The global financial crisis has raised questions about banking practices including lending and borrowing practices, risk management and corporate governance. An urgent call for systemic change underlies the need for a new, less selfish, version of capitalism that should be practiced by the global finance industry. This call for change is not new - early this year the British Prime Minister, Gordon Brown, said at the G20 meet that: ”it is time for a values based market which is premised on a shared global ethics. A market with morals is possible based on demanding responsibility from all and fairness to all”.
An integrated approach to banking which considers the economic, environmental and social footprint of its policies and practice is increasingly becoming a necessary component in the process of change and the attempt to transform how businesses and banks relate to each other. Sustainable finance deals with institutional policies, or systems of analysis, where all financial decisions aim at an integrated approach to optimise a company’s economic, environmental and social footprint. Sustainable finance can therefore be seen as a strategic financial decision regarding a company’s risk and value rating inboth the short and long term.
The notion of sustainable finance is further fueled by the need to reinstate banks as centres of trust and to ensure that decision making is driven by a moral compass. At the same time, the banks extend their role as institutions of trust and integrity by committing to such standards.
Is finance value neutral?
The biggest hurdle in developing a framework for sustainable finance lies in the understanding that conventional finance is seen as a mere transaction tool. It is referred to as a value neutral system that is merely an intermediary in the exchange of demand and supply in the money markets.
This understanding of finance as a transaction tool has resulted in criticism of one of the few existing frameworks to promote sustainable finance - the Equator Principles. The Equator Principles are a voluntary set of guidelines for determining, assessing and managing social and environmental risk in project financing. Banks chose to model the Equator Principles on the environmental standards of the World Bank and the social policies of the International Finance Corporation. As of October 2009, 67 financial institutions have adopted the Equator Principles, which have become the de facto standard for banks and investors on how to assess major development projects around the world. The Principles apply to all new project financings globally with total project capital costs of US$10 million or more across all industry.
Apart from the fact that the Equator Principles are confined to project financing only, the real problem lies in the structure of conventional finance which provides no incentive to actually to evaluate the criteria in an integrated way. Critics have increasingly dismissed the Equator Principles as toothless and mere greenwash as they have no monitoring procedures nor are there any punishments for those signatories who contravene the principles.
Islamic finance is fundamentally sustainable finance
The truth is, to see banking as a value neutral industry is a misplaced notion, one that stems from its neo-liberal provenance. This has perpetuated the disjuncture between community, environment and business. More than ever, the world is standing back to watch how the finance sector scales this current crisis and charts its way forward.
Arguably sustainability sits within the syntax of Islamic finance. This is because Islamic finance is premised on social welfare aspirations. Islamic finance is a banking system that is characterised by the principles of Shari’ah or Islamic law. By the nature of its very system it is inherently ethical. For example the fundamental tenet of wealth purification through giving of income to the poor through ’zakat’. Further, economic satisfaction is broadened to encompass the spiritual and material.
Currently the centres of Islamic finance are concentrated in the Middle East and South-East Asia (predominately Indonesia and Malaysia) but is spreading into North Africa and Europe. It is regulated by the Islamic Financial Services Board (IFSB), an international standard-setting body which ‘promotes and enhances the soundness and stability of the Islamic financial services industry by issuing global prudential standards and guiding principles for the industry’.
Although I exercise caution in saying that Islamic finance can offer a blueprint for a new financial system, arguably the underlying principles provide a convergence towards a ‘real economy’ and herald a more prudently managed and governed financial system. The transformative values that underline Islamic finance could prove to be the tipping point in developing a comprehensive regime for sustainable finance.
Understanding responsibility
To reiterate, at heart, sustainable finance must emphasize a shared ethics of fairness and responsibility.
The problem nevertheless is that in Islamic finance, responsibility has been drawn in the negative. For example, Islamic banks cannot invest in ‘haram’ activities, cannot indulge in ‘riba’ and cannot be involved in excessive leverage and speculative activities. This is deemed necessary in order to shield market players from disproportionate risk exposures.
This negative iteration of responsibility does not however convey to the stakeholder the positive value proposition that underpins Islamic finance which relates to morals, principles and integrity. For example, property rights can be enjoyed in trust as long as man follows God and remains worthy of trust. Other examples include moderation (iqtisad), adl (justice), ihsan (kindness par excellence), amanah (honesty), spending to meet social obligations (infaq), sabr (patience) and istislah (public interest).
Negative responsibility are responsibilities not to harm and have a stronger call of obligation in law. Positive responsibility invoke some positive act to benefit another (Pogge, 2002). Negative responsibility promotes a reactive, compliance mindset. Positive responsibility, which is a positive act to benefit another invokes a proactive approach that is growth oriented. This is because it promotes a framework for action beyond compliance and provides ownership of decision making.
An integrated approach to Islamic finance
When the negative and positive responsibilities that underpin the principles of Islamic finance are recognized, a more integrated implementation of sustainability standards can be tabled.
Much needs to be done in the area in terms of guidelines, toolkits and comprehensive sustainability criteria development. When properly implemented, sustainable finance will be a crucial key in linking how businesses are funded.
What could potentially be useful is a ‘sustainability competency framework’ in developing financial criteria. Among the factors that need to be considered include:
- How to implement clear, consistent, ethical standards and procedures that will prevent controversy and reputational risk
- Best practice in accountability mechanisms for compliance and resolving disputes
- Positive obligations: what are they and how to apply
- Impact in the area of risk management
What is clear is that Islamic finance provides a wide canvas to explore sustainability in an integrated way. Islamic financial institutions can potentially provide the stewardship in the area in which conventional financial institutions are perceived to have failed.
Link: http://csr-asia.com/weekly_detail.php?id=11871
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