ISLAMIC ECONOMY: PHILOSOPHICAL FOUNDATIONS

AND THE EXPERIENCE OF INDONESIA

Iwan Triyuwono(Shari’ah Accounting Professor)

Department of Accounting - Brawijaya UniversityJl. Mayjend Haryono 165 Malang - Indonesia

Ph. +62341-551396; Fax. +62341-553834Email address: iwant@fe.unibraw.ac.id; iwantri@yahoo.com

• Shari’ah is the Islamic law that governs a Moslem daily life. It is derived from al-Qur’an (the Holy Book) and al-Hadist (the sayings of Nabi Muhammad)

• The main important tenet of the Shari’ah in doing business and economy is the prohibition of riba (usury, interest)

• Moslem scholars contend that riba is exploitative, unjust and makes an economic system unhealthy. Instead of riba, the Shari’ah directs Moslem to employ profit-loss sharing system (PLS) and zakat

Philosophical Foundations

• Islamic economics is “a social science which studies the economic problems of a people imbued with the values of Islam” (Mannan 1986, 18)

• Islamic economics is a science that studies the allocations of resources to create and distribute wealth for mankind and universe for the purpose of returning (worshipping) to God

• What is meant by wealth here is a holistic one that includes economic wealth (money income), mental wealth (such as happiness, empathy, feeling of brotherhood, etc), and spiritual wealth (such as, thankfulness to God, feeling of closeness to God, feeling of unity with God, other persons, and universe, etc).

• In the broadest sense, the resources includes physical (economic) resource, mental resource (such as, honesty, respect for others, justice, etc), and spiritual resource (such as the belief of that all things belong and return to God, the belief of that all human beings are vicegerents of God, the belief that human beings should be accountable for their actions to God, etc)

• A credo of Islamic economics says that any increase on wealth or any consumption of wealth will make an individual to be closer to God

• There will be a different reality if the concepts of resources and wealth merely are limited to physical or economic ones. Under the concepts, human beings are entrapped only on a worldly life and never be directed to a spiritual life. Thus, the reality of life is just a materialistic life

• In micro contexts, Islamic economic system ideally is supported by management system and accounting system that are also based on Islamic values

• Islamic Management (Shari’ah Management) is a science or a practice of managing resources to make and distribute holistic wealth for guiding all human beings to return to God

• Islamic Accounting (Shari’ah Accounting) is a science or a practice of accounting that functions as a medium for providing information and fulfilling accountability to awake users’ God consciousness

• The above concepts highly appreciate the relationship between human being and human being, between human being and nature, and between human being and God

• The philosophical foundations:– (1) Tawhid, – (2) Rububiyyah, – (3) Khilafah, and – (4) Tazkiyah

• Tawhid is the essence of Islamic teaching. It is about the recognition that there is no gods, except the God (Allah). The God is One. It implicates that human being only submits him/her self to the will of God that implicitly recognizing the God’s sovereignty

• The will of God governs the relationship between human being and human being, between human being and nature, and between human being and God

• Rububiyyah is divine arrangements that relate to nourishment, sustenance, and power of directing all things towards their perfection

• Khilafah is human being’s status and role as vicegerent of God on earth and his/her relations with other human being, nature, and God

• Tazkiyah is purification of human being in the sense of purifying his/her “self” from any (physical and non-physical) dirty, purifying the relationship between human being and human being, between human being and universe, and between human being and God

Islamic Banking: Getting Rid of the Interest

• As mentioned above, Islamic law (the Shari’ah) forbids a Moslem on doing riba (interest) transactions. Islamic bank is run based on profit-loss sharing system (PLS)

• Under the PLS, an Islamic bank is running a business based on a real economy, that is, profit or loss yielded from a business. The profit or loss then is shared with a businessman and those who have saving account or deposit account on the bank accordance with an agreement or based on capital shared on the business.

• In the case of musharakah (partnership), the profit earned from a business is shared based on the capital invested in the business

• Musharakah (partnership) is actually participation of two or more persons in a certain business with defined amount of capital invested according to a contract for jointly carrying out a business and for sharing profit and loss in specified proportions

• Musharakah essentially is a joint capital. Islamic bank and businessman contribute capital to a business. Profit (or loss) earned from the business is shared in an proportion (the capital shared)

• Under mudharabah, one party provides capital and the other utilizes it for business purposes under the agreement that profit from the business will be shared according to a specified proportion

• In a simpler notion, mudharabah is a joint capital-skill. Islamic bank contributes 100% capital and businessman contributes skill (in doing business). Profit earned from the business is shared on an agreed portion

• Equity-based financing – Musharakah– Mudharabah

• Sales-based financing– Murabahah– Bai bi tsaman ajil

• Fee-based financing

The Experience of Indonesia

• In the world level, Islamic banking has grown to be 15%. Its assets reach US $ 260 trillion. In 1997, there were 176 Islamic banks and in 2004 there have been 267 Islamic banks that operate in 60 countries including non-Moslem countries (Bahrain Monetary Agency 2004)

• Indonesia at the first time legally functions Islamic bank in 1992, that is, at a few moment after issuing Banking Act No. 7/1992. The Act consents any bank to operate based on interest or based on profit-sharing

• In 1992, there were 1 Islamic commercial bank and 2 Islamic rural banks

• In 2008, there were 5 Islamic commercial banks, 131 Islamic rural banks, 27 Islamic business units with 953 offices

• Up to 2008, the Islamic bank’s transactions volume has reached Rp. 49,55 trillion which covers 2.14% of market share in Indonesia (Bank Indonesia 2008)

Table 1The Development of Islamic Banks in

Indonesia

NoIslamic bank 1992 2008

1 Islamic commercial bank 1 5

2 Islamic rural bank 2 131

3 Islamic business unit 0 27

4 Islamic saving and loan cooperative

na 2,470*)

Source: Bank Indonesia (2008), Timberg (2009), and other sources*) This amount is not exactly in 2008 (see Timberg 2009, 3)

Table 2The Growth of Islamic Banks’ Assets and Market Share in Indonesia (US $)

NoIslamic bank 1992 2008

1 Assets 52 million

260 trillion

2 Market share n.a. 2.14%

Source: Bank Indonesia (2008) and Timberg (2009)

The Islamic Banking Regulations

• The development of Islamic bank in Indonesia is strongly supported by the Government. It began in 1992 when the Banking Act No. 7/1992 was issued. Then, it was amended as to be Act No. 10/1998

Table 3The Supporting Regulation of Islamic Bank

NoAct Concerning Description

1 Act No. 7/1992 Banking The Act utilizes the term of profit-sharing system, instead of Shari’ah banking system.

2 Act No. 10/1998 Amendment of Act No. 7/1997

Explicitly the Act mentions the terms of Shari’ah principle as the basis for Islamic bank

3 Act No. 21/2008 Islamic bank The Act specially regulates the Islamic banking in Indonesia

The Islamic Accounting Standards

• Other instrument that also has a very significant role in fostering the Islamic bank in Indonesia is accounting standard. Ikatan Akuntan Indonesia (IAI) – the Association of Indonesian Accountants – has set ten statements of financial accounting standards (Pernyataan Standar Akuntansi Keuangan, PSAK) for Islamic bank

Table 4Statement of Islamic Accounting Standards

NoPSAK Year Concerning

1 PSAK No. 59 2002 Accounting standard for Islamic bank

2 PSAK No. 101 2007 Islamic Financial Statements

3 PSAK No. 102 2007 Accounting for Murabahah

4 PSAK No. 103 2007 Accounting for Salam

5 PSAK No. 104 2007 Accounting for Istishna’

6 PSAK No. 105 2007 Accounting for Mudharabah

7 PSAK No. 106 2007 Accounting for Musharakah

8 PSAK No. 107 2009 Accounting for Ijarah

9 PSAK No. 108 2009 Accounting for Solving the Problem of Murabahah Financing

10 PSAK No. 109 2009 Accounting for Zakat, Infaq, and Shadaqah

CAMELS: the Performance Measurement of the Islamic Bank

• Bank Indonesia applies CAMELS as performance measurement of the Islamic bank. Good or bad performance of the bank heavily depends on the instrument. CAMELS is actually applied to assess the performance of conventional bank. It is designed especially for the conventional bank that of course has different values with the Islamic bank

• When the Islamic bank is assessed by utilizing the CAMELS, then it is possible that the behavior and the performance of the management of Islamic bank is the same as the conventional bank

• Ideally, there should be an instrument that is designed and applied special for the Islamic bank based on Islamic values. Say, ANGELS [Amanah management, Non-economic wealth, Give out (a broader distribution of wealth), Earnings, Liquidity, and Sensitivity to market] may be recognized as an alternative instrument for that purpose (Triyuwono 2005)

Shari’ah Supervisory Board

• To make sure that the Islamic bank is always in accordance with Islamic teachings, every Islamic bank furnishes itself with internally independent organizational unit, that is, Shari’ah Supervisory Board [Dewan Pengawas Syari’ah (DPS)]. Its function is to ensure that all products and activities of Islamic bank have complied with Islamic teachings

• At the national level, there is also a National Shari’ah Board [Dewan Syari’ah Nasional (DSN)]. DSN can issue fatwas regarding all products and services. It undertakes critical assessment on Islamic financial institution’s products and services and ensures that all of them are in accordance with Islamic injunctions

Other Islamic Financial Institutions

• Besides the Islamic bank, we can also find other Islamic financial institutions, such as, Islamic capital market and Islamic insurance, and Islamic pawnshop

• Islamic capital market and Islamic pawnshop have not been practiced yet independently, they are attached to the conventional one. The Islamic insurance (takaful) has been run as an independent business entity

• The practice of capital market is closely related to the injunction of not doing gambling. In Islamic capital market, gambling is not permitted. Thus, short-selling is not allowed in that market

• In Indonesia, there is no special Islamic entity for stock exchange. But, there is Jakarta Islamic Index (JII) in the Indonesian Stock Exchange [Bursa Efek Indonesia (BEI)]. JII is a group of shares of thirty companies listed in BEI

• They are the shares the companies of which are grouped by certain Islamic criteria such as not producing and selling products or services that prohibited by the Shari’ah, not involving in riba transactions, not doing gambling, and so forth

Concluding Remarks

• It is worth to note that Islamic economy is not identical with Islamic bank and other Islamic financial institutions. The Islamic bank and other Islamic financial institutions are only ones of economic institutions of the economic system. They are the financial sector of the system

• Other institutions in real sector are also a part of the system. The institutions in real sector should not be forgotten in developing Islamic economic system

• Other instrument that should be implanted and be always in action is morality. It is a very soft instrument that its existence is a must in the Islamic economy. Without it, there is no Islamic economy, even though the products and services are the Islamic ones. Morality is an esoteric spirit. It makes the Islamic economy to be alive

• Thank you very much!