Sustainable and Socially Responsible investing: Islamic banks should act now!

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The United Nations Development Program (UNDP) defines Sustainable and Socially Responsible Investment (SRI) as the deployment of funds with the aim to generate social and environmental impact as well as a financial return. SRI can be channeled through many vehicles such as sukuk, investment funds and social banks and can be funded by governments, foundations, high net worth individuals as well as institutional investors. SRI targets impact driven organizations in the public, private and not-for profit sectors.

Sustainability threats and opportunities

Economic and social inequalities have never been stronger. Indeed, at least one billion people today live below the poverty line with problems of access to healthcare, inadequate nutrition and unsanitary housing conditions. On climate change, the effects of extreme natural disasters generate an annual loss of $ 520 billion and create 26 million new poor every year according to the World Bank.

In response to this critical situation, the international community adopted in 2015 the Sustainable Development Goals (SDG) to end poverty, protect the planet and ensure prosperity for all as part of a new 15-year sustainable development agenda.

According to the Sustainable Development Solutions Network, 1.5-2.5% of the global GDP may be needed to finance the achievement of the SDGs in all countries. Obviously, the public sector cannot raise these huge funds by itself. Consequently, there is a need to involve the Private and the non-profit sector through SRI.

Islamic banks still searching for a distinctive positioning

In general, Islamic banks operate in dual markets where they compete with each other and with conventional banks as well. In this competition process, building a competitive advantage is key to expanding market share and sustaining growth. In fact, Islamic banks rely heavily on debt-based instruments (perceived as similar to conventional banking products) and usually lack economies of scale, which makes pricing differentiation hard to achieve. As a result, it seems that in many markets the clearest competitive advantage of Islamic banking is still sharia compliance, which makes attracting customers on a non-religious ground challenging.

On another note, many researchers point out to the weakness of Islamic banks’ socially responsible initiatives (ASAUTAY, CASSON, MAALI, NAPIER, MOHD NOR…). Islamic banks’ performance in this field is even lower than conventional banks’.  The current situation seems paradoxical. On the one hand, Islamic commercial law, a cornerstone of Islamic banks’ identity, strongly emphasizes, among others, the principles of social justice and beneficence, on the other hand, Islamic banks’ customers expect those banks to be strongly active on this front.

Embedding SRI into the fabric of Islamic banks

In the past, Sustainability and Social Responsibility (CSR) used to be a peripheral activity disconnected from the company’s value chain. Nowadays, CSR has become part of the fabric of a majority of large companies. That is, companies are increasingly seeking to generate economic value in a way that also produces value for society by addressing its challenges. This approach, called Shared Value, connects a company success with social and environmental progress.

Today, more than 80% of Islamic finance assets internationally are within Islamic Banking. Hence, implementing SRI in the Islamic finance sector cannot be successful without the banks’ involvement. There is clearly an opportunity for Islamic banks to lead the international finance industry in bridging the gap between finance and sustainable development. It will allow these banks to clarify their genuine value proposition based on their core values, serve their customers’ expectations and channel funds to address social and environmental challenges especially in OIC countries.

This article was published at the 28th March issue of IFN : https://www.islamicfinancenews.com/sustainable-and-socially-responsible-investing-islamic-banks-should-act-now.html

Challenges down the road…

There are obviously challenges that need to be addressed as far as leveraging SRI as a competitive advantage by Islamic banks goes. First, embedding SRI into the banks’ strategies and operations supposes making investment priorities (Environment, education, health, inequality…), defining the objective for the selected investment areas, revamping the products, organizing and marketing the products and services, and reporting achievements.

Second, Islamic banks need to quantify the relationship between profit maximizing and social and environmental impact. This quantification is critical because managers are typically assessed and rewarded based on financial performance. The challenge in elucidating this relationship stems from the non-standardization of social performance indicators, from the difficulty of isolating the effect of  social and environmental initiatives on financials keeping everything else constant and, latterly, from the mismatch between the long and short term orientations of social investments and financial indicators respectively.

Finally, as in any strategic shift, success depends on how change is managed. Involving external and internal stakeholders from the very beginning of the process, relying on a comprehensive communication strategy and putting in place a reward system are key for an effective implementation.