Integrating Commercial Finance and Islamic Social Finance

(M. Gabril Asade)

I. Background
The initial intention to establish Islamic Finance System was to provide an alternative for
conventional financial system which is based on Riba (interest-based). Islamic financial system
which is based on profit sharing is seen as more justice financing solution. However, the high
risk encountered by Islamic Financial Institution and competition with the conventional
financial institutions, eventually forced Islamic Financial Institutions to finally replicate the
conventional business model, especially in banking sector. This kind of system finally did not
help the creating of new entrepreneurs as the wider access to the source of funding is not
available for the poor. As a consequence, sharia institutions which is social-based started to
emerge. Social financial institutions focuses on providing products and financing facilities for
low income society and the needy. It is expected that the poor and the needy also have access
to financial sector and therefore can go out of poverty and contribute to the economy at large.
Islamic social finance basically utilizes social religious funding which is considered to have a
huge potency in Indonesia such as zakah, infak, charity (sedekah) and waqf and others. It is
very important for the two models of sharia financial institutions synergize and integrate to
create kemashlahatan or the wider benefit for all segments of community.
Social finance focusing on poverty eradication needs to be integrated with sharia
commercial finance focusing on self-finance sustainability. To make this happen, form of
operational and unique products/services strategies are needed as well as the suitable
arrangement to ensure that the business model of each system is not conflict one another and
the objective to create inclusive economy growth can be achieved. At the end of this paper you
will know the integrated models of Islamic social finance and commercial finance, effective
integrated models of Islamic social finance and commercial finance in terms of legal basis,
products and services, human resources, infrastructures and other aspects, implications of
integration of Islamic social finance and commercial finance and its policy recommendations
required.
II. Integrated Models of Islamic social finance (ISF) and Commercial Finance
The integrated models of Islamic social finance is the models of the source of money that
aim to social interest. The establishment of this models because the Islamic Finance System
eventually doesn’t reflect the sharia-objective at all. It’s being influence by the commercial
finance to reduce the risk to be covered by Islamic Finance System which at the end become
reflect injustice. ISF models that are used in an attempt of achieving inclusive growth namely,
zakat, waqf, sadaqoh, and Islamic micro-finance.
Zakat is, one form of religious funding, an obligatory contribution which is prescribed by
Islam on all Muslims having wealth above an exemption limit at a rate fixed by the Sharī’ah.
The objective is to make available to the state a proportion of the wealth of the well-to-do for
distribution to the poor and needy. The Quran (9:60) specifies the following eight categories
of Zakat recipients: Al-Fuqarā (the poor), Al-Masākīn (The needy or the destitute), Al-‘āmilīna
‘Alayha (Zakat administrators), Al’Mu’allafate-Qulūbuhum (those whose hearts are
reconciled; that is, those who have embraced or are inclined towards Islam), Fi al-Riqāb
(People in bondage or slavery), Al-Ghārimīn: (People burdened with debt), Fī-sabīlillāh (those
in the path of God), and Ibn al-Sabīl (The wayfarer, or stranded traveller). Most of these eight
recipients are directly or indirectly linked to humanitarian or development assistance. The
implementation of zakat is facing some limitations so that it is not fully effective, because there
is still poor public awareness of the role of zakat for the economy, public distrust of weak and
non-transparent government institutions, lack of state support in regulating law of zakat and no
standards available about zakat in the midst of heterogeneous people who are unfamiliar with
zakat. Most of people only know that zakat payment is only during the month of Ramadan, in
addition to zakat fitrah rarely people who understand the law of other zakat obligations.
(Qadawi, 2013)
A waqf (plural awqāf) is the product of a voluntary endowment of assets or funds to a trust,
whose usufruct is earmarked for purposes specified by the founder. One of the important
aspects of Waqf relates to its objective, which is doing charity in exchange of reward from the
Creator. The objective of Waqf may be for the society at large, including the provision of
religious services, socio-economic relief to the needy segment, the poor, education, and
environmental, scientific, and other purposes. 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 centres.
(Ahmed,2007)
Sadaqah, voluntary donation, in Islam is multi-dimensional, relating to all the spheres of
human life: religious, legal, spiritual, moral, social, economic and political. It is religious in the
sense that giving in charity is considered an act of worship. Individuals are encouraged to
constantly give in charity hoping for rewards from Allah. The more an individual is sincerely
involved in helping fellow mankind in charity, the closer he or she becomes to Allah and the
higher is the chance of attaining success in the hereafter.
Islamic Micro-Finance is the provision of formal financial services to poor and low-income
people, as well as others systematically excluded from the financial system. Microfinance is
proven to be an effective development tool for poverty alleviation in many countries across the
globe. Microfinance industry is rapidly expanding worldwide with the target to eradicate
poverty. Although it is argued that Microfinance institutions have not been reaching the poorest
of the poor yet, their programs have brought numerous benefits to the poor.
III. Integrated Models of Islamic Social Finance and Commercial Finance in terms of
Legal Basis, Products and Services, Human Resources, Infrastructures and Other
Aspects
In term of legal basis, ISF and commercial finance categorized into three categories, (i)
principle of equity, this principle emphasis the prohibition of predetermined payments ( riba )
with a view to protecting the contracting party in financial institutions ; The prohibition of
excessive uncertainty (gharar) as manifested by contract ambiguity or elusiveness of payoff
that would nullify the contract and others. (ii) The principle of participation, lies at the heart of
Islamic finance, ensuring that increases in wealth accrue from productive activities. The profit
comes with risk taking, so investment return has to be earned in tandem with risk-taking and
not with the mere passage of time, which is also the basis of prohibiting riba. (iii) Principle of
ownership, the rulings of “do not sell what you do not own” (for example, short-selling),
mandate asset ownership before transacting. Islamic finance has, thus, come to be known as
asset-based financing, forging a robust link between finance and the real economy. It also
requires preservation and respect for property rights, as well as upholding contractual
obligations by underscoring the sanctity of contracts. (Hussein et al, 2015)

In terms of products and services, human resources, infrastructures and other aspects,
there are two types, PLS ( Profit and Loss Sharing ) and non-PLS financing.

A. PLS Financing Products

1. Musharakah is a profit-and-loss sharing partnership and the most authentic form of
Islamic financing. It is a contract of joint partnership where two or more partners
provide capital to finance a project or own real estate or movable assets, either on a
permanent or diminishing basis. Partners in musharakah have a right to take part in
management; they seem to bear the greatest risk among all Islamic financing modes
with the potential for earning the highest reward. However, whereas profits are
distributed according to pre-agreed ratios, losses are shared in proportion to capital
contribution.

2. Mudârabah is a profit-sharing and loss-bearing contract where one party supplies

funding (financier as principal) and the other provides effort and management expertise
(mudarib or entrepreneur as agent) with a view to generating a profit. The share in
profits is determined by mutual agreement but losses, if any, are borne entirely by the
financier, unless they result from the mudarib’s negligence, misconduct, or breach of
contract terms.

B. Non-PLS Financing Products

1. Murâbaḥah is a popular Shari’ah-compliant sale transaction mostly used in trade
and asset financing. The bank purchases the goods and delivers them to the customer,
deferring payment to a date agreed by the two parties. The expected return on
murâbaḥah is usually aligned with interest payments on conventional loans, creating a
similarity between murâbaḥah sales and asset-backed loans. Unlike conventional loans,
after the murâbaḥah contract is signed, the amount being financed cannot be increased
in case of late payment or default, nor can a penalty be imposed, unless the buyer has
deliberately refused to make a payment.

2. Ijārah is a contract of sale of the right to use an asset for a period of time. It is
essentially a lease contract, whereby the leaser must own the leased asset for the entire
lease period. Since ownership remains with the leaser, the asset can be repossessed in
case of nonpayment by the lessee. However, the leaser is also responsible for asset
maintenance, unless damage to the leased asset results from lessee negligence. This
element of risk is required for making ijārah payments permissible.
 3. Salam is a form of forward agreement where delivery occurs at a future date in
exchange for spot payment. Such transactions were originally allowed to meet the
financing needs of small farmers as they were unable to yield adequate returns until
several periods after the initial investment. A vital condition for the validity of a salam
is payment of the price in full at the time of initiating the contract, or else the outcome
is a debt-against-debt sale, which is strictly prohibited under Shari’ah. The subject
matter, price, quantity, and date and place of delivery should be precisely specified in
the contract. In the event that the seller can neither produce the goods nor obtain them
elsewhere, the buyer can either take back the paid prices with no increase, or wait until
the goods become available. Should one of the parties fail to fulfill their contract, the
bank will get back its initial investment, but will have to accept the lost profit.

4. Istisna’ is a contract in which a commodity can be transacted before it comes into

existence. The unique feature of istisna’ (or manufacturing) is that nothing is exchanged
on the spot or at the time of contracting. It is perhaps the only forward contract where
the obligations of both parties are in the future. In theory, the istisna’ contract could be
directly between the end user and the manufacturer, but it is typically a three-party
contract, with the bank acting as intermediary. Under the first istisna’ contract, the bank
agrees to receive payments from the client on a longer-term schedule, whereas under
the second contract, the bank (as a buyer) makes progress installment payments to the
producer over a shorter period of time.

IV. Implications of Integration of Islamic Social Finance and Commercial Finance

The objective of maximizing profit in conventional commercial finance is mostly in
conflict with the objective of triple bottom-line (outreach, sustainability and welfare impact) in
conventional social finance, since conventional social finance is not part of conventional
commercial finance, and there is no overarching guidance which covers both conventional
commercial finance and social finance. Therefore, conventional commercial finance is
unsustainable, while conventional social finance is unachievable, so that the integration
between conventional commercial finance and conventional social finance to achieve the
wellbeing of the society is very unlikely. Meanwhile, under Islamic economic system, Islamic
finance is not only about
commercial finance, but also
covers social finance with
similar objective to achieve
falah (wellbeing and
prosperity in this world and
in the hereafter). Meanw hile,
Islamic commercial finance
is inherently stable, while
Islamic social finance could
simultaneously achieve triple bottom-line (Ascarya, 2016a). Moreover, the pillars of Islamic
economic and finance encompass Islamic commercial finance (such as partnership, real
activities, governance and ethical), as well as Islamic social finance (such as zakat, infaq,
sadaqah and waqf). Therefore, in a country adopting dual financial system, financial system
stability and resiliency could be enhance by integrating commercial finance and Islamic social
finance but in the other side it could shifting or moving away the Islamic financial system from
ideal sharia concept and moving closer or mimicking the conventional system. (Ascarya, 2017)
V. Policy Recommendations for the Integration of Commercial Finance and Islamic
Social Finance
The development of Islamic economic and finance is not only concern with commercial
aspects, but it also concerns with social aspects (such as zakat, infaq and waqf), where both
aspects should not be separated. Hence, some policies should be conducted to make the
integration between commercial finance and Islamic social finance can be effectively
implemented. Islamic Financial Institution (IFI) such as Islamic Bank, could also adopt
Baitul maal wa tamwil (BMT) model combining commercial finance and Islamic social
finance to improve their stability and sustainability, as well as to contribute to financial
system stability. The authority should provide incentives for IFI combining commercial
finance and Islamic social finance. The authorities may not need to provide incentives, but
they need to provide appropriate regulations for Islamic Bank combining commercial
finance and Islamic social finance. Government should not only cover the performance of
Islamic commercial finance, but it should also cover the performance of Islamic social
finance, all with respect to maslahah (not just usual quantitative measures), such as using
“Islamic Bank Maqashid Index”. Standardized national Reporting and information system
for Islamic Social Finance (including zakat, waqf and Islamic Microfinance) must be
developed immediately, implemented and enforced. Implementing incentive system of
Islamic Social Finance reporting in organizational level and national level (in terms of
award and soundness indicator). (Ascarya, 2017)
VI. Conclusion
The development of Islamic economic and finance is not only concern with commercial
aspects, but also it concerns with social aspects, such as zakah, infaq and other Islamic social
funds (ZIS), as well as waqf (Waf), where both aspects should not be separated. Therefore, the
integration between commercial and social finance could not only alleviate poverty, improve
socio-economic wellbeing through the achievement of holistic financial inclusion and triple
bottom-line, but it could also improve economic growth and financial system stability.
Integrated models of slamic social finance (ISF) and commercial finance must be implemented
and managed well by the authority in order to create economic justice and achieve inclusive
economy growth. Some policies need also to be concerned by the authority so that to ensure
that the business model of each system is not conflict one another.
VII. References
Ascarya (2016a). Integration of Islamic Commercial and Social Finance in Micro-Small
Scale. Presentation, in International Seminar and The 2nd JIMF Call For Papers,
Surabaya, October 27-28.

Ascarya (2017). Baitul Maal wat Tamwil (BMT) as an Integrated Islamic Social and
Commercial Financial Institution in Indonesia. In: ISRA-TR-IRTI, ed. The Islamic
Commercial Law Report 2018. ISRA, Thompson Reuters and IRTI, pp.104-107.

Qardawi, Yusuf Al. 2013. Fiqh Al Zakah. Islamic Book Trust.

Ahmed, Habib. 2007. “Waqf-Based Microfinance: Realizing the Social Role of Islamic
Finance.” World Bank.

Hussein, Mumtaz, S. Asghar and Turk, Rima (2015). An Overview of Islamic Finance.
Washington: International Monetary Fund.