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CIBAFI: Sustainability Guide for Islamic Financial Institutions (IFIs)

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CIBAFI: Sustainability Guide for Islamic Financial Institutions (IFIs) Iqtisad, Islam, Islamic banking, Maqasid, PLS, Shariah, Sukuk, Waqf, Zakat, Provision, Green Sukuk

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  1. Sustainability Guide for Islamic Financial Institutions (IFIs) Guidelines for Islamic Banks 2022
  2. General Council for Islamic Banks and Financial Institutions Jeera III Tower , Office 51, Building No. 657, Road No. 2811, Block No. 428, Manama, Kingdom of Bahrain P.O. Box No. 24456 Legal Deposit Number: 978-99901-26-24-2 All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, or stored in any retrieval system of any nature without prior written permission, except for permitted fair dealing under the Copyright, Designs and Patents Act 1988, or in accordance with the terms of a license issued by the Copyright, Designs and Patents Act 1988, or in accordance with the terms of a license issued by the Copyright Licensing Agency in respect of photocopying and/or reprographic reproduction. Application for permission for other use of copyright material, including permission to reproduce extracts in other published works shall be made to the publisher(s). Full acknowledgement of the author, publisher(s), and source must be given. © General Council for Islamic Banks and Financial Institutions.
  3. ABOUT THE GENERAL COUNCIL FOR ISLAMIC BANKS AND FINANCIAL INSTITUTIONS (CIBAFI) I CIBAFI is an international organisation established in 2001 and headquartered in the Kingdom of Bahrain. CIBAFI is affiliated with the Organisation of Islamic Cooperation (OIC). CIBAFI represents the Islamic financial services industry globally, defending and promoting its role, consolidating co-operation among its members, and with other institutions with similar interests and objectives. With over 130 members from more than 30 jurisdictions, representing market players, international intergovernmental organisations, professional firms, and industry associations, CIBAFI is recognised as a key piece in the international architecture of Islamic finance. In its mission to support the Islamic financial services industry growth by providing specific activities and initiatives that leverage current opportunities while preserving the value proposition of Islamic finance, CIBAFI is guided by its Strategic Objectives, which are, 1) Advocacy of Islamic Finance Values and Related Policies & Regulations; 2) Sustainability and Innovation Integration; 3) Industry Research and Analysis; and 4) Professional Development.
  4. CONTENTS Acronyms 5 List of Tables 6 6 7 8 9 10 11 13 14 16 23 27 35 38 List of Figures Statement by the Secretary General Acknowledgements Members of the CIBAFI Sustainability Working Group About This Guide Background Defining Islamic Sustainable Development Sustainability Guide Implementation Process Principle 1 – Sustainability Integration Principle 2 – Sustainability Governance Principle 3 – Environmental and Social Sustainability Risk Management Principle 4 – Monitoring, Reporting and Communication Principle 5 – Coordination and Collaboration Conclusion Appendixes 4 Sustainability Guide for Islamic Financial Institutions (IFIs) 39 40
  5. ACRONYMS AAOIFI BoD CIBAFI CSR ESG ESMS GDP GRI IFIs IIFM IILM IIRA ILO ISO MDGs NDCs OECD OIC SC SDGs SIGMA SOP SRI UN UNDP WBCSD Accounting and Auditing Organisation for Islamic Financial Institutions Board of Directors General Council for Islamic Banks and Financial Institutions Corporate Social Responsibility Environmental , Social and Governance Environmental and Social Risk Management System Gross Domestic Product Global Reporting Initiative Islamic Financial Institutions International Islamic Financial Market International Islamic Liquidity Management Corporation Islamic International Rating Agency International Labour Organisation International Organisation for Standardization Millennium Development Goals Nationally Determined Contributions Organisation for Economic Co-operation and Development Organisation of Islamic Cooperation Sustainability Committee Sustainable Development Goals Sustainability Integrated Guidelines for Management Project Standard Operating Procedure Sustainable, Responsible and Impact Investing United Nations United Nations Development Programme World Business Council for Sustainable Development Guidelines for Islamic Banks 5
  6. LIST OF TABLES Table 1 . The Sustainable Development Goals (SDGs) Table 2. Examples of Focus Areas and the Corresponding Sustainability Targets Table 3. Examples of ESG Considerations in Financing and Investment Decisions Table 4. Sectors with Higher Environmental Risk Table 5. Examples of Social Targets and Corresponding Risk Management Requirements Table 6. Sustainability Disclosure Examples Table 7. Reconfiguring the ESG Augmented Maqasid Al-Shariah Framework Table 8. Examples of ESG Integration in Financing and Investment Decisions Table 9. Sustainability Guide Implementation Framework with Assessment Indicators and Measurement Examples 11 15 19 29 34 37 47 48 49 LIST OF FIGURES Figure 1. Bank’s Integrated Approach in Incorporating the Principles Figure 2. A Top-Down Approach for Sustainability Integration in Banks Business Activities Figure 3. Steps to Integrating Sustainability in a Bank’s Strategy Figure 4. SRI Approaches and Strategies Figure 5. Integrating ESG Factors in the Traditional Internal Credit Assessment Figure 6. Stakeholders Interest Augmented Sustainability Governance Model Figure 7. Environmental and Social Sustainability Risks Management Process Figure 8. Impact Assessment Process for Financing and Investment Decisions Figure 9. Maqasid Al-Shariah Evaluation Framework 6 Sustainability Guide for Islamic Financial Institutions (IFIs) 15 16 17 20 21 24 28 36 45
  7. Statement by the SECRETARY GENERAL To meet the challenges of global sustainability , a paradigm shift in the way the planet is managed is urgently needed. The magnitude of the world’s problems, both economically and environmentally, is enormous, necessitating collaborative efforts from all stakeholders. Multiple global efforts have been made in the last three decades to address sustainability challenges, first through the Millennium Development Goals (MDGs) in 2000 and then through the Sustainable Development Goals (SDGs) in 2015. The SDGs have taken an important step forward by tying all countries together and universalizing the expectations of sustainable development beyond the MDGs’ focus on developing countries. As a key stakeholder, the global financial sector has undoubtedly remained at the forefront of these efforts to achieve global sustainability. As the leading voice in the Islamic financial services industry (IFSI), CIBAFI recognized the importance of sustainability challenges for IFSI and the world and formed a Sustainability Working Group (SWG) to assist in the development of the CIBAFI Sustainability Guide for Islamic financial institutions. This Guide is comprised of the Five Principles of Sustainability, based on Maqasid Al-Shariah (objectives of Shariah). These Principles were created to promote sustainable development in the Islamic banking industry by assisting Islamic banks in integrating sustainability into their business activities while taking environmental, social, and economic objectives into account. The Guide also includes recommendations for implementing and assessing the Principles of Sustainability. We hope that this Guide will provide Islamic banks with the necessary guidelines, paving the way for the Principles to be incorporated into their business plans and activities. Dr. Abdelilah Belatik Secretary General Guidelines for Islamic Banks 7
  8. ACKNOWLEDGEMENTS The Secretariat would like to convey its sincere thanks to the CIBAFI Sustainability Working Group (SWG) members who took part in the discussions and provided their extensive input. We want to thank all of them for their valuable time, guidance, and contributions. We also express our gratitude to the individuals who have contributed to making this Sustainability Guide a success. We would like to appreciate Maribel Lim, Mariam Ali, May Arshi, Dr. Muhammad Bilal, Rachid Ettaai, and Zainab Al Owainaty from the CIBAFI Secretariat, and Prof. Dr. Mehmet Asutay and Dr. Dalal Aassouli, CIBAFI consultants, for their contributions and efforts in the different phases of production of this Guide. We are also thankful to Dr. Adriana KocornikMina, Dr. Ahcene Lahsasna, Dr. Ali Adnan Ibrahim, Dr. Faisal Atbani, Dr. Ginanjar Dewandaru, Dr. Johanna Dichtl, Mr. Marco Van Der Ree, Dr. Mohamed Ali Elgari, Mr. Peter Casey, Mr. Rafe Haneef, Mr. Syed Faiq Najeeb, and Dr. Tariqullah Khan for providing their valuable comments and suggestions. Also, we are thankful to the Islamic Development Bank (IsDB) for their support in the development of the Sustainability Guide. We trust that the Guide will provide valuable insights to the Islamic banking institutions around the globe on the significance of sustainability. In addition, it will be a helpful tool to understand, fulfil, and communicate their role in making the Islamic financial services industry more inclusive and sustainable   8 Sustainability Guide for Islamic Financial Institutions (IFIs) Dr. Abdelilah Belatik Secretary General
  9. MEMBERS OF THE CIBAFI SUSTAINABILITY WORKING GROUP Co-Chair Mr . Mohammad Fairuz Mohd Radi Bank Muamalat Malaysia Berhad Co-Chair Dr. Muhammad Alyami The Islamic Corporation for the Development of the Private Sector (ICD) Members Mr. A.S.M. Rezaul Karim Mr. Abdessamad Issami Mr. Ahmed Abdullah Salim Alwaily Mr. Ahmed Abdulkhaleq Ismael Mr. Ali Yousif Al Khaja Mr. Alibek Nurbekov H.E. Amin El Sharkawi Mr. Bassam Ahmad Abu Ghazaleh Mr. Emad Al-Saadi Dr. Fahad Bin Ali Alelayan Mr. Magdy Mohamed Al-Shahed Mr. Mohamad Maidani Mr. Moosa Tariq Khoury Dr. Salman Syed Ali Mr. Seifullah Demirlek Dr. Sutan Emir Hidayat Mr. Yameen Abdul Sattar Ms. Basma Abdulrahman Aljar (until November 2020) Mr. Norlymalis Jazzuir Kamarudin (until February 2021) Dr. Ali Adnan Ibrahim (until November 2021) Organisation Islami Bank Bangladesh Limited Umnia Bank Bank Nizwa Cihan Bank for Islamic Investment & Finance Al Salam Bank Astana International Financial Centre (AIFC) United Nations Bahrain (Former Resident Coordinator) Jordan Islamic Bank Palestine Islamic Bank Bank Al Jazira Al Baraka Bank Egypt Islamic Development Bank Dubai Islamic Bank Islamic Development Bank Institute (IsDBI) Al Baraka Turk Participation Bank Komite Nasional Ekonomi dan Keuangan Syariah (KNEKS) Kuwait Finance House Ithmaar Bank Bank Muamalat Malaysia Berhad Al Baraka Banking Group Guidelines for Islamic Banks 9
  10. About This Guide Purpose of the Guide The Sustainability Guide for Islamic Financial Institutions (IFIs) was developed to promote sustainable development in the Islamic banking industry by supporting Islamic banks in integrating sustainability in their business activities while considering environmental, social, and economic objectives. The Guide is structured around five Principles of Sustainability, which are as follows: The Five Principles of Sustainability 3 1 Sustainability Integration Sustainability Governance 2 Environmental and Social Sustainability Risk Management 5 Monitoring, Reporting and Communication Coordination and Collaboration 4 Who and What is it Meant for The Guide is designed as a guidance tool for Islamic banking practitioners working at various levels in Islamic banks. Implementing the Five Principles of Sustainability can drive sustainability in the Islamic banking industry while fostering collaboration between Islamic banks, regulators, standard-setting bodies, and other international institutions who share the same goals of sustainability. Scope of Application This Guide is considered a general reference for Islamic banks. Each Islamic bank operates in different jurisdictions with its own distinctive political economy, legal and regulative environment, and available economic and financial resources. Therefore, this Guide’s Principles of Sustainability can be adapted depending on the bank’s capabilities within the organisation and the macro environment. While this Guide is intended for Islamic banks, the Principles may be applicable, with some modifications, to other segments of the Islamic financial services industry such as Islamic capital markets, Takaful, and Islamic social finance institutions. Moreover, this Guide makes only limited reference to procedures for sustainability integration in deposit services, products development, and some other services. CIBAFI will continue to work in these areas and may also revise this Guide to reflect market developments in the future. 10 Sustainability Guide for Islamic Financial Institutions (IFIs)
  11. Background The magnitude of the issues the world has been experiencing , both economically and environmentally, is lost on no-one. The November 2021 United Nations Climate Change Conference (COP26) in Glasgow sought to devise compelling initiatives to combat the climate crisis. Later in 2022, a follow-up conference on this same issue will convene to discuss a global biodiversity framework. Exploitative production and unchecked consumption habits through the market economy have resulted in catastrophic environmental, financial, and socioeconomic impacts. Poverty remains a pressing issue; exclusion and disenfranchisement of the impoverished remains a critical challenge in the 21st century, despite the initial progress made by Millennium Development Goals (MDGs) in promoting liveable wages and equitable working conditions. The emergence of the Sustainable Development Goals (SDGs) paradigm by the United Nations (UN), which has become part of national public policy in many countries, stands as an official declaration of the unacceptable economic and financial behaviour of individuals, firms, and corporations which have caused enormous disruption to natural and human life. The call for consideration in all economic and financial decision-making to contemplate the sustainability of all the stakeholders has been the central discourse and policies of multilateral organisations led by the declaration of SDGs by the UN. The SDGs comprise 17 goals, set out in Table 1, accompanied by 169 associated targets and 232 indicators. Table 1. The Sustainable Development Goals (SDGs) Goal: 1 Goal: 2 Goal: 3 Goal: 4 Goal: 5 Goal: 6 Goal: 7 Goal: 8 Goal: 9 Goal: 10 Goal: 11 Goal: 12 Goal: 13 Goal: 14 Goal: 15 Goal: 16 Goal: 17 No Poverty Zero Hunger Good Health and Well-Being Quality Education Gender Equality Clean Water and Sanitation Affordable and Clean Energy Decent Work and Economic Growth Industry, Innovation and Infrastructure Reduced Inequalities Sustainable Cities and Communities Responsible Consumption and Production Climate Action Life Below Water Life on Land Peace, Justice and Strong Institutions Partnerships for the Goals Guidelines for Islamic Banks 11
  12. SDGs have taken a crucial step by binding all the countries globally and universalizing the expectations of sustainable development beyond the developing country focus of MDGs . Therefore, global mobilization for climate change and the SDGs have become the leading global policymaking issues in recent years. The nature of current challenges is not confined to a particular country or region, but instead requires organised, structural, and international mobilization. Every stakeholder must become involved, including banks and financial institutions. As part of the global mobilization, most UN member countries have become party to the SDGs and incorporated them in their public policy as a vital and positive sign for change. While the financial sector has always been an essential instrument of prosperity and development throughout history, in recent years the growth and movement of capital within the financial sector have become objectives in their own right rather than instruments for facilitating economic activity, growth, and development. The financial sector has consequently expanded through artificial products and mechanisms, resulting in further disconnection from the real economy. The growing asymmetry between the real economy and the financialised economy indicates the issues of wider unsustainability – the global GDP was only 8.3% of the total financial assets in 2019, showing the enormous pressure exerted on the resources in the world. Moreover, banks and financial institutions have created demand far beyond the reasonable level through their lending and financing channels. The results are twofold: strain on global resources, and an escalation of the environmental crisis. Further, increased access to finance is not translating into equitable resources for the impoverished – an injustice that must be addressed. In order to confront these challenges, the new consensus around SDGs, which has increased stakeholder expectations, should be considered as part of the rescuing process – rescuing humans, land, and labour – to prevent further deterioration of the conditions. An official UNbased index1, other multilateral institutions and, unofficially, many indices and studies have been developed to measure SDGs’ performance in all jurisdictions. A further important step, in 2021, was the creation by the International Financial Reporting Standards Foundation, with widespread governmental and international support, of a new International Sustainability Standards Board to create new disclosure standards – starting with a focus on the climate. The public concern surrounding the aforementioned challenges has spurred the growth of socalled ESG investing, where ESG stands for Environmental, Social and Governance. Although the (older) ESG paradigm is capable of embracing the SDGs, it is broader and less precisely defined. In some areas, this has led to allegations of “greenwashing”, in which businesses choose to be assessed under the definitions that most suit them. The term Sustainable, Responsible and Impact Investing (SRI) is also used and overlaps with both ESG and SDGs. In response to these trends, there have been important developments within the financial sector, including the emergence of green bonds and green Sukuk and initiatives by bank supervisors; for example, the Network for Greening the Financial System. Initiatives have also emerged from the sector itself, notably the promises made at COP26 by the Glasgow Financial 1. www.sdgindex.org. 12 Sustainability Guide for Islamic Financial Institutions (IFIs)
  13. Alliance for Net Zero , a coalition of banks, insurers, and major investors. This is part of a process in which banks and financial institutions are expected to align themselves with the sustainable development paradigm as part of a global community. Correspondingly, the increased focus in financial markets on sustainable development, and the initiatives, both private and public, that result present tremendous opportunities for sustainable finance in general and Islamic finance in particular. To respond to these demands and opportunities, and for reasons of principle, Islamic banks and financial institutions have to develop the necessary frameworks, mechanisms, practices, and measurements to demonstrate their sustainable development credibility in economic, social, environmental, and governance spheres. This requires going beyond the common pattern of a purely negative Shariah screening process to one of the positive choices within an enhanced governance system. Defining Islamic Sustainable Development An essential part of the Islamic paradigm is that the universe and the Earth were created with a very fine balance (mizan) and that human beings are expected to maintain or sustain that balance. The term mizan is indicative of the connectedness of all the stakeholders within a sustainable world, including its economy. In other words, the universe, the Earth, humans, the environment, and the animal world as well as the physical world, are in balance within themselves and in their interactions with each other. All of creation must be given equal opportunity space for their growth and development as the mizan or their nature (fitra) requires. Human beings are considered vicegerent, or khalifah, and are therefore charged with the responsibility of preventing disruption to this balance and ensuring that everything and everyone can coexist in harmony. Islamic banks have their own part to play in fulfilling this Islamic paradigm to restore mizan; therefore, this is something that should permeate all their actions. Sustainable development within the Islamic paradigm can, therefore, be defined as follows: “Recognising the complementarity nature of all the stakeholders to reach unity (tawhid) within the balance (mizan), which requires the recognition and provision of an opportunity space for the given (fitra) development path for each stakeholder to reach their perfection, where the growth of each stakeholder has to be in harmony with other stakeholders’ leading to inter-and-intra generational justice (adalah) through the actualization of equilibrium- based (ihsani) governance”. This definition is reflected in the Five Principles of Sustainability suggested by the Guide as well as their implementation process. Guidelines for Islamic Banks 13
  14. Note that this view sees everything in creation as a stakeholder in the operations of every Islamic bank , and the position of these stakeholders needs to be recognised in the governance of the bank. Since it is not possible for these stakeholder interests to be articulated directly, the proposals in this Guide establish a sustainability function in the form of Sustainability Committee (SC) at a high level within each bank essentially as a proxy representative for these stakeholders. To put this understanding of the Islamic cognitive system into action, Maqasid Al-Shariah (the objectives of Shariah) is an important methodological tool which reflects the maximization of benefit while at the same time preserving order, protecting equality, and reducing harm. Classically, Maqasid Al-Shariah is interpreted in relation to humans. However, on the basis argued above, it should in fact be interpreted as the well-being of all stakeholders so that the mizan-based worldview is reflected in the outcomes of any actions. In line with the Islamic sustainability definition provided in this Guide, one modern view of Maqasid Al-Shariah classifies it within four objectives and eight corollaries2, which covers the original five objectives and further extends it to provide a sustainability approach. (i) Invigorating the value of human life (a) Faith (b) Human rights (ii) Invigorating the human self (a) Self (b) Intellect (iii) Invigorating the society (a) Posterity (b) Social entity (iv) Invigorating the physical environment (a) Wealth (b) Environment (Ecology) Appendix A sets out some details on the Islamic ethics for sustainable development and provides a more detailed view of how a Maqasid-based approach might be used within the process suggested in this Guide to analyse the activities of an Islamic bank in pursuit of sustainability. Sustainability Guide Implementation Process The implementation of the Sustainability Guide should be based on an integrated approach in incorporating the Principles in the Bank’s business plans and activities. This consists of several stages with key action areas per stage, as depicted in Figure 1. The time dedicated to each stage depends on the Bank’s sustainability integration status and resources availability. 2. Najjar’s concept of Maqasid Al-Shariah. Adapted from Bedoui and Mansour (2014, pp. 567-568); modified version 14 Sustainability Guide for Islamic Financial Institutions (IFIs)
  15. Figure 1 . Bank’s Integrated Approach in Incorporating the Principles 1. Internal Assessment of Sustainability Focus Areas 2. Alignment with the Bank’s Vision, Mission, and Strategy 3. Operational Integration 4. Internal and External Education 5. Monitoring and Reporting Source: CIBAFI For the internal assessment of Sustainability Focus Areas, a Bank should refer to the national development plans and strategies as well as any priority sectors set by the respective governments where the Bank operates. These could include the national commitments under the 2015 Paris Agreement, its SDGs agenda, the Nationally Determined Contributions (NDCs) targets, national taxonomies, national visions, national development strategies, etc. The Sustainability Focus Areas should be aligned with the Bank’s vision, mission, and strategy. The Bank should also establish a Sustainability Strategy with specific and measurable targets. Table 2 provides examples of focus areas and the corresponding sustainability targets. Table 2. Examples of Focus Areas and the Corresponding Sustainability Targets Sustainability Focus Areas Climate Action Sustainability Targets Clean Water and Sanitation • Align the Bank’s financing portfolio with the goals of the Paris Agreement. • Promote energy efficiency financings. • Promote responsible business practices such as zero-waste, zero- emissions, community impact, etc. • Develop green financial products such as green home financing, green cards, etc. • Issue green and SRI Sukuk. • Incorporate environmental due diligence into the lending process. • Expand Islamic social financing to support low-income communities and promote financial inclusion. • Invest in projects targeting the education sector. • Allocate a percentage of the Bank’s financings to clean water and sanitation projects. Women’s Economic Empowerment • Support women’s economic empowerment projects. • Support financial literacy programs for women entrepreneurs. Reduced Inequalities The following section of the Guide presents the Five Principles of Sustainability and detailed guidance on the operational integration of sustainability targets for each Principle. Guidelines for Islamic Banks 15
  16. Principle 1 – Sustainability Integration An Islamic bank should consider the impact of its business activities by adopting a proactive integration approach whereby sustainability objectives are identified, implemented, and assessed. This may be based on the Maqasid Al-Shariah Evaluation Framework discussed in Appendix A. This approach should encompass five key areas, as depicted in Figure 2. Figure 2. A Top-Down Approach for Sustainability Integration in Banks’ Business Activities Sustainability Integration Bank’s Bank's Strategy Strategy Resource Resource Management Management Standard Standard Operating Operating Procedures Procedures (SOPs) (SOPs) Capacity Capacity Enhancement Enhancement Business Business Activities Activities The following section provides practical steps in integrating sustainability in the five areas mentioned in Figure 2. Guidelines on the Implementation and Assessment of Principle 1 The Bank’s Strategy An all-embracing vision that incorporates sustainability objectives into the strategic planning process should guide the Bank’s strategy. This requires a top-down approach in incorporating sustainability into the Bank’s overall business strategy, guiding principles, values, and business development targets. A strategy that incorporates sustainable development should provide a framework to guide investment and financing, drive performance, manage risks, and engage stakeholders. Successful implementation of the strategy depends on how the Bank prioritises its sustainability objectives and monitors their implementation to contribute to business growth while promoting impact. To do so, the board and senior management should first understand the values and relevance of sustainability to their business. Management’s support is fundamental to nurturing a supportive culture to drive the sustainability agenda and initiate sustainability-related activities across a Bank. This is particularly significant, considering Islamic logic requires the incorporation of stakeholder interest to achieve sustainability. It is also vital for a Bank to clearly communicate its approach to sustainability integration, so all its key stakeholders are clear on how the Bank views and interprets sustainability integration. Figure 3 highlights the key steps to sustainability integration in a Bank’s strategy. 16 Sustainability Guide for Islamic Financial Institutions (IFIs)
  17. Figure 3 . Steps to Integrating Sustainability in a Bank’s Strategy 1. Establish a corporate vision that drives sustainability within the Bank 2. Set strategic SMART (Specific, Measurable, Achievable, Realistic and Timebound) goals to implement sustainability objectives 3. Develop strategies for addressing sustainability issues 4. Set measurable key performance indicators (KPIs) and targets to improve the performance of the sustainability targets in order to achieve the vision 5. Monitor and assess the impact of sustainability integration Source: CIBAFI The Bank’s Resource Management A Bank can manage its environmental footprint by ensuring efficient use of materials and resources such as energy and water consumption, effective waste management in physical operations, and supply chains. The Bank should also develop a common understanding of the circular economy concept by promoting a culture of responsible business through waste reduction and material reuse by minimizing the use of resource inputs and creating waste, pollution, and carbon emissions. The Bank’s Standard Operating Procedures (SOPs) A Bank should provide guidance for sustainability integration in its business activities. This can be achieved through its standard operating procedures (SOPs). SOPs should clearly outline the scope and plans for sustainability objectives integration, implementation, and assessment. The SOPs should apply to all processes and staff of the Bank and should periodically be reviewed in the internal auditing process. A Bank can also develop a corporate sustainability policy that details its approaches, principles, and commitments regarding sustainability integration, as well as the framework for its implementation. The Bank’s Capacity Enhancement Initiatives A Bank should develop dedicated sustainability teams and training programmes for its personnel to better understand its sustainability strategy and integrate it into the Bank’s business activities. The sustainability team should also inform the decision-making process, including the Shariah Committee/Shariah Supervisory Board, on the sustainability impact of product development and financing lines. In addition, capacity enhancement should comprise the following activities: • Setting clear roles and responsibilities at different stages of the sustainability integration process. • Identifying business functions (e.g., internal audit) involved in reviewing and verifying the sustainability SOPs implementation. Guidelines for Islamic Banks 17
  18. • Providing necessary training on sustainability understanding, integration, and assessment. • Making sure specific personnel are accountable for assessing and monitoring sustainability objectives implementation. The Bank’s Business Activities Overall, the Bank should consider the following criteria in assessing sustainability considerations in projects, business activities and customers: • In general, any activity that promotes good and prevents harm is acceptable. • Business activities that have positive environmental and social impacts should be prioritized; these could include: • Productive sustainable business financing • Sustainable energy infrastructure • Energy efficiency • Clean transportation • Islamic social finance mechanisms • Water and waste management • Green and social credit (Qard al-Hasan) lines • Impact investing and responsible finance • Business activities that support the achievement of national sustainable development plans and strategies should be integrated into the Bank’s focus areas. To do so, the Bank should develop a broader sustainability integration strategy for its business activities, which consists of the systematic inclusion of ESG objectives in the following activities and services: Financing and investment activities Sustainability integration in financing and investment activities consist in integrating nonfinancial considerations, such as environmental and social impact, alongside the common economic considerations. As Banks are the primary supplier of financing in a country, their role is crucial in promoting impact. In this regard, a Bank should: • Systematically consider sustainability considerations as part of its investment and financing decisions. • Apply qualitative and quantitative ESG analysis to inform financing and investment decisions. Consideration of ESG factors can be made at the portfolio level and/ or investment decision level. Therefore, when deciding between financings and investments, all factors being equal, those with better ESG performance should be selected. In addition, Banks can rely on their internal analysis or third-party research to assess environmental, social and governance issues3. 3. ESG analysis frameworks vary. Some apply “hard” thresholds in particular areas, for example to exclude certain activities like fossil fuel development, but within permitted areas will choose the activities with the best scores. Some apply a scoring approach across the board. Other variants are also possible. 18 Sustainability Guide for Islamic Financial Institutions (IFIs)
  19. • Consider financing and investment activities with lower environmental and social risks and, hence, should optimise between financial risk and environmental and social risks. • Develop a sustainability framework that identifies a regularly reviewed list of sectorspecific and/or country-specific material sustainability issues. These issues are then assessed, prioritised, and integrated into the Bank’s financing and investment models and strategies. Table 3 lists examples of ESG criteria assessed in investment decisions. Table 3. Examples of ESG Considerations in Financing and Investment Decisions Type4 Category Example E Climate change Carbon emissions, climate change mitigation, climate change adaptation, environmental strategy, sustainable agriculture E Pollution Air polluting emissions, spills, waste prevention and management E Water Use of water resources, water management and conservation E Energy Energy consumption, energy resources management E Biodiversity Land, flora, and fauna diversity E Animal welfare Animal testing S Financial inclusion Islamic social financing, diversity and inclusion S Women empowerment Women entrepreneurs’ access to finance S Community involvement Social impact of business operation, products and services community development S Human capital Diversity and inclusion, training and development S Advancement of knowledge and art Awareness, education and art-related activities G Corporate governance Board skills, the balance of power and authority within the board, quality of accounting and audit, management turnover, shareholders’ rights, disclosure of remuneration, Board independence and expertise G Market behaviour and business ethics Blocking competition, short-selling, transparency for investors business integrity, executive pay S and G Involvement in controversial situations Corruption, violation of human rights S and G Human rights in the workplace Work conditions, health and safety, non-discrimination Source: CIBAFI adapted from OECD, 2020 4. E = Environment, S = Social and G = Governance Guidelines for Islamic Banks 19
  20. Several types of strategies can be used to integrate sustainability factors in investment portfolios . These investment approaches include impact investing, sustainable investing, green investing, ethical investing, socially responsible investing, etc. Figure 4 outlines these approaches, which are explained in more detail in Appendix B. Figure 4. SRI Approaches and Strategies⁵ SRI approaches and strategies Screening of investments strategy Negative/exclusionary screening Integration of ESG goals Impact/community investing Corporate engagement & Shareholders action Sustainability-themed investment Positive/best in class screening Norm-based screening Source: Aassouli (2016) For financing decisions, the Bank should prioritise sustainable finance strategies and instruments such as green Sukuk, SRI Sukuk, sustainability Sukuk, green loans, etc. as they support sustainability objectives. When it comes to the Islamic modes of financing targeting customers, the Bank can use sustainability-linked financing whereby funds are committed to environmental and/or social impact projects. 5. The publication from which the figure is taken used the SRI paradigm, but the approaches are equally applicable to SDGs or ESG paradigms. 20 Sustainability Guide for Islamic Financial Institutions (IFIs)
  21. Internal credit assessment The traditional bank credit analysis involves verifying and determining the creditworthiness of a potential client by looking at their financial state , credit reports, and business cash flows. The assessment criteria include leverage, liquidity, profitability, coverage, operational efficiency, earnings quality, and other quantitative and qualitative indicators. The Bank can incorporate sustainability considerations in the credit analysis process by conducting an ESG performance analysis along with traditional credit analysis when making investment and financing decisions. This analysis would evaluate a company's creditworthiness on its ability to pay its debt obligations and liabilities, and assess the impact of ESG using either in-house ESG research and scores, third-party ESG scores, or proprietary ESG scores. Traditional credit assessment criteria should be revisited to integrate environmental and social sustainability criteria in addition to the economic sustainability criteria. These include the cost of environmental measures, the use of renewable energy, resource protection, conservation of workplaces, employees’ social security, etc. To facilitate information-gathering, the Bank should also consider adding ESG information into the loan/financing application form. Where financing is sought in relation to a particular project, the approach to the ESG factors will be slightly different. In particular, while governance can only be considered prudent at the level of the client, it may well be appropriate to consider environmental and social criteria at the level of the project. This will allow the Bank to encourage positive moves by clients to improve environmental and social performance; for example, a fossil fuel company diversifying into solar energy. Figure 5 presents the components of the credit risk analysis-integrating ESG factors. Figure 5. Integrating ESG Factors in the Traditional Internal Credit Assessment •Leverage • Leverage •Liquidity • Liquidity •Profitability • Profitability • Coverage •Coverage • Operational Efficiency •Operational Efficiency • Earning Quality •Earning Quality Quantitative Indicators Qualitative Indicators Business/industry ••Business/industry risk risk quality ••CreditCredit quality enhancement enhancement • Performance behavior • Performance behavior • Management risk • Management risk ••Relationship risk risk Relationship ••Compliance risk risk Compliance •Environmental • Environmental •Social • Social • Governance •Governance ESG Factors Source: CIBAFI Guidelines for Islamic Banks 21
  22. Deposit services Deposits from savers are an essential source of financial strength for Islamic banks . These include current accounts deposits, often based on Qard or Wadiah, savings deposit accounts, and investment deposits, which are generally based on Mudarabah or Wakalah. A Bank’s investment decisions of profit-sharing accounts should be informed by thorough ESG analysis to ensure sustainability compliance. In addition, the Bank should clearly communicate its investment approach to its depositors by detailing the particular sustainability criteria that are considered in their investment strategy, beyond negative screening based on Shariah compliance. Product development Financial innovation implies seeking new products with unique features for existing financial needs. It necessitates multidisciplinary considerations involving a deep understanding of Islamic jurisprudence. Financial innovation in Islamic finance must be within the Shariah parameters and tested against the Maqasid Al-Shariah, both in form and substance, where the primary objective is to realise benefits to all the stakeholders. As part of the product development strategy, a Bank should develop new products or enhance existing products that positively impact the environment and society and align with its corporate mission and values. The ESG assessment process should be incorporated alongside the Shariah governance mechanism during the product design and development phases. This should be based on various factors such as customer needs, the broader stakeholders needs, social and environmental impacts, local development challenges, etc. Other services A Bank should also incorporate sustainability objectives in the other services it offers – advisory services, wealth management, remittance management, and so on. For example, in addition to the traditional financial analysis in the selection process of investments, ESG criteria should be integrated into the wealth management practices, excluding industries and companies with poor ESG performance by gradually reducing the exposure of portfolio to industries and companies with poor ESG performance. ESG analysis consists of assessing the impact of all material factors, including ESG factors, on the companies’ performance. In analysing ESG information, a Bank can rely on external ESG research providers, companies’ information, internal ESG research, etc. Social responsibility Social responsibility through profit redistribution is one of the key dimensions of IFIs’ social responsibility compared to conventional financial institutions. It encompasses almsgiving (zakat), endowment (waqf), charity (sadaqah), and interest-free loans (qard al-hasan). Sustainability considerations should also drive Islamic banks’ profit redistribution activities. 22 Sustainability Guide for Islamic Financial Institutions (IFIs)
  23. Principle 2 – Sustainability Governance The emergence of Islamic banking should be hailed as a crucial development in modern Muslim history. However, Islamic banks have generally been organised around the institutional logic of the existing system as part of their corporate governance. This corporate governance system is dominated by shareholder value maximisation, rather than broader concepts of stakeholder governance. Islamic banks, so far, have aimed to fulfil the requirements of Islamic logic by incorporating Shariah governance into their corporate governance. However, Shariah Committees/Shariah Supervisory Boards are generally focused on transaction-based negative screening. On the other hand, as set out in Appendix A, sustainable development requires a more proactive role representing the interest of all the stakeholders in everyday operations, including resource allocation. As already noted, the Islamic paradigm sees everything in creation as a stakeholder in each Islamic bank, and their interests need to be represented, by proxy, within the governance system of the bank. While it is heartening to see that some Islamic banks, albeit on a limited scale, have institutionalised a Sustainability Committee (SC) at the same level as the Risk Committee and Audit Committee, as practised by some conventional banks, this should be the standard practice. The SC should provide opinions on the sustainability compliance of any financing line or operation of Islamic banks. The SC should also work closely with the Shariah Committee/Shariah Supervisory Board, as well as other committees, to ensure sustainable development and advise the Shariah Committee/ Shariah Supervisory Board on the sustainability consequences of their potential decisions. The SC’s relationship with the Shariah Committee/Shariah Supervisory Board should be formulated in a structural manner. It is suggested that SC provide direct input on the Shariah compliance process relating to product development, financing lines, and all operations of Islamic banks so that necessary infrastructure for sustainability or ESG can be ensured. This will ensure negative screening is complemented with positive screening whereby Shariah objectives are achieved and will provide a significant development on the current governance structure to elevate the position of Islamic banks vis-à-vis sustainable development. Having the SC located at a significant hierarchal level and tasking them with auditing the sustainability consequences of products, financing and other operations and providing input to the Shariah Committee/Shariah Supervisory Board should be considered a significant improvement towards the mizan ideal of the Islamic paradigm. It is expected that in time, SC can become an essential office with a ‘Chief Sustainability Officer’. Guidelines for Islamic Banks 23
  24. Guidelines on the Implementation and Assessment of Principle 2 In line with the Islamic paradigm regarding sustainable development in general , and the Sustainability Governance Principle presented above, this section aims to provide guidance on the implementation of the Principle and identify the sustainable development governance model and procedure. The rationale is provided for a specific and specialised SC, and its working mechanism is identified. Sustainable Development Governance Model and Procedure The sustainable development governance model for Islamic banks, as described above, is articulated in Figure 6. Figure 6. Stakeholders Interest Augmented Sustainability Governance Model AGM Internal & External Stakeholders Clients, employees as well as civil society, trade unions and specialised environmental and humanitarian NGOs BOARD Overall oversight on sustainability compliance review Shariah Committee/Shariah Supervisory Board Oversight on Shariah related matters to ensure Shariah compliance of operations, products and financing by also considering the sustainability in relation to Maqasid Risk Management Committee Oversight on sustainability risk management in line with SC reporting Credit Committee Audit Committee Oversight on sustainability compliance in line with SC reporting Provide independent assessment of the sustainability compliance Sustainability Committee (SC) Provide independent assessment of the sustainability related consequences of projects, financing solutions and products through enabling function Management Ensure executions of business and operations are sustainable compliant in all the aspects defined by Maqasid Al-Shariah and provide support and the necessary sources Reporting Information/input Flow 24 Sustainability Guide for Islamic Financial Institutions (IFIs) Source: CIBAFI
  25. As responsible institutions , Islamic banks are expected to develop the necessary governance framework for practising and reporting sustainable development in the following ways: • Moving towards recognition of all the stakeholders within the Islamic normative definition (as described in Appendix A); • Crafting mission and vision statements of banks that are reflective of the commitment to sustainable development; • The BoD setting up a sustainability governance policy framework and the rationale for an SC as an enabling function; • The BoD creating the necessary sustainability governance responsibility and accounting framework to ensure the commitment of the Bank for the sustainable development initiatives; • The BoD developing the necessary institutional body (SC) to ensure sustainability compliance as defined and directed by the ESG framework; • Conducting its enabling function, SC tailoring sustainable governance policy to meet the recognised best practice; • SC planning the necessary strategy and governance mechanism for sustainability integration; • SC forming the necessary framework for the relations between different stakeholders; including clients, employees as well as civil society, specialised environmental, climate and humanitarian NGOs, and trade unions; • Establishing necessary strategies and practices to ensure the Bank’s operations and product development initiatives are in line with sustainable development as defined by SC; • SC developing an effective opportunity space for innovative products, competitive solutions and new financial instruments to organically endogenize sustainable development in operations and financing; • Advancing policies and strategies to ensure that the financing/credit policy of the Bank is in line with sustainable development; • SC organising and overseeing all sustainable development policies, strategies, practice development, and implementation; • SC reporting to the BoD regularly on the sustainable practices of the Bank and the sustainability impact of its operations and financing lines; • SC providing input to the management on the evaluation of operations and financing lines vis-à-vis sustainability consequences; • SC keeping the credit as well as the risk (management) committees informed so steps can be taken to identify the risk management of sustainability-related outcomes of operations, products, and financing lines; • SC communicate the Shariah Committee/Shariah Supervisory Board on the sustainability consequences of the operations, products, and financing lines on which they are required to make a decision. The Shariah Committee/Shariah Supervisory Guidelines for Islamic Banks 25
  26. • • • • • • • Board should be trained to take into account sustainable development consequences of operations, products and financing lines through the input provided by the SC; SC establishing the necessary sustainable development-related risk management processes, including environmental and social risk management; SC structuring communication channels with the internal and external stakeholders and must consider the input provided with them in ensuring the sustainability development consequences of the operations and financing lines; SC complying with internationally recognised sustainable development standards; SC creating a framework to effectively disclose the sustainability performance and communicate to the related parties; Developing the methodology for evaluating sustainable development compliance; Producing a clear and informative annual sustainability report to identify the strategies, policies, practices, and activities as well as the consequences of operations, products, and financing lines; and SC undertaking a training and awareness programme on the Bank’s sustainability processes for effective sustainability implementation and monitoring. The SC should carry out its sustainability governance functions concerning their Bank in the following areas concerning their operations, financing solutions and business lines: • Environmental sustainability; • Poverty and economic empowerment; • Social empowerment and human rights; • Advancement of knowledge and art; • Financial inclusion and empowerment; • Innovative Islamic products development, competitive solutions, and new financial instruments; • Social sustainability; • Capacity building in society and environment; • Collaborative partnerships; • Coordination of the sustainability activity between various committees; and • The broader compliance with the Bank’s ethical standards in accordance with the local requirements of laws and regulations as well as the principles of generally adopted international practice. Reporting The Bank should keep its external stakeholders up-to-date on its performance in the above categories through an annual report devised by the SC under current reporting standards. A semi-annual reporting system should be developed to ensure the sustainability performance progress towards best practices in relation to the existing committees and the Board. 26 Sustainability Guide for Islamic Financial Institutions (IFIs)
  27. Composition The SC should be composed of individuals specialised in various disciplines and practices to develop an integrated approach for sustainability compliance in relation to operations , products development and financing solutions.   Principle 3 – Environmental and Social Sustainability Risk Management Environmental and social sustainability is an essential consequence expected to be delivered by Islamic banks. The social sustainability aspect of sustainable development practice by Islamic banks may seem to be a novel concept, which is normatively defined within the Islamic paradigm. Islamic banks must consider individuals and other stakeholders as part of their extended stakeholders as expected by the Islamic paradigm and must aim to ensure equilibrium in the society implying that everyone receives an equitably distributed wealth, and that natural environment is allowed to grow and develop as intended. Furthermore, social aspects of sustainability are prominent within the SDGs and will therefore figure within any SDG-based framework. Environmental and social risks negatively affect banks’ reputations and the wider financial stability risks. Therefore, integrating social and environmental considerations into financing and investment decisions requires appropriate risk management tools, which improves the risk perception of activities integrating sustainability considerations. Guidelines on the Implementation and Assessment of Principle 3 In applying the Principle, a Bank should: • Integrate ESG risks in its existing risk management framework; • Develop a clear understanding of environmental and social risks associated with its financing and investment activities; • Assess the potential impacts of the identified environmental and social risks; and • Implement an environmental and social risk management system (ESMS) to systematically identify and address environmental and social risks in investment and financial transactions. In this regard, a Bank should adopt an integrated approach for environmental and social sustainability risk management, as shown in Figure 7. Guidelines for Islamic Banks 27
  28. Figure 7 . Environmental and Social Sustainability Risks Management Process 1. Identification - Screening of activities and industries 2. Categorization - Assigning E&S risk levels based on internal models or industry standards 3. Analysis - Extensive analysis for medium and high-ESG risk transactions 4. Mitigation - Risk mitigation measures for issues that have been identified in the screening and analysis stages 5. Monitoring - Based on a predefined action plan that is informed by the Sustainability Guide Source: CIBAFI A. Environmental Risk Management Environmental risk can arise from the provision of financial services to business customers operating in sensitive sectors. Environmental issues include climate change, biodiversity loss, pollution, waste storage and disposal, hazardous substance, etc. In addition, environmental risk can translate into several other risks to banks. These include credit risk, market risk, liquidity risk, operational risk, and reputational risk. Therefore, for effective environmental risk management, the Bank should: • Develop a clear understanding of environmental risks associated with its business activities and establish an integrated assessment to identify environmental impact. In addition, the Bank should take a consistent approach to environmental risk and issues across different business lines (e.g., financing contracts, profit-sharing investment accounts, product development, etc.), where possible; • Inform its risk management department to consider using data from both publicly available and proprietary sources; and • Disclose all relevant information on its material environmental risk exposures to relevant stakeholders to promote transparency and facilitate decision-making. Identification • The Bank should identify material environmental risks at both customer and portfolio levels. This consists in identifying sectors with higher environmental risk and assessing their potential impact on the Bank. Table 4 provides examples of sectors with higher environmental risk. 28 Sustainability Guide for Islamic Financial Institutions (IFIs)
  29. Table 4 . Sectors with Higher Environmental Risk Sectors Agribusiness and commodity foods Aerospace and defence Building materials Chemicals Metals and mining Oil and gas Environmental Risks • Water availability for communities and the ecosystem • Biodiversity loss • Waste risks • GHG emissions • Aircraft engine emissions • GHG emissions • Waste risks • Water use, scarcity, efficiency, and decontamination risks • Climate change • Waste, pollution, and toxicity • Water and electricity risks • Air pollution • Waste risks • GHG emissions • Pollution from wellhead • Transport spills and leaks • Water use and contamination risks • For sectors with higher environmental risk, the Bank should develop industry-specific environmental guidelines, which explain the environmental risk assessment process based on the sector of operation. The Bank can also rely on internationally-recognised sustainability standards to manage its environmental risk. Categorization • In order to identify sectors with higher environmental risk, the Bank should develop specific risk criteria such as the level of greenhouse gas emissions, deforestation and pollution, biodiversity loss, waste risks, climate change risks, etc. • The Bank should then use these criteria to characterise the magnitude of potential environmental impacts associated with each transaction or at a portfolio level. Analysis • The Bank should conduct an environmental risk analysis for customers as part of its credit analysis for financing transactions based on its own analysis or external assessments. • In assessing the customers, the Bank should consider their capacity and experience in managing environmental risks. Mitigation • A due diligence process should be implemented for transactions with higher environmental risk, including a more advanced environmental risk assessment of the customers. Guidelines for Islamic Banks 29
  30. • The Bank should also develop and implement a specific internal approval process in the case of transactions and customers with high environmental risks. Monitoring • The Bank should actively manage and monitor its environmental risk exposures on an ongoing basis at both customer and portfolio levels. • At the portfolio level, the Bank should develop quantitative and qualitative indicators to monitor and assess its exposures to environmental risk. • At the customer level, the Bank should request relevant environment-related disclosures from customers and monitor their exposure to environmental risk. • In the case of a customer with high environmental risk, the Bank may request the customer to mitigate his environmental risk exposure. • The Bank can consider reducing its exposure to the customer in case of persisting high environmental risk. In addition, the Bank could also re-assess the customer relationship. B. Social Sustainability and Social Risk Management Social sustainability, as discussed above, is one of the essential consequences expected from any economic and financial activity conducted by Islamic banks. The Guide, therefore, identifies three main areas where social sustainability can be articulated and categorised: • Poverty and economic empowerment; • Social empowerment and human rights; and • Advancement of knowledge and art. Regarding these three categories for Islamic sustainable development vis-à-vis social sustainability, relevant benchmarks in the form of social targets and corresponding risk management requirements are determined as follows: Poverty and Economic Empowerment The Bank should: • Develop sharing and participatory financing through innovative products development and offerings to reduce debt in society. This will help sustain individuals and society by expanding stakeholding in society and enabling Islamic banks to reach their distinctive potential; • Focus on innovative product and service offerings to ensure that necessary funds can be generated to invest in equity financing and extend Qard al-Hasan financing offerings to empower individuals and society; • Generate the necessary institutional arrangements and product development for Micro- and SMEs (MSMEs), such as creating specialised funds to provide equity financing for MSMEs; 30 Sustainability Guide for Islamic Financial Institutions (IFIs)
  31. • Develop funds for financing start-ups; • Strategically select financing choices of sectors by prioritising productive sectors over less productive sectors in order to meet the initial need of people, alleviating economic challenges and poverty and helping job creation which is essential for economic empowerment. For example, sustainable agriculture and manufacturing sectors could be prioritised in order to normalise food costs for those with lower household incomes; • Innovate products and financing mechanisms tailored to low income and disadvantaged groups, including microfinancing; • Prioritise poverty alleviation and economic empowerment through credit and risk management committees as part of positive screening; • Develop financial inclusion strategies to empower individuals rather than contribute to their financialisation by indebting them; • Improve accessibility to financial facilities and services, as part of financial inclusion policies; • Contribute to public policy on financial literacy strategy to educate and train customers and clients to increase their understanding of the benefits from these facilities and services and develop skills to avoid indebtedness; • Develop economic empowerment related projects so that individuals can live with their dignities by earning a livelihood instead of leaving such an area to only zakat and charitable disbursement; • Create a waqf or partner with an existing waqf to empower vulnerable groups and support poverty alleviation projects; • Develop collaborative economic empowerment related engagement with civil society to contribute to empowerment and inclusiveness; • Develop direct strategies to be women inclusive in their operation, financing, and business; • Support and empower the disadvantaged and excluded groups; for example, by assisting with energy access to impoverished communities without stable access to energy. • Develop training sessions and projects in entrepreneurship to help empower the youth and develop their skills; • Facilitate innovative educational financing products and facilities to provide equal opportunities; • Develop education-based initiatives to empower poor and vulnerable groups; • Develop and sponsor work experience and placement programmes for students; • Support health service provision related initiatives to prevent destitution; and • Join governmental and multilateral institutional projects aimed at economic empowerment. Guidelines for Islamic Banks 31
  32. Reporting The Bank should disclose strategies , policies, and practices related to economic empowerment and poverty as listed above in the Bank’s sustainability reporting. Social Empowerment and Human Rights The Bank should: • Treat all individuals as equals and with dignity and respect, irrespective of their religion, race, colour, age, gender, or nationality; • Develop diversity and inclusion policies to ensure everyone is respected in the workplace, and that no client is excluded; • Develop equal opportunity policies; • Uphold human rights for ‘good life’ in operations and financing; • Recognise and respect the labour and social standards in line with Islamic norms and international good-practices within the Bank concerning operations and financing; • Develop positive screening criteria for human rights, environmental, cultural and labour rights; • Provide training on human rights and inclusiveness for its staff; • Express willingness for policies towards universal basic income; • Contribute to education and health provision related initiatives for social welfare; • Develop policies to avoid financing weapons, ammunition and related industries and technologies, as well as any other illegal or non-permissible activities; • Collaborate with organisations and institutions that benefit society through activism for social inclusion; • Sponsor and support community programmes, such as sports activities and educational activities and training projects that empower youth; • Acknowledge a commitment to a social role that the Bank maintains within its society; • Develop and apply self-regulatory practices and management systems that foster a relationship of confidence and trust between the banks, businesses and the community; • Work closely with the local community in line with local initiatives; • Support employees’ involvement in charities; • Extend its charitable activity to vulnerable communities, including refugees; • Develop policies for compliance with customer protection legislation; • Develop policy and compliance mechanisms to deal with consumer compliance effectively; and • Develop policies concerning data management to respect privacy. 32 Sustainability Guide for Islamic Financial Institutions (IFIs)
  33. Reporting The Bank should develop disclosure strategies to communicate its performance in relation to social empowerment and human rights . Advancement of Knowledge and Art The Bank should: • Allocate funds for research and development within the Bank and in other reputable research centres; • Support establishing educational and research institutions to advance research and teaching in Islamic economics, finance, banking, accounting, management and governance; • Undertake knowledge dissemination related initiatives such as conferences and publications in Islamic economics, finance, banking, management and governance, as well as support such initiatives; • Support arts-related activities that contribute to the embellishment of society; • Funding and sponsorships for training and awareness programme in general and in specific areas (such as banking, Shariah and ethical areas), including sustainable development and financial literacy; and • Establish a waqf or join an existing waqf to advance knowledge and finance arts-related activities. Reporting The Bank should develop disclosure policies and measurements to communicate the advancement of knowledge and arts-related activities to the larger society. Table 5 presents examples of social targets and corresponding risk management requirements. Guidelines for Islamic Banks 33
  34. Table 5 . Examples of Social Targets and Corresponding Risk Management Requirements Target Requirement (Examples) in Operation and Financing Activities Risk Management and Monitoring Poverty and Economic Empowerment • Improvement in the share of PLS financing • Increasing Qard al-Hasan financing • Increasing MSMEs financing • Financial inclusion of the un-bankable sector of the society • Increased financing to value-added sectors for job creation • Innovative product development for financing to lower-income groups • Waqf, zakat and charitable giving for poverty alleviation and empowerment projects • Diversity and gender empowerment • Entrepreneurship and internship/ work placement The SC should develop targets and measures for: • PLS financing percentage • Qard al-Hasan financing percentage • MSMEs financing percentage • Financing for value-added sectors in percentage • Financial inclusion-related financing percentages • Financing extended to lowerincome groups • Women working in every level in terms of percentage • Number of youths trained in entrepreneurship • Number of start-up financings • Number of students in work placement Social Empowerment and Human Rights • • • • • • The SC should establish definitions and targets for: • The active stakeholders • Promotion process and equal opportunities • Working hours, holidays etc. • The working conditions of labour in the financed projects • Universal income and minimum wage • Number of sponsorships for sports • Number of customer complaints • • • • • Advancement of Knowledge and Art 34 Recognition of all the stakeholders Equal opportunities Diversity and inclusion Human rights and good life Labour standards in the Bank Labour standards in financing and projects Sponsoring vulnerable communities Contributing to health and education provision Supporting and sponsoring sports activities Upholding customer protection Community and charity • Research and development • Sponsoring research and education • Products development for education financing • Supporting and sponsoring art Sustainability Guide for Islamic Financial Institutions (IFIs) The SC should develop targets and measures for: • Research and development spending percentage • Sponsoring research and education percentage • Funding percentage for art
  35. Principle 4 – Monitoring, Reporting and Communication The development of measuring, monitoring, and reporting tools enhances the credibility of a Bank in terms of sustainability integration. The objective is to measure how banks can and should have a positive impact by deploying capital and resources. While banks report on their sustainability in various ways (sustainability reporting, integrated reporting, CSR reporting, etc.), it is important to harmonise reporting practices at the Islamic financial industry levels to promote transparency and accountability. International guidelines for corporate sustainability reporting include the Global Reporting Initiative (GRI), the International Organisation for Standardization (ISO), the World Business Council for Sustainable Development (WBCSD), the Sustainability Integrated Guidelines for Management (SIGMA) project, AAOIFI Governance Standard on CSR, Conduct and Disclosure for IFIs, etc. It is, however, likely that in due course most of these will be superseded by standards emerging from the International Sustainability Standards Board. The following section provides guidance on sustainability integration monitoring, reporting and communication. Guidelines on the Implementation and Assessment of Principle 4 In applying the principle, the Bank should: • Report its sustainability practices and how it targets specific groups of stakeholders in its sustainability reports; • Regularly monitor, review and report on the compliance to these Principles; • Develop sustainability and impact assessment criteria for its financing activities. The impact measurement should include quantitative as well as qualitative metrics, taking into consideration sector specifics. Figure 8 below provides an example of the impact assessment process for financing and investment decisions. The process can be adapted to other Bank decisions; • Develop scorecards incorporating qualitative and quantitative criteria to measure the economic, social, and environmental impact of its business activities; and • Communicate its sustainability policies and requirements to relevant stakeholders, including clients, investors, regulatory authorities, Shariah Committees/Shariah Supervisory Boards, rating agencies, suppliers, etc. Guidelines for Islamic Banks 35
  36. Figure 8 . Impact Assessment Process for Financing and Investment Decisions6 Screening Determine whether the investing or finance decision needs an environmental and social impact assessment.   Preliminary Assessment Determine both positive and negative environmental and social consequences related to the investing and finance decision. Mitigation Monitoring Once negative social or environmental impacts of an investment or financing decision have been predicted, an assessment of specific mitigating factors needs to be conducted. Carry out monitoring activities related to environmental and social impact as well as the implementation of mitigating factors.     Reviewing Review of the social and environmental impact after the financing or investment decision is executed. Source: CIBAFI The Bank should report on its sustainability integration via a Sustainability Report, which will demonstrate the Bank's commitment to sustainable development and ultimately achieving human well-being. • Sustainability disclosure should be divided into five sections according to the integrated approach in incorporating the Principles: i. The Bank’s approach in assessing the Sustainability Focus Areas; ii. How the Bank ensures the alignment of the Sustainability Focus Areas with its vision, mission, and strategy; iii. The operational integration process of sustainability in the Bank’s business activities; iv. The Bank’s internal and external capacity building and awareness initiatives to promote sustainability integration; and v. The monitoring and reporting mechanisms to ensure the quality of reported sustainability information. • Sustainability disclosure should comprise both financial and non-financial information. Non-financial information can be quantitative or qualitative. Table 6 provides examples of financial and non-financial disclosure. • The Bank should also implement internal assurance arrangements to ensure the sustainability information disclosure's quality, completeness, and accuracy. 6. Adapted from the Environmental Impact Assessment (EIA) process. 36 Sustainability Guide for Islamic Financial Institutions (IFIs)
  37. Table 6 . Sustainability Disclosure Examples Information Type Financial Examples • Clean energy expenditure • Total green financing in the previous year • Amount of green Sukuk issued • Amount of Islamic social financing • The total amount of solid waste generated Quantitative • Metric tons of greenhouse gas emissions • The total amount of energy used/revenues • The total amount of solid waste/revenues • Energy saved due to conservation and efficiency improvements Non-Financial Qualitative • Governance processes • The organisation’s impact on the state of biodiversity • Waste minimisation and management • Natural resources conservation • Employment creation • The organisation’s impact on financial inclusion Guidelines for Islamic Banks 37
  38. Principle 5 – Coordination and Collaboration A Bank needs to leverage local, regional, and international partnerships to accelerate the integration of sustainability objectives in its business activities while supporting the achievement of national visions and strategies as well as international standards. The section below provides guidance on coordination and collaboration activities to accelerate sustainability integration in Bank’s activities. Guidelines on the Implementation and Assessment of Principle 5 To implement this Principle, a Bank should: • Commit to relevant international standards and best practice initiatives to accelerate the contribution of the Islamic financial industry to sustainability; • Support and participate in the CIBAFI sustainability initiatives to promote sustainability integration at the Islamic financial industry level; • Collaborate with other Islamic financial institutions locally, regionally and internationally to further the implementation of the Principles; and • Contribute to stakeholders engagement and dialogue on sustainability-related issues and initiatives. Key industry stakeholders include the AAOIFI, the IIFM, the IILM, the IIRA, and the IFSB. Other important stakeholders include the Bank’s customers, the local government and agencies, non-profit organisations, private-sector organisations, and the local community. Examples of relevant international policies and standards include: • The International Labor Organisation (ILO) Declaration on Fundamental Principles and Rights at Work; • The Global Reporting Initiative (GRI); • The Equator Principles; • The Universal Declaration of Human Rights; • The Rio Declaration on Environment and Development; and • The United Nations Convention against Corruption. 38 Sustainability Guide for Islamic Financial Institutions (IFIs)
  39. Conclusion This document presents a Sustainability Guide for Islamic banks to develop the necessary capacity to address sustainability issues prevalent in their jurisdictions and in the global society through methodology , process, and content inspired by Islamic principles. However, it is an indicative document that does not mandate standards for Islamic banks, as these banks operate in different regulatory and legal environments as well as in different political economies. This Guide is predicated on the argument that sustainability embeddedness requires an integrated approach. It provides a unique definition of sustainability within Islamic principles and the Islamic moral economy. In such an approach, negative screening based on Shariah compliance that has been practised in Islamic banks must be extended to internalise positive screening as part of sustainable development. Islamic banks’ governance mechanisms, generally based on shareholder value maximisation, should expand towards the broader stakeholder governance model. At its core, sustainability is a requirement of Islamic logic which is expected to be produced by aligning with Maqasid Al-Shariah. Islamic banks should not treat sustainability as an exogenous necessity, but as an embedded imperative and actualisation of Maqasid Al-Shariah. The process and timeline for the Guide’s implementation will depend on the sustainability embeddedness and readiness status of each institution. However, considering the pressing nature of sustainability issues, Islamic banks must demonstrate the willingness to proactively develop frameworks to address these matters, as is necessitated by Islamic ethical principles. Guidelines for Islamic Banks 39
  40. Appendixes Appendix A . Islamic Sustainable Development Paradigm In the course of preparing this Guide, CIBAFI sought input from a number of academic experts in Shariah and Islamic economics. While not all the material we received was included within the main sections of the Guide, it did help to shape out thinking, and it provides valuable perspectives on what sustainability means and why it matters in the context of Islamic finance. We have therefore brought the material together in this Appendix. In order to do so, we have had to edit and reshape it, but we hope we have stayed true to the original intentions of those who contributed it. Not all of the opinions expressed necessarily represent consensus views. However, debate and challenge have always been valued as part of Islamic paradigm, and readers of an Appendix like this should be able to judge for themselves whether they agree with the views set out here, and how they might apply them in their own institutions. The fundamentals of Islamic finance and economics “Finance is not about ‘making money’ per se. It is a ‘functional’ science in that it exists to support other goals – those of the society. Therefore, the better aligned a society’s financial institutions are with its goals and ideals, the stronger and more successful the society will be”7 . In essence, Islamic finance emerges from a set of Islamic normative principles as identified by the Islamic economics movement in the 1950s, as the colonial period was drawing to an end. In its development, a process of Islamisation was considered as a methodological base, rather than an authentic emergence. As a result, the institutional logic of conventional banking has been opted and its operations are subjected to Shariah compliance. This resulted in an eclectic institutional logic: religious logic represented by Shariah compliance combined with a conventional banking logic8. However, instead of such an eclectic methodology resulting in a socalled “emergent” pattern, Islamic norms beyond Islamisation could, it is argued, have provided the main thrust and base to develop Islamic economics as an expression of Maqasid Al Shariah9. Islamic paradigm for sustainable development Economics has traditionally been regarded as a descriptive science devoid of value judgements, and therefore not concerned with ethical issues. However, relegating economics to the science of optimisation without normative features and focusing on efficiency and maximisation has resulted in the unsustainable nature of the present economy and society. Due to its focus on optimisation, economics aims at efficiency and does not consider equity, and consequently, economics does not consider substantive justice beyond the legality of the transactions. Within this ‘economics’ worldview, sustainability remains at best a possible outcome of an ethical foundation that does not consider sustainability as an essential quality. 7. (Shiller, 2012: 7; Chapra, 1992, 2000) 8. (Sencal and Asutay, 2019) 9. (Asutay, 2019; Sencal and Asutay, 2019) 40 Sustainability Guide for Islamic Financial Institutions (IFIs)
  41. Shaping Islamic economics around the term ‘economics’ has prevented the Islamic ethical paradigm from shaping the understanding of the economy and finance. Instead of the Islamisation approach described above, emergent methodology based on Islamic cognitive system should have been used to develop authentic and organic theories, institutions, and practices in the economy and finance spheres. Theoretically, Islamic banking and finance should be shaped by Islamic cognitive system, which, as discussed below, has as an essential feature of sustainable development through extended stakeholding governance. However, due to operating within conventional institutional logic with additional Shariah compliance, they have not developed sustainable practices through Islamic logic in their operations and financings10. In other words, until now, Islamic banks and financial institutions declared their ethicality through negative screening, which involves removing interest (riba), excessive uncertainty (gharar) and avoiding sinful industries. However, the new paradigm requires positive screening such as environmental and social consequences along with the negative screening shaped by Shariahbased prohibitions. In addition, the incorporation of sustainability in the form given by Islamic substantive morality as set out below requires certain adjustments in the corporate governance discourse, structure, and practice of Islamic banks beyond shareholder value maximisation. For example, the initial change has to start with Islamic banks’ mission and vision statements, as most of the Islamic banks have firm shareholder emphases11 and market economy-oriented mission and vision statements which avoid making references to stakeholders in the widest sense. From Islamic cognitive system to a wider view of sustainability While there are positive developments in the rescue process of people, planet, and profit, neither the conventional SDG nor indeed the ESG paradigm questions the prevailing economic and business model, as they only consider moderating the consequences of the existing system. The Islamic paradigm, on the other hand, aims to tackle the problem at the core by proposing an extended stakeholding-based balance (mizan) worldview within the Islamic cognitive system of development under tawhid (the indivisible oneness concept of monotheism in Islam). For this paradigm, the concept of iqtisad (an Arabic term for a broader term of economics) will be an essential guide and the reference point, as iqtisad located within the Islamic paradigm directly, makes sustainability an essential requirement. Although iqtisad is commonly translated as ‘economics’, in its origin it goes beyond the maximising and efficiency worldview of ‘economics’ and instead speaks to a substantive moral outcome of its process. Examining the word itself shows the ethicality to be considered in economy and finance spheres; iqtisad as an Arabic word comes from the roots of ‘qasd’ and ‘qist’. ‘Qasd’ indicates ‘directing towards an objective’, ‘true path’, ‘in line with an aim’, ‘equable’ and ‘temperate’, while ‘qist’ refers to ‘just share’ and hence ‘justice12. Therefore, iqtisad is defined as ‘giving the right of everything’, ‘to locate everything in its place’, and hence ‘establishing justice’. Iqtisad also refers to directing towards an objective, which implies emancipation and empowerment of all stakeholders within stakeholder-centred development. Within such a semantic world, which should shape the 10. (El-Gamal, 2006; Asutay, 2007, 2012, 2013, 2019; Abdullah and Asutay, 2021; Khan, 2019; Mergaliyev et al., 2021; Sencal and Asutay, 2021) 11. (Rudnyckyj, 2014; Sencal and Asutay, 2021) 12. (Al-Hasani, 1989) Guidelines for Islamic Banks 41
  42. attitudes of Muslims and their organisations , ethicality and sustainability are thus embedded in the process and outcome. Within the moral perspective of Islam, iqtisad aims to maintain an inherent balance, or ‘mizan’. Humans are considered the custodians who ensure this balance is maintained. The term ‘balance’ indicates the connectedness of all the stakeholders within a sustainable world, including its economy. All aspects of the physical realm – humans, the environment, the animal world – sustain mizan within themselves and in their interactions with each other. Therefore, Islamic cognitive system for development as informed by iqtisad relates to sustaining this balance and order (see for example Qur’an 55:1-9). Within this view, development requires all stakeholders to be given equal opportunity space for their growth and development as the balance (mizan) or their nature (fitra) requires. From this perspective, every creature in existence is given a development path as part of their nature to reach perfection in harmony with other stakeholders14. The Islamic paradigm suggests that the disruption or transgression of mizan results in tension and crises. For example: • Poverty: denial of accessibility to resources created by Allah (swt); • Environmental crisis: denial of opportunity space of the environment to develop due to exploitation; • Social crisis: denial of the right of each actor to function; • Economic crisis: denial of each factor of production of the opportunity space to develop according to their due rights, etc.; and • Human rights violations: denial of individuals to develop as their nature or the nature of creation requires. The Islamic cognitive system through the axioms of Islamic economics provides us with the necessary tools to construct an economic system to sustain mizan and protect stakeholders by preventing transgression or departure from balance. The cognitive system of Islam has tawhid as an essential feature, interpreted as complementarity to reach unitarity. All creatures as stakeholders are connected and complement each other in the balanced world so that unitarity can be achieved. Hence, in the economic and financial worlds, the interest of all the extended stakeholders must be considered, as by creating all things that we have around us are considered stakeholders. In this extended stakeholder model of the balanced (mizan) world, sustainability becomes essential through the axiom of perfection, which implies ‘development opportunity space towards perfection’. Thus, Islamic cognitive system for development suggests that all stakeholders are created with the path of perfection, and therefore they should be given equal opportunity space to sustain their development; when there are barriers towards perfection, they should be removed. This is substantiated with the axiom of ‘collective stakeholders’ growth, which directly suggests as part of this balanced world that growth can only be in harmony; i.e., growth can only be achieved by considering the interest of all the stakeholders in having this opportunity space so that justice (adalah) can be achieved. 14. (Khan, 2019; Asutay, 2019) 42 Sustainability Guide for Islamic Financial Institutions (IFIs)
  43. As part of this cognitive system , justice is considered an articulation of the nature of the relationship between all the stakeholders. Thus, recognising the rights of each of the stakeholders in any process is an imperative of the Islamic paradigm. When justice is not enough to overcome the disruption of balance, in order to correct it and to bring to the balanced level, equilibrium and moderating role-concerning consequences (ihsan) are considered crucial to maintain sustainability. Ihsan in this process works by establishing the necessary equilibrium between different stakeholders. This organic emergence, therefore, suggests that when there is a disruption of balance (mizan), it can be overcome through ihsan. It is also important to note that a further essential part of the Islamic cognitive system is that whatever we have around us is trust (amanah), implying that interest and development must be internalised. Thus, in this embedded sustainable development, human beings, as the custodians of nature and resources, are charged with the responsibility of ensuring the mizan; humans are considered vicegerent (khalifah), imbued with the duty of safeguarding this balance and preventing disruptions to harmonious coexistence. Since Islamic banks and financial institutions have been operating within the existing banking and finance institutional logic, they have generally followed negative screening based on Shariah compliance. However, considering the pressing sustainability issues, the sector should move to the mizan paradigm, aimed at the well-being of humans and all the stakeholders and ensuring that Islamic institutional logic prevails in the operations and business activities. Thus, Islamic logic should not be limited to the negative screening of transactions, but the entire operations can work in line with the balanced worldview so that any Shariah-compliant financing or products development, for example, is at the same time sustainability compliant. Therefore, the logic of Shariah compliance risk should be expanded beyond negative screening-sourced risks to include risks that emerge from a lack of response to positive screening, such as noncompliance with environmental risk. In other words, for example, in the current Shariah governance, an Islamic financing line extended by Islamic banks could be devoid of riba, excessive gharar and sinful industries; however it may, for example, result in environmental damage or excessive CO2 emissions. However, the tawhidi methodology aiming for mizan requires such consequences to be considered simultaneously, as intention (niyyah) cannot be divorced from the consequence in Islamic logic. Based on the Islamic paradigm described above, it is possible to produce an integrated definition of sustainability, which is based on the Islamic principle of public interest (maslahah) in promoting good and preventing harm across all processes and activities. Accordingly, sustainable development within the Islamic paradigm can be defined as follows: “Recognising the complementarity nature of all the stakeholders to reach unity (tawhid) within the balance (mizan), which requires the recognition and provision of an opportunity space for the development path for each stakeholder to reach their perfection, where the growth of each stakeholder has to be in harmony with other stakeholders’ leading to inter- and-intragenerational justice (adalah) through the equilibrium based (ihsani) governance”. Guidelines for Islamic Banks 43
  44. Sustainable development : the Maqasid Al-Shariah approach In order to actualise the Islamic cognitive system as explained so far, Maqasid Al-Shariah (the objectives of Shariah) is considered as an important methodological tool. Maqasid AlShariah is interpreted as human well-being by contemporary Islamic economists following the interpretation pioneered by Al-Ghazali. However, on the basis of the Islamic sustainability definition provided above, it should in fact be interpreted as the well-being of all stakeholders so that the mizan-based worldview should be reflected in the outcomes of any actions. As regards the description of Maqasid Al-Shariah, the seminal works14 in the field mostly classify it according to the level of necessity. Hence, Maqasid are organised into three hierarchical levels15: • Necessities (daruriyyat), which must be protected and promoted. According to the Ghazalian description, being crucial for sustaining life and reaching salvation (falah) in this world and in the hereafter, necessities include the protection of faith, the soul, wealth, the mind, and offspring. These are considered the foundations of human life; • Complements (hajiyyat), which are supplementary to the essential necessities which facilitate life; and • Embellishments (tahsiniyyat), which will lead to improvement and the attainment of balance (mizan). It should be noted that Al Shatibi (2004) regarded the hierarchical relationship between these categories as essential, meaning the completion of each level and hence protection of the previous level are necessary. In searching for an articulation of Maqasid Al-Shariah to reflect an extended stakeholding approach within mizan, Abdel Majid Najjar16 provides a current view of Maqasid Al-Shariah classified within four objectives and eight corollaries, which are useful to provide a balanced (mizan) or sustainability approach: (i) Invigorating the value of human life (a) Faith (b) Human rights (ii) Invigorating the human self (a) Self (b) Intellect (iii) Invigorating the society (a) Posterity (b) Social entity (iv) Invigorating the physical environment (a) Wealth (b) Environment (Ecology) 14. (Such as Al Shatibi, 2004) 15. (Hassan and Asutay, 2017) 16. (See: Bedoui and Mansour, 2014; Asutay and Harningtyas, 2015; Mergaliev et al., 2021) 44 Sustainability Guide for Islamic Financial Institutions (IFIs)
  45. The accomplishment of both primary and corollary objectives is essential , and therefore all the objectives should be balanced and considered to be equally important. In order to operationalise this framework, the Maqasid corollaries are articulated and detailed in ‘dimensions’. ‘Dimensions’ are then articulated in ‘elements’, and ‘elements’ are articulated in ‘indicators’. Figure 9. Maqasid Al-Shariah Evaluation Framework Maqasid Al-Shariah Evaluation Framework Invigorating the value of human life Invigorating the human self Invigorating the society Invigorating the physical enviornment Faith Human rights Self Intellect Posterity Soical entity Weath Ecology Dimensions Dimensions Dimensions Dimensions Dimensions Dimensions Dimensions Dimensions Elements Elements Elements Elements Elements Elements Elements Elements Indicators Indicators Indicators Indicators Indicators Indicators Indicators Indicators Source: Mergaliyev, Asutay, Avdukic & Karbhari (2021); Asutay & Harningtyas (2015) Examples of how this table might be populated in an Islamic finance context might be as follows: Example 1: Maqasid Objective 1: Invigorating the value of human life Corollary 1: Faith Dimension 1: Elimination of negative elements that breed injustice in transactions Element 1: Non-ribawi product Indicator 1: Expansion of risk-sharing products Example 2: Maqasid Objective 4: Invigorating the physical environment Corollary 2: Ecology Dimension 1: Elimination of financing projects creating environmental risk/hazard Element 1: Financing screening through environmental impact screen Indicator 1: Environmental screen reporting demonstrating environmental impact compliance Guidelines for Islamic Banks 45
  46. Islamic banking and ESG within Maqasid Al-Shariah methodology17 The outlines of an ESG framework precede the SDGs , and therefore considerable work has been conducted to apply this framework to the business and operational activity of financial institutions and banks so that they can deliver sustainable development. The Maqasid Al-Shariah evaluation framework-based process defined in Figure 9 provides a structure to operationalise ESGs – even SDGs within the Islamic logic for Islamic banks. The matrix based on Najjar’s Maqasid framework can be tilted to articulate sustainability objectives or ESG. A correlation between the Maqasid methodology identified in Figure 9 and the ESG logic can be established, which can give an operational frame for Islamic banks and financial institutions to work towards Islamic logic and comply with ESG. Table 7 articulates in a new form an ESG augmented Maqasid Al-Shariah Framework in line with Figure 9. In this Table, Maqasid goals are summarised in the form of ‘Human Life’, ‘Economic’, ‘Environmental’, ‘Societal’ and ‘Governance’ Goals. ‘Faith’ is not a core element of either ESG or the SDGs, but in this formulation needs to be added to them as the main Maqasid goal, which should be populated by the traditional Maqasid (objectives). This is done in the first column. 17. (Asutay, 2019) 46 Sustainability Guide for Islamic Financial Institutions (IFIs)
  47. Table 7 . Reconfiguring the ESG Augmented Maqasid Al-Shariah Framework Faith Human Life (Maqasid Goal 1 [Corollary 1]) (Maqasid Goal 1 [Corollary 2] & 2) Substantiative: • Sustaining Mizan • Actualising Khalifah Role Prohibitions: • Riba, Ghara, Maysir, Sinful Industries, Investments, Income and Financing • Human well-being • Health Provisioning • Education and Development • Training for Skill and Capacity Development Mandatory: • Zakat Voluntary: • Waqf Charity • • Research and Development Financial Planning Related Skill Development • Human Rights • Consumer Protection Economic and financial (Maqasid Goal 4, Corollary 1) • • • Responsible Investment Strategies Societal Governance (Maqasid Goal 4, Corollary 2) (Maqasid Goal 3) (Maqasid Goal 1 [Corollary 2] and 3 [Corollary 2]) • Climate • • • Environmental Protection Invigoration of Environment • Through Proactive Strategies • Green Financing • Strategies Ihsani Governance • Disclosure and Transparency • Preventing Unethical Practices such as Fraud, Embezzlement and Conflicts of Interest • Defining Responsibilities for Members and Governance Bodies • Independence and Confidentiality of Information • Managerial Structure • Employee Relations • Employee Compensation and Rights • Executive Compensation • Sustainability Disclosure Impact Investment Strategies Productive and Real Economy Oriented Financing Strategies • Anti-poverty Programmes • Fair Pricing of Islamic Banking Products and Services • Environmental Integrated Islamic Financing Services Provision • • Sustainable Use of Resources Harmonious Relationship between Stakeholders Social Responsibility Programmes Social Capital Development Social Capacity Development • Diversity Human Rights • Consumer Protection • Animal Welfare Figure 9 and Table 7 together are capable of offering a complete Maqasid Al-Shariah-based ESG assessment guide for Islamic banks. Guidelines for Islamic Banks 47
  48. Appendix B . SRI Approaches and Strategies18 • The screening of investments strategy: can be negative, positive/best-in-class, and norm-based. Whereas negative screening excludes some companies and sectors due to ESG criteria, under positive screening, “best-in-class” investments are made in firms to contribute to ESG goals. Norm-based screening uses international standards on best practices to make decisions on investment. • The integration of ESG goals: ESG considerations are integrated into traditional financial analysis. A related strategy is sustainability-themed investments, which refers to financing sustainable industries such as clean energy, green technology, etc. This evaluation takes into consideration the specificities of each sector, and is based on the principle that long-term economic growth is not possible unless it is based on respect for the environment and humanity. • Impact/community investing: whereby investments are made to solve social and environmental problems. Under this strategy, capital is invested in underserved communities or in businesses that have a social and environmental purpose. • Corporate engagement and shareholder action: whereby shareholders influence companies to engage in ESG-related investments by explicitly expressing their views and preferences towards these issues. Appendix C. The Guide’s Approach in Integrating ESG Factors in Investment and Financing Decisions Financial institutions can use different approaches, practices and tools to integrate ESG factors into their investment and financing decisions. Institutions can also incorporate the three ESG factors or focus on selected factors. The level of integration depends on various considerations, such as the institution’s commitment to sustainability, its sustainability focus areas, internal expertise, long-term strategic goals, etc. Below are examples that summarise the ESG integration in financing and investment decisions in the context of financial institutions: Table 8. Examples of ESG Integration in Financing and Investment Decisions Financing and Investment Decisions Examples of ESG Integration Fundraising Capital Budgeting Investments Issuance of Green, Sustainable and SRI Sukuk Prioritise projects that have environmental and social impacts and good governance. ESG considerations can be embedded in traditional capital budgeting techniques. Screening of investments using SRI strategies. Prioritise Investments with positive ESG scores. 18. Aassouli (2016). 48 Sustainability Guide for Islamic Financial Institutions (IFIs)
  49. Appendix D . Sustainability Guide Implementation Framework and Measurement The table below provides a framework for the Guide’s implementation together with examples of assessment indicators. The framework can be used by Islamic banks as a reference when reporting on sustainability. It should be noted that the Islamic sustainable development definition, along with Maqasid Al-Shariah’s consequence based evaluation framework (Figure 9) and its ESG Augmented Framework (Table 7), shapes and informs the Strategic Goal, Nature of Assessment, and Measurement. For example, in point 2 (Alignment with the Bank’s vision, mission and strategy), the Strategic Goal of ensuring Sustainability Focus Areas to be aligned with Bank’s vision, mission and strategy necessitate that the vision, mission and strategy have to be redefined according to philosophy and factors identified the Islamic sustainable definition provided by this Guide and therefore they should gear their vision, mission and strategy around extended stakeholder approach. Accordingly, its Measurement (Assessment of the Bank’s Sustainability Strategy and sustainability targets by focus area) must reflect the Maqasid Al-Shariah based evaluation framework in the sense of identified consequences as depicted in the Evaluation Framework Figure 9 and Table 7. Similarly, for example, Corporate and Shariah Governance, as part of the Implementation Framework, in its Strategic Goal, must consider the implications of extended stakeholder-based definition provided by this Guide as identified in Figure 6, while Measurement concerning assessment has to be conducted through Maqasid Al-Shariah’s expected consequences as specified in Figure 9 and Table 7. Table 9. Sustainability Guide Implementation Framework with Assessment Indicators and Measurement Examples Sustainability Guide Implementation Framework 1. Internal Assessment of Sustainability Focus Areas 2. Alignment with the Bank’s vision, mission and strategy Strategic Goal To assess Sustainability Focus Areas at the management's level To ensure that the Sustainability Focus Areas are aligned with the Bank’s vision, mission, and strategy Nature of Assessment Measurement Qualitative List of Sustainability Focus Areas with the rationale behind selecting them. Qualitative Assessment of the Bank's Sustainability Strategy and sustainability targets by focus area. 3. Operational Integration Guidelines for Islamic Banks 49
  50. • Corporate and Shariah Governance • Sustainability Integration • Environmental and Social Risk Management To institutionalise Qualitative sustainability by integrating sustainability in the corporate and Shariah governance structure of the Bank To integrate Qualitative/ sustainability Quantitative considerations in the Bank’s business activities To identify, categorise, analyse, mitigate, and monitor environmental and social risks Assessment of the Bank's Corporate and Shariah Governance structure. Financing and Investment Activities: • ESG integration in investment portfolios and decisions (examples: ESG analysis in equity and fixed-income analysis, statistical techniques using ESG scores, etc.). • Sustainable finance strategies (examples: % of green Sukuk, SRI Sukuk, sustainability Sukuk, green loans in total financing). Internal Credit Assessment: • ESG performance analysis (ESG research and scores, third-party ESG scores or proprietary ESG scores). • ESG information in the loan/financing application form. Qualitative/ Identification: Quantitative • Assessment of material environmental and social risks. • Industry-specific environmental guidelines. • Sustainability standards to manage environmental risk. Categorisation: • Risk criteria (examples: level of greenhouse gas emissions, deforestation and pollution, biodiversity loss, waste risks, climate change risks, etc.). Analysis: • Environmental risk analysis (example: capacity and experience of customers in managing environmental risks). Mitigation: • Due diligence process for transactions with high environmental risk. • Internal approval processes for transactions with high environmental risks. Monitoring: • Qualitative indicators (example: risk mitigation strategies). • Quantitative indicators (example: carbon footprint). 50 Sustainability Guide for Islamic Financial Institutions (IFIs)
  51. 4 . Internal and External Education 5. Monitoring and Reporting To promote sustainability awareness internally and externally To ensure that the Bank’s sustainability disclosure complies with the Guide’s Sustainability Qualitative Assessment of the Bank’s internal and external capacity building and awareness initiatives to promote sustainability integration. Qualitative Assessment of the quality of reported sustainability information based on the Guide’s Sustainability Implementation Framework. Appendix E. References • Aassouli, Dalal (2016) Can the integration of SRI principles in Islamic Finance help bridge the gap between Aspirational Islamic Moral Economy and Realistic Islamic Finance? University of California-Berkeley, United States: 28th Society for the Advancement of Socio-Economics (SASE) annual meeting. • Abdullah, Hanimon & Asutay, Mehmet (2021) Constituting Islamic Corporate Governance Theory through Islamic Moral Economy, in T. Azid, M. Mukhlisin, N. Akbar and M. Tahir (eds.), Monetary Policy, Islamic Finance, and Islamic Corporate Governance. pp.13-36. London: Emerald. • Al Shatibi, Ibrahim Moosa (2004) Al Muwafaqat Fe Usool Al Shariah. Beirut: Dar Al- Ma’rifah. • Al-Hasani, B. (1989) The Concept of Iqtisad, in B. Al-Hasani and A. Mirakhor (eds.), Essays on Iqtisad: The Islamic Approach to Economic Problem. Silver Spring, M.D.: Nur. • Ahmad, Khurshid (1994) Islamic Approach to Development: Some Policy Implications. Islamabad: Institute of Policy Studies. • Asutay, M. (2007). A Political Economy Approach to Islamic Economics: Systemic Understanding for an Alternative Economic System. Kyoto Bulletin of Islamic Area Studies 1(2): 3-18. • Asutay, Mehmet (2012) Conceptualising and Locating the Social Failure of Islamic Finance: Aspirations of Islamic Moral Economy vs. the Realities of Islamic Finance. Journal of Asian and African Area Studies, 11(2), pp.93-113. • Asutay, M. (2013) Development in Islamic Banking in Turkey: Emergence, Regulation and Performance. In Islamic Finance in Europe: Towards a Plural Financial System. Cattelan, V. Cheltenham: Edward Elgar Publishing. • Asutay, Mehmet (2019). Islamic Political Economy & Islamic Moral Economy: Rationale, Foundations and Philosophy. Working Paper, Durham Centre for Islamic Economics and Finance, Durham University Business School, Durham University, UK. • Asutay, Mehmet & Harningtyas, Astrid Fionna (2015) Developing Maqasid al-Shariah Index to Evaluate Social Performance of Islamic Banks: A Conceptual and Empirical Attempt. International Journal of Islamic Economics and Finance Studies, 1(1): 5-64. Guidelines for Islamic Banks 51
  52. • Bedoui, H. E. & Mansour, W. (2014) Performance and Maqasid al-Shariah’s Pentagon- Shaped Ethical Measurement. Science and Engineering Ethics, 21 (3): 555-576. • Chapra, M. Umer (1992) Islam and the Economic Challenge. Leicester: Islamic Foundation. • Chapra, M. Umer (2000) The Future of Economics: An Islamic Perspective. Leicester: Islamic Foundation. • El-Gamal, M. (2006) Islamic Finance: Law, Economics, and Practice Cambridge: Cambridge University Press. • Hassan, Zulkifli & Asutay, Mehmet (2017) Maslahah in Stakeholder Management for Islamic Financial Institutions. The Islamic Quarterly, 61(4): 505-537. • Khan, Tariqullah (2019) Venture waqf in a circular economy. ISRA International Journal of Islamic Finance, 11(2): 187-205. • Mergaliyev, Arman; Asutay, Mehmet; Avdukic, Alija and Karbhari, Yusuf (2020) Higher Ethical Objective (Maqasid al-Shariah) Augmented Framework for Islamic Banks: Assessing the Ethical Performance and Exploring its Determinants. Journal of Business Ethics, 170: 797–834. • OECD, (2020). OECD Business and Finance Outlook 2020: Sustainable and Resilient Finance, Paris: OECD Publishing. • Rudnyckyj, D (2014) Economy in practice: Islamic finance and the problem of market reason. American Ethnologist, 41(1), 110–127. • Sencal, Harun & Asutay, Mehmet (2021) Ethical Disclosure in the Shariah Annual Reports of Islamic Banks: Discourse on Shariah Governance, Quantitative Empirics and Qualitative Analysis. Corporate Governance: The International Journal of Business in Society, 21(1): 175211. • Shiller, R (2012) Finance and the Good Society. Economics Books, Princeton University Press. 52 Sustainability Guide for Islamic Financial Institutions (IFIs)
  53. Guidelines for Islamic Banks 53
  54. General Council for Islamic Banks and Financial Institutions (CIBAFI) Email: cibafi@cibafi.org Telephone No.: +973 1735 7300 Fax No.: +973 1732 4902 WWW.CIBAFI.ORG