Chapter 13 integrating value based intermediation into business models a proposed guideline for islamic banks

offering vital perceptions to banks’ management, analysts, shareholders,and policymakers on the importance of the VBI information disclosuresand how to deliver it using the business model

https://doi.org/10.1142/9781800612426 0013

Chapter 13 Integrating Value-Based Intermediation into Business Models:

A Proposed Guideline for Islamic Banks

Salaheldin Hamad, Fong-Woon Lai, and Muhammad Kashif Shad

Abstract

The value-based intermediation (VBI) has been recently announced by the Central Bank of Malaysia (Bank Negara) as a vital driver in expand-ing the responsibilities and influence of Islamic finance in the future It aims to reinforce the foundations of Islamic finance in social justice and advocate a value-based economy via increased integrity, inclusivity, and sustainable growth This chapter analyses the current practices of VBI information for Islamic banks operating in Malaysia Also, it proposes a guideline to communicate VBI information to stakeholders through the bank’s business model as the core of integrated reporting (IR) Using a sample of all the 16 Islamic banks operating in Malaysia, content analysis was employed to collect data over a four-year period from 2017 to 2020 The results revealed that the adoption of IR and VBI has seen consider-able interest among the research sample Approximately 82% of all banks

in our selection have embedded the VBI information in the recent annual reports of 2020 More than half (7 out of 13) of VBI adopter banks have applied IR to draw and communicate the VBI information to stakehold-ers Additionally, the IR framework and business models represent the best strategic tools banks could utilize to provide the VBI progress in

a holistic, concise, and useful manner compared to traditional reporting practices This chapter contributes to the Islamic finance literature by

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offering vital perceptions to banks’ management, analysts, shareholders, and policymakers on the importance of the VBI information disclosures and how to deliver it using the business models.

Keywords: Integrated Reporting, Business Model, Value-Based

Inter-mediation, Sustainable Growth, Islamic Banking.

13.1 Introduction

Islamic finance and banking have grown to be one of the most signif-icant industries as they are critical to a markets’ financial stability

(Jan et al., 2019; Hoque & Liu, 2021) The year 2020 has seen a

neg-ative influence of the COVID-19 pandemic on the global economy, especially the financial system However, the total worth of Islamic Financial Services Industry (IFSI) reached USD 2.70 trillion in 2020 compared to USD 2.44 trillion in 2019 Hence, the IFSI maintained its upward trend, growing at a rate of 10.7% year over year, and the indicators of financial stability remain adequate (IFSB, 2021) Islamic banks can be found in more than 20 countries; Malaysia is considered one of the pioneers in this industry: It has 16 Islamic banks with a total asset of worth around USD 254 billion in 2019 and total funds account for 38.0% of the total deposits of the banking sector (BNM, 2021) Consequently, this industry occupies a significant posi-tion in the Malaysian business context by offering various financial services in line with Sharia principles for a sizable customer base Recently, all businesses have become interested in not only achiev-ing financial success but also sustainable growth (Christ & Burritt, 2019) Hence, Islamic banks should change their strategy to investi-gate new avenues for addressing social and environmental concerns

to ensure long-term sustainability, while working side by side with the government to accomplish the “Sustainable Development Goals (SDGs)”, which were introduced in 2015 by the United Nations (UN)

as part of their global agenda to be achieved by 2030 (United Nations, 2015)

In keeping with this tendency, Malaysia took the lead among other countries with sizeable Islamic banking industries by introducing a new strategy paper, including an initiative known as “Value-Based

Intermediation” in March 2018 by Bank Nigari Malaysia (BNM) It sought to strengthen the Islamic banks’ responsibility to positively influence society, economy, and environment In addition, it aims

to generate a solid Islamic financial market that can attain inno-vation and sustainable growth while maintaining the stockholders’ long-term interests (BNM, 2018b)

Integrated reporting (IR) is the most recent corporate reporting which focuses on the value creation process to create sustainable value for shareholders and society through a business model (Hamad

et al., 2020; Nwachukwu, 2021) A business model is a tool that

allows the organization to illustrate the value creation process to its

stakeholders (Norris et al., 2021) While some Islamic banks have

responded to the above call to follow the VBI and insert it into their strategy and reporting, the conventional reporting method has many disadvantages since it focuses only on the financial side Therefore,

it is considered an inappropriate way to communicate the VBI dis-closures to stakeholders In this instance, IR and the banks’ business model could be the proper way to disclose how banks are aligning their strategy, products, and activities with the VBI as well as show their achievement

In this chapter, the authors answer two main research questions: First, what are the current practices of VBI disclosures among the Islamic banks in Malaysia? Second, how can these banks utilize the

IR and its business models to embed the VBI achievements? Due to the newness and limited spread of VBI globally, only very few prior

research have investigated it (Hassan & Nor, 2019; Mahadi et al.,

2019; Yusof & Ali, 2021) Additionally, to the best of our knowledge,

no investigation has been conducted to present a suitable reporting paradigm to communicate the VBI achievements to stakeholders Consequently, this chapter provides a novelty and expands on the VBI knowledge by analyzing the current practices of VBI disclosures

in the initial stages of implementation and proposing a guideline

to communicate VBI disclosures through the bank’s business model

as the core of integrating reporting This chapter is constructed as follows: Section 13.2 gives some background; Section 13.3 provides the preliminary guideline; Section 13.4 describes the methodology; Section 13.5 discusses the results; Section 13.6 offers conclusion and future research

13.2 Background

13.2.1 Value-based intermediation (VBI) initiative

The VBI is a recent initiative that emerged in the Malaysian Islamic finance sector in July 2017 as a collaborative work between the BNM and several Islamic bank practitioners The VBI is defined in the

strategy paper in 2018 as an intermediation function that aims to

deliver the intended outcomes of Sharia through practices, conduct, and offerings that generate positive and sustainable impact to the economy, community and environment, consistent with the sharehold-ers’ sustainable returns and long-term interests (BNM, 2018b) This

means VBI has two main objectives First, it assists the financial institution to create positive and long-term influence on the three pillars of sustainability Second, it strives to satisfy and maintain the interests of shareholders All of these must happen in line with the Sharia principles and foundations

Later on, BNM has issued several papers to support and guide Islamic banks in implementing VBI One of these documents high-lighted a framework that gives the main points of VBI, such as the guiding principles, application stages, and the underpinning thrusts (BNM, 2018a) The framework aims to improve the business environ-ment by engaging the key stakeholders to recognize the three pillars

of sustainability (people, profit, and plant), encourage innovation, and create long-term value

Furthermore, BNM provided a “VBI Scorecard” tool to evaluate the Islamic banks’ performance by identifying the qualitative and quantitative VBI results, providing a specific score from 0 to 100 to each VBI practitioner in order to indicate the VBI progress (BNM, 2018c) Finally, the last document highlighted the financial risk man-agement issue in Islamic finance It provided a “VBI Financing and Investment Impact Assessment Framework (VBIAF)” which helps the Islamic banks to create an efficient system for risk management system used in financing products and services that incorporate the VBI concern (BNM, 2019) It accelerates the impact-based risk man-agement system application for evaluating Islamic banks’ investment and financing activities following the individual VBI commitments The VBI is the most recent initiative that emerged in Islamic finance and banking Hence, not much academic research has looked

into this idea The study by Arshad et al (2018) was one of the

first to use a case study to investigate the benefits of VBI practices highlighted in the BNM’s first paper, including efficiency, innovation, and ecosystem

As a result of the connection between VBI and Sharia princi-ples, various studies focused on addressing the VBI from Maqasid al-Sharia’s perspective Hassan and Nor (2019) reviewed the Sharia principles and objectives that were initiated in VBI Their results showed certain principles founded in the VBI, e.g., enhancing social responsibility, creating value, and realizing fairness and justice

Con-sistently, from the same Sharia standpoint, Mahadi et al (2019)

observed that applying VBI could allow Islamic financial institu-tions to offer their consumers valuable products and services through Islamic social finance

Another study by Sara et al (2019) recommended that Islamic

banks apply the VBI and embed it in their strategy to generate

sustainable growth over waqf projects Finally, using the qualitative

methods of research, Yusof and Ali (2021) studied Sharia governance

as one of the VBI determination factors They mentioned that the combination of the Sharia board and Sharia committee could play a vital role in the success of VBI implementation

13.2.2 Integrated reporting in Islamic industry

Lately, integrated reporting (IR) has earned considerable interest among academics and practitioners as an evolving corporate

report-ing technique (Hamad et al., 2020; Rinaldi et al., 2018) More than

2000 organizations in over 70 nations use the IR framework to estab-lish their reporting (IIRC, 2020) In Malaysia, the CG monitor high-lighted that the number of firms that adopt IR has increased from

97 firms in 2018 to 105 in 2019 Forty of them are classified as large-capital firms, 7 are mid-cap firms, and the remaining 56 are small-cap firms (SCM, 2020)

The prior literature proved several benefits of the IR adoption

It enhances the quality of information by providing a more durable and proficient way of corporate reporting, integrating financial and sustainability disclosures (Adhariani & de Villiers, 2019) IR mit-igates information asymmetries and reporting burden (Cortesi &

Vena, 2019; Jaffar et al., 2019) and improves the firm’s profitability

(Iredele, 2019), especially the return of assets (Albetairi et al., 2018)

and earnings per share (EPS) (Cortesi & Vena, 2019) Further, IR plays a major role in reducing the different types of financing costs,

whether the cost of equity capital (Vena et al., 2019) or the cost of debt (Raimo et al., 2021) These can make IR accepted generally

and may ultimately take the place of current corporate reports in

the future (Pavlopoulos et al., 2017).

Despite the importance and advantages of IR to all types of orga-nizations, it is still not commonly employed by Islamic financial insti-tutions Likewise, less attention has been paid to IR adoption by prior research in Islamic finance and banking However, Gelmini (2017) claims that Islamic finance is a vitally important area of study for the cultural setting in which IR might be implemented This study explored the IR of three different Islamic banks from three coun-tries, including South Africa, to determine the motivations behind adopting IR in these banks and measuring the corresponding level

of IR disclosure with the Islamic setting and Sharia In addition, another study explored the elements of IR that are associated with the Islamic NGOs and for Islamic NGOs to improve accountability

(Ramli et al., 2018).

Emerging research has focused on how the waqf reporting can

be enhanced using the adoption of IR For instance, Mansor et al.

(2018) provided a modified waqf reporting in line with the IR and its business model framework to achieve sustainable Islamic social

finance In a similar way, Masruki et al (2020) also suggested a waqf

IR model consisting of four discloser scopes to improve the waqf among the waqf institutions

To explore the market reactions and financial performance in

Islamic banks after adopting IR, Buallay et al (2020) studied the

effect of IR on the Islamic and traditional banks’ performance in the Gulf countries Results showed that IR does not significantly influ-ence Islamic banks’ financial (ROE) and operational (ROA) perfor-mance; however, it negatively affects the market (TQ) performance

13.2.3 Value-based intermediation and integrated

reporting

VBI is still a relatively new research topic in Islamic finance Hence, limited prior research work has addressed how to report the VBI

initiative information for the financial institutions In this regard, Ramli and Muhamed (2018) analyzed the IR application in a sam-ple of two Islamic banks in one year They highlighted that those banks are ready to adopt VBI in their reporting and encouraged them to entrench the VBI in their strategy and reporting By the same token, using a case study of two Islamic banks in Malaysia, Kasri and Kamal (2021) investigated the application of IR by ana-lyzing these two banks’ annual reports and studying how IR supports the concept of Maqasid Sharia They point out that the role of VBI undertaking by banks in creating values can be improved by using the six capitals and business model of IR

However, these few prior studies have not addressed the current situation of VBI practices in banks or how to embed and disclose them in their reporting system Consequently, this chapter aims to fill the above literature gap and contribute not only by exploring the Islamic banks’ VBI disclosures but also illustrating how IR can

be applied to show the banks’ VBI accomplishments The following sections will go into further detail about it

13.3 Proposed Guideline

This chapter presents several arguments to prove why Islamic banks should consider the IR framework elements, including the business model, as the best instruments to include the VBI information in their reporting First, the primary purpose of IR is to maintain “inte-grated thinking” and clarify in what way organizations can generate value for stakeholders (IIRC, 2021) Likewise, in the Islamic banking industry, the VBI appeared to allocate additional awareness to create value creation to broader stakeholders (BNM, 2018b)

Second, BNM suggested Islamic banks to depend on the IR frame-work for various purposes For example, agreeing with the VBI first paper, Islamic banks’ self-governance can be assessed using IR as one such method (BNM, 2018b) Also, it improves the disclosures and helps in establishing a suitable environment to apply the VBI Further, BNM persuaded Islamic financial institutions to apply the

IR to disclose the risks in their reporting (BNM, 2019)

Third, VBI and IR are similar in prioritizing the shareholders and their interests; then, the other stakeholders, such as employees,

lenders, and depositors, will follow them Furthermore, the two con-cepts focus on making a combination of financial and

sustainabil-ity information (BNM, 2018a; Pavlopoulos et al., 2019) Fourth, the

bank’s business model is the essence of the IR framework; it allows the bank to demonstrate how value is created to the stakeholders

(Norris et al., 2021) Therefore, Islamic banks might employ this

model to integrate VBI and demonstrate how to generate sustain-able value to stakeholders

Finally, IR is the most recent corporate reporting and analytical tool which recognizes multiple kinds of disclosures, financial and non-financial, qualitative or quantitative, historical or forward-looking

in a condensed manner Consequently, the VBI disclosures may be enclosed and communicated using the IR and its business model The present research suggests a preliminary guideline to disclose the VBI information with the IR framework and its business model for Islamic banks (see Table 13.1) This guideline offers a report-ing structure on how the VBI information and achievements will be brought to light utilizing the IR framework It might present bank executives with new ideas on using the IR framework to improve their VBI disclosures

13.4 Research Methodology

To achieve the first objective of this chapter, the current practices of VBI information for Islamic banks working in Malaysia are analyzed

We have depended on a sample comprising all the Islamic banks operating in Malaysia based on the Bank Niagara website The rea-son behind choosing these banks is that BNM requires only Islamic financial institutions in Malaysia to adopt the VBI in their opera-tions (BNM, 2018b) Due to the different specialized characteristics

of Islamic banks, we have excluded the other financial institutions such as Takaful operators The work has been performed through

a deep review of the annual reports, sustainability reports, annual integrated reports, and websites of all 16 Islamic banks for a period

of four years from 2017 to 2020 This study has applied a qualitative research method, involving an analysis of all the obtainable literature

on IR and VBI as well as the qualitative manual content analysis of all the sample reports to achieve the research objectives

Table 13.1 Proposed guideline to associate VBI disclosures into the IR.

The VBI essential Involving with the IR

1 Financial sustainability

It concentrates on profitability and

value creation, measured by:

• Return on assets

• Quality of assets (Impairment

ratio)

• Strength of capital

• Liquidity

• Performance

Banks could benefit from the various quantitative indicators focusing on the financial capital impact to exhibit the sustainability of the bank’s financial situation

• Outlook

To emphasize the expected changes over time

2 Real economy level of

support

Keep humanity safe and bring

benefit to everybody employing

innovative Sharia contract

implementations, measured by:

• Percentage of total financial

assets that are used to benefit

the real economy directly

• Earning produced from such

financial intermediation

operations

• Unique financial instruments

aimed at enhancing the

efficiency of real economic

activities

• Managing the liquidity

• Performance

Banks could benefit from the various quantitative indicators to show how they support the real economy

• Business model

Banks could benefit from business model input, output, and outcome to highlight the financial activities and results that directly or non-directly positively influence the real economy

• Risk and opportunities

Banks can use it to underline the probable real economy risks and opportunities

3 Creating values for a wider

group of stakeholders

It concentrates on avoidance and

reduction of negative impacts and

promotes realization of positive

impacts for stakeholders, measured

by:

• Percentage of total financial

assets that are used to create

values

• Determining and monitoring

positive and negative impacts of

transactions

• Business model

The core of IR allows the banks to use it as a lens to show how sustainable value is created for the stakeholder by transforming the six capitals into output and outcome

• Strategy and resource allocation

Banks could embed the financial intermediation such as financial intermediation operations

• Governance

Banks use it to show how banks can control the positive and negative impacts of intermediation activities

(Continued)

Table 13.1. (Continued)

The VBI essential Involving with the IR

• Triple bottom line (economic

resiliency, social empowerment,

and environmental

regeneration)

• Contributions to SDGs

• Maintaining a constant level

between the actual and

expected effects of

intermediation activities

4 Islamic banks efforts

Combination of crucial VBI

underpinning thrusts inside six

attributes:

• Leadership

• Products and services

• Organizational structure

• Human resource instruments

• Management systems

• Reporting of performance

Banks could depend on the above IR elements to emphasize these six efforts in addition to:

• Organizational overview and external

environment

• Basis of preparation and presentation

Source: Modified from the VBI scoreboard and IIRC framework (BNM, 2018c; IIRC,

2021).

13.5 Findings and Discussion

To draw attention to the current disclosure practices of the VBI initiative, Table 13.2 and Figure 13.1 describe the Islamic banks’ participation in the VBI and IR as well as the alignment with the SDGs The findings showed that the application of VBI is becom-ing more common among Islamic banks It goes from 7 in 2017 to

13 Islamic banks in 2020 In other words, almost 82% of all banks

in the research sample have implanted VBI information in their

2020 reporting This result reflects an acceptable rate of response from the Islamic banks to the call of BNM to follow the VBI from

2017 This could happen because of the awareness of participant banks to the benefits of VBI in improving their roles and respon-sibilities in the Islamic finance intermediation industry toward the stakeholders