Ethics in Islamic Finance: Looking Beyond Legality (Part 1/2)

By Habib Ahmed


conference-islamic-financeThe pioneers of Islamic economics asserted that an economy based on Islamic values and principles would produce a moral economic system serving the needs of not only Muslims but humanity at large.

The economy would strive to fulfill the goals of Shari`ah and result in achieving a just and vibrant economy.

The financial sector was expected to entail risk-sharing features and serve all sections of the population thereby bringing about equity, stability and growth.

The manifestation of Islamic economics, however, ended up as sub-economies in the financial sector. While the growth of Islamic financial industry in its short history has been impressive, there is a general feeling that Islamic finance has failed to fulfill the social and ethical goals of Shari`ah.

Although the criticisms labeled against the industry need to be verified empirically, there is a need to come up with a clear understanding of what is considered ethical in Islamic finance. Addressing this issue would require examining the nature and responsibilities of a firm. Archie Carroll (1979) and Mark Schwartz and Archie Carroll (2003) identify the responsibilities of a firm as economic, legal, ethical and philanthropic/discretionary.

The economic responsibility is obvious given that firms supply goods and services to earn profit. Firms have to comply with all the laws and regulations of a country in the pursuit of profit. Other than the economic and legal responsibilities, the society also expects firms to follow certain ethical norms. Finally, it may be desirable for firms to be philanthropic, though this is left to their choice and discretion.

Being a part of the moral economy and following the Shari`ah principles, the nature of responsibilities for Islamic firms in general and Islamic banks in particular changes. Islamic banks have to conform not only to the national laws and statutes, but also to the Islamic law of contracts at the transactions level. Furthermore, being ethical is required of an Islamic firm, not just expected. As ethics is considered a key for Islamic banking practice, there is a need to define its scope from an Islamic perspective. Note that ethics is difficult to define even for conventional businesses. For Islamic banks it becomes even more difficult as it will include the ethical standards that apply to conventional banks and some additional requirements.

As Islamic banks comply with the values and principles of Islam, there are additional factors that influence ethics. Specifically, two other norms of morals and laws will also affect ethics of Islamic banks. Whereas there is some discussion on the relationship between Islamic Law on ethics, there is no research (to the best of my knowledge) linking ethics of Islamic banking practice to moral issues. This paper attempts to fill this gap by providing a framework of ethics for Islamic finance by linking it to morality. I argue that to arrive at an appropriate Islamic stance on the ethics for Islamic banking there is a need to go beyond the legalistic arguments and examine the moral principles derived from Islamic teachings.

To have the discussion in some perspective, the paper examines the ethical issues arising from debt, a key instrument used by the banking sector. Whereas the ideal model of Islamic banking envisaged a two-tier mudarabah model (a special kind of partnership where one partner gives money to another for investing it in a commercial enterprise), Islamic finance turned out to be one that is dominated by debt-based instruments.

Although debt will be an integral part of an Islamic financial system, its magnitude and impact on individuals and society may have certain moral implications. However, the moral consequences of debt have been ignored in the Islamic finance practice and discourse. This is apparent from the indifference shown by some practitioners, Shari`ah scholars and Islamic economists towards larger share of debt in the economy, both at the individual and national levels. The lack of concern towards increasing debt levels stems mainly from adopting a legalistic approach that asserts that as long as debt is created by Shari`ah compliant means, its level is not considered a problem. I argue that this legalistic approach can lead to unethical practice as it ignores the broader issues related to moral teachings of Islam.

The paper is organized as follows: To have a clear understanding of different norms, the next section provides definitions of morals, ethics and laws. Section 3 discusses the three norms from an Islamic perspective. After providing a classification of acts as legal and moral, the section reviews the relationship of ethics with law and morality. In Section 4, the implication of moral teachings of Islam on ethics of Islamic banking practice is discussed in relation to financing debt. The last section concludes the paper by providing some suggestions of improving ethical practices of Islamic banks.

Morals, Ethics and Laws

Norms in any society can be distinguished as morals, ethics and laws. To avoid confusion about these concepts and to determine how they are related to each other, there is a need to clarify what they mean. Geoffrey Hazard defines morals as: “notions of right and wrong that guide each of us individually and subjectively in our daily existence.” (Law, 58)

Werber Erhard and others view morality as a societal issue and define it as: “the generally accepted standards of what is desirable and undesirable; of right and wrong conduct, and what is considered by that society as good behavior and what is considered bad behavior of a person, group, or entity.” (Integrity, 35-6)

They place morality in the realm of ‘social virtue domain’. Morals are embedded in cultures and determined by a variety of factors such as upbringing, education, religion and environment. Morals tend to have emotional orientation whereby its validity is taken as given.

Hazard defines ethics as: “norms shared by a group on a basis of mutual and usually reciprocal recognition.” (Law, 453)

Erhard and others provide a more elaborate definition of ethics as: “the agreed on standards of what is desirable and undesirable; of right and wrong conduct; of what is considered by that group as good and bad behavior of a person, sub-group, or entity that is a member of the group, and may include defined bases for discipline, including exclusion.” (Integrity, 36)

They identify ethics to be in the realm of ‘group virtue domain’. One way in which ethics can be understood is to examine the ends or consequences of actions or activities. Thus, an act will be ethical: “when it promotes good of society or more specifically, when the action is intended to produce the greatest net benefit (or lowest net cost) to society when compared to all of the other alternatives.” (Law, 512)

Laws are: “norms formally promulgated by a political authority that are enforceable and more or less regularly enforced through a legal process based on adjudication.” (448)

Erhard and others put law in the realm of ‘governmental virtue domain’ and defines it as: “the system of laws and regulations of right and wrong behavior that are enforceable by the state through the exercise of its policing powers and judicial process, with the threat and use of penalties, including its monopoly on the right to use physical violence”. In general, law entails a body of rules which can be formed through statutes, decrees and edicts, decisions of judges or jurists, etc. While ethics entails standards that members of a group are encouraged to follow and realize, law sets clear rules and standards that are enforced by higher body (such as government) by using punishment and sanctions (Differentiating, 50)

The norms of a society residing at different levels as morals, ethics and laws have unique features and are interrelated. Whereas morals relate to individuals and are subjective, ethics is more rational and can change in the context of a group. Ethics is considered as an aggregate concept whose components are morality.

Unlike law, ethics and morals cannot be adjudicated or enforced by an authority. In the Western legal scholarship there is a debate among the legal theorists on the role morality plays in laws. While the positivist theorists (such as H.L.A. Hart) view law as amoral, interpretive theorists (such as Ronald Dworkin) link laws to morality.

Hazard (1994-1995) takes the interpretive view and maintains that ethics and morals shared by individuals and community can influence laws. With concerted efforts, it is possible for individuals in a community to convert a moral norm into a law. Although the three norms are expected to be complimentary, yet they can potentially contradict each other. For instance, enacted laws can turn out to be either unethical or immoral. Examples of such laws included ones that legalize slavery and discrimination.

As mentioned, the relevant norms affecting financial institutions are laws and ethics that govern their operations and activities. While laws apply equally to all firms, ethical norms in the organizational setting are more specific to tasks and situations which members in a firm face (Approaches, 12)

Davies identifies some of the ethical norms for financial institutions as: “conduct operations with integrity and due skill, care and diligence, organize the affairs responsibly and effectively with adequate risk management systems, observe proper standards of market conduct, ensure that conflict of interest does not exist, pay attention to the interests of its customers and treat them fairly, etc.” (Ethics, 282)

Ethics, Morality and Legality from an Islamic Perspective

The essence of Islamic worldview is tawheed which means oneness and sovereignty of God (Allah). Though tawheed means unity of God and creation, it has implications related to all aspects of life including economics and finance. The concept of tawheed also implies that God is the only source of value and norms. Thus, all discussions on law and morality ensue from this concept (Shari`ah, 17)

Islam, being a complete code of life provides rules and norms for economic activities and transactions. Islamic economics and finance will reflect the Islamic worldview and, as such, is driven by Islamic laws and morals related to economic transactions.

The underlying principle guiding Shari`ah is that: “God orders the good because it secures the welfare of the community and forbids evil because it is evil and because it is against the public good” (Meaning, 122)

As Shari`ah entails all the teachings of Islam, it is understood to include both Islamic morals and laws. The implication is that Islamic law and morality are expected to contribute positively to the welfare and public good (maslahah). For the purposes of this paper, however, we use three domains of norms discussed above: morals related to individuals (and society), ethics belonging to groups including organizations, and laws governed and implemented by entities with legal and regulatory authority.

The distinction between laws and morals can be made by examining the section of Islamic jurisprudence known as hukm taklifi (defining law). Accordingly, “any human act will fall under one of the following five types: obligatory (wajib or fard), recommended (mandub), reprehensible (makruh), permissible (mubah) and forbidden (haram)” (Islamic Ethics, 195).

Kamali contends that: “while the first and last types of activities (wajib and haram) have legal force, the remaining three activities fall in the domain of morals that cannot be adjudicated in courts. When Shari`ah proscribes usury or gambling, these become legal obligations.” (Shari`ah, 47) However, Islamic teachings encouraging people not to cause injury to women and elderly or animals reflect “the moral underpinnings of Shari`ah” (49)

The moral teachings in Islamic Shari`ah will take the form of encouraging the recommended and avoiding the reprehensible. The morals related to the recommended and the reprehensible are derived by from Shari`ah. While there are some clear indications about morality in the texts, others are implied and are extracted indirectly. Example of a clear recommendation is found in the Prophetic sayings:

“Feed the hungry, relieve the distressed and visit the sick.”

An example of an indirect implied norm can be observed in the saying of Prophet Muhammad:

“Oh God, I seek your refuge in You from niggardliness.” (Al-Bukhari)

The implication of the above hadith is that niggardliness is a morally reprehensible act and as such should be avoided. Similar conclusions can be drawn from the verses of the Qur’an. Syed Uddin derives some norms for business related practices from different verses of the Qur’an. For example, he concludes that Qur’an (17: 36) can mean “honesty and truthfulness; investigation and verification before action; right and ethical conduct; true witness’. Qur’an (11: 85) can be interpreted as ‘no deception in measure and weight, mischief and corruption is avoided.” (Understanding, 21)

Note that while the legal issues were adjudicated by independent courts in Islamic societies, the institution of hisbah (in charge of promotion of good and prevention of evil) historically functioned to support moral values. This not only shows the difference of the legal and moral aspects in the light of Shari`ah, but is also indicative of the importance that Islamic societies place on morality in general. Given the above framework, the roles of law and morality on ethics at the organizational level are discussed next.


Works Cited

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Taken with slight editorial modifications from

This paper was presented at the 8th. International Conference on Islamic Economics and Finance, held in Doha, Qatar, 19 to 21 December 2011. It is republished here with kind permission of the author and the organizers.

Habib Ahmed is the Sharjah Chair at Durham University. He was Manager, Research and Development, Islamic Banking Development Group, The National Commercial Bank (NCB), Kingdom of Saudi Arabia. He also worked at Islamic Research & Training Institute of the Islamic Development Bank Group, Saudi Arabia and taught at the University of Connecticut, USA, National University of Singapore, and University of Bahrain. He has been a member of the Capital Adequacy Working Group of Islamic Financial Services Board (IFSB) which is responsible for, among others, setting standards and guidelines for Islamic banks and financial institutions.



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