Ethical banking and Islamic finance – the path to responsible banking

Khofiz Shakhidi, Chairman, Alif Bank 

In recent years, the global financial landscape has witnessed a significant shift in market attitudes towards banking and finance. No longer are consumers, investors, and businesses solely interested in the provision of traditional financial services by their banks. Instead, there is an expectation for these institutions to be adopting a holistic view, looking beyond revenue generation and contributing back to society in a tangible manner.

The industry has responded, leading to the rise of what has now been termed ethical banking. Built on the foundations of sustainability, equity, responsibility, and governance, ethical banking emphasises a commitment to socially conscious practices. The link between ethics and banking might not be immediately apparent, but through understanding the structure of different products like bank saving accounts and investment funds, there is an evident connection.

For example Socially Responsible Investment (SRI) Funds invest in companies that meet specific ethical criteria. These funds typically avoid industries such as tobacco, weapons, or fossil fuels, and instead focus on companies with positive social, environmental, and governance practices. Banks can also offer current accounts that ensure customers’ money is not used to support industries with negative social or environmental impacts. These accounts may have additional features, such as carbon offsetting or donations to charitable causes.

Determining what ethical causes need to be prioritised can be subjective. However, the advantage of ethical banking is the transparency it promotes between the client and the bank. They often provide clear information about how customer deposits are used, the impact of investments, and their adherence to ethical standards. This transparency allows customers to make informed decisions and hold banks accountable for their practices.

If we look at the adoption of ethical banking practices, I see there are three different paths of integration. The first is based on traditional banks reviewing their legacy processes and introducing changes that adhere to the ethical demands of their client base. The second is the launch of ethical banking brands – fintech challenger businesses that have launched products and services centred on ethical banking.

The third option, which I believe delivers an innovative and sustainable way of introducing ethical financial practices, is the use of Islamic finance as a framework to meet ethical banking objectives.

Ethical banking’s natural alignment with Islamic finance 

While they may seem like distinct concepts, ethical banking and Islamic finance share common values and principles, particularly in promoting socially responsible and ethical financial practices. Islamic finance is guided by strict principles on what is deemed to be permissible in accordance with Sharia, and these principles are naturally linked.

For example, Halal, or permissible activities, can be conceptualised within the framework of ethical investments. It ensures that all financial activities are conducted in a manner that upholds ethical standards and promotes social responsibility while aligning with the principles of Islamic law. Such activities include investments that align with Islamic values and include healthcare, renewable energy, and socially responsible projects that benefit society. In contrast, Haram, or prohibitive activities in accordance with Sharia, prevent investment into unethical and harmful activities, such as gambling, alcohol, tobacco, and weapons – also known as haram.

Social justice and charity are also part of the Islamic finance system. Formally termed as social justice and redistribution, both concepts emphasise the redistribution of wealth through mandatory charity (Zakat) and voluntary giving (Sadaqah), with the aim of empowering disenfranchised members of society.

Importantly, both Islamic finance and ethical banking recognise the importance of engaging with stakeholders, including customers, investors, and the community. They seek to foster long-term relationships and ensure that the interests of all stakeholders are taken into consideration. One could argue this is why Islamic finance is scaling at pace. Currently worth $4 trillion, the ICD-Refinitic Islamic Finance Development Indicator projects the sector to be valued at $ 6 trillion by 2026.

Retailer customers of Islamic banks already have principles of sustainability at the forefront of their minds. Commissioned by the Islamic Finance Council UK, a 2022 survey revealed that 90% of retail customers believe it is important for their banks to provide products aligned with the UN’s Sustainable Development Goals. If achieved, 70% of customers would be inclined to increase their use of their bank’s products.

The path to responsible banking 

We are only just scratching the surface when it comes to responsible and ethical banking. It is likely to witness continued growth, innovation, and collaboration with financial institutions striving to align their operations with sustainability objectives, social responsibility, and ethical principles. The focus on long-term value creation, stakeholder engagement, and positive societal impact will be central to their strategies.

Islamic finance already embodies these principles, making Islamic banks ideally positioned to lead on ethical products and services. In this sense, any consideration of ethical banking needs to take into account the activities of Islamic banks in both established and emerging markets.