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Humanomics Islamic banking contribution in sustainable socioeconomic development in Indonesia: An epistemological approach Ari Pratiwi,

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To cite this document: Ari Pratiwi, (2016) "Islamic banking contribution in sustainable socioeconomic development in Indonesia: An epistemological approach", Humanomics, Vol. 32 Issue: 2, pp.98-120, https:// doi.org/10.1108/H-12-2015-0085 Permanent link to this document: https://doi.org/10.1108/H-12-2015-0085 Downloaded on: 13 March 2018, At: 08:38 (PT) References: this document contains references to 36 other documents. To copy this document: [email protected] The fulltext of this document has been downloaded 1439 times since 2016*

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Islamic banking contribution in sustainable socioeconomic development in Indonesia An epistemological approach

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Ari Pratiwi

Paramadina University, Jakarta, Indonesia Abstract

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Purpose – As a prominent actor in terms of achieving sustainable socioeconomic development, especially in rural areas, Islamic banks are urged to pursue their main objective. It is required to set the objective accordingly from time-to-time to continuously make a positive contribution to the sustainable socioeconomic development. Hence, the integration of the external factors such as government’s economic target (macro) into Islamic banking’s objectives (micro) is needed.

Design/methodology/approach – This research attempts to identify factors that might prevent the sustainable economic development activities within the micro–macro circular causal model established by Tawhidi String Relation (TSR) methodology. Findings – The research clearly found that the existing Islamic banking’s business and directions had an uncorrelated connection with Indonesia’s economic objective. Nevertheless, the Islamic banking’s Musharakah and Mudharabah contract for Usaha Mikro Kecil Menengah [(UMKM) (Micro, Small Medium Enterprises)] was showing the positive correlation to their financial performance indicator. Hence, Islamic banking is strongly suggested to be more focused on these two types of partnership financing contract to UMKM. Furthermore, its value and volume is needed to be expanded to build Indonesia’s sustainable socioeconomic foundation. Then the positive gross domestic product (GDP) growth will be achieved. Originality/value – The existing research covering the sustainability index is mainly only based on the macro perspective, while in this research, the integration between the micro and macro perspectives between government objectives and Islamic banking objectives is needed. This interaction and integration between the two are in line with the concept of the TSR methodology.

Keywords Islamic banking, Sustainable development, Micro small medium enterprises, Tawhidi string relation, UMKM Paper type Research paper

1. Introduction In Indonesia, Islamic financial institutions consist of banks, with their diverse scopes and areas, including Islamic commercial banks (BUS), Islamic banks as the business units of conventional banks (UUS) and Islamic rural banks (BPRS); and non-banks, such as multifinance companies, Baitul Maal wa Tamlik (BMT) and Takaful. Ismal (2013) stated that Islamic banking in Indonesia, as part of Indonesia’s financial institutions, Humanomics Vol. 32 No. 2, 2016 pp. 98-120 © Emerald Group Publishing Limited 0828-8666 DOI 10.1108/H-12-2015-0085

The author gives special sincere gratitude to Prof Masudul Alam Choudhury and Dr Rifki Ismal for all the endless supports and advice that led the author to this point of the author’s Islamic economy learning journey.

has already provided its own lending or financing services, and of course by complying with its Islamic principles and values. Although it is strongly attached to the Islamic rules that restrict some common practices of the conventional banking, the contribution

Sustainable socioeconomic development

development has been positive so far. However, Indonesia’s financial inclusion index was only recorded at less than 20 per cent (World Bank, 2011). It means that 80 per cent of Indonesian people (age 17 years old) are yet to have access to financial institutions,

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of Islamic banking, as the financial intermediary, toward Indonesia’s economic

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both for saving and financing. Overall, Indonesia’s Islamic banking has only covered 4.6

per cent of the national market shares (Ernst & Young, May 2013), which only equals to serving less than 1 per cent of Indonesia’s population. Bank Indonesia acknowledged this condition by issuing Bank Indonesia Regulation Number 14/22/PBI/2012. The regulation is concerning Credit Allocation or Financing by Bank and Supporting Instruments in terms of developing micro, small and medium enterprises (UMKM). It was a clear direction from Bank Indonesia that all banks, including Islamic banks, are obliged to provide credit or financing services to UMKM at minimum 20 per cent from the banks’ total credit or financing. It is in line with Bank Indonesia’s vision to establish and develop the competences of Islamic banking to support activities in the real sectors and, ultimately, to realize the national development implementation that drives justice, unity and equitable development. To accomplish the vision, Bank Indonesia set the mission to be translated into some actions in strengthening and driving the positioning of Islamic banking as a credible, efficient and prudent financial institution, which is also more than capable to support the sustainable national development, to drive the stable financial system and to bank the un-bankable community. Therefore, to accelerate the development of Islamic banking in Indonesia, Bank Indonesia has been focusing on some areas of strategic implementation, including increasing the Shariah compliance, increasing the quality of prudential banking operations, increasing the operational efficiency and competitiveness, increasing the stability of the banking system, increasing the expertise and quality of human resources and optimizing the social roles of Islamic banking in developing micro, small and medium enterprises (UMKM) (Bank Indonesia, 2007). To support Indonesia’s economic development, one of the key highlights is building the unique-shared pattern of sustainable development on the selected areas that is applicable in targeted areas. The successful criteria of this pattern are the base to generate the index. The existing index was generated typically based only on macro indicators. Only taking a macro view eliminated the household or organization preferences, which led to unmatched objectives between the household and government. Contrary to the existing index, the Islamic sustainability index is generated to ensure the sustainable pattern is focusing on the mashlahah which means focusing on the sustainable human’s well-being. Hence, identifying key factors (including the micro preferences) is deemed imperative to build the sustainability index. Furthermore, the macro and micro index will be used during the learning process to provide the performance result for all of the actors of the Sustainable Development program, and also to notify them about actions required to achieve their objective of realizing the well-being. The other identified issue on the sustainable development is the inequitable economic development. This inequitable economic development especially in the rural areas turns to be the biggest challenge for Islamic banking to enter the local market. Indonesia with

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its lack of infrastructure supports and such circumstance will surely cost Islamic banking much in terms of the investment costs to enable it to access the areas. In fact, this is actually one of the reasons behind Indonesia’s low financial inclusion index. Bank Indonesia has set the objective of Islamic banking in supporting the real economy on the grassroots, but, unfortunately, it seems that Islamic banking has covered the urban areas only. Furthermore, the usage of Mudharabah and Musharakah financing was low. These two financing types are considered as the effective way to drive a more active participation of Islamic banking for the further development of real economy. The partnership principles provide the ability to enable the transfer of knowledge and technology supports to small medium enterprises (SMEs) or micros, especially for those living in the rural areas. Thereby, such supports for the SMEs and micros are expected to be able to reinforce all of the efforts to achieve the community well-being, and at the end will also contribute significantly in increasing our national economic performance. However, the total values of both Mudharabah and Musharakah were only around 3035 per cent (OJK, 2015), compared to the Murabaha financing contract (2008-2014) that reached over 55 per cent of the total financing values. The Mudharabah and Musharakah actually offer more benefits for real economy, but unfortunately the Islamic banking has not optimized them the most. Therefore, there should be attempts to identify the causes and cope with them, and one of the feasible attempts is to build a new model.

1.1 Islamic banking in the sustainable socioeconomic development A story of Umar bin Khatab about how his policies[1] run the economy during his tenure (Ahmad, 2003) can be an important lesson. Umar set a good example that managing sustainable economic development requires the inclusion of social considerations and Tawhid. His policies proved that the realization of Islamic ecosystem successfully made people and the Government take actions properly with respect to the future. And, as a result, the human well-being during his tenure was also improving. This macro point of view by Umar is important to be included into the micro view of the Islamic banking in the present time. By this approach, the Islamic banking is believed to might be able to contribute actively toward the sustainable socioeconomic development.

Other cases, like Bank Rakyat Indonesia and Grameen Bank in Bangladesh, also assert the comparable insight, wherein the equitable and integrated development on numerous areas is indeed one of the main cores in efforts to realize the sustainable national economic development. Hadinoto and Retnadi (2007) shared his experiences as the CEO of Bank Rakyat Indonesia. In his opinion, the rural communities actually need more than the capital distribution. They also do need market enablement, advisory services regarding product packaging and managerial issues and also the realization of information technology. The business management and accounting skills are deemed vital for any business for further growth, or else it would not sustain in the long term. Not least important, the foregoing expertise should also be supported by a good understanding on the social characters. Blending with local people does help Islamic banking to obtain the acceptance and adoption from local communities regarding its financial products for micro enterprises. Also, better product quality, better product packaging, better management and higher market awareness will inevitably boost the micro enterprises’ bargaining power in front of the larger corporations.

Yunus (2003), as the founder of Grameen Bank and Nobel award winner, also acknowledged that understanding the social conditions and needs (referring to poor women in this case) helped him to identify and propose a new mechanism to distribute and maintain the capital readiness to cope with the poverty reduction as the main objective. During the process, the team provided the education program about technology utilization for the product quality improvement. Besides, they also succeeded in being appealing to consumers by establishing product display.

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Stimulating the real sector, especially the micro enterprise financing, as the part of

Islamic banking’s main agenda of the sustainable development should cover social, ethical and economic factors. Including these factors into the sustainable development agenda is believed to be useful to generate the capabilities to achieve the long-term goal. Hence, the sustainable development will eventually assist in creating a pathway to realize the sustainable socioeconomic development. For that reason, the reliable human resources as the agents of change on the field are definitely crucial. The agents should be the ones to understand the business landscape within the coverage areas. Deep understanding on the local circumstances will help Islamic bank’s available resources to support the micro enterprises and become their preferred business partner. In addition, ethical factors are also unquestionably important when interacting with the Islamic banking and its agents of change. Ethics are derived from Tawhid, comprising the Qur’an and the Sunnah. Therefore, the participation of local government and local Ulamas is really required to maintain the knowledge development and implementation of Tawhid for close people and other economic actors who support the sustainable socioeconomic development. Technology is used to help the day-to-day operation by providing transparent information to the community and public. Supported with the right SME (subject to the business industries owned in the respective area), technology will be able to optimize the natural resources efficiently, while maintaining the continuation of the resources for the future usage as well. In summary, to realize Indonesia’s sustainable economic development, it is imperative to achieve and maintain the sustainable well-being of each individual; better and more equal distribution of wealth will be realized through the combination of good political wills, social attitudes, ethics and well-defined economic goals. The Islamic banking should contribute more on real economy development especially in the rural area, not only because it is the main objective of Islamic banking itself, but for it also brings more opportunities for Islamic banking to grow better in the future. The socioeconomic contribution for the real economy has to be the soul that underlies how the Islamic banking is running its business, and it should be included as the top measure in evaluating the bank performance, on top of the conventional measures, such as return on assets (ROA) and non performing loan (NPL).

1.2 The epistemological model of Unity of Knowledge applied to community (C) and micro enterprise (E) unifying linkages (participation, complementarities)

This model was constructed by Choudhury (2009a) and described the correlation between communities and micro enterprises and how the communities helped micro enterprises to grow and the other way round. This complementariness between community and micro enterprises is modeled in the diagram below (see Figure 1). Some researchers have taken the Indonesian Islamic banking case in relation to micro enterprises and identified how Islamic banks with Islamic principles positively

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Figure 1. Communities and micro enterprise complementary model contribute to the performance of micro enterprises. Taken into account the Tawhidi String Relation (TSR) concept and previous researches on the roles of Indonesian Islamic banking in micro enterprises, this research uses some variables, which are: • Total financing (V1) Mudarabah (M1) Musharakah (M2) Murabahah (M3)

Istisna (Ist). Mudarabah, Musharakah and Murabahah are combined as MMM to

denote an integrated financing scheme with diversification on it as desired by shareholders and in the social context. • Debt/asset ratio (V2). Values are represented by debt which is an inter-bank liability and asset is the total investments. • Deposit/financing ratio (V3).

Those variables are to be reviewed to investigate whether poverty alleviation is prioritized in Islamic financing among some choices in Islamic banks to manage and distribute their assets. The MMM is selected to see how Islamic banking deeply focuses on developing the micro enterprises and actively participating in the community development. Ideally, Islamic banking should gain more benefits if it runs Islamic investment rather than inter banks placement. Hence, the financing choices are more favorable to sustain the Islamic banking business leading to the selection of MMM to do Islamic investment including the ethical and social aspects during the decision process. However, variables used in this research will be used and needed to be enhanced by field survey or taking more secondary macro variables data to give more views on how Islamic banking incorporates its micro and macro view in addressing the sustainability

of socioeconomic development with the aspect from outside of Islamic banking such as people who have directly interacted with Islamic banks.

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1.3 Research objective and significances

This research attempts to identify factors that might prevent the sustainable economic development activities within the micro-macro circular causal model established by TSR. In this regard, the main objective is to achieve the socioeconomic development as the micro-macro interfaced sustainability index. It is not only identifying the factors, but more on how the socioeconomic development supports both current and future goals. The conceptual and quantitative sustainability index will help the actors of sustainability system to act and set the goals of each socioeconomic development activity in reference to the main objective, which is social well-being (Mashlahah). Islamic banking as one of the vital actors in achieving the sustainable socioeconomic development, especially in rural areas, has to be in line with this main objective and set its own objective accordingly from time-to-time to contribute positively to the main objectives. The objectives have to be drilled down to operational level activities to support the Islamic banking’s objectives. Identifying the obstacles on the operational activities and mitigating those with the right action plans will keep the Islamic banking running on its right trail.

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2. Methodology The methodology used in this research is TSR (see Figure 2 above). TSR examines the overall view of the system, how the agents or actors within the system always influence one another through interaction and integration process. These interaction and integration then lead the system to evolve to be a new system that is based on the learning process taking place during the previous (dynamic) interaction and integration. TSR believes that each part of the learning process is already induced with ethics and morals derived from the Qur’an and the Sunnah. Based on the Islamic point of view, the social well-being is the objective of the interaction and integration process. For that reason, the TSR interaction, integration and evolution processes have the main objective to achieve the social well-being, and it is translated into the well-being function.

Figure 2.

Tawhidi String

Relation

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This research defines the inclusion of environmental treatment in the sustainable development that results in the inter-systemic ideas. The inter-systemic ideas are the complementarities between efficiency and equity, and also the complementarities between economic, social, ethical and institutional interactions (Choudhury, 2007b). With this interaction and integration among economic, social, ethical and institutional aspects as complementary, actors or variables will then evolve the universe in the Unity of Knowledge induced into the world system (Choudhury, 2014). This interaction and integration among variables will be simulated and analyzed as the quantitative analysis using VAR/VECM.

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Furthermore, the secondary data (see Table I) were collected from Indonesia statistical center (BPS), Financial Services Authority (OJK) and Indonesia Central Bank (BI). The data used are time-series quarterly data from 2005 to 2014 as a collection of data from multiple sources above. There are some critical terms used in this research related to the TSR methodology. The terms were applied into the case of Islamic banking and sustainable socioeconomic development as elaborated below:

2.1 Sustainability Sustainable development is the circumstance wherein the development succeeds in meeting the needs of present time without risking the ability of future generations to meet their own needs (Brundtland, 1987). Orientation on production and marginal consumption, environment consciousness and also capital consciousness lead to the issues of depreciation. A number of ethical aspects derived from Tawhid are invoked in the decision-making process, regarding every activity related to the sustainable development. The ethical aspects themselves include (but not limited to) environment, justice, equality and moral consideration. Hence, the sustainability requires both interaction and integration among social, economic and ethical aspects, and this balance acts as the complementarities of the well-being to ensure its sustainability.

2.2 Well-being

Sustainable development focuses on the continuity to support all generations, both for present and future needs as well, which is commonly called as the human or social well-being. Well-being is the measure of complementarities existing between ethical choices and social choices represented by their variables and relations according to the TSRs objectives, namely the unity of knowledge and the unity of choices. The continuity in addressing social well-being from time to time will generate a well-being function to guarantee that it will be always in line with the goal of accomplishing a sustainable socioeconomic development.

Table I. Secondary data collected for this research

Group of data

Variables identified

Macro data Islamic banking micro data

Real GDP growth ROA, OER, Mudharabah and Musharakah (MM) financing contract value for UMKM in percentage of total MM financing values

2.3 Circular causation The decision-making process involving interaction and multi-aspects consideration mentioned above creates a circular causation among the social, economic and Tawhid aspects of the unity of knowledge and the unification between variables. In nature, it is considered more as the multi-causal relationship instead of the mono-causal one. Therefore, there should be a two-way interaction among variables to enable them to establish the integration among the variables.

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2.4 Unity of knowledge

Every decision-making process retrieves knowledge from the knowledge pool as the basis to help people in making decision about particular issues. People will learn the impact of any decision they just made, and this learning process will subsequently drive the emergence of a new knowledge. Thereby, the knowledge found during the learning process will be stored back into the knowledge pool that is, based on Tawhid, called as the Unity of Knowledge. The learning process itself will always continue until the end of the world because of its epistemology of oneness mentioned in the Qur’an as “pairing” between the good things of life for well-being. 3. Result and analysis

3.1 Islamic social and economy structure view in the case of Islamic banking

In the TSR methodology, the learning process, naturally, might result in either negative or positive outputs, which is as per the knowledge. Each of the knowledge is collected and kept in the knowledge pool. And later, the whole knowledge pool will be used as the base of any following interaction and integration, or the decision-making process as well. The pool of knowledge itself is known as the Unity of Knowledge (Choudhury, 2014). Furthermore, the comprehensive Islamic Socioeconomic Structure View (Pratiwi, 2015) which derived from the TSRs concept is believed as the only way to maintain the sustainability of socioeconomic development (see Figure 3). The sustainability focuses on the capability to sustain the social well-being. Each of the learning process is the form of circular causation of “good” outputs from macro and micro views. Hence, the sustainability is shaped by outputs of the learning process, and the sustainability itself is known as the well-being function (Choudhury, 2014). In the socioeconomic development case, the Islamic banking as the financial intermediary will definitely play crucial roles. Islamic banking ought to consider the

Figure 3. Islamic banking’s Islamic social and economic structure view

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micro-macro point of view. It is necessary for the Islamic banking to adopt the Islamic Socioeconomic Structure View in the decision-making process. Thereby, both the objective of sustainability (social well-being) and the business objective of Islamic banking itself will always stay on track. Hence, it is clear that the thoughts derived from complementarities and ethics always become the basis for the Islamic banking thinking process. Adopting the view also means there should be some interaction and integration occurring between the Islamic banking and other sub systems (actors) within the system. The process of accumulating and shaping the knowledge during the learning process itself occurs simultaneously with the interaction and integration among the actors. Meanwhile, the knowledge formed beforehand will be used as the basis for the subsequent learning process. For comparison, in the TSR, the initial knowledge is derived from the Qur’an and the Sunnah (Choudhury, 2014), as the only set of knowledge revealed by Allah for human being, and the knowledge pool explained above acts the similar function like that set of divine knowledge. Hence, the knowledge derived from the Qur’an and the Sunnah also becomes the thinking process basis in the Islamic banking. Based on the foregoing details, this research adopts the TSR methodology. TSR examines the overall view of the system, how the agents or actors within the system always influence one another through interaction and integration process. The process of interaction and integration drives the system to evolve to be a new system based on the learning process taking place during the process. The sustainability of the system required an integration and interaction among the variables from macro views (surrounding the system) and micro views (within the system). Adopting such a holistic view into Islamic banking system is believed to bring about sustainability development for Islamic banking as well as the other surrounding systems, such as SMEs/micros, people and the government. It will then, bring a bigger impact if the same view is also adopted by the other systems surrounding Islamic banking. Along with integrated view on the daily operational decisions and business plans of economic players (Islamic banking, SMEs/micros), it will lead into more solid socioeconomic foundation. Furthermore, in the case of Indonesia, sustainable socioeconomic development of Indonesia can be achieved. The Islamic social and economic structure view for Islamic banking (see Figure 3) has the well-being as their sole objective. Specifically, the human well-being [W(u)] is the main goal of the Maqasid as Shariah of the whole integrated systems. In the TSR view, the well-being objectives of the Islamic banking are derived from all variables of macro and micro views as formulated in equation (1) below.

W(u) 5 f (macro-variablei, micro-variablesj) (u), where i 5 1, 2, …, n; j 5 1, 2, …, n;

(1)

Therefore, only focusing on one aspect may not produce the best objective result of the well-being itself (Figure 4). Besides well-being, the interaction and integration of all variables referred to [Xi (u)] will also produce u (knowledge) to be pulled in into the pot of knowledge [X(u) ; {u} ]. The knowledge taken from the previous iteration is then taken into the consideration in the

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Figure 4. Variables reviewed for the empirical analysis next iteration. As part of the transformation, each of the iteration will generate a positive and negative learning. Both of them will enrich system in its tenure to achieve the well-being.

The choices both bad-s and good-s are available for human to choose. Further, the available choices consciously were selected and reviewed during the thinking and decision-making processes with the guide of Qur’an and Sunnah. It should leave the bad-s behind and take the good-s accordingly. Consciously expanding the choices to address broader human well-being target was the key. One example in the case of Islamic banking explained further the correlation between government and Islamic banking.

One of the examples is zakah. Zakah collection and distribution are government responsibilities. The more zakah funds collected by government show the wealth of the community was increased. The more effective zakah fund distributed by government shows the increment on the number muzakki and/or reducing the number of mustahiq. Islamic banking who consciously selected and reviewed zakah as one of its performance indicators, was tend to have more preference and thoughts to any choices that related to the success of zakah programs in its operation decisions. Hence, Islamic banking as the financial intermediary will put its preferences to finance on SMEs/micros rather than corporate to generate more muzakki. It shows that Islamic banking consciously took necessary actions to make this zakah program run successfully. At the other side, government as regulator then creates necessary policies and incentives to support Islamic banking to run its zakah-related programs. Policies were made by the government as a result of government’s preferences to ensure the Islamic banking business remains and grow together with the growing of community’s wealth. The government and Islamic banking then monitored the success of the program and gained the experiences as knowledge and pulled it back to the knowledge pool. Necessary actions to put aside the bad-s choices found during the learning will be defined as part of the learning process. Hence, the interaction and integration of Islamic banking from and to government is established. Both consciously work as a “team” to achieve the same objectives which is the increasing of community’s wealth. Furthermore, community’s wealth is translated into the better human well-being.

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Zakah in the example above is considered as the macro variable. This variable is needed to be included into the Islamic banking objectives together with its micro variables (namely ROA and OER). This interaction and integration between selected choices (represented by variables) by Islamic banking was represented as the Islamic Social Economic Structure view (see Figure 3). Furthermore, in this research, the following choices (marked as black-box in Figure 4) were analyzed in empirical way. 3.2 Empirical data analysis

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Quantitative analysis was used in this research to analyze the secondary data representing the above variables (see Table I). TSR methodology focuses on the learning process by doing the integration and interaction among reviewed variables. The learning process was presented by the changes of the dependent variables from the changes of independent variables which is the same pattern with the linear model as the well-being function below:

u 5 a 1 bt1xt1 1 bt2xt2 1 bt3xt3 1 bt4xt4 1 «

(2)

Where: u AVERAGE_THETA denotes sustainability Index, which is a monotonic transformation of the Social Wellbeing Function as indicated by TSR methodology; x1 GDPg which denotes growth of the real GDP (in percentage); x2

POBO which denotes PO/BO: PO/BO 1/(BO/PO) 1/OER; operating expense ratio (OER) is percentage value of the operating expense value against gross operating income value (Ismail, 2010). Hence, 1/OER is the income value generated from the each amount expenses spend;

x3

ROA which is a percentage value of profit value against asset value (Bank Indonesia, 2007). This indicator is another way to measure the business healthiness; and MMUMKM which denotes percentage of Mudharabah and Musharakah (MM) for UMKM financing contract value of total MM financing values (in percentage).

x4

The circular causations for x1 to x4 are estimated in the regression equations. These equations are obtained as follows: x1 5 a 1 x2 5 a 2

1b x 1b x 1b x t2 t2 t3 t3 t4 t4 1b x 1b x 1b x t1

t1

t3

t3

t4

t4

x3 5 a 1 bt1xt1 1 bt2xt2 1 bt4xt4 3

x4

1b x 1b x 1b x t1 t1 t2 t2 t3 t3

1 bt5u 1 «

(3)

1 bt5u 1 «

(4)

1 bt5u 1 «

(5)

5 a4 1 bt5u 1 « (6) The expected correlation of each variable (u, x1 to x4) to the well-being function was noted in Table II. Furthermore, the u was constructed by the explanatory equation in the other variables (u value data set). Firstly, the variable (xi) will be represented and

Correlation between x values and W values u values x1 positive

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x2 to x4 positive

u positive

Based on the historical data, the best real GDP growth was selected based on the highest GDP growth and lowest inflation rate (see Figure 5) u 10 for the selected x’s value (xt) based on Shura’s decision, which is 0.0388 u 0 the highest difference between x’s value to selected x’s value (|xi xt|) The x’s value within the highest |x i xt| to xt, the u value will be prorated accordingly between 0 to 10 u 10 for the highest x’s value u 0 for the lowest x’s value in the range of observation The x’s value within the highest to the lowest, the u value will be prorated accordingly between 10 to 0 u is calculated as the average value of all u values from each x1 to x4

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Table II. u values and each variable correlations to well-being values

Figure 5. Best u values

measured as uI (see Table II). u is the index value of each variable (Choudhury, 2014). Second, the u (AVERAGE_THETA) value was calculated from the average of all ui values (see Figure 6 below).

In this research, linear modeling using VAR/VECM was generated for all circular causations and well-being functions that represent the above equations [equations (2)(6)]. With the equation (2), the first form of u values (sustainability index) were generated based on the linear model generated by VAR/VECM. VECM represents the shorter period of learning that consciously induces other independent variables during the model creation and consists of 40 learning periods (Y2005-Y2014).

3.2.1 Estimated u values as the sustainable index. The u equation generated from VAR/VECM estimation process is stated in equation (8) below. Furthermore, the first form of estimated u values (uE1) was generated from this equation and pictured out in Figure 7 as the black-dashed line. 3.2.2 Estimation of vector error correction model for circular causation. Summary of the coefficient value and correlation independent variables with its dependent variable in the circular causation together is summarized in Table III below. Each of the variables (x1 to x4) and the average theta were tested on the unit root. Based on the results, the data were not stationary (level 0). Subsequently, the variables’ group was also tested for co-integration. The results showed that co-integration among

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Figure 6.

Average theta

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Estimated u and

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Original u

Well-being functions

Average theta

Average theta POBO GDP growth MMUMKM ROA

Negative 0.303104 Positive 0.019157 Negative 0.23106 Negative 0.677732

POBO Negative 3.299199 Negative 0.063203 Positive 0.762312 Positive 2.235974

GDP growth Positive 52.20038 Negative 15.82214 Negative 12.06141 Negative 35.37789

MMUMKM Negative 4.327884 Positive 1.311799 Negative 0.082909 Positive 2.933148

ROA

Constant

Negative 1.475509 3.131529 Positive 0.447232 0.949178 Negative 0.028266 0.059991 Positive 0.340931 0.72357 2.122339

variables did exist. Therefore, the VECM was used to estimate both shortrun and long-run associations among variables. The VECM estimation of each variable was reviewed (x1 to x4) to simulate the circular causation and the well-being function that represent the empirical model of long-run and short-run associations. The long-run model is expressed in equations (7)-(11). A summary of the coefficient values and association independent variables with the dependent variables are presented in Table III. During the shock test of each variable, it shows that the shock on MMUMKM, ROA and POBO has a positive impact on the other variables. Hence, MMUKM and POBO should be changed in a positive way to have the same wave as the other variables. Furthermore, the average theta shock had a positive impact on other variables in the long run. Even though some of the variables responded negatively, they rebounded to positive values. Hence, the more the system worked as a complementary, the more the system responded in a positive way. A GDP shock created system stability in MMUKM in the long run. A GDP shock showed positive stability at POBO and is very relevant with economic theory that an increase of GDP will increase the income generated from each rupiah spent by Islamic banks. On the contrary, it shows negative feedback to ROA and average theta. Hence, the GDP

Table III. VECM result summary

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increment does not come from ROA but might be the result when the ROA of Islamic banks is smaller than overall GDP. 3.2.2.1 AVERAGE_THETA (u) estimation. Overall, it shows that all variables significantly impact average theta in the long run. There is also a significant stability adoption (l negative) of the average theta in the long run (Table IV):

112

AVERAGE2THETA(21) 5

52.200 * GDPg(21) 2 3.299 * POBO (21)

[23.8273]

[53.8711]

21.476 * ROA(21)24.328 * MMUMKM (21) [229.2288] [214.093] 1 3.132 1 e

(7)

(R2 5 0.886, F-Stat 5 17.576)

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Overall, it shows that all variables significantly impact GDPg both in the short run and long run. There is significant stability adoption (l negative) in the long run (Table V):

Association with

Findings

GDPg

Changes in GDPg/changes in Average theta 52.200 per cent in GDPg. This shows that any positive changes in GDPg will drive the average theta to move positively. Both average theta and GDP were on the same learning path. This means economic performance (represented by GDP) determines socioeconomic development despite the roles of other variables. In fact, Islamic banks contribute to GDP (even though it still very small compared to conventional banks) and, hence, are participating in socioeconomic development Changes in POBO/changes in average theta3.299% in POBO. This shows POBO negatively contributes to the well-being indicator by way of the knowledge variable, theta. From the micro view of Islamic banking operations, inefficient operations may trigger a downturn in terms of socioeconomic development. With limited real sector contributions (mostly SMEs), Islamic banks should strongly maintain efficiency to positively impact socioeconomic development MM contract value to MSMEs was negatively correlated with average theta with a value of 4.328%. This shows MM contracts to MSMEs by Islamic banks negatively contribute to average theta, implying that the quality of Islamic bank MSME financing (such as the quality of monitoring, evaluating, supervising and mentoring) is less than expected causing a less optimal impact to socioeconomic development in the community Changes in ROA/changes in average theta1.476% in ROA. This shows a change in ROA contributes negatively to the rate of average theta. This implies Islamic banking operations leading to receivable profit may not improve the quality of society (higher socioeconomic development). The earnings of Islamic banks come from activities less associated with socioeconomic development as also identified in the economic and banking interpretation of other variables above

POBO

MMUMKM

ROA

Table IV. Average theta estimation analysis

Sustainable 20.0283 * ROA (21) 2 0.083 * MMUMKM (21) 2 0.063 * POBO(21) socioeconomic [214.8196] [210.1314] [18.6117] development 1 0.019 * AVERAGE2THETA(21) 1 0.060 1 e [219.7240] (8)

GDPg(21) 5

(R2 5 0.991, F-Stat 5 262.536) 3.2.2.2 POBO estimation. Overall, it shows that all variables significantly impact POBO in the long run (Table VI).

5

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POBO(21)

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215.822 * GDPg(21) 1 0.447 * ROA(21) 11.312 * MMUMKM (21) [221.9644] [22.4931] [13.6500] 20.303 * AVERAGE2THETA(21) 2 0.949 1 e [252.6270] (9) (R2 5 0.156, F-Stat 5 0.421)

3.2.2.3 ROA estimation. Overall, it shows that all variables significantly impact ROA in the long run. There is stability adoption (l negative) for ROA in the long run (Table VII).

ROA(21)

5

2.933 * MMUMKM (21) 2 0.678 * AVERAGE 2THETA(21) [230.5519] [13.0561] 1 2.236 * POBO(21) 2 35.378 * GDPg(21) 22.122 1 e [224.0671] [218.7131] ( R2

(10)

5 0.563, F-Stat 5 2.922)

3.2.2.4 MMUMKM estimation. Overall, it shows that all variables significantly impact micro, small and medium enterprises (MSME) finance in the long run. There is stability adoption (l negative) for MMUMKM in the long run (Table VIII).

Association with

Findings

Average theta

Changes in average theta were positively associated with real GDP growth with a value of 0.019%, showing that average theta is in line with real GDP growth. Hence, increasing the contribution of Islamic banks to GDP would boost social well-being presented by average theta Changes in GDPg/change in POBO0.063% in GDPg. This shows that any positive changes in GDPg will negatively affect the revenue generated by spending by Islamic banks. This might mean that Islamic banks do not put enough resources into supporting revenue generation that impacts GDP A change in MM contracts for MSMEs was negatively associated with GDP growth with a value of 0.083%, showing that MM contracts to MSMEs do not really support real GDP growth Changes in GDPg/change in ROA0.0283% in GDPg. Again, this shows that Islamic banks do not contribute much to the macroeconomic objective of increasing real GDP growth

POBO

MMUMKM ROA

Table V. Real GDP growth analysis

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Association with

Findings

Average theta

Average theta was negatively associated with POBO with a value of 0.303%. This shows that Islamic banks do not spend in areas that positively contribute to average theta. From the micro view of Islamic banking operations, inefficient operations may cause a downturn in socioeconomic development. With its limited contribution to the real sector (mostly SMEs), Islamic banks

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should strongly maintain efficiency to positively impact socioeconomic

GDPg

MMUMKM

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ROA Table VI. POBO analysis

Association with

Findings

Average theta

Average theta was negatively associated with ROA with a value of 0.678%. This shows Islamic banks need to manage asset returns. One possible way is by focusing more on MSMEs with MM contracts Changes in ROA/changes in real GDP growth35.378% in ROA. This shows that Islamic banks do not contribute much to the macroeconomic objective of increasing real GDP growth Every 1% change in revenue generated from expenses spent positively impacted ROA with a value of 2.236%. This shows that Islamic bank revenue is supported by the expenses spent to operate the business. Furthermore, the spending objective needs to be reviewed further to sustain the business by focusing on the MM contracts Changes in ROA/changes in MMUMKM 2.933% in ROA. This shows MM contracts to MSMEs by Islamic banks positively contribute to ROA. Hence, the focus on MSME using MM contracts will generate a positive improvement to ROA

GDPg POBO

MMUMKM Table VII. ROA analysis

development Growth of real GDP was not positively associated with POBO with a value of 15.822%. This shows that Islamic banks might not spend in areas that create positive GDP growth. This might mean that Islamic banks do not spend enough to support revenue generation that impacts GDP Changes in POBO/changes in MMUKM 1.312% in POBO. This shows MM contracts to MSME by Islamic banks positively contribute to POBO ROA was positively associated with POBO with a value of 0.447%. It shows that ROA and POBO are on the same learning path. Islamic bank revenue is supported by expenses spent to operate the business. Furthermore, the spending objective needs to be reviewed further to sustain the business by focusing on the MM contracts

MMUMKM(21) 5

20.231 * AVERAGE2THETA(21) 1 0.762 * POBO(21) [216.2391] [16.2560] 212.061 * GDPg(21) 1 0.341 * ROA(21) 2 0.724 1 e [214.2391] (11) [14.5317]

(R2 5 0.388, F-Stat 5 1.439) 3.2.3 Well-being function analysis. u denotes the sustainability index, which is a monotonic transformation of the Social Well-being Function as indicated in TSR

Association with

Findings

Average theta

Changes in MMUMKM/changes in average theta - 0.231% in MMUMKM This shows that there are no integrated activities in MMUMKM that have contributed to positive learning. It might mean that Islamic banks should go back to the earlier years when the focus was more on MSME financing Every 1% change of GDPg was negatively associated with MM contracts to MSME with a value of 12.061. This might mean both MSMEs and Islamic Banks should perform better as economic players to be in-line with the learning path of real GDP growth Changes in MMUMKM/changes in POBO 0.762% in MMUMM. This shows MM financing contracts used for MSMEs positively generate more revenue from each Islamic bank expense spent. Hence, it proves that applying MM financing contracts does not lead to inefficiencies. Furthermore, with this finding, Islamic banks should prioritize MM financing contracts to MSMEs to generate more revenue Every 1% change of ROA was positively associated with financing distribution for MSMEs by MM contracts with a value of 0.341%. This shows that Islamic banks are on the right track focusing on MSMEs, even though the existing size is not significant yet. Furthermore, Islamic banks should allocate more financing in this area while preparing necessary supporting resources

GDPg

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POBO

ROA

Sustainable socioeconomic development

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Table VIII.

Musharakah and Mudharabah financing to UMKM analysis

methodology. In general, the real u value of Islamic banking is described as an open-down parabola (negative quadratic equation) trend line (refer to Figure 8). The equation of u is as follows: u 5 a 1 b.t 1 c.t2 5 5.2913 1 0.0135x 2 0.00035x2 2 (R 5 5.2913 1 0.0135x 2 0.00035x2)

(12)

The changes of u are constructed as the first differential of the quadratic equation of equation (12), as follows:

Figure 8. Average u

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g 5 d(u)/dt 5 b 1 2.c.t 5 0.0135 2 0.0007x

(13)

This shows that the changes of u (g) follow the negative slope (du/dt 0.0007) of the linear equation (13), which means the changes of u run negatively from time to time. The estimated u value is illustrated as a black dotted line (uE1) in Figure 7. uE1 represents the estimated u value of the long-run pattern. The trend line for this estimated u (refer to Figure 9) is constructed in the following equation:

u

5 a 1 b.t 1 c.t2 5 14.011 2 2.0755x 1 0.0626x2 (R2 5 0.5136) E1

(14)

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The changes of uE1 (g1) are constructed as the first differential of equation (14) as follows: g1 5 d(uE1)/dt 5 b 1 2.c.t 522.0755 1 0.1252x

(15)

According to the concept of VECM, there are adaptive processes of estimation calculation. This means the previous coefficient of the variables will impact the next coefficient of the same variables. Hence, the impact of the previous policy will then impact the future condition in the estimation process.

3.3 Propose actions to improve Islamic banking contribution to real economy Based on the results of the Well-Being Function analysis, the integrated Islamic Socioeconomic View is strongly suggested for Islamic banks to apply. This new view

Figure 9. Estimated u (uE1)

will give Islamic banks an option to measure their contribution to economic development. The sustainability index (u) was generated from Islamic banks as the micro view and the government objective as the macro view. Hence, the government (in this case BI and OJK, 2014) should also apply the same view to construct new policies that are aligned with the preferences of Islamic banks. Furthermore, this strong interaction and integration along with the view of complementarities of all reviewed variables will provide Indonesia a sustainable socioeconomic foundation for current and

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future needs.

The foregoing cases verify one fundamental lesson for further development of Islamic banks, namely, that Islamic banking is definitely the best practice for sustainable socioeconomic development of the real economy in terms of financing and loans, even compared to conventional banks. With partnership financing contracts, such as Mudharabah and Musharakah (MM), Islamic banks serve as partners of their customers, either through active or semi-active participation, and therefore Islamic banks are expected to understand the customers’ businesses well and become an intrinsic part of business growth. These two types of contract, as the first Islamic banking product, are the fundamental rules for Islamic economic transactions ( Fiqh al-Muamalah). The empirical analysis in the previous section proved that MM financing contracts to MSMEs grow both Islamic banks and the MSMEs. Although the association of MMUMKM to average theta and GDPg was negative, it is believed that if Islamic banks increase the value and volume of MM financing contracts to MSMEs, then the association will return to positive. A positive slope of MM financing contracts to MSME actually occurred from 2005 to 2010, but Islamic banks gradually reduced financing composition away from MSMEs in favor of non-MSMEs in 2010. In short, the change in direction will bring long-term impacts. In addition, considering the effectiveness of MM financing contract to social and economic contributions especially rural areas, in its capacity as the financial intermediary, the Islamic banking is strongly encouraged to penetrate and expand a larger market in the rural areas. The MM financing contracts are conducted based on the equity sharing or profit sharing, involving the capital owner or investor ( shahib al-mal) and the user of the investor’s capital (mudharib) as one single entity. Subsequently, mudharib will not only invest the capital flows to rural communities, but also bring along the skilled labors, technology and Government’s policies to increase the success rate of the investment. Hence, the more transparent the flow of information in this investment contract is carried out, the smoother the Islamic banking operations in both maintaining the implementation of Islamic principles and reducing the investment risks will be. 4. Summary The integrated Islamic Socioeconomic view was the alternative way to look Islamic banking contribution in the real economy. The non-financial performance indicator is generated by the index from this view. This indicator was called as the sustainability index which combines the macro and micro view of the Islamic banking. The MM financing for UMKM was proven to have a positive correlation for both ROA and POBO. Furthermore, the change of direction, from UMKM to non-UMKM was identified as one of the cause to negative learning process in the sustainability index. Hence, Islamic banking has consciously gone to UMKM (with MM financing), as it has a positive

Sustainable socioeconomic development 117

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impact on financial performance indicator (ROA, POBO), as well as the sustainability index. In addition, considering the effectiveness of MM financing contract to social and economic contributions especially rural areas, in its capacity as the financial intermediary, the Islamic banking is strongly encouraged to penetrate and expand a larger market in the rural areas. Applying the MM financing contracts in the partnership investment especially for rural people, as the form of current or new micro enterprises, requires a significant number of Islamic banking’s frontline agents. Furthermore, the following research is required to understand the working model of Islamic banking in addressing this.

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The other suggested researches as the continuation of this paper are: (1)identifying factors (including ethics) and ways on how wealth disparities could be reduced; (2) what will be environmental/climate change could be impacted through preferences/choices especially during the recursive knowledge pooling (learning process).

Note 1. Umar bin Khatab focused on four major areas: managing the production site by only producing primary products and services to support daily life, managing the consumption by utilizing the products until the end of its lifetime, equal economic distribution to avoid poverty which would lead to humans utilizing the natural resources without thinking about the future and mashlahah is the main objective to define any government economic rules (i.e. taxes, products embargo).

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Perbankan Syariah, Direktorat Perbankan Islamic Banking Indonesia and Otoritas Jasa Keuangan, available at: www.ojk.go.id/data-statistik-perbankan-syariah Bank Indonesia (2007), “Sistem Penilaian Tingkat Kesehatan Bank Umum berdasarkan Prinsip Syarih”, Bank Indonesia Banking Regulation (PBI) Number 9/1/PBI/2007, Islamic Banking Committee, available at: www.bi.go.id/id/peraturan/kodifikasi/bank/documents/19e25b9 bc0b84eb4b41e416c2744ba96lampiran620.pdf

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Chapra, M.U. (2000), The Future of Economics: An Islamic Perspective, Gema Insani Press. Choudhury, M.A. (2007a), The Universal Paradigm And The Islamic World-System, World Scientific Publication.

Choudhury, M.A. (2009b), “Microfinance as a poverty reduction tool – a critical assessment”, UN DESA Working Paper No. 89. Choudhury, M.A. and Hoque (2004), “A paradigm for Islamic banking”, An Advanced Exposition of Islamic Economics and Finance, The Edwin Mellen Press, Lewiston, NY. Daly, H.E. (2002), “Sustainable development: definitions, principles, policies”, paper presented at World Bank Conference, Washington, DC. Dornbusch, R., Fischer, S. and Startz, R. (2011), Macroeconomics, Mcgraw-Hill. Dusuki, A.W. (2009), “Banking for the poor: the role of Islamic banking in microfinance initiatives”, Humanomics, International Journal of Systems and Ethics , Vol. 25. Gujarati, D. and Porter, D. (2003), Basic Econometrics, McGraw-Hill. Gyekye, A.B., Oseifuah, E.K. and Vukor-Quashie, G.N.K. (2012), “The impact of research and development on socio-economic development: perspectives from selected developing economies”, Journal of Emerging Trends in Economics and Management Sciences. Hamid, M.A. (2001), The Role of Islamic Banking in the Development of Small Entrepreneurs , Islamic Banking Training and Research Academy. Kahf, M. (1969), Fiqh Al Zakah (Volume II) A Comparative Study of Zakah, Regulations And Philosophy in the Light of Qur’an and Sunna from Dr Yusuf Al Qardawi , King Abdulaziz University Jeddah. Nasution, M.E. and Usman, H. (2007), Proses Penelitian Kuantitatif, Lembaga Penerbit Fakultas Ekonomi Universitas. Perdana, A. (2011), “The evolution of poverty alleviation policies: ideas, issues and actors”, Employment, Living Standards, And Poverty in Contemporary Indonesia, Institute of Southeast Asian Studies. Pindyck, R. (2009), Microeconomics, Pearson Education.

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Rahman, R.A. and Dean, F. (2013), Challenges and Solutions in Islamic Microfinance, Accounting Research Institute, Universiti Teknologi MARA, Emerald Group Publishing, Selangor.

Thoha, A. (2000), Mukaddimah Ibn Khaldun, Pustaka Firdaus. United Nation (2012), “Sustainable development Rio2, the future we want”, available at: http://S ustainabledevelopment.Un.Org/Rio20.Html Widjojo, P.M.J.M.A. (2013), Buku Pegangan Prerencanaa Pembangunan Daerah 2014:

Memanatapkan Perekonomian Nasional Bagi Peningkatan Kesejahteraan Rakyat Yang Berkeadilan, Kementrian Perencanaan Pembangungan Nasional/Badan Perencanaan Pembangungan Nasional, available at: www.bappenas.go.id/

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Corresponding author Ari Pratiwi can be contacted at: [email protected]

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