Silmi Mohamed Radzi, and Dr. Noor Suhaida Kasri
According to a 2017 report by the Credit Suisse Research Institute (CSRI), the total global wealth in 2017 reached USD280 trillion, 27% higher than a decade ago. Despite total global wealth showing an increase, the equitable distribution of wealth still remains an issue. The wealthiest 1% of the world’s population now owns 50.1% of the world’s wealth. Recently, a group of researchers undertook a study for the World Inequality Database (WID) to measure inequality in Middle Eastern countries. The study concluded that inequality level in Muslim countries is among the highest in the world with the top 10% of the total population holding 61% of the total income share. The question then is has Islamic banking played its role in addressing the issue of inequality?
Islamic Banking Assets vis-à-vis Income Inequality
The Islamic banking sector has grown tremendously in value and geographical reach since it first inception three decades ago. It was reported in the Islamic Financial Services Industry (IFSI) Sustainable Report 2017 that the global Islamic banking assets in 2016 have reached USD1.493 trillion, hence dominating the total Islamic financial services assets globally. Despite the impressive growth, it was found that countries with the biggest share in the Islamic banking assets tend to have a high level of income inequality.
Table 1 shows the list of countries that currently hold big shares in Islamic banking assets and depicts their level of income inequality based on the Gini coefficient score:
Source: World Inequality Database, Department of Statistics Malaysia, Islamic Financial Services Board
Despite having difficulties in showcasing the latest data and matching the asset size to income inequality, Table 1 above reveals several important issues. First, the income gap between the Bottom 50% of the population compared to the Top 10% is quite sizeable. In UAE for example, half of the community were sharing 11% of the total income while the Top 10% enjoyed more than half of the slice. Such unbalanced wealth distribution is clearly shown in the result of Gini Coefficient in those countries. Almost all the said countries were already half way to achieving perfect inequality! Not to mention the poor level of transparency and documentation issues that have caused drawbacks in sourcing the data.
The question now is how should Islamic banks execute the mandate ordained by the Shariah especially in addressing inequality in wealth distribution?
Maqasid Shariah and Circulation of Wealth
Islamic banking in general is imbued with the letter and spirit of Shariah. Hence an objective of Shariah with regard to Islamic banking is to preserve the circulation of wealth. The Quran clearly states:
“And what Allah restored to His messenger from the people of the towns -it is for Allah and for the messenger for (his) near relatives and orphans and the (stranded) traveler-so that it will not be perpetual distribution among the rich from you. And whatever the messenger has given you, take, and what he has forbidden you, refrain from. And fear Allah, indeed Allah is severe in penalty.” [Al-Hashr: 7]
Distribution in this context means distributing wealth as widely as possible among members of society without causing any impairment to those who have acquired wealth lawfully (ISRA, 2011). It is meant to avert wealth concentration and establish a feasible system of economy where everyone has the freedom and liberty to undertake economic activities (Islamic Banker, 2018). Thus, in order to achieve this particular objective, Shariah encourages investments and exchange contracts (al-bai’). Moreover, it incorporates the duty of sharing through its redistributive mechanism such as zakah. Islam also promotes sadaqa, hibah and waqf in which the doers are motivated with rewards from Allah. On the other hand, Shariah discourages wealth accumulation by prohibiting hoarding activities and interest (riba).
Islamic banks as intermediaries have a big role to play in ensuring the attainment of equitable wealth distribution thus reducing the gap of inequality. To emphasize this role, the International Shariah Research Academy for Islamic Finance (ISRA), Islamic Research and Training Institute (IRTI) and Durham University jointly issued the Kuala Lumpur Declaration that states:
“The Shariah emphasizes risk sharing as a salient characteristic of Islamic financial transactions. This is not only exemplified in equity-based contracts, like musharakah and mudarabah, but even in exchange contracts, such as sales and leasing, whereby risk is shared by virtue of possession”.
Risk Sharing Banking Model: Investment Account
Risk sharing refers to an activity that involves a “contractual or societal arrangement whereby the outcome of a random event is borne collectively by a group of individuals or entities involved in a contract or by individuals or entities in a community”. In its 2016 research paper, ISRA revealed that banking with risk sharing model offers more stability, profitability and linkage to real economy as compared to the present risk transfer model. Tables 2 and 3 below demystify the difference in a hypothetical bank balance sheet between a risk sharing and a risk transfer model of investment account:
Table 2: Result on Depositor’s Return and Bank’s Margin of Current (Risk Transfer) Model
Table 3: Result on Depositor’s Profit and Bank’s Profit for The Risk Sharing Model
Source: ISRA. 2016
Based on the Tables above, in terms of fragility, risk sharing model offers a less fragile balance sheet in both adverse and extreme situation with only 0.6% and 1.3% of decline in profit respectively. Risk transfer model on the other hand faced a change of 4.5% and 9.1% respectively indicating a higher volatility in bank’s margin. In terms of profit, both depositor and bank bear the risk and thus entitled to enjoy an advantage of higher return via risk sharing model owing to the real-sector-linked and not overnight policy rate (OPR) linked as in the risk transfer model. Hence, risk sharing serves the real economy than merely acting as lender and borrower in risk transfer model. Moreover, risk sharing promotes financial inclusion as the members of the public can own low-denomination tradable securities and reduces income inequality (ISRA, 2016).
It is worthy to note of late there have been calls from Shariah scholars for Islamic banks to move away from extensive use of tawarruq, a debt-based financing to equity-based financing, from risk transfer to risk sharing business. In Malaysia for instance, it was revealed in Bank Negara Malaysia’s Financial Stability and Payment Systems Report 2016 that tawarruq is the dominating contract in Islamic banks. Diagram 1 shows that tawarruq financing amounts to 22.4% of total financing portfolios.
Diagram 1: Composition of financing by Shariah contracts
Source: Bank Negara Malaysia, 2016
Some Shariah scholars have argued that tawarruq arrangement is not real but superficial trade. It does not add real value to the real economy as the sale transaction is correlated to an external factor. Furthermore, the motive of transaction is obviously to benefit from the transfer of money from one party to the other as the parties involved in reality do not intend to acquire the commodity (ISRA, 2016).The economic effect of tawarruq arrangement reflects interest-debt-based arrangement where money is lent and paid back later in a bigger portion. Such arrangements distance Islamic banks from being the panacea for equitable wealth distribution.
Relying on the spirit of Maqasid Shariah, Islamic banks must address the issue of inequality in wealth distribution. In doing so, Malaysia has taken the lead. On July 20, 2017 Bank Negara Malaysia launched a ‘Value Based Intermediation’ (VBI) initiative. The VBI introduction has changed the mindset of Islamic banks from being a mere Shariah-compliant intermediary into a more inclusive and sustainable intermediation function. VBI intermediation generates not only positive and sustainable impact to the economy, community and environment but also financial returns to shareholders.
In closing, similar initiatives could be replicated by other Islamic banks globally as a way forward to address the issue of inequitable wealth distribution.
Credit Suisse Research Institute. (2017). Global Wealth Report 2017: Where Are We Ten Years after the Crisis? Available at: https://www.credit-suisse.com/corporate/en/articles/news-and-expertise/global-wealth-report-2017-201711.html.
Islamic Financial Services Board. (2017). Islamic Financial Services Industry Stability Report
International Shariah Research Academy for Islamic Finance, Islamic Research and Training Institute and Durham University. (2012). Kuala Lumpur Declaration. Available at: www.assaif.org/ita/content/download/29881/154535/version/1/…/KL+Declaration.pdf.
Bouheraoua, S., Mohd. Rasid, M. E. S., Kasri, N. S., Lajis, S. M., Hassan, H. K., Shishani, A. & Alaeddin, O. (2016). Implementing the IFSA Investment Account: A Risk-Sharing Banking Model. ISRA Research Paper (No. 87/2016). Kuala Lumpur: ISRA
Bank Negara Malaysia. (2016). Financial Stability and Payment Systems Report 2016. Kuala Lumpur: BNM.
Kasri, N. S., Abd Rahman, Z., Mohamad, S. & Habib, F. (2016). Issues in Islamic Hedging Practices: A Critical Analysis. ISRA Research Paper (No. 88/2016). Kuala Lumpur: ISRA.
A statistical measure of the degree of variation represented in a set of values, used especially in analysing income inequality. 0.0 indicates perfect equality, 1.0 (or 100%) indicates perfect inequality. It is worthy to note here that the above information on income inequality for Iran, Saudi Arabia, UAE, Kuwait and Qatar are taken from the earlier mentioned WID study. It was reasoned in the study that the inconsistency in the given year was due to the lack in transparency and access to data. Hence the information given in the said report is based on the data that was made available. While for Malaysia, the data on income inequality is imported from Malaysia’s Department of Statistics. Meanwhile for the shares on asset, all the figures are extracted from the IFSB Stability Report for the respective years except for 2008 and 2009 as the data were not available.
Interest rate at which a depository institution lends or borrows funds with another depository institution in the overnight market.