Paper Title: Islamic Social Finance and Commercial Finance: A Marriage Made in Heaven?

Author:        Luqyan Tamanni, Indra Indra, Yaser Taufik Syamlan and Anita Priantina

Publisher:    Journal of Islamic Accounting and Business Research, Vol. 13 No. 8, 2022.

This paper aims to explore different forms and models of integration between Islamic commercial finance and social finance including the problem that arise as well as the solution of each of the models to promote inclusive economic growth.

Authors mention that blending Islamic social and commercial finance can create a larger pool of funds, however, they ignore that the capital providers in both institutions have different motives. Blending is possible through blending funding from people with dual motives, i.e. commercial as well as social. Where integration might work more effectively is in creating cost synergies.

It can also breed cross selling opportunities. As a person graduate to non-poverty status through Islamic social finance, it might become a bankable client for accelerated financing through Islamic commercial banks. Sharing the information about clients can also reduce the screening and targeting cost. Authors discuss the prospect of operational integration between Islamic commercial and social finance. 

One issue not discussed in the paper is that repayment rates in microfinance are generally very high. Therefore, given the higher asset quality, the capital requirements must be rationalized to a lower level to allow small microfinance institutions catering to concentrated communities by providing access to finance to a group from same community.

Authors explain that Islamic commercial financial institutions engage in social finance as complimentary activity rather than as core activity. It is akin to corporate organizations doing corporate social responsibility work, but much less funds, human resources and capital is allocated for it.  

Authors also discuss the role of government. In some ways, government can use mandatory integration by giving certain targets to commercial finance institutions. In some countries like Pakistan, the central bank gives credit allocation targets to the banks to provide financing to the agriculture sector. In Islamic finance literature, many authors have recommended that statutory liquidity requirements stipulating cash reserve requirements shall also include provision of providing credit to the socially important sectors.

In some other ways, public-private linkage can also create linkage between Islamic commercial and social finance. For instance, if government subsidizes cost of a financial service, then Islamic commercial financial institutions like banks can provide access to capital to the clients at a significant discount to the average rate of return on financing.

This has happened in Covid-19 where governments have provided subsidized credit through banks to the socially important sectors and distressed firms.

However, this approach does not make the market mechanism more humane. In fact, it may have the potential to encourage rent seeking and more relaxed response by expecting government subsidies which increase fiscal expenditure and might subsequently lead to more fiscal borrowing in future that has an inflationary impact.  Authors also emphasize about the role of education. Social awareness and empathy should be built in teaching methods and curriculum so that future corporate managers, investment managers, entrepreneurs and investors have the right values which underpin their preferences, choices and behaviour.