The ‘S’ in ESG (environmental, social and governance) often takes a back seat to the other two pillars. However, the pandemic and recent existential threats of inequality and polarisation have thrust it into the limelight, emphasising its critical importance in keeping the social fabric worldwide intact. In the quest to address these societal challenges, securing adequate capital is essential to making impactful progress. According to Oxfam’s estimates, ending extreme hunger requires annual investments of US$37bil until 2030. Additionally, a further US$525bil, equivalent to 0.7 percent of global gross domestic product (GDP), must be committed every year to construct 300 million affordable homes with necessary utility connections for the 3 billion people who need them by 2030. Amidst this daunting backdrop, Islamic finance shines as a beacon of hope, offering untapped potential to elicit a wellspring of funds for advancing social causes. An ethical imperative As a matter of fact, the letter ‘S’ is also synonymous with Islamic finance, symbolising adherence to Shariah or Islamic law, which underscores the imperative of inculcating ethical and socially responsible practices in financial dealings.The intersection between Islamic finance and ESG investing is rooted in the overarching intent of Shariah to uphold justice (adl) and strive for excellence in goodness (ihsan).Islamic finance advocates social justice through its emphasis that wealth should be generated and distributed in a fair and equitable manner rather than accumulated through exploitative means like usury and speculative transactions. It also promotes increased access to financial services for unserved and underserved populations, fostering economic inclusivity, which is central to the social dimension of ESG. Going beyond compliance, Islamic finance aspires to contribute to the broader goal of delivering wholesome value propositions not only to customers and investors but also to wider stakeholders. In parallel, ESG encourages firms to safeguard human rights, enhance labour standards and positively impact society at large. Purpose-driven banking Projected to reach US$6.7 trillion in asset size by 2027, the Shariah-compliant financial industry appears to be a natural fit with ESG principles, not just in theory but also in tangible ways. This year marks a decade since sustainability sukuk made its debut in 2014, which raised US$500mil for immunisation programmes saving children’s lives in developing countries. Malaysia has since demonstrated leadership in this realm by launching two innovative social sukuks. The first is Sukuk Ihsan, the inaugural sukuk featuring a ‘pay-for-success’ mechanism that links sukuk returns to the achievement of predefined education quality outcomes; the second is Sukuk Prihatin, a first-of-its-kind digital sukuk, the proceeds of which are earmarked for post-Covid-19 recovery efforts (see Figure 1). Looking ahead, policymakers and financial institutions are poised to harness this ethical convergence to propel a wave of sustainable financial innovation that transcends the capital market. In 2017, Bank Negara Malaysia (BNM) introduced the Value-Based Intermediation (VBI), calling on Islamic banks to incorporate social and environmental considerations into their financing decisions. This directive has catalysed the adoption of four strategies that could elevate the ‘S’ agenda, heralding a new era of purpose-driven banking. The first is to mainstream all forms of Islamic philanthropy, including zakat (alms), waqf (endowment), and sadaqah (donation), into formal financial products and services. This philanthropic capital can be channelled in the form of a funding escalator for the purpose of incubating the entrepreneurs to build their creditworthiness and business track record, paving the way for them to secure commercially driven funding later. One example is the iTEKAD programme, which uses returned zakat to offer benevolent microfinance to marginalised groups such as single mothers and people with disabilities, augmented by structured financial literacy and business acumen trainings. Since its inception in 2020, iTEKAD has mobilised over RM40mil, benefiting more than 3,000 microentrepreneurs. More to be done Building on this progress, more efforts should be made to scale up the offering of blended finance solutions, which combine zakat and cash waqf with traditional sources of funds to finance high-impact development projects that address urgent socioeconomic needs, such as access to clean water and sanitation, healthcare, education and food security. Within this scheme, the Islamic philanthropic arms would function as concessionary capital, de-risking the projects to attract private investors seeking to make financial returns alongside social impact, thereby contributing to substantial cost savings for the government. Moreover, the footprint of Islamic philanthropy should be extended to encompass other services, notably takaful, to provide financial protection to low-income households, acting as a safety net in times of calamities and misfortunes. The second is that Islamic banks should explore the use of alternative non-debt-based instruments such as venture capital and private equity, as a concern is looming over growing indebtedness, which could further deepen existing disparities and keep many—especially those in poor and developing countries—in destitution. The third, as social impact financing gains traction, is that it is crucial for Islamic banks to proactively engage with relevant stakeholders to understand the interests and issues that are material to their well-being. This helps banks adapt their practices to the values and expectations of the communities they serve in a timely and meaningful manner, leading to improved trust and collaboration. Finally, Islamic banks need to develop a comprehensive measurement system to quantify and evaluate the long-term outcomes of their products and operations on people’s prosperity. This entails utilising multiple tools, such as the Theory of Change, an impact scorecard, the Social Return on Investment (SROI), randomised controlled trials, and many more. This evidence-based approach not only bolsters the credibility and transparency of Islamic banks but also enables them to plan, monitor, and optimise their social impact. It is time we raised the bar on Islamic finance to better drive positive change in society. The views expressed here are the writer’s own. Figure 1. This figure shows that in most previous years, the sustainability sukuk market was dominated by green sukuk issuance, except since 2021. This shift can be attributed to the heightened demand for capital to fund social welfare assistance and stimulate economic recovery in the aftermath of the Covid-19 ‘Great Lockdown’. Source: Thomson Reuters Eikon; Author’s calculations.
