, his desire for popularity may be motivated by money-income rather than the desire to win friends among bankers. furthermore the jurist‟s prestige is important for the bank. because the bank seeks religious clientele the prestige of the jurists on its ssb arguably serves as a marketing tool [37]. one can assume that more prestigious the members of the ssb, the more shari’ah-compliant and trustworthy the institution will appear to religious account holders, investors, and partners. therefore if the jurists are seen as profit motivated “yes-men,” than groups of the religious public, potential investors, will become more skeptical of the islamic banking system than they already are [4]. because prestige is important to both the jurist and the bank it is likely the jurist will be given more deference by the bank when developing a product or issuing a fatwa, thereby increasing the jurist‟s prestige among other members of the islamic banking industry and subsequently protecting himself from the criticism of other jurists and academics. 3) power like prestige, a jurist‟s power or the lack thereof, in and outside an institution may motivate his rulings. however unlike a more public jurist, fatwas issued by an ssb garner less attention because the are directed at a very specific audience. thus the concept of a “power trip” may be more popular among federal judges or qadi’s and is less likely to occur in the private domain of an ssb [44]. 34 however this does not mean jurists who specialize in banking are less motivated to gain power, but rather that power, like the other elements, is valued and manipulated differently. for the purposes of economic analysis there are two types of power that may motivate a ruling: power outside the institution, and power within the institution. 34 a “power trip” is when the judge attempts to “change the world” through a ruling. because the judicial decision made by the jurists on an ssb in are tailored to a very specific questioner and are generally in reference to a financial transaction there is unlikely a greater policy motives influencing the decisionmaking process. ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 12 first power outside the institution, the less influential of the two. in highlighting the role power outside the institution i will focus sheikh usmani‟s fatwa regarding sukuk discussed early in the paper. sheikh usmani has acquired prestige and is a heavily cited authority in the world of islamic banking [48]. because of this prestige he also has a sufficient amount of power outside his respective institution such that he can influence the islamic market place with a single fatwa [48]. 35 while it is unlikely that the sheikh‟s fatwa regarding sukuk was motivated by a self-interest in maximizing this power it is clear that he has gained authority in the industry and such authority may be a desirable form of nonpecuniary-income to other jurists. we can assume, however, that if a similar fatwa regarding sukuk were issued by a less-prestigious jurist, it would have had less influence outside the institution in the “free market” of islamic jurisprudence [12] [28]. therefore we can further hypothesize that if such power outside a jurist‟s respective institution is desirable a jurist may be motivated to attain more prestige and power so their fatwas’ receive recognition and gain wider influence. the effect to which the desire to maximize this type of power functions as a motivator for islamic jurists is arguable. essentially the question is to what extent do less powerful jurists of an ssb want the same amount of power as someone like sheikh usmani. in answering the question, i believe the jurists are pious such that the desire for power outside the institution would be secondary when issuing a ruling as the key goal is to uphold the divine law, rather then increase the jurist‟s fortitude in the financial world. in a sense piety requires humbleness, and a humble jurist cannot, or should not, be motivated by power when interpreting god‟s law. thus the jurists‟ motivation for power outside the institution is limited. however the second type of power, power inside the institution is likely to play a greater role in the judicial decision-making process. because of the fatwa’s non-binding nature in the “free-market” of islamic law, as well as the accepted fallibility and pluralism of ijtihad, the jurist‟s power is most often limited to the institution that has posed the question [37] [28]. therefore it is more likely that the jurist is motivated to maintain enough power in his institution so that his position on the ssb remains a relevant and authoritative. thus power within an institution is more influential and may motivate a jurist to prohibit a transaction so that the institution will continue seek approval of a reformed version of that transaction. because the prohibition forces the bank and the ssb to seek a compromise later, the prohibition temporarily increases the jurist‟s power within the institution during the latter advisory period. on the other hand, if the jurist outright approves of a transaction his work is complete in regards to that transaction and power within the institution is less relevant. conclusively, a jurist may be motivated at times to prohibit transactions in order to gain power within the institution rather then power outside the institution. this type of power is desirable simply 35 in this regard, robbins cites [54]. for the reason that people may enjoy more authoritative positions in the workplace as it increases ones self-worth. yet because the desire for power is constrained by a jurists preference to be pious i believe the power element is limited in its influence. finally a posnerian argument against the idea that a jurist has motivation to prohibit a transaction in order to increase power within the institution may be that increased power would subsequently decrease the jurist‟s leisure time. 4) leisure under the economic model of judicial decision-making leisure is a form of nonpecuniary income, and an increase in leisure would decrease pecuniary income [44]. according to posner the leisure preference may be the reason federal judges place so much emphasis on judicial economy [45]. likewise a jurist on ssb might also approve a transaction or contract for the leisure time it would create after because the approval process would end and there would be little or no need for any follow up meetings or review. like the federal judges posner analyzed, islamic jurists may also like a bit of down time, therefore issuing shorter fatwas or deeming a product or transaction permissible may be motivated by the desire to increase judicial efficiency and possibly leisure time. understandably, the more power the jurist is afforded the more responsibility he would have, and subsequently less leisure time would be available to him. therefore we can also assume that the motivation for power and the motivation for leisure are normally at odds with one another in the judicial decision-making process. thus one may contrast the motivation for power to prohibit a transaction, with the motivation for leisure time and the approval of a transaction or issue a shorter fatwa. yet the hypothesis regarding leisure time and short fatwas may be more correlative than anything indicative as a leisure preference in the ssb. rather issuing shorter fatwas may be an indicator of the legalist method as issuing shorter fatwas is recommended and has historically been practiced in islamic jurisprudence [36]. therefore a series of short fatwas may be more consistent with the legalist method. however this does not rule out the motivation to approve a contract or transaction in order to increase leisure time afterwords. conclusively a leisure preference may motivate a jurist to approve transactions but the leisure preference is constrained by the preference for money-income, power, and piety. 5) piety piety is the final and most valued element to be discussed. although not addressed by posner, i am positive of piety‟s role as both a motivator and constraint in religious jurisprudence. for purpose of this section piety will be defined the modification of acts according to one‟s conscious fear of god, the day of judgment, and the hereafter. piety is likely to motivate the religious jurists behavior even if it is directly at odds with other pecuniary interests. above all the other elements in the economic model, i believe piety has the ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 13 greatest influence in the islamic jurist decision-making process. like the other elements in posner‟s theory, piety does have an economic value in this world, yet it is distinct because the full value of a piety preference is not recognized until after death. the value of piety in this world is the value of piety in one‟s reputation and ones intrinsic value of themselves. thus a religious jurist is more likely to value himself and his work if his work is motivated by a piety preference. for this reason the element of piety encompasses posner‟s elements of reputation, self-respect, and intrinsic pleasure of the work [45]. piety also has extrinsic economic and commercial value. ideally a jurist of religious law would like to be known for his piety above all other characteristics. piety is what makes the jurist credible to his questioner and motivates the questioner to ask that jurist in particular [12]. piety is a necessary trait because it suggests that the jurist worthy of stating divine law and that his opinion is worthy of being followed [12]. in this way, piety functions like reputation, yet contains the added benefit of increasing ones credibility and character for truthfulness. furthermore, the ultimate goal of all muslims is to attain paradise in the hereafter, the acts one commits have a value after death. because a muslim is judged by the totality of his deeds, any bad deed will have a lasting effect that will greatly outweigh any temporal economic gain achieved in this world [32]. 36 therefore if a muslim jurist strives to be pious, any ruling that is intentionally misleading presented under the guise of piety could have grave consequences in the next life where this world‟s money-income has no value. thus piety motivates the jurist to be honest, to uphold the shari’ah, and to avoid hypocrisy, something viewed harshly in islamic theology [32]. 37 most importantly, piety constrains urges motivated by money-income, power, and prestige, so that they become sinful temptations rather then economic motivators. it is my belief that piety‟s presence as an element minimizes the value the jurist places on the other elements and motivates the jurist to adhere to the legalist method because legalism limits the jurist‟s spiritual liability and insulates the judicial decision-making process from impropriety. iv. conclusion 36 11:15-16 “those who desire the life of the present and its glitter,to them we shall pay (the price of) their deeds therein, without diminution. they are those for whom there is nothing in the hereafter but the fire: vain are the designs they frame therein, and of no effect and the deeds that they do!” [32]. 37 4:142, 145 “the hypocrites they think they are over-reaching allah, but he will overreach them: when they stand up to prayer, they stand without earnestness, to be seen of men, but little do they hold allah in remembrance…the hypocrites will be in the lowest depths of the fire: no helper wilt thou find for them…” [32]. because of the influence of piety described in the prior section, i believe the legalist theory is the best method of understanding judicial decision-making of the jurists on an ssb. although this conclusion may appear circular, it is not. it follows logically that if the jurist is motivated by piety he conforms to the legalist method in an attempt to limit his liability before god. if the jurist deviates from the legalist methods there is the possibility of transgression, and because legalism limits opportunities to deviate it provides the safest path of judicial decision-making. thus the preference for piety makes legalism a more attractive means of decision-making. this conclusion is supported by research conducted on federal judges indicating that where the law is clear legalism is used and rulings are consistent [21]. here i believe the shari’ah and subsequent works of fiqh are generally clear such that the jurist is rightly guided by the texts. therefore, i fundamentally disagree with the idea that the formality of legalism is being misused for capitalist purposes. piety restricts the jurist to his texts and canons of interpretation; anything outside the shari’ah sources would “taint” the opinion, an opinion that by its nature is intended to be an expression of god‟s law [12]. a pious jurist is aware of these temptations and adheres to the shari’ah by avoiding them through legalism. the shari’ah is not only the law dictated by the jurist, but the shari’ah dictates the jurist‟s behavior including decision-making process. the shari’ah is holistic, all acts, including judicial decision-making are subject to legal categorization, and often sorted by the intent of the actor. because allah is the ultimate enforcer of the shari’ah any intentionally misleading opinions are subject to judgment on the final day. as the famous hadith states “the one who performs ijtihad and reaches the right answer will receive two rewards [from god], and the one who performs ijtihad and reaches the wrong answer will receive one reward [from god]” [46]. 38 the caveat is that the ijtihad must be performed sincerely. again, it is the intent of the jurist that matters. therefore one can assume that feigning the use of ijtihad in order to promote impermissible acts would be punished in the hereafter. thus legalism and its formalistic nature provide a safe avenue of judicial decision-making that is the process most often used among the jurists of an ssb. does the allencompassing nature of the shari’ah protect itself from intentional misinterpretation motivated by economic or political gains? i believe ideally yes, it should. however this presumes private jurists and legal scholars have behaved in accordance with the divine law when issuing rulings throughout history, and there is evidence to suggest that this was not always the case [12]. 39 therefore the question becomes whether or not modern islamic jurisprudence should become subject to the same critiques of legal realism that is now prevalent in the u.s. 38 in this regard, quraishi cites [43]. 39 ali khan discusses the charges made by orientalist joseph schacht that islamic law had fraudulently copied earlier judeochristian and grecian legal traditions. ejif – european journal of islamic finance no2, april (2015) http://www.ojs.unito.it/index.php/ejif issn 2421-2172 14 legal system. however unlike questions posed in the u.s. as to whether or not judges are or should be influenced by religious belief, the question here is whether or not islamic judges are influenced by anything other than religious belief [19]. although other scholars have attacked the sincerity of the islamic banking industry‟s attempt to uphold the shari’ah, their claims are overly cynical and improper as they lack any empirical data to support them. thus a solution to this disagreement necessarily calls for the type of empirical research used to probe the minds of federal judges [15]. moreover, would such a critical analysis help or reshape our understanding of fiqh? would it create a rise demand for the now dead school of literalism (zahiri madhhab) as a means of insulating the shari’ah from outside influence [46]? 40 would realism create the same cynicism and skepticism now confronting the u.s. judiciary? there are two short answers. first, if one thinks the psychological and socialscience based approaches to understanding judicial decisionmaking have been successful or beneficial in promoting justice in the court system then perhaps it could be helpful to the islamic legal realm. on the other hand if one thinks these forms of legal realism have subjected the judiciary to unwarranted criticism of being political actors then perhaps now is not the best time to critically analyze islamic jurists. essentially, the question is should the idea of an objective and pious islamic jurist as described in this paper be forever tarnished by legal realism and critical legal studies, as the ideal of the objective u.s. judge was “slain” and “killed again” by legal realists and critically legal studies [19]? i leave the answers to these questions up to the jurists themselves and all those passionate about islamic law and finance. after the most recent financial crisis it has become apparent that market integrity is needed. in many cases islamic finance provides solutions that will help restore market integrity. in the islamic financial institution integrity rests with the shari‟ah board and its jurists. therefore, in my opinion the study of their decision making process is needed to maintaining the integrity of shari‟ah compliance. however, in the end the most sincere answer always is “allah knows best.” acknowledgment i dedicate this piece to dr. jeremy blumenthal. without his guidance and scholarship this paper would not exist. he had a wonderful smile and a kind heart. we miss him dearly. thank you professor. references 40 “the zahiri position was well summed up by the famous andalusian zahiri scholar ibn hazm: „whoever gives a legal decision on the basis of his personal opinion will be making decisions without knowledge, for there is no knowledge about religious matters outside the knowledge of the qur'an and the traditions [of the prophet muhammad].‟ applying only the apparent meaning of those texts, zahiris believed, will protect the law of god from corruption by human whim” [46]. 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[56] d. williams, “the last word,” islamic banking & fin. mag., march 19, 2009. ejif – european journal of islamic finance editorial team editor in chief prof. paolo pietro biancone, university of turin, italy editorial board prof. dian masyita, university of padjadjaran, indonesia prof. abdulazeem abozaid, qatar faculty of islamic studies – qatar prof. ahmad aref almazari, king saud university, saudi arabia prof. nidal a. alsayyed, inayah islamic finance research institute, usa prof. roberta aluffi, university of turin italy prof. ghassen bouslama, neoma business school campus de reims, france prof. nazam dzolkarnaini, salford university, uk prof. kabir hassan, university of new orleans, usa prof. khaled hussainey, university of plymouth, uk prof. rifki ismal, university of indonesia prof. tariqullah khan, hamad bin khalifa university, qatar prof. ali khorshid, icma centre reading university uk prof. amir kia, utah valley university, usa prof. laurent marliere, université paris-dauphine france prof. federica miglietta, university of bari italy prof. hakim ben othman, university of tunis tunisia prof. mohamed ramady, king fahd university of petroleum and minerals, saudi arabia prof. mamunur rashid, nottingham university, malaysia prof. younes soualhi, international islamic university malaysia prof. laurent weill, university of strasbourg, france